UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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xý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 20152018
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| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 001-03040
QWEST CORPORATION
(Exact name of registrant as specified in its charter)
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Colorado (State or other jurisdiction of incorporation or organization) | 84-0273800 (I.R.S. Employer Identification No.) |
100 CenturyLink Drive, Monroe, Louisiana (Address of principal executive offices) | 71203 (Zip Code) |
(318) 388-9000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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| Title of Each Class | | Name of Each Exchange on Which Registered |
6.5%7.75% Notes Due 20172030 | | New York Stock Exchange |
7.375% Notes Due 20512030 | | New York Stock Exchange |
7.5%6.875% Notes Due 20512033 | | New York Stock Exchange |
7.00%7.125% Notes Due 20522043 | | New York Stock Exchange |
7.00%7.25% Notes Due 20522025 | | New York Stock Exchange |
| 6.75% Notes Due 2021 | | New York Stock Exchange |
| 6.125% Notes Due 2053 | | New York Stock Exchange |
| 6.875% Notes Due 2054 | | New York Stock Exchange |
| 6.625% Notes Due 2055 | | New York Stock Exchange |
7%7.00% Notes Due 2056 | | New York Stock Exchange |
| 6.5% Notes Due 2056 | | New York Stock Exchange |
| 6.75% Notes Due 2057 | | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF CENTURYLINK, INC., MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS I(1) (a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION I(2).
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No xý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No xý
Indicate by check mark whether the registrantregistrant: (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 xý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes xý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. oý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o | | Accelerated filer o | | Non-accelerated filer xý (Do(Do not check if a
smaller reporting company) | | Smaller reporting company o |
| | | | | | Emerging growth company o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No xý
On March 1, 2016,21, 2019, one share of common stock was outstanding. None of Qwest Corporation's common stock is held by non-affiliates.
DOCUMENTS INCORPORATED BY REFERENCE: None.
TABLE OF CONTENTS
Unless the context requires otherwise, references in this Annual Reportreport to "QC" refer to Qwest Corporation, references to "Qwest," "we," "us," "the Company" and "our" refer to Qwest Corporation and its consolidated subsidiaries, references to "QSC" refer to our direct parent company, Qwest Services Corporation and its consolidated subsidiaries, references to "QCII" refer to QSC's direct parent company and our indirect parent company, Qwest Communications International Inc., and its consolidated subsidiaries and references to "CenturyLink" refer to QCII's direct parent company and our ultimate parent company, CenturyLink, Inc. and its consolidated subsidiaries.subsidiaries including Level 3 Parent, LLC, referred to as "Level 3".
PART I
Special Note Regarding Forward-Looking Statements
This report and other documents filed by us under the federal securities law include, and future oral or written statements or press releases by us and our management may include, forward-looking statements about our business, financial condition, operating results and prospects. These "forward-looking" statements are defined by, and are subject to the "safe harbor" protections under, the federal securities laws. These statements include, among others:
forecasts of our anticipated future results of operations, cash flows or financial position;
statements concerning the anticipated impact of our transactions, investments, product development and other initiatives, including the impact of our participation in government programs;
statements concerning the anticipated impact of the Tax Cuts and Jobs Act enacted in late 2017;
statements about our liquidity, profit margins, tax position, tax rates, asset values, contingent liabilities, growth opportunities and growth rates, business prospects, regulatory and competitive outlook, market share, product capabilities, investment and expenditure plans, business strategies, capital allocation plans, financing alternatives and sources, and pricing plans; and
other similar statements of our expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts, many of which are highlighted by words such as “may,” “will,” “would,” “could,” “should,” “plan,” “believes,” “expects,” “anticipates,” “estimates,” “projects,” “intends,” “likely,” “seeks,” “hopes,” or variations or similar expressions with respect to the future.
These forward-looking statements are based upon our judgment and assumptions as of the date such statements are made concerning future developments and events, many of which are beyond our control. These forward-looking statements, and the assumptions upon which they are based, (i) are not guarantees of future results, (ii) are inherently speculative and (iii) are subject to a number of risks and uncertainties. Actual events and results may differ materially from those anticipated, estimated, projected or implied by us in those statements if one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect. All of our forward-looking statements are qualified in their entirety by reference to our discussion of factors that could cause our actual results to differ materially from those anticipated, estimated, projected or implied by us in those forward looking statements. Factors that could affect actual results include but are not limited to:
the effects of competition from a wide variety of competitive providers, including decreased demand for our traditional wireline service offerings and increased pricing pressures;
the effects of new, emerging or competing technologies, including those that could make our products less desirable or obsolete;
our ability to attain our key operating imperatives, including simplifying and consolidating our network, simplifying and automating our service support systems, strengthening our relationships with customers and attaining projected cost savings;
our ability to safeguard our network, and to avoid the adverse impact on our business from possible security breaches, service outages, system failures, equipment breakage, or similar events impacting our network or the availability and quality of our services;
the effects of ongoing changes in the regulation of the communications industry, including the outcome of regulatory or judicial proceedings relating to intercarrier compensation, interconnection obligations, special access, universal service, broadband deployment, data protection and net neutrality;
our ability to effectively adjust to changes in the communications industry and changes in the composition of our markets and product mix;
possible changes in the demand for our products and services, including our ability to effectively respond to increased demand for high-speed data transmission services;
our ability to successfully maintain the quality and profitability of our existing product and service offerings and to introduce profitable new offerings on a timely and cost-effective basis;
our ability to generate cash flows sufficient to fund our financial commitments and objectives, including our capital expenditures, operating costs, debt repayments and dividends payments;
changes in our operating plans, corporate strategies, or capital allocation plans, whether based upon changes in our cash flows, cash requirements, financial performance, financial position, market conditions or otherwise;
our ability to effectively retain and hire key personnel and to successfully negotiate collective bargaining agreements on reasonable terms without work stoppages;
CenturyLink’s ability to timely realize the anticipated benefit of its November 1, 2017 business combination with Level 3, including its ability to use Level 3’s net operating losses in the amounts projected;
the negative impact of increases in the costs of CenturyLink’s pension, health, post-employment or other benefits, including those caused by changes in markets, interest rates, mortality rates, demographics or regulations, which could affect our business and liquidity;
adverse changes in our access to credit markets on favorable terms, whether caused by changes in our financial position, lower debt credit ratings, unstable markets or otherwise;
our ability to meet the terms and conditions of our debt obligations, including our ability to make transfers of cash in compliance therewith;
our ability to maintain favorable relations with our key business partners, suppliers, vendors, landlords, lenders and financial institutions;
our ability to collect our receivables from financially troubled customers;
any adverse developments in legal or regulatory proceedings involving us or our affiliates, including CenturyLink;
changes in tax, communications, healthcare or other laws or regulations, in governmental support programs, or in general government funding levels;
the effects of changes in accounting policies, practices or assumptions, including changes that could potentially require future impairment charges;
the effects of adverse weather, terrorism or other natural or man-made disasters;
the effects of more general factors such as changes in interest rates, in exchange rates, in operating costs, in public policy, in the views of financial analysts, or in general market, labor, economic or geo-political conditions; and
other risks referenced in "Risk Factors" in Item 1A or elsewhere in this report or other of our filings with the SEC.
Additional factors or risks that we currently deem immaterial, that are not presently known to us or that arise in the future could also cause our actual results to differ materially from our expected results. Given these uncertainties, investors are cautioned not to unduly rely upon our forward-looking statements, which speak only as of the date made. We undertake no obligation to publicly update or revise any forward-looking statements for any reason, whether as a result of new information, future events or developments, changed circumstances, or otherwise. Furthermore, any information about our intentions contained in any of our forward-looking statements reflects our intentions as of the date of such forward-looking statement, and is based upon, among other things, existing regulatory, technological, industry, competitive, economic and market conditions, and our assumptions as of such date. We may change our intentions, strategies or plans (including our dividend or other capital allocation plans) at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.
ITEM 1. BUSINESS
Overview
We are an integrated communications company engaged primarily in providing an array of communications services to our residentialbusiness and businessresidential customers. Our communicationsspecific products and services are detailed below under the heading "Operations - Products and Services."
Our ultimate parent company, CenturyLink, Inc. ("CenturyLink"), has cash management arrangements between certain of its subsidiaries that include local voice, high-speed Internet, private line (including special access), network access, Ethernet, information technology, video, wirelesslines of credit, affiliate obligations, capital contributions and dividends. As part of these cash management arrangements, affiliates provide lines of credit to certain other ancillary services. In certain localaffiliates. Amounts outstanding under these lines of credit and regional markets, we also provide local access and fiber transport servicesintercompany obligations vary from time to competitive local exchange carriers ("CLEC"). We strive to maintain our customer relationships by, among other things, bundling our service offerings to provide our customers with a complete offering of integrated communications services.
We generatetime. Under these arrangements, the majority of our totalcash balance is advanced on a daily basis for centralized management by CenturyLink. From time to time we may declare and pay dividends to Qwest Services Corporation ("QSC"), our direct parent, using cash owed to us under these advances, which has the net effect of reducing the amount of these advances. We report the balance of these transfers on our consolidated operating revenues from services provided in the 14-state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington, and Wyoming. We referbalance sheet as advances to this region as our local service area.affiliates.
We were incorporated under the laws of the State of Colorado in 1911. Our principal executive offices are located at 100 CenturyLink Drive, Monroe, Louisiana 71203 and our telephone number is (318) 388-9000.
On April 1, 2011, our indirect parent QCII became a wholly-owned subsidiary of CenturyLink, Inc. in a tax-free, stock-for-stock transaction.
For certain products and services we provide and for a variety of internal communications functions, we use portions of CenturyLink's telecommunications network to transport data and voice traffic. Likewise, CenturyLink uses our telecommunications network to transport data and voice traffic in order to fulfill services to its customers and a variety of internal communications functions.
For a discussion of certain risks applicable to our business, see "Risk Factors" in Item 1A of Part I of this Annual Report. The summary financial information in this section should be read in conjunction with, and is qualified by reference to, our consolidated financial statements and notes thereto in Item 8 and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of Part II of this Annual Report.
Financial and Operational Highlights
The following table summarizes the results of our consolidated operations: | | | | Years Ended December 31, | Years Ended December 31, |
| | 2015(1) | | 2014 | | 2013 | 2018 | | 2017(1) | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| Consolidated statements of operations summary results: | | | | | | |
| Operating revenues | $ | 8,964 |
| | 8,838 |
| | 8,753 |
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| Operating revenue | | $ | 8,493 |
| | 8,550 |
| | 8,910 |
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| Operating expenses | 6,704 |
| | 6,726 |
| | 6,675 |
| 5,833 |
| | 6,237 |
| | 6,586 |
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| Operating income | $ | 2,260 |
| | 2,112 |
| | 2,078 |
| $ | 2,660 |
| | 2,313 |
| | 2,324 |
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| Net income | $ | 1,074 |
| | 970 |
| | 964 |
| $ | 1,665 |
| | 1,657 |
| | 1,085 |
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(1) | During 2015, we recognized an incremental $95 millionThe enactment of revenue associated with the Federal Communications Commission ("FCC") Connect America Fund Phase 2 support program. For additional information, see Note 1—BasisTax Cuts and Jobs Act in December 2017 resulted in a re-measurement of Presentationour deferred tax assets and Summaryliabilities at the new federal corporate tax rate of Significant Accounting Policies to our consolidated financial statements21%. The re-measurement resulted in Item 8a tax benefit of Part II of this Annual Report.$555 million. |
The following table summarizes certain selected financial information from our consolidated balance sheets: |
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| | 2015 | | 2014 |
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| Consolidated balance sheets summary information: | | | |
Total assets(1) | $ | 21,470 |
| | 22,185 |
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Total long-term debt(1)(2) | 7,239 |
| | 7,269 |
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| Total stockholder's equity | 8,907 |
| | 9,183 |
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| | 2018 | | 2017 |
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| Total assets | $ | 20,583 |
| | 20,869 |
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Total long-term debt(1) | 5,959 |
| | 7,281 |
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| Total stockholder's equity | 9,868 |
| | 9,337 |
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(1) | We adopted both ASU 2015-03 "Simplifying the Presentation of Debt Issuance Costs" and ASU 2015-17 "Balance Sheet Classification of Deferred Taxes" by retrospectively applying the requirements of the ASUs to our previously issued consolidated financial statements. See further discussion in Note 1—Basis of Presentation and Summary of Significant Accounting Policies to our consolidated financial statements in Item 8 of Part II of this Annual Report. |
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(2)
| Total long-term debt is the sum of current maturities of long-term debt and long-term debt (excluding note payable-affiliate of $855 million) on our consolidated balance sheets. For additional information on our total long-term debt, see Note 3—4—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements in Item 8 of Part II of this Annual Report.report. For information on our total obligations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Future Contractual Obligations" in Item 7 of Part II of this Annual Report.report. |
The following table summarizes certain of our operational metrics: |
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| | 2015 | | 2014 | | 2013 |
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| Operational metrics: | | | | | |
Total access lines(1) | 6,997 |
| | 7,334 |
| | 7,641 |
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Total high-speed Internet subscribers(1) | 3,546 |
| | 3,528 |
| | 3,429 |
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(1)
| Access lines are lines reaching from the customers' premises to a connection with the public network and high-speed Internet subscribers are customers that purchase high-speed Internet connection service through their existing telephone lines, stand-alone telephone lines, or fiber-optic cables. Our methodology for counting our access lines and high-speed Internet subscribers includes only those lines that we use to provide services to external customers and excludes lines used solely by us and our affiliates. It also excludes unbundled loops and includes stand-alone high-speed Internet subscribers. We count lines when we install the service. |
Our methodology for counting access lines and high-speed Internet subscribers may not be comparable to those of other companies.
Substantially all of our long-lived assets are located in the United States and substantially all of our total consolidated operating revenues arerevenue is from customers located in the United States.
Operations
We groupFor the reasons noted in Note 12—Products and Services Revenue to our products and services among three major categories: strategic services, legacy services and affiliates and other services. See descriptionsconsolidated financial statements in Item 1 of these categories below in the section "Products and Services". The following table provides a summaryPart I of our operating revenues by category: |
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| | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 |
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| Strategic services | $ | 3,433 |
| | 3,429 |
| | 3,342 |
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| Legacy services | 2,777 |
| | 2,987 |
| | 3,208 |
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| Affiliates and other services | 2,754 |
| | 2,422 |
| | 2,203 |
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| Total operating revenues | $ | 8,964 |
| | 8,838 |
| | 8,753 |
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Our operations are integrated into and reported as part of the segments of CenturyLink. CenturyLink's chief operating decision maker ("CODM") is our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports thatthis report, we file with the Securities and Exchange Commission ("SEC"). Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such,believe we have one reportable segment.
Products and Services
Our productsWhile most of our customized customer interactions involve multiple integrated technologies and services, include local voice, high-speed Internet, private line (including special access), network access, Ethernet, information technology ("IT"), video, wireless and other ancillary services. We offer our customers the ability to bundle together several products and services, such as high-speed Internet, video (including DIRECTV through CenturyLink's strategic partnership), voice and Verizon Wireless (through CenturyLink's strategic partnership) services. We believe our customers value the convenience and price discounts associated with receiving multiple services through a single company.
Most ofwe organize our products and services are provided usingaccording to the core technologies that drive them. We report our telecommunications network, which consists ofrelated revenue under the following categories: IP and data services, transport and infrastructure services, voice and collaboration services, IT and managed services, regulatory revenue and affiliate services, each of which is described in further detail below.
IP and Data Services
Ethernet. We deliver a robust array of networking services built on Ethernet technology. Ethernet services include point-to-point and multi-point equipment configurations that facilitate data switches, copper cables,transmissions across metropolitan areas and larger enterprise-class wide area networks. Our Ethernet technology is also used by wireless service providers for data transmission via our fiber-optic cables connected to their towers; and other equipment. Our network serves approximately 7.0 million access lines in 14 states and forms a portion of the public switched telephone network, or PSTN. For more information on our network, see "Business—Network Architecture" below.
Described in greater detail below are our key products and services.
Strategic Services
We primarily focus our marketing and sales efforts on our “strategic” services, which are those services for which demand generally remains strong and that we believe are most important to our future performance. Generally speaking, our strategic services enable our customers to access the Internet, connect to private networks and transmit and store data, and enhance the security, reliability and efficiency of our customers’ communications and data storage. Our strategic services are comprised of the following:
High-speed Internet.Retail Video.Our video services span a range of technologies aimed at consumers and business customers. We also offer various broadcast services to deliver audio and video feeds over fiber or satellite for broadcast and production firms
Transport and Infrastructure
Broadband. Our high-speedbroadband services deliver a cost-effective Internet services allow customers to connect to the Internetconnection through their existing telephone lines or fiber-optic cables atwhile companies enjoy high speeds. Substantially allspeed data transfer. A substantial portion of our high-speed Internetbroadband subscribers are located within the local service area of our wireline telephone operations;
Private Line. AWe deliver a private line (including special access) isbusiness data services), a direct circuit or channel specifically dedicated for the purpose of directly connecting two or more organizational sites. Private line service offers a high-speed, secure solution for frequent transmission of large amounts of data between sites, including wireless backhaul transmissions;
Ethernet.Unbundled Network Elements and Other. We provide select technology elements to other network carriers on a regional basis for the inclusion of those technologies in their offerings; and
Wavelength. We deliver high bandwidth optical networks to firms requiring an end-to-end transport solution with Ethernet services include point-to-pointtechnology by contracting for a scalable amount of bandwidth connecting sites or providing high-speed access to cloud computing resources.
Voice and multi-point equipment configurations that facilitate data transmissions across metropolitan areas and wide area networks. Ethernet services are also used to provide transmissionCollaboration
Voice. We offer a complete portfolio of traditional Time Division Multiplexing ("TDM") voice services to wirelessbusinesses and enterprises including Primary Rate Interface (“PRI”) service, providers that use our fiber-optic cables connected to their towers;local inbound service, switched one-plus, toll free, long distance and international services.
IT and Managed Services
Video.Information Technology ("IT") Services. Our videoIT-based services include primarily satellite digital television under CenturyLink's arrangement with DIRECTV that allows usdeliver strategic consulting and solutions to market, sellC-suite executives in mid to large enterprises. Services involve architecting technologies to address business needs. Solutions range from System Integration Services to Big Data Analytics, building and bill for its services under its brand name.managing strategic application suites such as SAP and deploying security technologies. In many cases, we operate and manage these solutions on behalf of customers once they are deployed.
Legacy Services
Our "legacy" services represent our traditional voice, data and network services, which include the following:Regulatory Revenue
Local Voice Services. We offer local calling services for our residential and business customers within the local service area of our wireline markets, generally for a fixed monthly charge. These services include a number of enhanced calling features and other services, such as call forwarding, caller identification, conference calling, voice mail, selective call ringing and call waiting, for which we generally charge an additional monthly fee. We also generate revenues from non-recurring services, such as inside wire installation, maintenance services, service activation and reactivation. For our wholesale customers, our local calling service offerings include primarily the resale of our voice services and the sale of unbundled network elements ("UNEs"), which allow our wholesale customers to use all or part of our network to provide voice and data services to their customers. Local calling services provided to our wholesale customers allow other telecommunications companies the ability to originate or terminate telecommunications services on our network. Local calling services also include network transport, billing services and access to our network by other telecommunications providers and wireless carriers;
Switched Access Services. As part of our wholesale services, we provide various forms of switched access services to wireline and wireless service providers for the use of our facilities to originate and terminate their interstate and intrastate voice transmissions;
ISDN. We offer integrated services digital network ("ISDN") services, which use regular telephone lines to support voice, video and data applications; and
WAN. We offer wide area network ("WAN") services, which allow a local communications network to link to networks in remote locations.
Affiliates and Other Services
Affiliates and other services consist primarily of Connect America Fund ("CAF") support payments, Universal Service Fund ("USF") support payments, USF surcharges and affiliate services.payments. We receive federal support payments from both CAF Phase 1 and CAF Phase 2 programs, and support payments from both federal and state USF programs. These support payments are governmentpayment subsidies designed to reimburse us for various costs related to certain telecommunications services, including the costs of deploying, maintaining and operating voice and high-speed Internetbroadband infrastructure in high-cost rural areas where we are not able to fully recover our costs from our customers.customers; and
Connect America Fund ("CAF"). We receive federal support payments from CAF II of the CAF program. The funding from the CAF II support program has substantially replaced the funding from the interstate USF surcharges are the amountsprogram that we collect based on specific items we list on our customers' invoicespreviously utilized to fund the Federal Communications Commission's ("FCC") universal service programs.support voice services in high-cost rural markets in 33 states.
Affiliate Revenue
Affiliate Services. We provide to our affiliates, telecommunication services that we also provide to external customers. Please see our products and services listed above for further description of these services. In addition, we provide to our affiliates IT support and services, which include computer system development and support services, network support and technical services.
From time to time, we may change the categorization of our products and services.
Additional Information
For further information on regulatory, technological and competitive factors that could impact our revenue, see "Regulation" and "Competition" under this Item 1 below and "Risk Factors" under Item 1A below. For more information on the financial contributions of our various services, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of Part II of this report.
Our Network
Most of our products and services are provided using our telecommunications network, which consists of fiber-optic and copper cables, high-speed transport equipment, data switches and routers, voice switches and other equipment. Our local exchange carrier networks also include central offices and remote site assets, and form a portion of the public switched telephone network. A substantial portion of our equipment operates with licensed software.
We continue to enhance and expand our network by deploying various technologies to provide additional capacity to our customers. Rapid and significant changes in technology are expected to continue in the telecommunications industry. Our future success will depend, in part, on our ability to anticipate and adapt to changes in technology and customer demands, including demands for enhanced digitization, automation and customer self-service capabilities. In addition, we anticipate that continued increases in internet usage by our customers will require us to make significant capital expenditures to increase network capacity or to implement network management practices to alleviate network capacity shortages. The FCC's definition of broadband service could create additional requirements for higher capital spending to address marketing and competitive issues. Any such additional expenditure could adversely impact our results of operations and financial condition.
Similarly, we continue to take steps to simplify and modernize our network. To attain our objectives, we plan to continue to pursue several complex projects that we expect will be costly and may take several years to complete. The costs of these projects could materially increase if we conclude that we need to replace any or all of our legacy systems.
Like other large communications companies, we are a constant target of cyber-attacks of varying degrees, which has caused us to spend increasingly more time and money to deal with increasingly sophisticated attacks. Some of the attacks result in security breaches, and we periodically notify our customers, our employees or the public of these breaches when necessary or appropriate. None of these resulting security breaches to date have materially adversely affected our business, results of operations or financial condition.
Similarly, like other large communication companies operating complex networks, from time to time in the ordinary course of our business we experience disruptions in our service. Although none of these outages have thus far materially adversely affected us, certain of these outages have resulted in regulatory fines, negative publicity, service credits and other adverse consequences.
We rely on several other communications companies to provide our offerings. We lease a portion of our core fiber network from our competitors and other third parties. Many of these leases will lapse in future years. A portion of our services are provided by other carriers under agency agreements or through reselling arrangements with other carriers. Our future ability to provide services on the terms of our current offerings will depend in part upon our ability to renew or replace these leases, agreements and arrangements on terms substantially similar to those currently in effect.
For additional information regarding our systems, network assets, network risks, capital expenditure requirements and reliance upon third parties, see "Risk Factors," generally, in Item 1A of Part I of this report, and, in particular, "Risk Factors—Risks Affecting Our Business" and "Risk Factors—Risks Affecting Our Liquidity and Capital Resources." For more information on our properties, see "Properties" in Item 2 of Part I of this report.
Patents, Trade Names, Trademarks and Copyrights
Either directly or through our affiliates, we have rights in various patents, trade names, trademarks, copyrights and other intellectual property necessary to conduct our business. Our services often use the intellectual property of others, including licensed software. We also occasionally license our intellectual property to others as we deem appropriate.
Our patent portfolio includes patents covering technologies ranging from data and voice services to content distribution to transmission and networking equipment. Patents give us the right to prevent others, particularly competitors, from using our proprietary technologies. Patent licenses give us the freedom to operate our business without the risk of interruption from the holder of the patent that has been licensed to us. We, or our affiliates, plan to continue to file new patent applications as we enhance and develop products and services, and we plan to continue to seek opportunities to expand our patent portfolio through strategic acquisitions and licensing.
We periodically receive offers from third parties to purchase or obtain licenses for patents and other intellectual property rights in exchange for royalties or other payments. We also periodically receive notices, or are named in lawsuits, alleging that our products or services infringe on patents or other intellectual property rights of third parties. In certain instances, these matters can potentially adversely impact our operations, operating results or financial position. For additional information, see “Risk Factors—Risks ImpactingAffecting Our Business” in Item 1A of Part I of this Annual Report,report, and Note 15—Commitments, Contingencies and ContingenciesOther Items to our consolidated financial statements in Item 8 of Part II of this Annual Report.report.
Sales and Marketing
We maintain local offices in most of the larger population centers within our local service area. These offices provide sales and customer support services to the communities in the community.our local markets. We also rely on our call center personnel and a variety of channel partners to promote sales of services that meet the needs of our customers. Our sales and marketing strategy is to enhance our sales by offering solutions tailored to the needs of our various customers and promoting our brands. Our offerings include both stand-alone services and bundled services designed to meet the needs of different customer segments.
We conduct most of our operations under the brand name "CenturyLink." Our satellite television service is offered on a co-branded basis under the "DIRECTV" name. The wireless service that we offer under CenturyLink's agency agreement with Verizon Wireless is marketed under the "Verizon Wireless" brand name.
Our sales and marketing approach to our residential customers emphasizes customer-oriented sales, marketing and service with a local presence. Our marketing plans include marketing our products and services primarily through direct sales representatives, inbound call centers, local retail stores, telemarketing and third parties, including retailers, satellite television providers, door to door sales agents and digital marketing firms. We support our distribution with digital marketing, direct mail, bill inserts, newspaper and television advertising, website promotions, public relations activities and sponsorship of community events and sports venues.
Similarly, our sales and marketing approach to our business customers includes a commitment to provide comprehensive communications solutions for business, wholesale and governmentalgovernment customers of all sizes, ranging from small business offices to select enterprise customers. We strive to offer our business customers stable, reliable, secure and trusted solutions. Our marketing plans include marketing our products and services primarily through digital advertising, direct sales representatives, inbound call centers, telemarketing and third parties, including telecommunications agents, system integrators, value-added resellers and other telecommunications firms. We support our distribution through digital advertising, events, television advertising, website promotions and public relations.
Network Architecture
Most of our products and services are provided using our telecommunications network, which consists of voice switches, data switches and routers, high-speed transport equipment, fiber-optic and copper cables and other equipment. Our local exchange carrier networks also include central offices and remote site assets. A substantial portion of our equipment operates with licensed software. As of December 31, 2015, we maintained approximately 436 thousand miles of copper plant and approximately 89 thousand miles of fiber-optic plant in our local exchange networks. We also maintain separate networks in connection with providing fiber transport and CLEC services.Regulation
We continue to enhance and expand our network by deploying broadband-enabled technologies to provide additional capacity to our customers. Rapid and significant changes in technology are expected to continue in the telecommunications industry. Our future success will depend, in part, on our ability to anticipate and adapt to changes in customer demands and technology. In particular, we anticipate that continued increases in broadband usage by our customers will require us to make significant capital expenditures to increase network capacity or to implement network management practices to alleviate network capacity shortages. The Federal Communications Commission has defined "broadband service" as Internet access service with a minimum transmission speed of 25 megabits per second, which could create additional requirements for higher capital spending to address marketing and competitive issues. Any such additional expenditures could adversely impact our results of operations and financial condition.
Similarly, we continue to take steps to simplify and modernize our network. To attain our objectives, we plan to continue to undertake several complex projects that we expect will be costly and take several years to complete. The costs of these projects could increase materially if we conclude that we need to replace any or all of our legacy systems.
Like other large telecommunications companies, we are a constant target of cyber-attacks of varying degrees, which has caused us to spend increasingly more time and money to deal with increasingly sophisticated attacks. Although none of our resulting security breaches to date have materially adversely affected our business, results of operations or financial condition, we periodically notify our customers, our employees or the public of select breaches.
We rely on several other communications companies to provide our offerings. We lease a significant portion of our core fiber network from our competitors and other third parties. Many of these leases will lapse in future years. All of our satellite television and wireless voice services are provided by other carriers under agency agreements, and some of our other services are reliant upon reselling arrangements with other carriers. Our future ability to provide services on the terms of our current offerings will depend in part upon our ability to renew or replace these leases, agreements and arrangements on terms substantially similar to those currently in effect.
For additional information regarding our systems, network, cyber risks, capital expenditure requirements and reliance upon third parties, see "Risk Factors", generally, in Item 1A of Part I of this Annual Report, and, in particular, "Risk Factors—Risks Affecting Our Business" and "Risk Factors—Risks Affecting Our Liquidity and Capital Resources." For more information on our properties, see Item 2 of Part I of this Annual Report.
Regulation
Overview
As discussed further below, our
Our domestic operations are subject to significant local, state and federal laws and regulations.
We are subject to significant regulationregulated by the Federal Communications Commission ("FCC"(the “FCC”), which regulates interstate communications, andvarious state utility commissions which regulate intrastate communications. These agencies (i) issue rules to protect consumers and promote competition, (ii) set the rates that telecommunication companies charge each other for exchanging traffic and (iii) have traditionally developed and administered support programs designed to subsidize the provision of services to high-cost rural areas. In most states,occasionally by local voice service, switched and special access services and interconnection services are subject to price regulation, although the extent of regulation varies by type of service and geographic region. In addition, we are required to maintain licenses with the FCC and with state utility commissions. Laws and regulations in many states restrict the manner in which a licensed entity can interact with affiliates, transfer assets, issue debt and engage in other business activities. Many acquisitions and divestitures require approval by the FCC and some state commissions. These agencies typically have the authority to withhold their approval, or to request or impose substantial conditions upon the transacting parties in connection with granting their approvals.agencies.
Historically, incumbent local exchange carriers ("ILECs") operated as regulated monopolies having the exclusive right and responsibility to provide local telephone services in their franchised service territories. As we discuss in greater detail below, passage of the Telecommunications Act of 1996, coupled with state legislative and regulatory initiatives and technological change, fundamentally altered the telephone industry by generally reducing the regulation of ILECs and creating a substantial increase in the number of competitors. We are considered an ILEC.
The following description discusses some of the major industry regulations that affect our traditional telephone operations, but numerous other regulations not discussed below could also impact us. Some legislation and regulations are currently the subject of judicial, legislative and administrative proceedings which could substantially change the manner in which the telecommunications industry operates and the amount of revenues we receive for our services. Neither the outcome of these proceedings, nor their potentialhave a substantial impact on us, can be predicted at this time.us. For additional information, see "Risk Factors" in Item 1A of Part I of this Annual Report.report.
The laws and regulations governing our affairs are quite complex and occasionally in conflict with each other. From time to time, we are fined for failing to meet applicable regulations or service requirements.
Federal Regulation
General
We are required to comply with the Communications Act of 1934. Among other things, this law requires our ILECs to offer various of our legacy services at just and reasonable rates and on non-discriminatory terms. The Telecommunications Act of 1996 materially amended the Communications Act of 1934, primarily to promote competition.
The FCC regulates the interstate services we provide, including the special accessbusiness data service charges we bill for wholesale network transmission and intercarrier compensation, including the interstate access charges that we bill to long-distance companies and other communications companies in connection with the origination and termination of interstate phone calls. Additionally, the FCC regulates a number of aspects of our business related to international communications services, privacy, homeland securitypublic safety and network infrastructure, including our access to and use of local telephone numbers and our provision of emergency 911 services. The FCC has responsibility for maintaining and administering support programs designed to expand nationwide access to communications services (which are described further below), as well as other programs supporting service to low-income households, schools and libraries, and rural health care providers.
In recent years, our operations and those of other telecommunications carriers have been further impacted by legislation and regulation imposing additional obligations on us, particularly with regards to providing voice and high-speed Internet service, bolstering homeland security, increasing disaster recovery requirements, minimizing environmental impacts and enhancing privacy. These laws include the Communications Assistance for Law Enforcement Act, and laws governing local telephone number portability and customer proprietary network information requirements. In addition,April 2017, the FCC has heightened its focus on 911 reliability. The FCC has imposed fines on us and other companiesrevised the regulation of the provision of data services to businesses providing greater freedom to respond to competition for 911 outages and has adopted new compliance requirements for 911 service. We are making investments to protect against future 911 outages as well as incurring compliance-related costs to meetthese business data services. Several parties appealed the FCC's 911 reliability standards. All of these lawsdecision and regulations may cause us to incur additional costs and could impact our ability to compete effectively.
In 2012, the FCC initiated a special access proceeding and requested data, information and documents to allow it to conduct a comprehensive evaluation of competition in the special access market. In late 2015, the FCC initiated a special access tariff investigation in order to review specific terms and conditions related to long-term special access contracts and discount plans. As part of its evaluations, the FCC is reviewing special access rates, terms and conditions.resulting remand proceedings remain pending. The ultimate impact of these proceedings on us of the FCC's recent actions is currently unknown. However, if the FCC were to adopt significant changes in regulations affecting special access services, this could adversely impact our operations or financial results.
Universal Service
In 2015, the FCC issued an order regulating the manner in which ILECs can discontinue or reduce certain copper-based services. This order requires ILECs to provide prior notice to certain customers of their proposed change in services, and in certain cases to provide replacement offerings on reasonably comparable terms and conditions. We expect that this order will limit our flexibility to react to changing conditions in the communications industry.
Intercarrier Compensation and Universal Service
For decades, the FCC has regularly considered various intercarrier compensation reforms, generally with a goal to create a uniform mechanism to be used by the entire telecommunications industry for payments between carriers originating, terminating, or carrying telecommunications traffic. The FCC has also traditionally administered support programs designed to promote the deployment of voice and high-speed Internet services in high-cost rural areas of the country.
In October 2011, the FCC adopted the Connect America and Intercarrier Compensation Reform order ("the 2011 order"), intended to reform the existing regulatory regime to recognize ongoing shifts to new technologies, including VoIP, and to re-direct universal service funding to foster nationwide broadband coverage. The 2011 order provides for a multi-year transition as terminating intercarrier compensation charges are reduced, universal service funding is explicitly targeted to broadband deployment, and line charges paid by end user customers are increased. These changes have increased the pace of reductions in the amount of switched access revenues related to our wholesale services, while creating opportunities for increased federal USF support and retail revenue funding.
In late 2011, numerous parties filed a petition for reconsideration with the FCC seeking numerous revisions to the 2011 order. Future judicial challenges to the 2011 order are also possible, which could alter or delay the FCC's proposed changes. In addition, based on the outcome of the FCC proceedings, various state commissions may consider changes to their universal service funds or intrastate access rates. Rulemaking designed to implement the order is not complete, and several FCC proceedings relating to the 2011 order remain pending. For these and other reasons, we cannot predict the ultimate impact of these proceedings at this time.
As a result of the 2011 order, a new Universal Service program was created to deploy broadband to unserved and underserved rural areas utilizing theCenturyLink accepted Connect America Fund or "CAF". The CAF substantially replaces interstate USF funding previously utilized to support voice service in high-cost rural markets. There are two phases to the CAF program, CAF Phase 1 is a one-time broadband grant program while CAF Phase 2 is a multi-year recurring subsidy program for more extensive broadband deployment in price-cap ILEC territories.
In August 2015, CenturyLink agreed to accept from the FCC CAF Phase 2 funding of approximately $500 million per year for six years to fund the deployment of voice and high-speed Internetbroadband capable infrastructure for approximately 1.2 million rural households and businesses in 33 states.states under the CAF II high-cost support program. Of these amounts, approximately $150 million is attributable to our service area, to provide service to approximately 0.3 million rural households and businessesbusiness in 13 states.of the 14 states in which we are the ILEC. The funding from the CAF Phase 2II support program is expected toin these 13 states has substantially supplantreplaced the funding we previously received from the interstate USF high-cost program that we previously utilized to support voice services in high-cost rural markets in these 13 states. In September of 2015, we began receiving payments from the FCC under the new CAF Phase 2 support program, which included (i) monthly payments at a higher rate than under the interstate USF support and (ii) a substantial one-time cumulative catch-up payment designed to address program transitioning issues.
CenturyLink and we declined annual funding of approximately $8 million in one state, and we expect the funding from the CAF Phase 2 support program for this one state will be auctioned by the FCC, perhaps in the latter part of 2016. In this one state, the interstate USF support we have historically received is expected to continue until the CAF Phase 2 auctions are completed.
As a result of accepting CAF Phase 2II support payments, for 13 states, we will beare obligated to make substantial capital expenditures to build infrastructure by certain specified milestone deadlines. Future funding is contingent upon our compliance with these infrastructure buildout commitments and certain other service requirements, including certain minimum transmission speed requirements (broadband service with download speeds of 10 megabits per second and upload speeds of 1 megabit per second). In addition, if we are not in compliance with FCC measures at the end of the six-year CAF Phase 2 period, we will have 12 months to attain full compliance. If we are not in full compliance after the additional 12 months, we would incur a penalty equal to 1.89 times the average amount of support per location received in the state over the six-year term, plus a potential penalty of 10% of the total CAF Phase 2 support over the six-year term for the state. For information on the risks associated with participating in this program, see "Risk Factors—Risks Relating to Legal and Regulatory Matters" in Item 1A of Part I inof this Annual Report.report.
Currently, it is unclear when the FCC will complete the development of the next phase of the CAF program expected to follow the CAF Phase II program and what that plan will entail. Although the FCC has taken certain initial steps, we cannot assure you when such replacement plan will be proposed or implemented.
For additional information about the potential financial impact of the CAF Phase 2II program, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of Part II of this Annual Report.report.
We received approximately $223 million, $135 million and $141 million of revenues from federal and state universal service support programs for the years ended December 31, 2015, 2014 and 2013, respectively. Such amounts represented approximately 1.6% of our 2015, 1.5% of our 2014 and 1.6% of our 2013 total operating revenues.
Broadband Regulation
In February 2015, the FCC adopted new regulations that regulatean order classifying Broadband Internet services as a public utilityAccess Services ("BIAS") under Title II of the Communications Act of 1934. We anticipate that these1934 and applying new regulations. In December 2017, the FCC voted to repeal most of those regulations and any related rules will be reviewed by both the courtsclassification of BIAS as a Title II service and Congress. Atto preclude states from imposing substantial regulations of their own on broadband. Opponents of this time, we cannot estimatechange have appealed this action in federal court and have advocated in favor of re-instituting regulation of Internet services under Title II of the Communications Act. Several states have also opposed the change and have initiated state executive orders or introduced legislation focused on state-specific Internet service regulation. The result of these appeals is pending and the potential impact this may have on our business.to us is currently unknown.
The FCC recently adopted a new broadband standard of 25 Mbps download speed and 3 Mbps of upload speed. At this time, we are not aware of any regulatory mandates requiring us to deploy this target speed. The new target is simply a benchmark by which the FCC will evaluate broadband deployment progress in the future. However, the FCC could attempt to utilize this broadband speed target in future regulatory proceedings.
State Regulation of Domestic Operations
In recent years, most states have reduced their regulation of ILECs. Nonetheless, some state regulatory commissions generally continue to regulate local service(i) set the rates intrastate access charges, state universal service funds and in some cases service quality. We are generally regulated under various formsthat telecommunication companies charge each other for exchanging traffic, (ii) administer support programs designed to subsidize the provision of alternative regulation that typically limit our abilityservices to increase rates for stand-alone, basic local voice service, but relieve us from the requirement to meet certain earnings tests. In a number of states, we have gained pricing freedom for the majority of retail services other than stand-alone basic consumer voice service. In most of the states in which we operate, we have gained pricing flexibility for certain enhanced calling services, such as caller identification and for bundled services that also include local voice service.
Under state law, we are typically governed by laws and regulations that (i)high-cost rural areas, (iii) regulate the purchase and sale of ILECs, (ii) prescribe certain reporting requirements, (iii)(iv) require ILECs to provide service under publicly-filed tariffs setting forth the terms, conditions and prices of regulated services, (iv)(v) limit ILECs' ability to borrow and pledge their assets, (v)(vi) regulate transactions between ILECs and their affiliates and (vi)(vii) impose various other service standards.
Unlike many In most states, local voice service, switched and business data services and interconnection services are subject to price regulation, although the extent of our competitors, as an ILEC we generally face "carrierregulation varies by type of last resort" obligations which include an ongoing requirement to provide service to all prospective and current customers in our service area who request service and are willing to pay rates prescribed in our tariffs. In certain situations, this may constitute a competitive disadvantage to us if competitors can choose to focus on low-cost profitable customers and withhold service from high-cost unprofitable customers. In addition, strict adherence to carrier-of-last-resort requirements may force us to construct facilities with a low likelihood of attractive economic return.geographic region.
We operate in states where traditional cost recovery mechanisms, including rate structures and state USF,
are under evaluation or have been modified. Recent changes to the federal tax code have prompted several states
to review regulated rates. As laws and regulations change, there can be no assurance that these mechanisms will
continue to provide us with any cost recovery.
For several years, we have faced various carrier complaints, legislation
Other Regulations
Our networks are subject to numerous local regulations, including codes that regulate our trenching and construction operations or that require us to obtain permits, licenses or franchises to operate. Such regulations are enacted by municipalities, counties or other investigations regardingregional governmental bodies, and can vary widely from jurisdiction to jurisdiction as a result. Such regulations may also require us to pay substantial fees.
Various federal and state laws govern our intrastate switched access rates in severalstorage, maintenance and use of our states.customer data, including a wide range of consumer protection, data protection, privacy, intellectual property and similar laws. The FCC's 2011 order preempted state regulatory commissions' jurisdiction over all terminating access charges, including intrastate access charges that have historically been subject to exclusive state jurisdiction. Excluding the rate implications contemplated on a prospective basis by this FCC order, we will continue to vigorously defendapplication, interpretation and seek to collect our intrastate switched access revenues subject to outstanding disputes. The outcomesenforcement of these disputes cannotlaws are often uncertain, and may be determined atinterpreted and applied inconsistently from jurisdiction to jurisdiction. Various federal and state legislative or regulatory bodies have recently adopted increasingly restrictive laws or regulations governing the protection or retention of data, and others are contemplating similar actions.
For additional information about these matters, see “Risk Factors—Risks Affecting Our Business” and “Risk Factors—Risks Relating to Legal and Regulatory Matters” in item 1A of Part I of this time. If we are required to reduce our intrastate switched access rates as a result of any of these disputes or state initiatives, we will seek to recover displaced switched access revenues from state universal service funds or other services. However, the amount of such recovery, particularly from residential customers, is not assured.report.
Competition
General
Primarily as a result of regulatory and technological changes, competition has been introduced and encouraged in each sector of the communications industry over the past couple of decades. As a result, we currently
We compete in a rapidly evolving and highly competitive market, and we expect intense competition from a wide variety of sources under evolving market conditions to continue. In addition to competition from larger national telecommunicationstelecommunication service providers, we are facing increasing competition from several other sources, including cable and satellite companies, wireless providers, technology companies, cloud companies, broadband providers, device providers, resellers, sales agents facilities-based providers, and sales agents. Technologicalsmaller more narrowly focused niche providers either using their own networks leasing parts of our network, or providing services such as VoIP, SD-WAN and security independent of network assets. The ability to provide such services independently of the network challenges more traditional solution selling. Further technological advances and regulatory and legislative changes have increased opportunities for a wide range of alternative communications service providers, which in turn have increased competitive pressures on our business. These alternate providers often face fewer regulations and have lower cost structures than we do. In addition, the communications industry has, in recent years, experienced substantial consolidation, and some of our competitors in one or more lines of our business are generally larger, have stronger brand names, have more financial and business resources and have broader service offerings than we currently do.
Wireless voice services are a significant source of competition with our traditional ILEC services. It is increasingly common for customers to completely forego use of traditional wireline phone service and instead rely solely on wireless service for voice services. We anticipate this trend will continue, particularly with younger customers who are less accustomed to using traditional wireline voice services. Technological and regulatory developments in wireless services, Wi-Fi, and other wired and wireless technologies have contributed to the development of alternatives to traditional landline voice services. Moreover, the growing prevalence of electronic mail, text messaging, social networking and similar digital non-voice communications services continues to reduce the demand for traditional landline voice services. These factors have led to a long-term systemic decline in the number of our wireline voice service customers.
The Telecommunications Act of 1996, which obligates ILECs to permit competitors to interconnect their facilities to the ILEC's network and to take various other steps that are designed to promote competition, imposes several duties on an ILEC if it receives a specific request from another entity which seeks to connect with or provide services using the ILEC's network. In addition, each ILEC is obligated to (i) negotiate interconnection agreements in good faith, (ii) provide nondiscriminatory "unbundled" access to all aspects of the ILEC's network, (iii) offer resale of its telecommunications services at wholesale rates and (iv) permit competitors, on terms and conditions (including rates) that are just, reasonable and nondiscriminatory, to colocate their physical plant on the ILEC's property, or provide virtual colocation if physical colocation is not practicable. Current FCC rules require ILECs to lease a network element only in those situations where competing carriers genuinely would be impaired without access to such network elements, and where the unbundling would not interfere with the development of facilities-based competition.
As a result of these regulatory, consumer and technological developments, ILECs also face competition from competitive local exchange carriers, or CLECs, particularly in densely populated areas. CLECs provide competing services through (i) reselling an ILEC's local services, (ii) using an ILEC's unbundled network elements or (iii) operating their own facilities.
Technological developments have led to the development of new products and services that have reduced the demand for our traditional services, as noted above, or that compete with traditional ILEC services. Technological improvements have enabled cable television companies to provide traditional circuit-switched telephone service over their cable networks, and several national cable companies continue to aggressively market these services. Similarly, companies providing VoIP services provide voice communication services over the Internet which compete with our traditional telephone service and our own VoIP services. In addition, demand for our broadband services could be adversely affected by advanced wireless data transmission technologies being deployed by wireless providers and by certain technologies permitting cable companies and other competitors to deliver generally faster average broadband transmission speeds than ours.
Similar to us, many cable, technology or other communications companies that previously offered a limited range of services are now offering diversified bundles of services, either through their own networks, reselling arrangements or joint ventures. As such, a growing number of companies are competing to serve the communications needs of the same customer base. Such activities will continue to place downward pressure on the demand for and pricing of our services.
As both residential and business customers increasingly demand high-speed connections for entertainment, communications and productivity, we expect the demands on our network will continue to increase over the next several years. To succeed, we and other network-based providers must continue to invest in our network to ensure that our networksit can deliver competitive services that meet these increasing bandwidth and speed requirements. We plan to continue to invest in our network to be able to meet this future demand and to compete effectively. In addition, network reliability and security are increasingly important competitive factors in our business.
Additional information about competitive pressures is located (i) under
In addition to facing direct competition from those providers described above, ILECs increasingly face competition from alternate communication systems constructed by long distance carriers, large customers, municipalities or alternative access vendors. These systems are capable of originating or terminating calls without use of an ILEC's networks or switching services. Other potential sources of competition include non-carrier systems that are capable of bypassing ILECs' local networks, either partially or completely, through various means, including the heading "Risk Factors—Risks Affecting Our Business" in Item 1Aprovision of Part Ibusiness data services or independent switching services and the concentration of this Annual Report and (ii) in the discussion immediately below, which contains more specific informationtelecommunications traffic on howa few of an ILEC's access lines. We anticipate that all these trends in competition have impactedwill continue and lead to decreased billable use of our services.networks.
Although our status as an ILEC continues to provide us advantages in providing local services in our local service area, as noted above, we increasingly face significant competition as an increasing number of consumers are willing to substitute cable, wireless and electronic communications for traditional voice telecommunications services. This has led to an increase in the number and type of competitors within our industry, price compression and a decrease in our market share. As a result of this product substitution, we face greater competition in providing local services from wireless providers, resellers and sales agents (including ourselves), social media hosts and broadband service providers, including cable companies. We anticipate this trend will continue, particularly as wireless services providers continue to improve their service offerings and our older legacy customers are replaced over time with younger customers who are less accustomed to using traditional wireline voice services. We also continue to compete with traditional telecommunications providers, such as national carriers, smaller regional providers, CLECs and independent telephone companies.
Some of our competitors are subject to fewer regulations than we are, which affords them competitive advantages against us. Under federal regulations, telecommunication providers are able to interconnect their networks with ours, resell our services or lease separate parts of our network in order to provide competitive services. Generally, we have been required to provide these functions and services at wholesale rates to our competitors, which allow our competitors to sell their services at lower prices. However, these rules have been and continue to be reviewed by state and federal regulators. In addition, wireless and high-speed Internetbroadband service providers generally are subject to fewer regulations, which may allow them to operate with lower costs than we are able to operate. For additional discussion of regulations affecting our business, see "Regulation" above.
As discussed below, competition for many of our services is based in part on bundled offerings. We believe our customers value the convenience of, and price discounts associated with, receiving multiple services through a single company. As such, we continue to focus on expanding and improving our bundled offerings.
Strategic Services
With respect to providing our strategic services, competitionAdditional information about competitive pressures is based on price, bandwidth, qualitylocated (i) under the heading "Risk Factors—Risks Affecting Our Business" in Item 1A of Part I of this report and speed of service, promotions and bundled offerings. Wireless carriers' fourth generation, or 4G, services are allowing them to more directly compete with our strategic services. In providing high-speed Internet services, we compete primarily with cable companies, wireless providers and other high-speed Internet service providers. Competition within our high-speed Internet services is based on price, bandwidth and service. We face competition in Ethernet based services(ii) in the wholesale market from cable companies and fiber based CLEC providers. In reselling DIRECTV video services, we compete primarily with cable and other satellite companies as well as other sales agents and resellers. Competition here is baseddiscussion immediately below, which contains more specific information on price, content and quality.
In providing private line services we compete primarily with national telecommunications providers, such as AT&T Inc. and Verizon Communications Inc. Additionally we are experiencing increasedhow these trends in competition for private line services from cable companies. Competition for private line services is based primarily on price, as well as network reach, bandwidth, quality, reliability and customer service.
The market for wireless services is highly competitive. We market and sell wireless services to customers who are buying these services as part of a bundle with one or more ofhave impacted our other services. In reselling Verizon Wireless services, we compete with national and regional carriers as well as other sales agents and resellers. Competition for our wireless services is based on the coverage area, price, services offered, features, handsets, technical quality and customer service.
Although we are experiencing intense competition in these markets, we believe we are favorably positioned due to our strong presence in our local service area. Many of our competitors for these strategic services are not subject to the same regulatory requirements as we are and therefore they are able to avoid significant regulatory costs and obligations. Throughout each of our competitive services, we continue to focus on expanding and improving our bundled offerings.
Legacy Services
The market for legacy services is highly competitive and is based primarily on pricing, packaging of services and features, quality of service and meeting customer care needs. We believe these customers value the convenience of and price discounts associated with, receiving multiple services through a single company. Within the telecommunications industry, these services may include telephone, wireless, video and Internet access. Accordingly, we and our competitors continue to develop and deploy more innovative product bundling, enhanced features and combined billing options in an effort to retain and gain customers. While we rely on reseller or sales agency arrangements to provide some of our bundled services, some of our competitors are able to provide all of their bundled services directly, which may provide them a competitive advantage.
Our resale and UNE customers are experiencing the same competition with CLECs, for local services customers as we are, as discussed above. We also compete with some of our own customers that are deploying their own networks to provide customers with local services. By doing so, these competitors take traffic off of our network.
Significant competitive factors in the local telephone industry include pricing, packaging of services and features, quality and convenience of service and meeting customer needs such as simplified billing and timely response to services calls.
We provide access services to other telecommunications providers to connect their customers and their networks to our network so that they can provide long-distance, transport, data, wireless and Internet services. We face significant competition for access services from CLECs, cable companies, resellers and wireless service providers. Our access service customers face competitive pressures in their businesses that are similar to those we face with respect to strategic and legacy services. To the extent that these competitive pressures result in decreased demand for their services, demand for our access services also declines.
Wireless telephone services increasingly constitute a significant source of competition with ILEC services, especially since wireless carriers have begun to compete effectively on the basis of price with more traditional telephone services. As a result, some customers have chosen to completely forego use of traditional wireline phone service and instead rely solely on wireless service for voice services. This trend is more pronounced among consumer customers, which comprise 62% of our access line customers. We anticipate this trend will continue, particularly if wireless service providers continue to expand their coverage areas, reduce their rates, improve the quality of their services and offer enhanced new services. Substantially all of our access line customers are currently capable of receiving wireless services from at least one competitive service provider. Technological and regulatory developments in wireless services, personal communications services, digital microwave, satellite, coaxial cable, fiber optics, local multipoint distribution services, WiFi and other wired and wireless technologies are expected to further permit the development of alternatives to traditional landline services. Moreover, the growing prevalence of electronic mail, text messaging, social networking and similar digital communications continues to reduce the demand for traditional landline voice services.
Improvements in the quality of VoIP service have led several cable, Internet, data and other communications companies, as well as start-up companies, to substantially increase their offerings of VoIP service to business and residential customers. VoIP providers frequently offer features that cannot readily be provided by traditional ILECs and may price their services at or below those prices currently charged for traditional local and long-distance telephone services for several reasons, including lower operating costs and regulatory advantages. Although over the past several years the FCC has increasingly subjected portions of VoIP operations to federal regulation, VoIP services currently operate under fewer regulatory constraints than local exchange carriers services. For all these reasons, we cannot assure that VoIP providers will not successfully compete for our customers.
In providing other legacy services, such as traditional services and ISDN, we compete primarily with national telecommunications providers and cable companies. Competition for these other legacy services is based primarily on price and bundled offerings.
Environmental Compliance
From time to time we may incur environmental compliance and remediation expenses, mainly resulting from owning or operating ofprior industrial sites or operating vehicle fleets or power supplies for our communications equipment. Although we cannot assess with certainty the impact of any future compliance and remediation obligations or provide you with any assurances regarding the ultimate impact thereof, we do not currently believe that future environmental compliance and remediation expenditures will have a material adverse effect on our financial condition or results of operations. For additional information, see "Risk Factors—Risks Relating to Legal and Regulatory Matters" in Item 1A of Part III of this Annual Reportreport and Note—15 Note 15—Commitments, Contingencies and ContingenciesOther Items included in Item 8 of Part II of this Annual Report.report.
Seasonality
Overall, our business is not materially impacted by seasonality. Our network-related operating expenses are, however, generally higher in the second and third quarters of the year. From time to time, weather related problems have resulted in increased costs to repair our network and respond to service calls in some of our markets. The amount and timing of these costs are subject to the weather patterns of any given year.year, but have generally been highest during the third quarter and have been related to damage from severe storms, including hurricanes, tropical storms and tornadoes in our markets along the Atlantic and Gulf of Mexico coastlines.
Employees
At December 31, 2015,2018, we had approximately 22,00019,000 employees, of which approximately 11,0008,400 are members of either the Communications Workers of America ("CWA") or the International Brotherhood of Electrical Workers ("IBEW"). See the discussion of risks relating to our labor relations in "Risk Factors—Risks Affecting Our Business" in Item 1A of Part I of this Annual Report.report and see Note 17—Labor Union Contracts to our consolidated financial statements in Item 8 of Part II of this report, for additional information on the timing of certain contract expirations.
Over the last several years, we have reduced our workforce primarily due to (i) integration efforts from CenturyLink's indirect acquisition of us, (ii) increased competitive pressures and (iii) the loss of access lines and related legacy revenues.
Website Access and Important Investor Information
Our website is the same as that of our ultimate parent company, CenturyLink, which is www.centurylink.com. We routinely post important investor information in the "Investor Relations" section of our website at ir.centurylink.com. The information contained on, or that may be accessed through, our website is not part of this Annual Report.report. You may obtain free electronic copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports in the "Investor Relations" section of our website (ir.centurylink.com) under the heading "SEC Filings." These reports are available on our website as soon as reasonably practicable after we electronically file them with the Securities and Exchange Commission ("SEC").
We have adopted CenturyLink's written code of conduct that serves as the code of ethics applicable to our directors, officers and employees, in accordance with applicable laws and rules promulgated by the SEC and the New York Stock Exchange. In the event that CenturyLink makes any changes (other than by a technical, administrative or non-substantive amendment) to, or provide any waivers from, the provisions of its code of conduct applicable to our directors or executive officers, CenturyLink intends to disclose these events on our website or in a report on Form 8-K filed with the SEC. The code of conduct, as well as copies of CenturyLink's guidelines on significant governance issues and the charters of their audit committee, compensation committee, nominating and corporate governance committee and risk evaluation committee, are also available in the "Corporate Governance" section of our website at www.centurylink.com/Pages/AboutUs/Governance/ or in print to any shareholder who requests them by sending a written request to our Corporate Secretary at CenturyLink, Inc., 100 CenturyLink Drive, Monroe, Louisiana, 71203.
Investors may also read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. For information on the operation of the Public Reference Room, you are encouraged to call the SEC at 1-800-SEC-0330. For all of our electronic filings, the SEC maintains aSEC's website at www.sec.gov that contains reports, proxy statements. From time to time CenturyLink also uses the website to webcast their earnings calls and certain of their meetings with investors or other information regarding issuers that file electronically withmembers of the SEC.investment community.
In connection with filing this Annual Report,report, our chief executive officer and chief financial officer made the certifications regarding our financial disclosures required under the Sarbanes-Oxley Act of 2002, and its related regulations.
Special Note Regarding Forward-Looking Statements and Related Matters
This Annual Report and other documents filed by us under the federal securities law include, and future oral or written statements or press releases by us and our management may include, forward-looking statements about our business, financial condition, operating results and prospects. These statements constitute "forward-looking" statements as defined by, and are subject to the "safe harbor" protections under, the federal securities laws. These statements include, among others:
forecasts of our anticipated future results of operations or financial position;
statements concerning the impact of our transactions, investments and other initiatives, including our participation in government programs;
statements about our liquidity, tax position, tax rates, asset values, contingent liabilities, growth opportunities and growth rates, acquisition and divestiture opportunities, business prospects, regulatory and competitive outlook, investment and expenditure plans, business strategies, capital allocation plans, financing alternatives and sources and pricing plans; and
other similar statements of our expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts, many of which are highlighted by words such as "may," "would," "could," "should," "plan," "believes," "expects," "anticipates," "estimates," "projects," "intends," "likely," "seeks," "hopes," or variations or similar expressions.
These forward-looking statements are based upon our judgment and assumptions as of the date such statements are made concerning future developments and events, many of which are beyond our control. These forward-looking statements, and the assumptions upon which they are based, (i) are not guarantees of future results, (ii) are inherently speculative and (iii) are subject to a number of risks and uncertainties. Actual events and results may differ materially from those anticipated, estimated, projected or implied by us in those statements if one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect. Factors that could affect actual results include but are not limited to:
the effects of competition from a wide variety of competitive providers, including lower demand for our legacy offerings;
the effects of new, emerging or competing technologies, including those that could make our products less desirable or obsolete;
the effects of ongoing changes in the regulation of the communications industry, including the outcome of regulatory or judicial proceedings relating to intercarrier compensation, interconnection obligations, access charges, universal service, broadband deployment, data protection and net neutrality;
our ability to effectively adjust to changes in the communications industry, and changes in the composition of our markets and product mix;
possible changes in the demand for, or pricing of, our products and services, including our ability to effectively respond to increased demand for high-speed broadband service;
our ability to successfully maintain the quality and profitability of our existing product and service offerings and to introduce new offerings on a timely and cost-effective basis;
the adverse impact on our business and network from possible equipment failures, service outages, security breaches or similar events impacting our network;
our ability to generate cash flows sufficient to fund our financial commitments and objectives, including our capital expenditures, operating costs, dividends, pension contributions and debt payments;
changes in our operating plans, corporate strategies, dividend payment plans or other capital allocation plans, whether based upon changes in our cash flows, cash requirements, financial performance, financial position, or otherwise;
our ability to effectively retain and hire key personnel and to successfully negotiate collective bargaining agreements on reasonable terms without work stoppages;
increases in the costs of CenturyLink's pension, health, post-employment or other benefits, including those caused by changes in markets, interest rates, mortality rates, demographics or regulations, could negatively impact CenturyLink, which may in turn affect our business and liquidity;
adverse changes in our access to credit markets on favorable terms, whether caused by changes in our financial position, lower debt credit ratings, unstable markets or otherwise;
our ability to maintain favorable relations with our key business partners, suppliers, vendors, landlords and financial institutions;
our ability to effectively manage our network buildout project and other expansion opportunities;
our ability to collect our receivables from financially troubled customers;
any adverse developments in legal or regulatory proceedings involving CenturyLink or QCII;
changes in tax, communications, pension, healthcare or other laws or regulations, in governmental support programs, or in general government funding levels;
the effects of changes in accounting policies or practices, including potential future impairment charges;
the effects of adverse weather or other natural or man-made disasters;
the effects of more general factors such as changes in interest rates, in operating costs, in general market, labor, economic or geo-political conditions, or in public policy; and
other risks referenced in Item 1A or elsewhere in this Annual Report or other of our filings with the SEC.
These factors should be considered in connection with any written or oral forward-looking statements that we or persons acting on our behalf may issue. Anticipated events may not occur and our actual results or performance may differ materially from those anticipated, estimated or projected if one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect. Additional factors or risks that we currently deem immaterial, that are not presently known to us or that arise in the future could also cause our actual results to differ materially from our expected results. Given these uncertainties, investors are cautioned not to unduly rely upon our forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements for any reason, whether as a result of new information, future events or developments, changed circumstances, or otherwise. Furthermore, any information about our intentions contained in any of our forward-looking statements reflects our intentions as of the date of such forward-looking statement, and is based upon, among other things, existing regulatory, technological, industry, competitive, economic and market conditions, and our assumptions as of such date. We may change our intentions, strategies or plans at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.
InvestorsLenders should also be aware that while we do, at various times, communicate with securitiesanswer questions raised by analysts, it is against our policy to disclose to them selectively any material non-public information or other confidential information. Accordingly, investorslenders should not assume that we agree with any statement or report issued by an analyst with respect to our past or projected performance. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
Unless otherwise indicated, information contained in this Annual Reportreport and other documents filed by us under the federal securities laws concerning our views and expectations regarding the communications industry are based on estimates made by us using data from industry sources, and on assumptions made by us based on our management'smanagement’s knowledge and experience in the markets in which we operate and the communications industry generally. You should be aware that we have not independently verified data from industry or other third-party sources and cannot guarantee its accuracy or completeness. Our estimates and assumptions involve risks and uncertainties and are subject to change based on various factors, including those discussed below in Item 1A of Part I of this Annual Report.
ITEM 1A. RISK FACTORS
The following discussion of “risk factors” identifies the most significant risks or uncertainties that could (i) materially and adversely affect our business, financial condition, results of operations, liquidity or prospects or (ii) cause our actual results to differ materially from our anticipated results or other expectations. YouThe following information should carefully consider these factors,be read in addition toconjunction with the other information set forthportions of this report, including "Special Note Regarding Forward-Looking Statements", "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Annual ReportItem 7 and our subsequent filings with the SEC, when evaluating our businessconsolidated financial statements and whether to purchase, sell or hold our securities.related notes in Item 8. Please note that the following discussion is not intended to comprehensively list all risks or uncertainties faced by us. Our operations or actual results could also be similarly impacted by additional risks and uncertainties that are not currently known to us, that we currently deem to be immaterial, that arise in the future or that are not specific to us, such as general economic conditions. In addition, certain of the risks described below apply only to a part of our business.
Risks Affecting Our Business
Our failure to simplify our service support systems could adversely impact our competitive position.
For many of our services, we can effectively compete only if we can quickly and efficiently (i) quote and accept customer orders, (ii) provision and initiate ordered services, (iii) provide customers with adequate means to manage their services and (iv) accurately bill for our services. To attain these goals, we believe we must digitally transform our service support processes to permit greater automation and customer self-service options. This digital transformation is complex and will require a substantial amount of resources, especially in light of the multiplicity of our systems. Development of systems designed to support this transformation will continuously require our personnel and third-party vendors to, among other things, (i) adjust to changes in our offerings and customers’ preferences, (ii) simplify our processes, (iii) improve our data management capabilities, (iv) eliminate inconsistencies between our legacy and acquired operations, (v) eliminate older support systems that are costly or obsolete, (vi) develop uniform practices and procedures, and (vii) automate them as much as possible. We cannot assure you that these undertakings will be successful. Our competitive position could be adversely impacted if we fail to continuously develop viable service support systems that are satisfactory to our current and potential customers.
We may not be able to compete successfully against current or future competitors.
Each of our offerings to our residentialbusiness and businessconsumer customers face increasingly intense competition from a wide variety of sources under evolving market conditions. In particular, (i) aggressive competition from a wide range of communications and technology companies has limited the prospects for several of offerings to our business customers; (ii) intense competition from wireless and other communications providers has led to a long-term systemic decline in the number of our wireline voice customers and (iii) strong competition from cable companies has impacted the growth of our broadband operations. We expect these trends will continue. For more detailed information, see "Business—Competition" in Item 1 of this report.
In addition to competition from larger national telecommunicationsa wide range of technology companies and communications providers (including those described above), we are facing increasing competition from several other sources, including cable and satellite companies, wireless providers, technologycloud companies, broadband providers, software developers, device providers, resellers, sales agents and facilities-based providers using their own networks as well as those leasing parts of our network. In particular, (i) intenseFurther competition from wireless and other communications providers has ledcould arise through industry consolidation, technological innovation, or changes in regulation, including changes allowing foreign carriers to a long-term systemic declinemore extensively compete in the number of our customers for wireline voice services, (ii) strong competition from cable companies and others has limited the growth of our broadband operations and (iii) aggressive competition from a wide range of technology companies and other market entrants has limited the prospects for our cloud computing operations. For more detailed information, see "Competition" under Item 1 of this Annual Report.U.S. market.
Some of our current and potential competitors (i) offer products or services that are substitutes for our traditional wireline voice services, including wireless voice and non-voice communication services, (ii) offer a more comprehensive range of communications products and services, (iii) offer products or services with features that we cannot readily match in some or all of our markets, including faster average broadband transmission speeds and(iv) install their services more quickly than we do, (v) have greater content, (iv) have market presence,marketing, engineering, andresearch, development, technical, capabilities, andprovisioning, customer relations, financial andor other resources, greater than ours, (v)(vi) have larger or more diverse networks with greater transmission capacity, or other advantages, (vi)(vii) conduct operations or raise capital at a lower cost than us, (vii)(viii) are subject to less regulation, which we believe enables such competitors to operate more flexibly than us with respect to certain offerings, (viii)(ix) offer services nationally or internationally to a larger geographic area or larger base of customers, (ix)(x) have substantially stronger brand names, which may provide them with greater pricing power than ours, or (x)(xi) have larger operations than ours, which may enable them to offer higher compensation packagescompete more successfully in connection with recruiting and retaining top technological, managerial andtalent, entering into operational talent.or strategic partnerships or acquiring companies. Consequently, these competitors may be better equipped to provide more attractive offerings, to charge lower prices for their products and services, to develop and expand their communications and network infrastructure more quickly, to adapt more swiftly to new or emerging technologies and changes in technologies or customer requirements, to devote greater resources to the marketing and sale of their products and services, to provide more comprehensive customer service, to provide greater resources to research and development initiatives and to take advantage of acquisitionbusiness or other opportunities more readily. In the past, several of our competitors and their operations have grown through acquisitions and aggressive product development. The continued growth of our competitors could further enhance their competitive positions.
Competition could adversely impact us in several ways, including (i) the loss of customers, and market share (ii) the possibility of customers reducing their usage of our services or shifting to less profitable services, (iii) reduced traffic on our networks, (iv)(ii) our need to expend substantial time or money on new capital improvement projects, (v)(iii) our need to lower prices or increase marketing expenses to remain competitive and (vi)(iv) our inability to diversify by successfully offering new products or services.
We are continually taking steps to respond to these competitive pressures, but these efforts may not be successful. Our operating results and financial condition would be adversely affected if these initiatives are unsuccessful or insufficient and if we otherwise are unable to sufficiently stem our continuing access line losses and our legacy revenue declines. If this occurred, our ability to pay our debt and other obligations and to re-invest in the business would also be adversely affected.insufficient.
Rapid technological changes could significantly impact our competitive and financial position.
The communications industry has been and continues to be impacted by significant technological changes, which in general are enhancing non-voice communications and enabling a broader array of companies to offer services competitivecompete with ours.us. Many of thosethese technological changes are (i) displacing or reducing demand for our wireline voice services, (ii) enabling the development of competitive products or services, or (iii) enabling our current customers to reduce or bypass use of our networks. Rapid changes in technology are increasing the competitiveness of the information technology services industry. In addition,networks, (ii) displacing or reducing demand for our broadband services, has been constrained by certainor (iii) enabling the development of competitive products or services. For years, the development of wireless and Internet-based voice and non-voice communications technologies permittingand social media platforms have reduced demand for our traditional voice services, and these trends continue. More recently, continuous improvements in wireless data technologies have enabled wireless carriers to offer competing products, and we expect this trend to continue as technological advances enable these carriers to carry greater amounts of data faster and with less latency. Technological advancements have also permitted cable companies and other of our competitors to deliver generally faster average broadband transmission speeds than ours. Demand forDevelopments in software have permitted new competitors to offer affordable products that historically required more expensive hardware investment. Rapid changes in technology have also placed competitive pressures on our broadband services could be further reduced by advanced wireless data transmission technologies being deployed by wireless providers, including "long-term evolution" or "LTE" technologies, especially if these wireless providers continuebusiness and enabled new competitors to increase their broadband transmission speed and decrease their service rates.enter our markets. To enhance the competitiveness of certain of our broadband services, we maywill likely be required to expendspend additional capital to install more fiber optic cable or to augment the capabilities of our copper-based services or to install more fiber optic cable.services.
We may not be able to accurately predict or respond to changes in technology or industry standards, or to the introduction of newly-offered services. Any of these developments could make some or all of our offerings less desirable or even obsolete.obsolete, which would place downward pressure on our market share and revenue. These developments could also require us to (i) expend capital or other resources in excess of currently contemplated levels, (ii) forego the development or provision of products or services that others can provide more efficiently, or (iii) make other changes to our operating plans, corporate strategies or capital allocation plans, any of which could be contrary to the expectations of our security holders or could adversely impact our operations. If we are not able to develop new products and services to keep pace with technological advances, or if those products and services are not widely accepted by customers, our ability to compete could be adversely affected and our market share could decline. Any inability to effectively respond to technological changes could also adversely affect ourbusiness operating results and financial condition, as well as our ability to service debt and fund other commitments or initiatives.results.
Even if we succeed in adapting to changes in technology or industry standards by developing new products or services, there is no assurance that the new products or services would have a positive impact on our profit margins or financial performance.
In addition to introducing new technologies and offerings, we may need, from time to time, to phase out outdated and unprofitable technologies and services. If we are unable to do so on a cost-effective basis, we could experience reduced profits. Similarly, if new market entrants are not burdened by an installed base of outdated equipment or obsolete technology, they may have a competitive advantage over us.
For additional information on the risks of increased expenditures, see "Risk Factors—Risks Affecting our Liquidity and Capital Resources—Our business requires us to incur substantial capital and operating expenses, which reduces our available free cash flow."
Our legacy and private line
Several of our services continue to experience declining revenues,revenue, and our efforts to offset these declines may not be successful.
Primarily as a result of the competitive and technological changes discussed above, we have experienced a prolonged systemic decline in our access lines andlocal voice, long-distance voice, network access revenues, which continue to decrease revenues generated from our legacy services. We have also experienced a decline in ourand private line revenues due torevenue. Consequently, we have experienced declining consolidated revenue for a prolonged period. More recently, we have experienced declines in revenue derived from the sale of certain of our customers' optimization of their networks, industry consolidation, price compressionbusiness products and technological migration to higher-speed services. The loss of private line services has placed downward pressure on our strategic revenues.
We have taken a variety of steps to counter these declines including:
in revenue, including an increased focus on selling a broader range of higher-growth strategic services which are described in detail elsewhere in this Annual Report;
an increased focus on serving a broader range of business, governmental and wholesale customers; and
greater use of service bundles.
demand. However, for the reasons described elsewhere in this Annual Report,report, most of these strategic servicesour more recent product and service offerings generate lower profit margins than our legacy and private linetraditional services, and some can be expected to experience slowing or no growth as increasing numbers of our existing or potential customers subscribe to these newer products.in the future. Moreover, we cannot assure you that the revenuesrevenue generated from our newnewer offerings will offset revenue losses associated with our legacy and private linetraditional services. In addition, our reliance on third parties to provide certain of these strategic services could constrain our flexibility, as described further below.
Our failure to meet the evolving needs of our customers could adversely impact our competitive position.
In order to compete effectively and respond to changing market conditions, we must continuously offer products and services on terms and conditions that allow us to retain and attract customers and to meet their evolving needs. To do so, we must continuously (i) invest in our network, (ii) develop, test and introduce new products and services and (iii) rationalize and simplify our offerings by eliminating older or overlapping products or services. Our ability to maintain attractive products and services and to successfully introduce new product or service offerings on a timely and cost-effective basis could be constrained by a range of factors, including network limitations, support system limitations, limited capital, an inability to attract key personnel with the necessary skills, intellectual property constraints, inadequate digitization or automation, testing delays, technological limits or an inability to act as quickly or efficiently as smaller, more nimble start-upother competitors. Similarly,In addition, new product or service offerings may not be widely accepted by our ability to grow through acquisitionscustomers. Our business could be limited by several factors, includingmaterially adversely affected if we are unable to maintain competitive products and services and to timely and successfully develop and introduce new products or services.
Our failure to strengthen our leveragerelations with our customers could harm our competitive position.
In mid-2017, CenturyLink Inc.'s Board of Directors formed a special committee of independent directors to review the entire Company's policies, procedures and inabilitypractices relating to identify attractively-priced target companies. Forconsumer sales, service and billing following a former employee’s allegations of sales-related misconduct. In late 2017, the special committee concluded its review and issued its key findings. Among other things, the committee found that (i) our investment in consumer sales monitoring was insufficient, (ii) our ordering and billing software contributed to customer confusion and (iii) systems and human errors contributed to inaccurate billing. As noted in our disclosures above, we are committed to simplifying and improving our customers’ experience and believe that we have already made progress in addressing these reasons,concerns. Nonetheless, given the complexity of the undertaking, we cannot assure you that we will timely and effectively implement changes that will adequately address all of our newservice support issues to the full satisfaction of our customers.
We could experience difficulties in consolidating, integrating, updating and simplifying our technical infrastructure.
Our ability to consolidate, integrate, update and simplify our systems and information technology infrastructure in response to our growth and changing business needs is important to our ability to develop and maintain attractive product orand service offerings willand to interface effectively with our customers. As discussed further under “Business-Network” in Item 1 of this report, we are currently undertaking several complex, costly and time-consuming projects to simplify, consolidate and modernize our network, which combines our legacy network and the networks of companies we have acquired in the past. Delays in the completion of these projects has hampered our progress, and any additional delays may lead to increased project costs or operational inefficiencies. In addition, there may be as successful as anticipated,issues related to our expanded or updated infrastructure that are not identified by our testing processes, and which may only become evident after we will be ablehave started to continuefully utilize the redesigned systems. Our failure to grow through acquisitions.modernize, consolidate and upgrade our technology infrastructure could have adverse consequences, including the delayed implementation of new service offerings, decreased competitiveness of existing service offerings, network instabilities, increased operating or acquisition integration costs, service or billing interruptions or delays, service offering inconsistencies, customer dissatisfaction, and the diversion of development resources. Any or all of the foregoing developments could have a negative impact on our business, results of operations, financial condition and cash flows.
We may not be able to successfully adjust to changes in our industry, our markets and our product mix.
Ongoing changes in the communications industry have fundamentally changed consumers’ communications expectations and requirements. In response to these changes, we have substantially altered our product and service offerings through acquisitions and internal product development. Many of these changes have placed a higher premium on sales, marketing and product development functions, and necessitated ongoing changes in our processes and operating protocols, as well as periodic reorganizations of our sales and leadership teams. In addition, we now offer a much more complex range of products and services, operate larger and more complex networks and serve a much larger and more diverse set of global customers. Consequently, we now face greater challenges in effectively managing and administering our operations and allocating capital and other resources to our various offerings. For all these reasons, we cannot assure you that our efforts to adjust to these changes will be timely or successful.
We could be harmed by security breaches damages or other significant disruptions or failures of our networks, information technology infrastructure or related systems owned or of those we operate for certain of our customers.operated by us.
We are materially reliant upon our networks, information technology infrastructure and related technology systems (including our billing and provisioning systems) to provide products and services to our customers and to manage our operations and affairs. We face the risk, as does any company, of a security breach or significant disruption of our information technology infrastructure and related systems. As a communications company that transmits large amounts of sensitive and proprietary information over communications networks, we face an added risk that a security breach or other significant disruption of our public networksnetwork, infrastructure or information technology infrastructure and related systems, or those that we develop, install, operate andor maintain for certain of our business customers, (which includes our wholesale and governmental customers) could lead to material interruptions or curtailments of service. Moreover, in connection with processing and storing sensitive and confidential customer data, we face a heightened risk that a security breach or disruption could result in unauthorized access to our customers' proprietary information on our public networks or internal systems or the systems that we operate and maintain for certain of our customers.information.
We make significant effortsstrive to maintain the security and integrity of information and systems under our control, and maintain contingency plans in the event of security breaches or other system disruptions. Nonetheless, we cannot assure you that our security efforts and measures will prevent unauthorized access to our systems, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service, computer viruses, malware, ransomware, distributed denial-of-service attacks, or other forms of cyber-attacks or similar events. These threats may derive from human error, hardware or software vulnerabilities, aging equipment or accidental technological failure. These threats may also stem from fraud, malice or sabotage on the part of employees, third parties or otherforeign nations, including attempts by outside parties to fraudulently induce our employees or could result from aging equipmentcustomers to disclose or grant access to our data or our customers’ data, potentially including information subject to stringent domestic and foreign data protection laws governing personally identifiable information, protected health information or other accidental technological failure.similar types of sensitive data. These threats may also arise from failure or breaches of systems owned, operated or controlled by other unaffiliated operators to the extent we rely on such other operationssystems to deliver services to our customers. Each of these risks could further intensify to the extent we maintain information in digital form stored on servers connected to the Internet.
Similar to other large telecommunications companies, we are a constant target of cyber-attacks of varying degrees. Although some of these attacks have resulted in security breaches, to datethus far, none of these breaches have resulted in a material adverse effect on our operating results or financial condition. You should be aware, however, that the risk of breaches is likely to increase due to several factors, including the increasing sophistication of cyber-attacks our greater use of open and software-defined networks, our increased operation of offshore systems, and our increased profile due to the growth of our organization and our customer base. You should be further aware that defenses against cyber-attacks currently available to U.S. companies are unlikely to prevent intrusions by a highly-determined, highly-sophisticated hacker. Consequently, you should assume that we will be unable to implement security barriers or other preventative measures that repel all future cyber-attacks. Any such future security breaches or disruptions could materially adversely affect our business, results of operations or financial condition, especially in light of the growing frequency, scope and well-documented sophistication of cyber-attacks and intrusions.
Although CenturyLink maintains insurance coverage that may, subject to policy terms and conditions (including self-insured deductibles, coverage restrictions and monetary coverage caps), cover certain aspects of our cyber risks, such insurance coverage may be unavailable or insufficient to cover our losses.
Additional risks to our network, infrastructure and related systems include:include, among others:
power losses or physical damage, whether caused by fire, adverse weather conditions, terrorism, sabotage, vandalism or otherwise;
capacity or system configuration limitations, including those resulting from changes in our customer's usage patterns, the introduction of new technologies or products, or incompatibilities between our newer and older systems;
theft or failure of our equipment;
software or hardware obsolescence, defects or malfunctions;
power losses or power surges;
physical damage, whether caused by fire, flood, adverse weather conditions, terrorism, sabotage, vandalism or otherwise;
deficiencies in our processes or controls;
our inability to hire and retain personnel with the requisite skills to adequately maintain or improve our systems;
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programming, processing and other human error; and
inadequate building maintenance by third-party landlords or other service failures of our third-party vendors and other disruptions that are beyond our control.vendors.
Due to these factors, we experience from time to time in the ordinary course of our business shortwe experience disruptions in our service, and could experience more significant disruptions in the future.future, especially if network traffic continues to increase and we continue to assume greater responsibility for managing our customers' critical systems and networks.
Disruptions, security breaches and other significant failures of the above-described networks and systems could:
disrupt the proper functioning of these networks and systems, which could in turn disrupt (i) our operationsoperational, billing or other administrative functions or (ii) the operations of certain of our customers who rely upon us to provide services critical to their operations;
require significant management attention or financial resources to remedy the damages that result or to change our systems, including expenses to repair systems, add new personnel or develop additional protective systems;
result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive, classified or otherwise valuable information of ours, our customers or our customers' end users, including trade secrets, which others could use for competitive, disruptive, destructive or otherwise harmful purposes and outcomes;
require us to notify customers, regulatory agencies or the public of data breaches;
require us to provide credits for future service under certain service level commitments we have provided contractually to our customers or to offer expensive incentives to retain customers;
subject us to claims for damages, fines, penalties, termination or other remedies under our customer contracts or service standards set by state regulatory commissions,regulators, which in certain cases could exceed our insurance coverage; or
result in a loss of business, damage our reputation among our customers and the public generally, subject us to additional regulatory scrutiny or expose us to prolonged litigation.litigation; or
We could experience difficulties in expanding and updating our technical infrastructure.
Our abilityrequire significant management attention or financial resources to expand and updateremedy the resulting damages or to change our systems, and information technology infrastructure in responseincluding expenses to our growth and changing business needs is important to our ability to maintain andrepair systems, add new personnel or develop attractive product and service offerings. As discussed further under “Business—Network Architecture” in Item 1 of Part I of this Annual Report, we are currently undertaking several complex, costly and time-consuming projects to simplify and modernize our network, which combines our legacy network and CenturyLink's networks. Unanticipated delays in the completion of these projects may lead to increased project costs or operational inefficiencies. In addition, there may be issues related to our expanded or updated infrastructure that are not identified by our testing processes, and which may only become evident after we have started to fully utilize the redesignedadditional protective systems. Our failure to modernize and upgrade our technology infrastructure could have adverse consequences, including the delayed implementation of new service offerings, decreased competitiveness of existing service offerings, network instabilities, increased operating or acquisition integration costs, service or billing interruptions, and the diversion of development resources.
Any or all of the foregoing developments could have a negative impact on our business, results of operations, financial condition and cash flows.
Negative publicity may adversely impact us.
Our ability to attract and retain customers depends in part upon external perceptions of our products, services, management integrity and financial performance. Customer complaints, governmental investigations, outages, or other service failures of networks operated by us could cause substantial adverse publicity affecting us. Similar events impacting other operators could indirectly harm us by causing substantial adverse publicity affecting our industry in general. In either case, press coverage, social media messaging or other public statements that insinuate improper actions by us or other operators, regardless of their factual accuracy or truthfulness, may result in negative publicity, litigation, governmental investigations or additional regulations. Addressing negative publicity and any resulting litigation or investigations may distract management, increase costs and divert resources. Negative publicity may have an adverse impact on our reputation and the morale of our employees. We could suffer similar adverse effects if shareholders, financial analysts or other financial professionals issue public statements that cast us or our industry in a negative light. Any of these developments could adversely affect our business, results of operations, financial condition, cash flows, prospects and the value of our securities.
Market prices for many of our services have decreased in the past, and any similar price decreases in the future will adversely affect our revenue and margins.
Over the past several years, a range of competitive and technological factors, including robust network construction and intense competition, have lowered market prices for many of our products and services. If these market conditions persist, we failmay need to continue to reduce prices to retain customers and revenue. If future price reductions are necessary, our operating results will suffer unless we are able to offset these reductions by reducing our operating expenses or increasing our sales volumes.
Our future growth potential will depend in part on the continued development and expansion of the Internet.
Our future growth potential will depend in part upon the continued development and expansion of the Internet as a communication medium and marketplace for the distribution of data, video and other products by businesses, consumers and governments. The use of the Internet for these purposes may not grow and expand at the rate anticipated by us or others, or may be restricted by factors outside of our control, including (i) actions by other carriers or governmental authorities that restrict us from delivering traffic over other parties' networks, (ii) changes in regulations, (iii) technological stagnation, (iv) increased concerns regarding cyber threats or (v) changes in consumers' preferences or data usage.
Our failure to hire and retain qualified executives, managers and employees,personnel could harm our operating results could be harmed.business.
Our future success depends on our ability to identify, hire, train and retain executives, managers and employees with technological, engineering, software, product development, operational, provisioning, marketing, sales, customer service, administrative, managerial and managerialother key skills. There is a shortage of qualified personnel in several of these fields nationallyparticularly in certain growth markets, such as the areas adjoining our Denver and in our headquarters city of Monroe, Louisiana, in particular.Seattle offices. We compete with several other companies for this limited pool of potential employees. As our industry increasingly becomes more competitive, it could become especially difficult to attract and retain top personnel with skills in high demand. Our workforce reduction and integration initiatives over the past couple of years have further increased the challenges of attracting and retaining talented individuals. In addition, subject to limited exceptions, none of our executives or domestic employees have long-term employment agreements. For all these reasons, there is no assurance that our efforts to recruit and retain qualified personnel will be successful.
Increases in broadband usage may cause network capacity limitations, resulting in service disruptions, reduced capacity or slower transmission speeds for our customers.
Video streaming services, gaming and peer-to-peer file sharing applications use significantly more bandwidth than other Internet activity such as web browsing and email. As use of these newer services continues to grow, our high-speed Internetbroadband customers will likely use much more bandwidth than in the past. If this occurs, we could be required to make significant capital expenditures to increase network capacity in order to avoid service disruptions, service degradation or slower transmission speeds for our customers. Alternatively, we could choose to implement network management practices to reduce the network capacity available to bandwidth-intensive activities during certain times in market areas experiencing congestion, which could negatively affect our ability to retain and attract customers in affected markets. While we believe demand for these services may drive high-speed Internet customers to pay for faster broadband speeds, competitiveCompetitive or regulatory constraints may preclude us from recovering the costs of the necessary network investments. Thisinvestments designed to address these issues, which could result in an adverseadversely impact to our operating margins, results of operations, financial condition and cash flows.
We have been accused of infringing the intellectual property rights of others and will likely face similar accusations in the future, which could subject us to costly and time-consuming litigation or require us to seek third-party licenses.
From time to time,
Like other communications companies, we receivehave increasingly in recent years received a number of notices from third parties or arehave been named in lawsuits filed by third parties claiming we have infringed or are infringing upon their intellectual property rights. We are currently responding to several of these notices and claims. Like other communications companies, we have received an increasing number of these notices and claims in the past several years, and expect this industry-wide trend will continue. Responding to these claims may require us to expend significant time and money defending our use of the applicable technology, and divert management’s time and resources away from other business. In certain instances, we may be required to enter into licensing agreements requiring royalty payments or, inpayments. In the case of litigation, we could be required to pay damages.significant monetary damages or cease using the applicable technology. If we are required to take one or more of these actions, our profit margins may decline.decline or our operations could be materially impaired. In addition, in responding to these claims, we may be required to stop selling or redesign one or more of our products or services, which could significantly and adversely affect our business, results of operations, financial condition and cash flows.
Similarly, from time to time, we may need to obtain the right to use certain patents or other intellectual property from third parties to be able to offer new products and services. If we cannot license or otherwise obtain rights to use any required technology from a third party on reasonable terms, our ability to offer new products and services may be prohibited, restricted, made more costly or delayed.
We may not be successful in protecting and enforcing our intellectual property rights.
We rely on various patents, copyrights, trade names, trademarks, service marks, trade secrets and other similar intellectual property rights, as well as confidentiality agreements and procedures, to establish and protect our proprietary rights. The steps we have taken, however, may not prevent unauthorized use or the reverse engineering of our technology. Others may independently develop technologies that are substantially equivalent, superior to, or otherwise competitive to the technologies we employ in our services or that infringe on our intellectual property. We may be unable to prevent competitors from acquiring proprietary rights that are similar to or infringe upon our proprietary rights, or to prevent our current or former employees from using or disclosing to others our proprietary information. Enforcement of our intellectual property rights may depend on initiating legal actions against parties who infringe or misappropriate our proprietary information, but these actions may not be successful, even when our rights have been infringed. If we are unsuccessful in protecting or enforcing our intellectual property rights, our business, competitive position, results of operations and financial condition could be adversely affected.
Our operations, financial performance and liquidity are materially reliant on various third parties.
Reliance on other communications providers. providers. To offer voice or datacertain services in certain of our markets, we must either purchase services or lease network capacity from, or interconnect our network with the infrastructure of, other communications carriers or cloud companies who typically compete against us in those markets. Our reliance on these leasesupply or interconnection arrangements limitsexposes us to multiple risks. Typically, these arrangements limit our control over the quality of our services and exposesexpose us to the risk that our ability to market our services could be adversely impacted by changes in the plans or properties of the carriers upon which we are reliant. In addition, we are exposed to the risk that the other carriers may be unwilling or unable to continue or renew these arrangements in the future on terms favorable to us, or at all. This risk is heightened when the other carrier is a competitor of ours andwho may benefit from terminating the agreement.agreement or imposing price increases, or a carrier who suffers financial distress or bankruptcy. If we lose these arrangements and cannot timely replace them, our ability to provide services to our customers and conduct our business could be materially adversely affected. Moreover, many of our arrangements with other carriers are regulated by domestic or foreign agencies, which subject us to the additional risk that changes in regulation could increase our costs or otherwise adversely affect our ability to provide services. Finally, even when another carrier agrees or is obligated to provide services to us to permit us to obtain new customers, it is frequently expensive, difficult and time-consuming to switch the new customers to our network, especially if the other carrier fails to provide timely and efficient cooperation.
Conversely, certain of our operations carry a significant amount of voice or data traffic for other communications providers. Their reliance on our services exposes us to the risk that they may transfer all or a portion of this traffic from our network to existing or newly-built networks, built, owned or leased by them, thereby reducing our revenues. For additional information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Business Trends" included in Item 7 of Part II of this Annual Report.revenue.
We also rely on reseller and sales agency arrangements with our affiliates and other communications companies to provide some of the services that we offer to our customers, including video services and wireless products and services. As a reseller or sales agent, we do not control the availability, retail price, design, function, quality, reliability, customer service, marketing or branding of these products and services, nor do we directly control all of the marketing and promotion of these products and services. Similar to the risks described above regarding our reliance upon other carriers, we could be adversely affected if these communication companies fail to maintain competitive products or services, or fail to continue to make them available to us on attractive terms, or at all.
Our operations and financial performance could be adversely affected if our relationships with any of these other communications companies are disrupted or terminated for any other reason, including if such other companies:
become bankrupt or experience substantial financial difficulties;
suffer work stoppages or other labor strife;
challenge our right to receive payments or services under applicable regulations or the terms of our existing contractcontractual arrangements; or
are otherwise unable or unwilling to make payments or provide services to us.
Reliance on other key suppliers and vendors. vendors. We depend on a limited number of suppliers and vendors for equipment and services relating to our network infrastructure. Our local exchange carrier networks consist of central officeinfrastructure, including fiber optic cable, software, optronics, transmission electronics, digital switches and remote sites, all with advanced digital switches.related components. If any of these suppliers experience interruptions or other problems delivering or servicing these network components on a timely basis, our operations could suffer significantly. To the extent that proprietary technology of a supplier is an integral component of our network, we may have limited flexibility to purchase key network components from alternative suppliers and may be adversely affected if third parties assert patent infringement claims against our suppliers or us. We also rely on a limited number of (i) software vendors to support our business management systems, (ii) content suppliers to provide programming to our video operations, and (iii) contractors to assist us in connection with our network construction and maintenance activities. In the event it becomes necessary to seek alternative suppliers and vendors, we may be unable to obtain satisfactory replacement supplies, services, utilities or utilitiesprogramming on economically attractive terms, on a timely basis, or at all, which could increase costs or cause disruptions in our services.
Reliance on utility providers and landlords. Our energy costs can fluctuate significantly or increase for a variety of reasons, including changes in legislation and regulation. Several pending proposals designed to reduce greenhouse emissions could substantially increase our energy costs, which we may not be able to pass on to our customers.
We lease many of our office facilities. Although the majority of these leases provide us with the opportunity to renew the lease, many of these renewal options provide that rent for the renewal period will be equal to the fair market rental rate at the time of renewal. Any resulting increases in our rent costs could have a negative impact on our financial results.
Reliance on governmental payments. We receive a material amount of revenue or government subsidies under various government programs, which are further described under the heading "Risk Factors—Risks Relating to Legal and Regulatory Matters." We also provide products or services to various federal, state and local agencies. GovernmentalOur failure to comply with complex governmental regulations and laws applicable to these programs, or the terms of our governmental contracts, could result in us being suspended or disbarred from future governmental programs or contracts for a significant period of time. Moreover, certain governmental agencies frequently reserve the right to terminate their contracts for convenience or to suspend or debar companies from receiving future subsidies or contracts under certain circumstances.if funding is unavailable. If our governmental contracts are terminated for any reason, or if we are suspended or debarred from governmental programs or contracts, our results of operations and financial condition could be materially adversely affected.
Violating our government contracts could have other serious consequences.
We provide services to various governmental agencies with responsibility for national security or law enforcement. These governmental contracts impose significant requirements on us relating to network security, information storage and other matters, and in certain instances impose on us additional heightened responsibilities, including requirements related to the composition of CenturyLink's Board of Directors. While we expect to continue to comply fully with all of our obligations under these contracts, we cannot assure you of this. The consequences of violating these contracts could be severe, potentially including the revocation of our FCC licenses in the U.S. (in addition to being suspended or debarred from government contracting, as noted above.)
If we fail to extend or renegotiate our collective bargaining agreements with our labor unions as they expire from time to time, or if our unionized employees were to engage in a strike or other work stoppage, our business and operating results could be materially harmed.
As of December 31, 2015,2018, approximately 50%44% of our employees were members of various bargaining units represented by the Communications Workers of America or the International Brotherhood of Electrical Workers. From time to time, our labor agreements with unions expire. Although we typically are able to negotiate new bargaining agreements, we cannot predict the outcome of our future negotiations of these agreements. We may be unable to reach new agreements, and union employees may engage in strikes, work slowdowns or other labor actions, which could materially disrupt our ability to provide services and result in increased cost to us. In addition, new labor agreements may impose significant new costs on us, which could impair our financial condition or results of operations in the future. To the extent they contain benefit provisions, these agreements may also limit our flexibility to change benefits in response to industry or competitive changes. In particular, post-employmentretirement benefits provided under these agreements could cause us to incur costs not faced by many of our competitors, which could ultimately hinder our competitive position.
Portions of our property, plant and equipment are located on property owned by third parties.
We rely on rights-of-way, colocation agreements, franchises and other authorizations granted by governmental bodies, railway companies, utilities, carriers and other third parties to locate our cable, conduit and other network equipment on or under their respective properties. A significant number of these authorizations are scheduled to lapse over the next five to ten years, unless we are able to extend or renew them. Our operations could be adversely affected if any of these authorizations terminate or lapse, or if the landowner requests price increases. Moreover, our ability to expand our network could depend in part on obtaining additional authorizations, the receipt of which is not assured.
Over the past few years, certain utilities, cooperatives and municipalities in certain of the states in which we operate have requested significant rate increases for attaching our plant to their facilities. To the extent that these entities are successful in increasing the amount we pay for these attachments, our future operating costs will increase.
In addition, we rely on rights-of-way, colocation agreements
We currently are, and in the past have been, subject to lawsuits challenging our use of rights-of-way. Similar suits are possible in the future. Plaintiffs in these suits typically seek to have them certified as class action suits. These suits are typically complex, lengthy and costly to defend, and expose us to each of the other authorizations granted by governmental bodies and other third parties to locate our cable, conduit and other network equipment on or under their respective properties. Our operations could be adversely affected if any of these authorizations terminate or lapse, or if the landowner requests price increases.general litigation risks described elsewhere herein.
Our business customers may seek to shift risk to us.
We furnish to and receive from our business customers indemnities relating to damages caused or sustained by us in connection with certain of our operations. Our customers’ changing views on risk allocation could cause us to accept greater risk to win new business or could result in us losing business if we are not prepared to take such risks. To the extent that we accept such additional risk, and seek to insure against it, our insurance premiums could rise.
We may not be able to dispose of assets or asset groups on terms that are attractive to us, or at all.
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In the past, we have disposed of assets or asset groups for a variety of reasons, and we may consider disposing of other assets or asset groups from time to time in the future. We may not be able to divest any such assets on terms that are attractive to us, or at all. In addition, if we agree to proceed with any such divestitures of assets, we may experience operational difficulties segregating them from our retained assets and operations, which could impact the execution or timing for such dispositions and could result in disruptions to our operations or claims for damages, among other things.
Unfavorable general economic conditions could negatively impact our operating results and financial condition.
Unfavorable general economic conditions, including unstable economic and credit markets, could negatively affect our business. Worldwide economic growth has been sluggish since 2008, and many experts believe that a confluence of global factors may result in a prolonged period of economic stagnation, slow growth or economic uncertainty. While it is difficult to predict the ultimate impact of these general economic conditions, they could adversely affect demand for some of our products and services and could cause customers to shift to lower priced products and services or to delay or forego purchases of our products and services. These conditions impact, in particular, our ability to sell discretionary products or services to business customers that are under pressure to reduce costs or to governmental customers that have suffered substantial budget cuts in recent years.operating under budgetary constraints. Any one or more of these circumstances could continue to depress our revenues.revenue. Also, our customers may encounter financial hardships or may not be able to obtain adequate access to credit, which could negatively impact their ability to make timely payments to us. In addition, as discussed further below, unstable economic and credit markets may preclude us from refinancing maturing debt at terms that are as favorable as those from which we previously benefited, at terms that are acceptable to us, or at all. For these reasons, among others, if currentweak economic conditions persist or decline,could adversely affect our operating results, financial condition, and liquidity could be adversely affected.liquidity.
For additional information about our business and operations, see "Business" in Item 1 of Part Ithis report.
Risks Relating to CenturyLink’s Recently-Completed Acquisition of this Annual Report.Level 3
We cannot assure you that our ultimate parent company, CenturyLink, will timely realize the anticipated benefits of the Level 3 business combination.
Our ultimate parent company, CenturyLink, expects to attain substantial benefits from its November 1, 2017 business combination with Level 3, including enhanced scale, cost savings and the receipt of Level 3’s net operating loss carryforwards. We cannot assure you that CenturyLink will be able to attain the anticipated benefits thereof.
The Level 3 acquisition poses various risks to CenturyLink and us.
CenturyLink incurred substantial expenses in connection with completing the acquisition of Level 3 on November 1, 2017, and CenturyLink expects to continue to incur substantial expenses in connection with integrating its operations with Level 3’s operations. For a variety of reasons, the integration process may not be successful. Moreover, in connection with the acquisition, CenturyLink incurred and assumed a substantial amount of indebtedness. Under the agreements that govern such indebtedness, CenturyLink is bound by various covenants and other provisions that impose restrictions on its ability to operate, and our corporate parent has guaranteed CenturyLink's debt and has secured such guaranty with a first priority interest in substantially all of its assets.
CenturyLink’s acquisition of Level 3 raises other risks.
CenturyLink’s acquisition of Level 3 and its ownership of Level 3 raise additional risks not described above. For additional information, see CenturyLink’s (i) definitive joint proxy statement/prospectus filed with the SEC on February 13, 2017 and (ii) Level 3's most recently filed annual report on Form 10-K, as updated by its subsequent quarterly reports on Form 10-Q.
Risks Relating to Legal and Regulatory Matters
We operate in a highly regulated industry and are therefore exposed to restrictions on our operations and a variety of claimsrisks relating to such regulation.
General. WeOur domestic operations are subject to significant regulationregulated by among others, (i) the Federal Communications Commission (“FCC”), which regulates interstate communications, (ii)FCC, various state utility commissions which regulate intrastate communications, and (iii) various foreign governments and international bodies, which regulate our international operations. occasionally by local agencies.
Generally, we must obtain and maintain certificates of authority oroperating licenses from these bodies in most territories where we offer regulated services. We cannot assure you that we will be successful in obtaining or retaining all licenses necessary to carry out our business plan, and, evenplan. Even if we are, the prescribed service standards and conditions imposed on us in connection with obtaining or acquiring control ofunder these licenses may impose on us substantialincrease our costs and limitations.limit our operational flexibility. We also operate in some areas of the world without licenses, as permitted through relationships with locally-licensed partners.
We are also subject to numerous requirements and interpretations under various international, federal, state and local laws, rules and regulations, which are often quite detailed and occasionally in conflict with each other. Accordingly, we cannot ensure that we arewill always be considered to be in compliance with all these requirements at any single point in time. time (as discussed further elsewhere herein). Our inability or failure to comply with the telecommunications and other laws of one or more countries in which we operate could prevent us from commencing or continuing to provide service therein.
The agencies responsible for the enforcement of these laws, rules and regulations may initiate inquiries or actions based on customer complaints or on their own initiative. Even if we are ultimately found to have complied with applicable regulations, such actions or inquiries could create adverse publicity that negatively impacts our business.
Regulation of the telecommunications industry continues to change, and the regulatory environment varies substantially from jurisdiction to jurisdiction. A substantial portion of our local voice services revenue remains subject to FCC and state utility commission pricing regulation, which periodically exposes us to pricing or earnings disputes and could expose us to unanticipated price declines. Interexchange carriers have filed complaints in various forums requesting reductions in our access rates. In addition, several long distance providers are disputingfrom time to time carriers or refusingother third parties refuse to pay amounts owed to us for carrying Voice over Internet Protocol ("VoIP") traffic, or traffic they claim to be VoIP traffic. Similarly, some carriers are refusing to pay access charges for certain calls between mobileof our services, or challenge our rights to receive certain service payments. Our future revenue, costs, and wireline devices routed through an interexchange carrier. There cancapital investment could be no assuranceadversely affected by material changes to or decisions regarding the applicability of government requirements, and we cannot assure you that future regulatory, judicial or legislative activities will not have a material adverse effect on our operations, oroperations.
Changes in the composition and leadership of the FCC, state commissions and other agencies that regulators or third parties will not raise material issues with regardregulate our business could have significant impacts on our revenue, expenses, competitive position and prospects. Changes in the composition and leadership of these agencies are often difficult to our compliance or noncompliance with applicable regulations.predict, and make future planning more difficult.
Risks associated with recent changes in regulation. Historically,Changes in regulation can have a material impact on our business, revenue or financial performance has beenperformance. Changes over the past couple of decades in federal regulations have substantially impacted by various aspects of federal regulation,our operations, including our receipt in the past of significant universal service payments designed to promote rural telephony. In October 2011, the FCC adopted the Connect America and Intercarrier Compensation Reform order ("the 2011 order") intended to comprehensively reform the existing regulatory regime to focus support on networks capable of providing new technologies, including VoIP and other high-speed Internet services, and re-direct federalrecent orders or laws overhauling intercarrier compensation, revamping universal service funding, and increasing our responsibilities to foster nationwide voiceassist various governmental agencies and high-speed Internet infrastructure. This initial ruling provides for a multi-year transition as intercarrier compensation charges are reduced, federal universal service funding is explicitly targeted to broadband deployment, and subscriber line charges paid by end-user customers are gradually increased.safeguard customer data. These changes, have, among other things, fundamentally altered the manner in which federal subsidies are calculated and disbursed to us (including terminating substantially all of the old universal service payments paid to us under predecessor support programs), and have substantially increased the pace of reductions in the amount of switched access revenues we receive from our wholesale customers. We expectcoupled with our participation in the FCC's CAF Phase 2new FCC support program willprograms, have significantly impactimpacted various aspects of our operations, financial results and capital expenditures, including the amount of revenue we collect from our wholesale customers and from federal support programs. We expect these impacts will continue in the coming years.future. For more information, see "Regulation""Business—Regulation" in Item 1 of Part Ithis report, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of Part II of this Annual Report.report.
Several judicial challenges to the 2011 order are pending and additional future challenges are possible, any of which could alter or delay the FCC's proposed changes. In addition, based on the outcome
Many of the FCC proceedings, various state commissions may consider changes to their rates and support programs. Moreover, FCC proceedings relating to implementation of the order remain pending. For these and other reasons, we cannot predict the ultimate impact of these proceedings at this time.
In addition, during the last few years Congress or the FCC has initiated various other changes, including various broadband and internet regulation initiatives including "network neutrality" regulations (as discussed further below) and actions that will restrict our ability to discontinue or reduce certain services, even if unprofitable. The FCC is also, among other things, investigating the special access tariffs of several carriers, including us, and considering changes in the regulation of special access services. Any of these recent or pending initiatives could adversely affect our operations or financial results. Moreover, many of the FCC'sFCC’s regulations adopted in recent years remain subject to judicial review and additional rulemakings, thus increasing the difficulty of determining the ultimate impact of these changes on us and our competitors.
Certain states have recently taken steps
Federal and state agencies that coulddispense universal service or other support program payments can, and from time to time do, reduce the amount of their universal service supportthose payments to incumbent local exchange companies. If these trends continue, we would suffer a reduction in our revenues from state support programs.us and other carriers.
Risks of higher costs. Regulations continue to create significant operating and capital costs for us. ChallengesRegulatory challenges to our tariffs by regulators or third partiesbusiness practices or delays in obtaining certifications and regulatory approvals could cause us to incur substantial legal and administrative expenses, and, if successful, such challenges could adversely affect the rates that we are able to charge our customers.operations.
Our business also may be impacted by legislation and regulation imposing new or greater obligations related to regulations or laws related to regulating broadband services, storing records, fighting crime, bolstering homeland security or cyber security, increasing disaster recovery requirements, minimizing environmental impacts, enhancing privacy, restricting data collection, protecting intellectual property rights of third parties, or addressing other issues that impact our business, including (i) the Communications Assistance for Law Enforcement Act, which requires communications carriers to ensure that their equipment, facilities, and services are able to facilitate authorized electronic surveillance, and (ii) the USA Freedom Act, which requires communication companies to store records of communications of their customers.business. We expect our compliance costs to increase if future laws or regulations continue to increase our obligations. In addition, increased regulation of our suppliers could increase our costs.
Increased risks of fines. We have recently paid certain regulatory fines associated with network or service outages, particularly with respect to outages impacting the availability of emergency - 911 services. WeOver the past couple of years, we believe that regulators are now pursuinghave assessed substantially higher fines than in the past for these types of incidents, and expectit is possible this trend towill continue.
Risks of reduced flexibility. As a diversified full service incumbent local exchange carrier in mostmany of our keyoperating markets, we have traditionally been subject to significant regulation that does not apply to many of our competitors. This regulation in many instances restricts our ability to change rates, to compete and to respond rapidly to changing industry conditions. In particular, cable television companies in recent years have been able to exploit differences in regulatory oversight, which we believe has helped them to develop service offerings competitive with ours. As our business becomes increasingly competitive, regulatory disparities between us andcould continue to favor our competitors could impede our ability to compete.competitors.
Risks posed by other regulations.regulations. All of our operations are also subject to a variety of environmental, safety, health and other governmental regulations. In connection with our current operations, we use, handle and dispose of various hazardous and non-hazardous substances and wastes. In prior decades, certain of our current or former subsidiaries owned or operated, or are alleged to have owned or operated, former manufacturing businesses, for which we have been notified of certain potential environmental liabilities. We monitor our compliance with federal, stateapplicable regulations or commitments governing these current and local regulations governing the management, discharge and disposal of hazardous and environmentally sensitive materials.past activities. Although we believe that we are in compliance with these regulations in all material respects, our management, discharge oruse, handling and disposal of hazardous and environmentally sensitive materials, mightor the prior operations of our predecessors, could expose us to claims or actions that could potentially have a material adverse effect on our business, financial condition and operating results.
Our participation in the FCC's Connect America Fund ("CAF") Phase 2 support program poses certain risks.
Our participation in the FCC's CAF Phase 2II support programsprogram subjects us to certain financial risks. If we fail to attain certain specified infrastructure buildout requirements, the FCC could withhold future CAF support payments until these shortcomings are rectified. In addition, if we are not in compliance with FCC measures atby the end of the six-year CAF Phase 2 period, we will have 12 months to attain full compliance. If we are not in full compliance after the additional 12 months,II program, we would incur a penalty equal to 1.89 times the average amount of support per location received in the state over the six-year term, plus a potential penalty of 10% of the total CAF Phase 2 support over the six-year term for the state. The amount of these penalties could be material.substantial penalties. To comply with the FCC's buildout requirements, we believe we will need to dedicate a substantial portion of our future capital expenditure budget to the construction of new infrastructure. The CAF-related expenditures could reduce the amount of funds we are willing or able to allocate to other initiatives or projects. In addition, if the FCC decides not to renew or extend the current CAF II program, or initiate a replacement program, these support payments could end at the termination of the program.
"Open Internet" regulation
Regulation of the Internet could limit our ability to operate our high-speed databroadband business profitably and to manage our broadband facilities efficiently.
In order
Since the creation of the Internet, there has been extensive debate about whether and how to continue to provide quality high-speed dataregulate Internet service at attractive prices, we believe we need the continued flexibility to respond to changingproviders. A significant number of congressional leaders, state elected officials and various consumer demands, to manage bandwidth usage efficiently for the benefitinterest groups have long advocated in favor of all customers and to invest in our networks.extensive regulation. In February 2015, the FCC adopted new regulations that regulate Internetregulated broadband services as a public utility under Title II of the Communications Act. Several companies, including us, have initiated judicial actions challengingAct of 1934. Although the newFCC voted to repeal most of those regulations which remain pending. The ultimate impactin December 2017, opponents of the newrescission have judicially challenged this action and continue to advocate in favor of re-instituting extensive regulation. Depending on the scope of any such future federal or state regulations, will depend on several factors, including the resultsimposition of pending litigation and the manner in which the new regulations are implemented and enforced. Although it is premature for us to determine the ultimate impactheightened regulation of the new regulations upon our Internet operations we currently anticipate that the proposed rules could hamper our ability to operate our data networks efficiently, restrict our ability to implement network management practices necessary to ensure quality service, increase the cost of network extensions and upgrades, and otherwise negatively impact our current operations. It is possible that Congress,As the FCCsignificance of the Internet expands, state, local or foreign governments may adopt new laws or regulations, or apply existing laws and regulations to the courts could take further action inInternet. We cannot predict the future to modify regulations affecting the provisionoutcome of broadband Internet services.any such changes.
We may be liable for the material that content providers or distributors distribute over our network.
Although we believe our liability for third party information stored on or transmitted through our networks is limited, the
The liability of private network operators for information stored or transmitted on their networks is impacted both by changing technology and evolving legal principles that remain unsettled in many jurisdictions. AsWhile we disclaim any liability for third-party content in our service contracts, as a private network provider we could be exposed to legal claims relating to third party content stored or transmitted on our networks. Such claims could involve, among others, allegations of defamation, invasion of privacy, copyright infringement, or aiding and abetting restricted activities such as online gambling or pornography. Although we believe our liability for these types of claims is limited, suits against other carriers have been successful and we cannot assure you that our defenses will prevail. If we decide to implement additional measures to reduce our exposure to these risks, or if we are required to defend ourselves against these kinds of claims, our operations and financial results could be negatively affected.
Any adverse outcome in any material litigation of CenturyLink or QCIIits affiliates could have a material adverse impact on our financial condition and operating results, on the trading price of our debt securities and on our ability to access the capital markets.
There are several material proceedings pending against CenturyLink and its affiliates, as described in Note 14—17—Commitments and Contingencies to ourthe consolidated financial statements included in Item 8 of Part II of CenturyLink's Annual Reportannual report on Form 10-K for the year ended December 31, 2015. Depending2018, and certain material proceedings pending against us, as described in Note 15—Commitments, Contingencies and Other Items in Item 8 of this report. Results of these legal proceedings cannot be predicted with certainty. Irrespective of its merits, litigation may be both lengthy and disruptive to our operations and could cause significant expenditure and diversion of management attention. We review our litigation accrual liabilities on their outcome,a quarterly basis, but in accordance with applicable accounting guidelines only establish accrual liabilities when losses are deemed probable and reasonably estimable and only revise previously-established accrual liabilities when warranted by changes in circumstances, in each case based on then-available information. As such, as of any given date we could have exposure to losses under proceedings as to which no liability has been accrued or as to which the accrued liability is inadequate. For each of these reasons, any of these mattersthe proceedings described in Note 15—Commitments, Contingencies and Other Items in Item 8 of this report, as well as current litigation not described therein or future litigation, could have a material adverse effect on our business, reputation, financial position, or operating results.results, the trading price of our securities and our ability to access the capital markets. We can give you no assurances as to the ultimate impact of these matters on our operating results or financial condition.us.
We are subject to franchising requirements that could impede our expansion opportunities or result in potential fines or penalties.
We may be required to obtain from municipal authorities operating franchises to install or expand certain facilities related to our fiber transport operations, and certain of our competitive local exchange carrier operations, and our facilities-based videoother services. Some of these franchises may require us to pay franchise fees. Many of our franchise agreements have compliance obligationsfees, and failuremay require us to comply may result inpay fines or penalties.penalties if we violate or exit our related contractual commitments. In some cases, certain franchise requirements could delay us in expanding our operations or increase the costs of providing these services.
We are exposed to risks arising out of recent legislation affecting U.S. public companies.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act, and related regulations implemented thereunder, are increasinghave increased our legal and financial compliance costs and makingmade some activities more time consuming. Any failure to successfully or timely complete annual assessments of our internal controls required by Section 404 of the Sarbanes-Oxley Act could subject us to sanctions or investigation by regulatory authorities. Any such action could adversely affect our financial results or our reputation with investors, lenders or others.
Changes in any of the above-described laws or regulations may limit our ability to plan, and could subject us to further costs or constraints.
From time to time, the laws or regulations governing us or our customers, or the government's policy of enforcing those laws or regulations, have changed frequently and materially. The variability of these laws could hamper the ability of us and our customers to plan for the future or establish long-term strategies. Moreover, future changes in these laws or regulations could further increase our operating or compliance costs, or further restrict our operational flexibility, any of which could have a material adverse effect on our results of operations, competitive position, financial condition or prospects.
For a more thorough discussion of the regulatory issues that may affect our business, see "Regulation""Business—Regulation" in Item 1 of Part I of this Annual Report.report.
Risks Affecting Our Liquidity and Capital Resources
CenturyLink's and our high debt levels expose us to a broad range of risks.
Our ultimate parent, CenturyLink, and we continue to carry significant debt. As of December 31, 2015,2018, the aggregate principal amount of our consolidated long-term debt, excluding unamortized premiums and discounts, unamortized debt issuance costs and capital lease and other obligations, was approximately $7.239$6.056 billion (excluding our note payable-affiliatepayable - affiliate of $855 million)$1.008 billion), which was included in CenturyLink's consolidated long-term debt of approximately $20.225$35.6 billion as of that date. As of the date of this Annual Report, approximately $3.085report, $4.3 billion aggregate principal amount of CenturyLink's consolidated debt securities (excluding capital lease and other obligations), which(which includes approximately $735$950 million of our debt securities,securities) is scheduled to mature prior to December 31, 2018.2021. While we currently believe that CenturyLink and we will have the financial resources to meet or refinance our obligations when they come due, we cannot fully anticipate our future performance or financial condition, the future condition of CenturyLink, the credit markets or the economy generally. We may incur unexpected expenses or liabilities, and we may have limited access to financing.
Our significant levels of debt can adversely affect us in several other respects, including:
limiting our ability to obtain additional financing for working capital, capital expenditures, acquisitions, refinancings or other general corporate purposes, particularly if, as discussed further in the risk factor disclosure below, (i) the ratings assigned to our debt securities by nationally recognized credit rating organizations are revised downward or (ii) we seek capital during periods of turbulent or unsettled market conditions;
requiring us to dedicate a substantial portion of our cash flow from operations to the payment of interest and principal on our debt, thereby reducing the funds available to us for other purposes, including acquisitions, capital expenditures, strategic initiatives, dividends;dividends, marketing and other potential growth initiatives;
hindering our ability to capitalize on business opportunities and to plan for or react to changing market, industry, competitive or economic conditions;
increasing our future borrowing costs;
increasing the risk that third parties will be unwilling or unable to engage in limiting or precluding us from entering into commercial, hedging or other financial or commercial arrangements with us;vendors, customers or other business partners;
making us more vulnerable to economic or industry downturns, including interest rate increases;
placing us at a competitive disadvantage compared to less leveraged competitors;
increasing the risk that we will need to sell debt securities or assets, possibly on unfavorable terms, or take other unfavorable actions to meet payment obligations; or
increasing the risk that we may not meet the financial covenants contained in our debt agreements or timely make all required debt payments.payments, either of which could result in the acceleration of some or all of our outstanding indebtedness.
The effects of each of these factors could be intensified if we increase our borrowings.
A portion of our indebtedness bears interest at variable rates. If market interest rates increase, our variable-rate debt will have higher debt service requirements, which could adversely impact our cash flows and financial condition.
25
Any failure to make required debt payments could, among other things, adversely affect our ability to conduct operations or raise capital.
Subject to certain limitations, our current debt agreements and the debt agreements of CenturyLink and its other subsidiaries allow us to incur additional debt, which could exacerbate the other risks described in this report.
Subject to certain limitations and restrictions, the current terms of our debt instruments and the debt instruments of CenturyLink and its other subsidiaries permit us or them to incur additional indebtedness. Incremental borrowings that impose additional financial risks could exacerbate the other risks described in this report.
We expect to periodically require financing, to meet our debt obligations as they come due. Due to the unstable economy and credit markets, we may notcannot assure you that we will be able to obtain such financing on terms that are acceptable to us, or at all.
We have a significant amount of indebtedness that we intend to refinance maturingover the next several years, principally through the issuance of debt. We may also need to obtain additional financing under a variety of other circumstances, including if:
revenue and cash provided by operations decline;
economic conditions weaken, competitive pressures increase or regulatory requirements change;
we undertake substantial capital projects or other initiatives that increase our cash requirements;
our payments of federal income taxes increase faster or in greater amounts than currently anticipated; or
we become subject to significant judgments or settlements, including in connection with one or more of the matters discussed in Note 15—Commitments, Contingencies and Other Items to our consolidated financial statements included elsewhere in this report.
Our ability to arrange additional financing will depend on, among other factors, our financial position, performance, and credit ratings, as well as prevailing market conditions and other factors beyond our control. Global financial markets continue to be unpredictable and volatile. Prevailing market conditions could be adversely affected by (i) general market conditions, such as disruptions in domestic or overseas sovereign or corporate debt atmarkets, geo-political instabilities, contractions or limited growth in the economy or other similar adverse economic developments in the U.S. or abroad and (ii) specific conditions in the communications industry. Volatility in the global markets could limit our access to the credit markets, leading to higher borrowing costs or, in some cases, the inability to obtain financing on terms that are as favorable as those from which we previously benefited, aton terms that are acceptable to us, or at all. See below “Risk Factors—Risks Affecting
In addition, our Liquidity and Capital Resources—CenturyLink and we planability to accessborrow funds in the public debt markets, and we cannot assure you that these marketsfuture will remain free of disruptions.”
We may also need to obtain additional financing or capital, or to investigate other methods to generate cash (such as further cost reductions ordepend in part on the sale of assets) under a variety of other circumstances, including if revenues and cash provided by operations decline, if economic conditions weaken, if competitive pressures increase, if regulatory requirements change, if CenturyLink is required to contribute a material amount of cash to its pension plans, if CenturyLink is required to begin to pay other post-retirement benefits significantly earlier than is anticipated, or if CenturyLink becomes subject to significant judgments or settlements in one or moresatisfaction of the matterscovenants in our debt instruments, which are discussed in Note 15—Commitments and Contingencies to our consolidated financial statements in Item 8 of Part II of this Annual Report and Note 14—Commitments and Contingencies to the consolidated financial statements in Item 8 of Part II of CenturyLink's Annual Report on Form 10-K for the year ended December 31, 2014. further below.
For all the reasons mentioned above, we can give no assurance that additional financing for any of these purposes will be available on terms that are acceptable to us, or at all.
If we are unable to make required debt payments or refinance our debt, we would likely have to consider other options, such as selling assets, issuing additional debt securities, cutting or delaying costs or otherwise reducing our cash requirements, or negotiating with our lenders to restructure our applicable debt. Our current and future debt instruments may restrict, or market or business conditions may limit, our ability to do some of these things on favorable terms, or at all. For these and other reasons, we cannot assure you that we could implement these steps in a sufficient or timely manner, or at all. Moreover, any steps taken to strengthen our liquidity, such as cutting costs, could adversely impact our business or operations.
Our various debt agreements include restrictions and covenants that could (i) limit our ability to conduct operations or borrow additional funds (ii) restrict out ability to engage in inter-company transactions and (iii) lead to the acceleration of our repayment obligations in certain instances.
We have borrowed substantial amounts of money from financial institutions or investors. Under the associated debt and financing arrangements, we are subject to various covenants and restrictions.
Our debt arrangements contain several significant limitations restricting our ability to, among other things:
issue guarantees;
pay dividends or other distributions to shareholders;
make loans, advances or other investments;
create liens on assets;
sell assets;
enter into transactions with affiliates; and
engage in mergers or consolidations.
These above-listed restrictive covenants could materially adversely affect our ability to operate or expand our business, to pursue strategic transactions, or to otherwise pursue our plans and strategies.
Our term loan requires us to maintain certain financial ratios. Our ability to comply with these provisions may be affected by events beyond our control.
Increasingly in recent years, certain debt investors have sought to financially benefit themselves by identifying and seeking to enforce defaults under borrowers' debt agreements. This development could increase the risk of claims made under our debt agreements.
Our failure to comply with the covenants and restrictions could result in an event of default, which, if not cured or waived, could accelerate our debt repayment obligations. Certain of CenturyLink's and our debt instruments have cross payment defaultcross-default or cross accelerationcross-acceleration provisions. When present, these provisions could have a wider impact on liquidity than might otherwise arise from a default or acceleration of a single debt instrument. Any such event could adversely affect our ability to conduct business or access the capital markets and could adversely impact our credit ratings. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources" in CenturyLink's quarterly and annual reports filed with the SEC for additional information about CenturyLink's indebtedness.
In addition, our ability to borrow funds in the future will depend in part on the satisfaction of the covenants in our term loan and other debt instruments. If we are unable to satisfy the covenants contained in those instruments, or are unable to generate cash sufficient to make required debt payments, the parties to whom we are indebted could accelerate the maturity of some or all of our outstanding indebtedness.
As noted above, ifelsewhere herein, we are unable to make required debt paymentscannot assure you that we could adequately address any such defaults, cross-defaults or refinance our debt, we would likely have to consider other options, such as selling assets, issuing additional securities, cutting costs or otherwise reducing our cash requirements, or negotiating with our lenders to restructure our applicable debt. The indentures governing our senior notes may restrict, or market or business conditions may limit, our ability to do some of these things on favorable terms or at all.
Our debt agreements and the debt agreements of CenturyLink and its other subsidiaries allow us to incur significantly more debt, which could exacerbate the other risks described in this Annual Report.
The termsacceleration of our debt instrumentspayment obligations in a sufficient or timely manner, or at all. For additional information, see Risk Factor—“We expect to periodically require financing, and the debt instruments of CenturyLinkwe cannot assure you that we will be able to obtain such financing on terms that are acceptable to us, or at all" and its other subsidiaries permit us to incur additional indebtedness. Additional debt may be necessary for many reasons, including those discussed above. Incremental borrowings that impose additional financial risks could exacerbate the other risks described in this Annual Report.Note 4—Long-Term Debt and Revolving Promissory Note.
Any downgrade in ourthe credit ratings of us could limit our ability to obtain future financing, increase our borrowing costs and adversely affect the market price of our existing debt securities or otherwise impair our business, financial condition and results of operations.
As noted above in Item 7 of Part II of this Annual Report, our
Nationally recognized credit rating organizations have issued credit ratings relating to the long-term debt is currently rated BBB- by Standardof CenturyLink, Inc. and Poor's Ratings Services; Baa3 by Moody's Investors Services; and BBB- by Fitch Ratings, all three of which are the lowest investment-grade ratings issued by eachus. Most of these agencies. Credit rating agencies continually review their ratings for the companies that they follow, including us. Credit rating agencies also evaluate the industriesare below “investment grade”, which results in which we operatehigher borrowing costs than "investment grade" debt as a whole and may change their credit rating for us based on their overall viewwell as reduced marketability of such industries.our debt securities. There can be no assurance that any rating assigned to any of these debt securities will remain in effect for any given period of time or that any such ratings will not be lowered, suspended or withdrawn entirely by a rating agency if, in that rating agency'sagency’s judgment, circumstances so warrant.
A downgrade of ourany of these credit ratings could could:
adversely affect the market price of some or all of our outstanding debt securities, securities;
limit our access to the capital markets or otherwise adversely affect the availability of other new financing on favorable terms, if at all, all;
trigger the application of restrictive covenants in certain of our debt agreements or result in new or more restrictive covenants in agreements governing the terms of any future indebtedness that we may incur, incur;
increase our cost of borrowing,borrowing; and
impair our business, financial condition and results of operations.
For more information on the credit ratings of our secured and unsecured debt, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Debt and Other Financing Arrangements” in Item 7 of this report.
26
Our business requires us to incur substantial capital and operating expenses, which reducereduces our available free cash flow.
Our business is capital intensive, and we anticipate that our capital requirements willintensive. We expect to continue to berequire significant cash to maintain and expand our network to remain competitive.
We expect to invest additional capital to expand and enhance our network infrastructure as a result of several factors, including:
changes in customers' service requirements, including increased demands by customers to transmit larger amounts of data at faster speeds;
technological advances of our competitors;
the coming years. As noted elsewhere in this Annual Report, we committed to spend substantial sums to constructdevelopment and launch of new services; or
our regulatory commitments, including infrastructure in connection withconstruction requirements arising out of our participation in the FCC's CAF Phase 2 program. In addition, asII program, which are discussed further under "Risk Factors—Risks Affecting Our Business—Increasesherein.
We may be unable to expand or adapt our network infrastructure to respond to these developments in broadband usage may cause network capacity limitations, resulting in service disruptions, reduced capacitya timely manner, at a commercially reasonable cost or slower transmission speeds for our customers," increased bandwidth consumption by consumers and businesses has placed increased demands on the transmission capacity of our networks. If we determine that our networks must be expanded to handle these increased demands or as needed to meet CAF Phase 2 infrastructure requirements, we may determine that substantial additional capital expenditures are required, even though there is no assurance that the returnterms producing satisfactory returns on our investment will be satisfactory. In addition, many of our growth and modernization initiatives are capital intensive and changes in technology could require further spending. investment.
In addition to investing in expanded networks, new products or new technologies, we must from time to time invest capital to (i) replace some of our aging equipment that supports many of our legacy services that are experiencing revenue declines or (ii) convert older systems to simplify and modernize our network. While we believe that our currently planned level of capital expenditures will meet both our maintenance and core growth requirements, this may not be the case if demands on our network continue to accelerate or other circumstances underlying our expectations change. Increased spending could, among other things, adversely affect our operating margins, cash flows, results of operations and financial position.
Similarly, we continue to anticipate incurring substantial operating expenses to support our incumbent services and growth initiatives. Although we have successfully reduced certain of our operating expenses over the past few years, weWe may be unable to furthersufficiently manage or reduce these costs, even if revenuesrevenue in some of our lines of business are decreasing. If so, our operating margins will be adversely impacted. For additional information, see Note 4—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements included in Item 8 of Part II of this report.
Adverse changes in the value of assets or obligations associated with CenturyLink's qualified pension plan could negatively impact CenturyLink's liquidity, which may in turn affect our business and liquidity.
A substantial amount of our employees participate in a qualified pension plan sponsored by CenturyLink (formerly QCII). On December 31, 2014,that has assumed the QCIIobligations under Qwest Communications International Inc.'s ("QCII") predecessor pension plan and a pension plan of an affiliate were merged into the CenturyLink Retirement Plan, which was renamed the CenturyLink Combined Pension Plan.plan.
The funded status of CenturyLink's qualified pension plan is the difference between the value of the plan's assets and the benefit obligation. The accounting unfunded status of CenturyLink's qualified pension plan was $2.215$1.6 billion as of December 31, 2015.2018. Adverse changes in interest rates or market conditions, among other assumptions and factors, could cause a significant increase in CenturyLink's benefit obligation or a significant decrease in the value of the plan's assets. These adverse changes could require CenturyLink to contribute a material amount of cash to its pension plan or could accelerate the timing of required cash payments. The amounts contributed by us through CenturyLink are not segregated or restricted and may be used to provide benefits to employees of CenturyLink's other subsidiaries. Based on current laws and circumstances, CenturyLink does not expect it will be required to make a contribution to its plan in 2016.2019. The actual amount of required contributions to its plan in 20172019 and beyond will depend on earnings on plan investments, prevailing interest and discount rates, demographic experience, changes in plan benefits and changes in funding laws and regulations. Any future material cash contributions could have a negative impact on CenturyLink's liquidity by reducing their cash flows, which in turn could affect our liquidity.
CenturyLink and we plan to access the public debt markets, and we cannot assure you that these markets will remain free of disruptions.
CenturyLink and we have a significant amount of indebtedness that we both intend to refinance over the next several years, principally we expect through the issuance of debt securities of CenturyLink, us or both. CenturyLink's and our ability to arrange additional financing will depend on, among other factors, the financial position, performance, and credit ratings of CenturyLink and QC, as well as prevailing market conditions and other factors beyond its or our control. Prevailing market conditions could be adversely affected by the ongoing disruptions in domestic or overseas sovereign or corporate debt markets, contractions or limited growth in the economy or other similar adverse economic developments in the U.S. or abroad. Instability in the global financial markets has from time to time resulted in periodic volatility in the capital markets. This volatility could limit CenturyLink's and our access to the credit markets, leading to higher borrowing costs or, in some cases, the inability to obtain financing on terms that are acceptable to it, or at all. Any such failure to obtain additional financing could jeopardize its and our ability to repay, refinance or reduce its or our debt obligations.
Other Risks
We regularly transfer our cash tofor centralized management by CenturyLink, which exposes us to certain risks.
Under our cash management arrangement with CenturyLink, we regularly transfer the majority of our cash tobalance for centralized management by CenturyLink, which we recognize on our consolidated balance sheets as advances to affiliates. Although CenturyLinkthese advances are periodically repays these advancesrepaid to fund our cash requirements throughout the year, at any given point in time CenturyLinkwe may owe usbe owed a substantial sum under this arrangement. Accordingly, developments that adversely impact CenturyLink could adversely impact our ability to collect these advances.
Terrorist attacks and other acts of violence or war may adversely affect the financial markets and our business.
Future terrorist attacks or armed conflicts may directly affect our physical facilities or those of our customers. These events could cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and world financial markets and economy. Any of these occurrences could materially adversely affect our business.
If conditions or assumptions differ from the judgments, assumptions or estimates used in our critical accounting policies or forward-looking statements, our consolidated financial statements and related disclosures could be materially affected.
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Ournotes including the judgments, assumptions and estimates applied pursuant to our critical accounting policies, which are described in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates" in Item 7 of Part II of this Annual Report, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that are considered "critical" because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. As a result, ifreport. If future events or assumptions differ significantly from the judgments, assumptions and estimates applied in connection with preparing our historical financial statements, our future financial statements could be materially impacted.
While frequently presented with numeric specificity, the forward-looking statements that we disseminate from time to time is based on numerous variables and assumptions (including, but not limited to, those related to industry performance and competition and general business, economic, market and financial conditions and additional matters specific to our business, as applicable) that are inherently subjective and speculative and are largely beyond our control. As a result, actual results may differ materially from our guidance or other forward-looking statements. Similarly, for a variety of reasons, we may change our intentions, strategies or plans at any time, which could materially alter our actual results from those previously anticipated. For additional information, see “Special Note Regarding Forward-Looking Statements” in Part I of this report.
We identified a material weakness in our critical accounting policies, these eventsinternal control over financial reporting as of December 31, 2018, and the occurrence of this or assumptionsany other future material weakness or significant deficiencies could have a material impactadverse effect on us.
Our management recently concluded that, as described under the heading Item 9A. Controls and Procedures, we had a material weakness as of December 31, 2018 and therefore as of that date did not maintain effective internal control over financial reporting, which is a requirement of the Securities Exchange Act of 1934. As a result of this assessment, management concluded a material weakness existed related to the ineffective design and operation of certain process level internal controls over the existence and accuracy of revenue transactions. The deficiency arose because we did not conduct an effective risk assessment to identify risks of material misstatement related to the existence and accuracy of revenue transactions.
We plan to execute our consolidatedplans to remediate the material weaknesses identified above as soon as feasible. However, the remedial measures we take may not be adequate to avoid other control deficiencies in the future. There can be no assurance that any system of internal control over financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management. As a result, it is possible that CenturyLink’s or our current or future financial statements may not comply with generally accepted accounting principles, will contain a material misstatement or will not be available on a timely basis, any of which could cause investors to lose confidence in CenturyLink or us and related disclosures.lead to, among other things, unanticipated legal, accounting and other expenses, delays in filing required financial disclosures, enforcement actions by regulatory authorities, fines, penalties, the delisting of CenturyLink’s or our securities and liabilities arising from litigation.
Lapses in disclosure controls and procedures or internal control over financial reporting could materially and adversely affect our operations, profitability or reputation.
There can be no assurance that our disclosure controls and procedures will be effective in the future or that we will not experience a material weakness or significant deficiency in internal control over financial reporting. Any such lapses or deficiencies may materially and adversely affect our business, operating results or financial condition, restrict our ability to access the capital markets, require us to expend significant resources to correct the lapses or deficiencies, expose us to regulatory or legal proceedings, including litigation brought by private individuals, subject us to fines, penalties or judgments, harm our reputation, or otherwise cause a decline in investor confidence.
We have a significant amount of goodwill, customer relationships and other intangible assets on our consolidated balance sheet.
If our goodwill or other intangible assets become impaired, we may be required to record a significant charge to earnings and reduce our stockholders' equity.
As of December 31, 2015,2018, approximately 58%51% of our total consolidated assets reflected on the consolidated balance sheet included in this Annual Reportreport consisted of goodwill, customer relationships and other intangible assets. Under U.S. generally accepted accounting principles, most of these intangible assets must be tested for impairment on an annual basis or more frequently whenever events or circumstances indicate that their carrying value may not be recoverable. From time to time, including in the fourth quarter of 2018, our affiliates or predecessors have recorded large non-cash charges to earnings in connection with required reductions of the value of their intangible assets. If our intangible assets are determined to be impaired in the future, we may similarly be required to record additional significant, non-cash charges to earnings during the period in which the impairment is determined to have occurred. Any such charges could, in turn, have a material adverse effect on our results of operation, financial condition or ability to comply with financial covenants in our debt instruments.
The Tax audits orCuts and Jobs Act will have a substantial impact on us.
The Tax Cuts and Jobs Act (the "Act") enacted in December 2017 significantly changed U.S. tax law by reducing the U.S. corporate income tax rate and making certain changes to U.S. taxation of income earned by foreign subsidiaries, capital expenditures, interest expense and various other items. The net impact of this Act as applied to date, has been favorable to us. However, the Act is quite complex and the impacts could potentially change as additional regulatory guidance is received from the Internal Revenue Service. As a result, our views on the Act’s ultimate impact on us could change.
Changes in tax laws or tax audits could adversely affect us.
For periods after
Like all large businesses, CenturyLink is subject to multiple sets of complex and varying tax laws and rules. Legislators and regulators at various levels of government may from time to time change existing tax laws or regulations or enact new laws or regulations. In many cases, the April 1, 2011 closingapplication of CenturyLink's acquisition of QCII, weexisting, newly enacted or amended tax laws may be uncertain and subject to differing interpretations that could negatively impact our operating results or financial condition. We are included in the consolidated federal income tax return of CenturyLink. As such, we could be severally liable for tax examinations and adjustments attributable to other members of the QCII or CenturyLink affiliated groups, as applicable. Significant taxpayers (such as QCII for periods prior to the CenturyLink acquisition and CenturyLink for periods after the CenturyLink acquisition) arealso subject to frequent and regular audits by the Internal Revenue Service as well asa broad range of federal, state and local tax authorities. These audits could subject us to tax liabilities if adverse positions are taken by these tax authorities.
Tax sharing agreements have been executed between QCII and previous affiliates, and QCII believes the liabilities, if any, arising from adjustments to previously filed returns would be borne by the affiliated group member determined to have a deficiency under the terms and conditions of such agreements and applicable tax law. We have not generally provided reserves for liabilities attributable to former affiliated companies or for claims they have asserted or may assert against us.
We believe that we have adequately provided for tax contingencies. However, CenturyLink's or QCII's tax audits and examinations may result in tax liabilities that differ materially from those that we have recognized in our consolidated financial statements. Because the ultimate outcomes of all of these matters are uncertain, we can give no assurance as to whether an adverse result from one or more of them will have a material effect on our financial results.
Legislators and regulators at all levels of government may from time to time change existing tax laws or regulations or enact new laws or regulations that could negatively impact our operating results or financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our property, plant and equipment consists principally of telephone lines, cable, central office equipment, land and buildings related to our operations. Our gross property, plant and equipment consisted of the following components: | | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2018 | | 2017 |
| Land | 3 | % | | 3 | % | 2 | % | | 3 | % |
Fiber, conduit and other outside plant(1) | 44 | % | | 42 | % | 48 | % | | 46 | % |
Central office and other network electronics(2) | 30 | % | | 30 | % | 29 | % | | 30 | % |
Support assets(3) | 21 | % | | 22 | % | 18 | % | | 18 | % |
Construction in progress(4) | 2 | % | | 3 | % | 3 | % | | 3 | % |
| Gross property, plant and equipment | 100 | % | | 100 | % | 100 | % | | 100 | % |
| |
(1) | Fiber, conduit and other outside plant consists of fiber and metallic cable, conduit, poles and other supporting structures. |
| |
(2) | Central office and other network electronics consists of circuit and packet switches, routers, transmission electronics and electronics providing service to customers. |
| |
(3) | Support assets consist of buildings, computers and other administrative and support equipment. |
| |
(4) | Construction in progress includes inventory held for construction and property of the aforementioned categories that has not been placed in service as it is still under construction. |
We own substantially all of our telecommunications equipment required for our business. However, we lease from third parties certain facilities, plant, equipment and software under various capital and operating lease arrangements when the leasing arrangements are more favorable to us than purchasing the assets. We also own and lease administrative offices in major metropolitan locations primarily within our local service area. Substantially all of our network electronics equipment is located in buildings or on land that we own or lease within our local service area. Outside of our local service area, our assets are generally located on 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 these agreements, due to their termination or expiration or in connection with legal challenges to our rights under such agreements.
Our net property, plant and equipment was approximately $7.4$8.1 billion and $7.2$7.9 billion at December 31, 20152018 and 2014,2017, respectively. For additional information, see Note 5—6—Property, Plant and Equipment to our consolidated financial statements in Item 8 of Part II of this Annual Report.report.
ITEM 3. LEGAL PROCEEDINGS
The
For information contained under subheading "Legal Matters"regarding legal proceedings in which we are involved, see Note 15—Commitments, Contingencies and ContingenciesOther Items to our consolidated financial statements included in Item 8 of Part II of this Annual Report is incorporated herein by reference.report.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
Unless the context requires otherwise, references in this report to "QC" refer to Qwest Corporation, references to "Qwest," "we," "us," "the Company" and "our" refer to Qwest Corporation and its consolidated subsidiaries, references to "QSC" refer to our direct parent company, Qwest Services Corporation and its consolidated subsidiaries, references to "QCII" refer to QSC's direct parent company and our indirect parent company, Qwest Communications International Inc., and its consolidated subsidiaries and references to "CenturyLink" refer to QCII's direct parent company and our ultimate parent company, CenturyLink, Inc. and its consolidated subsidiaries including Level 3 Parent, LLC, referred to as "Level 3".
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Not Applicable.
ITEM 6. SELECTED FINANCIAL DATA
The following tables of selected consolidated financial data should be read in conjunction with, and are qualified by reference
Omitted pursuant to our consolidated financial statements and notes thereto in Item 8 of Part II and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of Part II of this Annual Report.General Instruction I(2).
The comparability of the following selected financial data below is significantly impacted by CenturyLink's April 1, 2011 indirect acquisition of us and the resulting revaluation of our assets and liabilities. As a result of the acquisition, the following tables present certain selected financial data for two periods: predecessor and successor, which relate to the periods preceding the acquisition and the period succeeding the acquisition, respectively. The tables of selected financial data shown below are derived from our audited consolidated financial statements. These historical results are not necessarily indicative of results that you can expect for any future period.
Selected financial information from our consolidated statements of operations is as follows: |
| | | | | | | | | | | | | | | | | | | |
| | Successor(1) | | | Predecessor |
| | Year
Ended
December 31,
2015 (2) | | Year
Ended
December 31,
2014 | | Year
Ended
December 31,
2013 | | Year
Ended
December 31,
2012 | | Nine Months
Ended
December 31,
2011 | | | Three Months
Ended
March 31,
2011 |
| | (Dollars in millions) |
| Operating revenues | $ | 8,964 |
| | 8,838 |
| | 8,753 |
| | 8,848 |
| | 6,635 |
| | | 2,268 |
|
| Operating expenses | 6,704 |
| | 6,726 |
| | 6,675 |
| | 6,943 |
| | 5,436 |
| | | 1,630 |
|
| Operating income | $ | 2,260 |
| | 2,112 |
| | 2,078 |
| | 1,905 |
| | 1,199 |
| | | 638 |
|
| Income before income tax expense | $ | 1,733 |
| | 1,609 |
| | 1,566 |
| | 1,391 |
| | 892 |
| | | 490 |
|
| Net income | $ | 1,074 |
| | 970 |
| | 964 |
| | 849 |
| | 543 |
| | | 299 |
|
| |
(1)
| See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations" in Item 7 of Part II of this Annual Report for a discussion of unusual items affecting the results for the successor years ended December 31, 2015, 2014 and 2013. |
| |
(2) | During 2015, we recognized an incremental $95 million of revenue associated with the Federal Communications Commission ("FCC") Connect America Fund Phase 2 support program. For additional information, see Note 1—Basis of Presentation and Summary of Significant Accounting Policies to our consolidated financial statements in Item 8 of Part II of this Annual Report. |
Selected financial information from our consolidated balance sheets is as follows: |
| | | | | | | | | | | | | | | |
| | December 31, 2015 | | December 31, 2014 | | December 31, 2013 | | December 31, 2012 | | December 31, 2011 |
| | (Dollars in millions) |
| Net property, plant and equipment | $ | 7,374 |
| | 7,201 |
| | 7,208 |
| | 7,231 |
| | 7,506 |
|
| Goodwill | 9,354 |
| | 9,354 |
| | 9,354 |
| | 9,354 |
| | 9,354 |
|
Total assets(1) | 21,470 |
| | 22,185 |
| | 22,965 |
| | 23,710 |
| | 24,588 |
|
Total long-term debt(1)(2) | 7,239 |
| | 7,269 |
| | 7,464 |
| | 7,553 |
| | 8,281 |
|
| Total stockholder's equity | 8,907 |
| | 9,183 |
| | 9,613 |
| | 9,974 |
| | 9,865 |
|
| |
(1)
| We adopted both ASU 2015-03 "Simplifying the Presentation of Debt Issuance Costs" and ASU 2015-17 "Balance Sheet Classification of Deferred Taxes" by retrospectively applying the requirements of the ASUs to our previously issued consolidated financial statements. The adoption of both ASU 2015-03 and ASU 2015-17 reduced total assets by $272 million, $253 million, $237 million and $223 million in each year for the four years ended December 31, 2014, respectively, and ASU 2015-03 reduced total long-term debt by $110 million, $94 million, $72 million and $44 million in each year for the four years ended December 31, 2014, respectively. See further discussion in Note 1—Basis of Presentation and Summary of Significant Accounting Policies to our consolidated financial statements in Item 8 of Part II of this Annual Report. |
| |
(2)
| Total long-term debt is the sum of current maturities of long-term debt and long-term debt (excluding the note payable-affiliate balance) on our consolidated balance sheets. For additional information on our total long-term debt, see Note 3—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements in Item 8 of Part II of this Annual Report. For total contractual obligations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Future Contractual Obligations" in Item 7 of Part II of this Annual Report. |
Selected financial information from our consolidated statements of cash flows is as follows: |
| | | | | | | | | | | | | | | | | | | |
| | Successor | | | Predecessor |
| | Year
Ended
December 31,
2015 | | Year
Ended
December 31,
2014 | | Year
Ended
December 31,
2013 | | Year
Ended
December 31,
2012 | | Nine Months
Ended
December 31,
2011 | | | Three Months
Ended
March 31,
2011 |
| | (Dollars in millions) |
| Other data: | | | | | | | | | | | | |
| Net cash provided by operating activities | $ | 2,591 |
| | 2,801 |
| | 2,713 |
| | 2,774 |
| | 2,201 |
| | | 869 |
|
| Net cash used in investing activities | (1,220 | ) | | (1,251 | ) | | (1,381 | ) | | (1,528 | ) | | (1,191 | ) | | | (335 | ) |
| Net cash used in financing activities | (1,374 | ) | | (1,558 | ) | | (1,326 | ) | | (1,241 | ) | | (1,208 | ) | | | (525 | ) |
| Payments for property, plant and equipment and capitalized software | (1,247 | ) | | (1,165 | ) | | (1,264 | ) | | (1,266 | ) | | (1,036 | ) | | | (341 | ) |
The following table presents certain of our selected operational metrics: |
| | | | | | |
| | As of December 31, |
| | 2015 | | 2014 | | 2013 |
| | (in thousands) |
| Operational metrics: | | | | | |
Total access lines(1) | 6,997 |
| | 7,334 | | 7,641 |
Total high-speed Internet subscribers(1) | 3,546 |
| | 3,528 | | 3,429 |
| |
(1)
| Access lines are lines reaching from the customers' premises to a connection with the public network and high-speed Internet subscribers are customers that purchase high-speed Internet connection service through their existing telephone lines, stand-alone telephone lines, or fiber-optic cables. Our methodology for counting our access lines and high-speed Internet subscribers includes only those lines that we use to provide services to external customers and excludes lines used solely by us and our affiliates. It also excludes unbundled loops and includes stand-alone high-speed Internet subscribers. We count lines when we install the service. |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
All references to "Notes" in this Item 7 of Part II refer to the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report.report. Certain statements in this Annual Reportreport constitute forward-looking statements. See "Special Note Regarding Forward-Looking Statements and Related Matters"Statements" in Item 1of Part I of this Annual Reportreport for factors relating to these statements and "Risk Factors" in Item 1A of Part I of this Annual Reportreport for a discussion of certain risk factors applicable to our business, financial condition, results of operations, liquidity or prospects.
Overview
We are an integrated communications company engaged primarily in providing an array of communications services to our residentialbusiness and businessresidential customers. Our communicationsspecific products and services include local voice, high-speed Internet, private line (including special access), network access, Ethernet, information technology, video, wirelessare detailed below under the heading "Operations - Products and other ancillary services. In certain local and regional markets, we also provide local access and fiber transport services to competitive local exchange carriers. We strive to maintain our customer relationships by, among other things, bundling our service offerings to provide our customers with a complete offeringServices" in Item 1 of integrated communications services.Part I of this report.
We generate the majority of our total consolidated operating revenues from services provided in the 14-state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington, and Wyoming. We refer to this region as our local service area.
Our ultimate parent company, CenturyLink, Inc. ("CenturyLink"), has cash management arrangements between certain of its subsidiaries that include lines of credit, affiliate obligations, capital contributions and dividends. As part of these cash management arrangements, affiliates provide lines of credit to certain other affiliates. Amounts outstanding under these lines of credit and intercompany obligations vary from time to time. Under these arrangements, the majority of our cash balance is advanced on a daily basis tofor centralized management by CenturyLink. From time to time we may declare and pay dividends to Qwest Services Corporation ("QSC"), our direct parent, using cash owed to us under these advances, which has the net effect of reducing the amount of these advances. We report the balance of these transfers on our consolidated balance sheet as advances to affiliates.
At December 31, 2018, we served 3.1 million broadband subscribers. Our methodology for counting broadband subscribers may not be comparable to those of other companies. We no longer report or discuss access lines as a key operating metric given the significant migration in our industry from legacy services to IP-enabled services.
For the reasons noted in Note 9—12—Products and Services RevenuesRevenue to our consolidated financial statements in Item 8 of Part II of this Annual Report,report, we believehave determined that we have one reportable segment.
We currently categorize our products, services and revenuesrevenue among the following threesix categories:
StrategicIP and data services, which include primarily high-speed Internet, private line (including special access),VPN data networks, Ethernet, Verizon WirelessIP and other ancillary services;
Legacy servicesTransport and infrastructure, which include broadband, private line (including business data services) and other ancillary services;
Voice and collaboration, which includes primarily local voice, Integrated Services Digital Network ("ISDN") (which use regular telephone lines to supportincluding wholesale voice, video and data applications), switched access and traditional wide area network ("WAN") services (which allow a local communications network to link to networks in remote locations); andother ancillary services;
AffiliatesIT and managed services, which include information technology services and managed services, which may be purchased in conjunction with our other servicesnetwork services;
Regulatory revenue,, which consist primarily of Universal Service Fund ("USF") and Connect America Fund ("CAF") support payments Universal Service Fund ("USF") support payments, USF surcharges and services we provide to our affiliates.other operating revenue. We receive federal support payments from both CAF Phase 1 and CAF Phase 2 programs, and support payments from both federal and state USF programs.programs and from the federal CAF II program. These support payments are government subsidies designed to reimburse us for various costs related to certain telecommunications services including the costs of deploying, maintaining and operating voice and high-speed Internetbroadband infrastructure in high-cost rural areas where we are not able to fully recover our costs from our customers. USF surcharges are the amounts customers; and
Affiliate services, we collect based on specific items we list on our customers' invoices to fund the Federal Communications Commission's ("FCC") universal service programs. We provide to our affiliates, telecommunication services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support services, network support and technical services.
At December 31, 2015,
From time to time, we operated approximately 7.0 million access lineschange the categorization of our products and served approximately 3.5 million high-speed Internet subscribers. Our methodology for counting access linesservices, and high-speed Internet subscribers, which is described furtherwe may make similar changes in the operational metrics table below under "Results of Operations", may not be comparable to those of other companies.future.
The following analysis is organized to provide the information we believe will be useful for understanding material trends affecting our business.
Business Trends
Our financial results were impacted by several significant trends, which are described below. We expect that these trends will continue to affect our results of operations, cash flows or financial position.
Strategic services. We continue to see shifts in the makeup of our total revenues as customers move to lower margin strategic services, such as high-speed Internet and video services, from higher margin legacy services. Revenues from our strategic services represented 38%, 39% and 38% of our total revenues for the years ended December 31, 2015, 2014 and 2013, respectively. During 2015, we experienced price compression due to competition, which negatively impacted the growth of our strategic revenues. We continue to focus on increasing subscribers of our high-speed Internet services, particularly among consumer and small business customers. We believe that continually increasing the scope and connection speeds of our high-speed Internet services is important to remaining competitive in our industry. As a result, we continue to invest in our broadband network, which allows for the delivery of higher speed broadband services to a greater number of customers. We compete in a maturing broadband market in which most customers already have broadband services and growth rates in new subscribers have slowed. Moreover, as described further in "Risk Factors" in Item 1A of Part I of this Annual Report, demand for our high-speed Internet services could be adversely affected by competitors continuing to provide services at higher broadband speeds than ours or expanding their advanced wireless data service offerings. Demand for our private line services (including special access) continues to decline due to customers' optimization of their networks, industry consolidation and technological migration to higher-speed services. Additionally, we face competition in Ethernet based services in the wholesale market from cable companies and fiber based CLEC providers;
Legacy services. Revenues from our legacy services represented 31%, 34% and 37% of our total revenues for the years ended December 31, 2015, 2014 and 2013, respectively. We expect these percentages to continue to decline. Our legacy services revenues have been, and we expect they will continue to be adversely affected by access line losses and price compression. Intense competition and product substitution continue to drive our access line losses. For example, many consumers are replacing traditional voice telecommunications service with substitute services, including (i) cable and wireless voice services and (ii) electronic mail, texting and social networking services. We expect that these factors will continue to negatively impact our business. As a result of the expected loss of revenue associated with access lines, we continue to offer our customers service bundling and other product promotions to help mitigate this trend, as described below;
Service bundling and product promotions. We offer our customers the ability to bundle multiple products and services. These customers can bundle local services with other services such as high-speed Internet, video and wireless. While we believe our bundled service offerings can help retain customers, they also tend to lower our profit margins;
Operating efficiencies. We continue to evaluate our operating structure and focus. This involves balancing our workforce in response to our workload requirements, productivity improvements and changes in industry, competitive, technological and regulatory conditions;
Pension and post-retirement benefits expenses. Our controlling parent company, CenturyLink, is required to recognize in its consolidated financial statements certain income and expenses relating to its pension and post-retirement health care and life insurance benefits plans. These income and expenses are calculated based on several assumptions, including among other things, discount rates, mortality rates and expected rates of return on plan assets that are generally reset at December 31 of each year. Changes in CenturyLink's assumptions can cause significant changes in the net periodic pension and post-retirement benefits income and expenses we recognize. CenturyLink allocates the service costs of these plans to us and certain of its other affiliates. The allocation of service costs to us is based upon our employees who are currently earning benefits under the plans; and
Disciplined capital expenditures. Our capital expenditures continue to be focused on our strategic services such as broadband and the deployment of "fiber to the tower", which is a type of telecommunications network consisting of fiber-optic cables that run from a wireless carrier's mobile telephone switching office to cellular towers to enable the delivery of higher bandwidth services supporting mobile technologies than would otherwise generally be available through a more traditional copper-based telecommunications network.
While these trends are important to understanding and evaluating our financial results, the other transactions, events, uncertainties and trends discussed in "Risk Factors" in Item 1A of Part I of this Annual Report may also materially impact our business operations and financial results.
Results of Operations
The following table summarizes the results of our consolidated operations for the years ended December 31, 2015, 20142018, 2017 and 2013:2016: | | | | Years Ended December 31, | Years Ended December 31, |
| | 2015(1) | | 2014 | | 2013 | 2018 | | 2017(1) | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| Operating revenues | $ | 8,964 |
| | 8,838 |
| | 8,753 |
| |
| Operating revenue | | $ | 8,493 |
| | 8,550 |
| | 8,910 |
|
| Operating expenses | 6,704 |
| | 6,726 |
| | 6,675 |
| 5,833 |
| | 6,237 |
| | 6,586 |
|
| Operating income | 2,260 |
| | 2,112 |
| | 2,078 |
| 2,660 |
| | 2,313 |
| | 2,324 |
|
| Other expense, net | 527 |
| | 503 |
| | 512 |
| 501 |
| | 522 |
| | 561 |
|
| Income tax expense | 659 |
| | 639 |
| | 602 |
| 494 |
| | 134 |
| | 678 |
|
| Net income | $ | 1,074 |
| | 970 |
| | 964 |
| $ | 1,665 |
| | 1,657 |
| | 1,085 |
|
| |
(1) | During 2015, we recognized an incremental $95 millionThe enactment of revenue associated with the Federal Communications Commission ("FCC") Connect America Fund Phase 2 support program. For additional information, see Note 1—BasisTax Cuts and Jobs Act in December 2017 resulted in a re-measurement of Presentationour deferred tax assets and Summaryliabilities at the new federal corporate tax rate of Significant Accounting Policies to our consolidated financial statements21%. The re-measurement resulted in Item 8a tax benefit of Part II of this Annual Report.$555 million. |
The following table summarizes our access lines, high-speed Internet subscribers and number of employees: |
| | | | | | | | |
| | As of December 31, |
| | 2015 | | 2014 | | 2013 |
| | (in thousands) |
| Operational metrics: | | | | | |
Total access lines(1) | 6,997 |
| | 7,334 |
| | 7,641 |
|
Total high-speed Internet subscribers(1) | 3,546 |
| | 3,528 |
| | 3,429 |
|
| Total employees | 22.0 |
| | 23.0 |
| | 22.8 |
|
| |
(1)
| Access lines are lines reaching from the customers' premises to a connection with the public network and high-speed Internet subscribers are customers that purchase high-speed Internet connection service through their existing telephone lines, stand-alone telephone lines, or fiber-optic cables. Our methodology for counting our access lines and high-speed Internet subscribers includes only those lines that we use to provide services to external customers and excludes lines used solely by us and our affiliates. It also excludes unbundled loops and includes stand-alone high-speed Internet subscribers. We count lines when we install the service. |
Operating RevenuesRevenue
The following tables summarize our consolidated operating revenuesrevenue recorded under our threesix revenue categories: |
| | | | | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2015 | | 2014 | | |
| | (Dollars in millions) | | |
| Strategic services | $ | 3,433 |
| | 3,429 |
| | 4 |
| | — | % |
| Legacy services | 2,777 |
| | 2,987 |
| | (210 | ) | | (7 | )% |
| Affiliates and other services | 2,754 |
| | 2,422 |
| | 332 |
| | 14 | % |
| Total operating revenues | $ | 8,964 |
| | 8,838 |
| | 126 |
| | 1 | % |
|
| | | | | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2014 | | 2013 | | |
| | (Dollars in millions) | | |
| Strategic services | $ | 3,429 |
| | 3,342 |
| | 87 |
| | 3 | % |
| Legacy services | 2,987 |
| | 3,208 |
| | (221 | ) | | (7 | )% |
| Affiliates and other services | 2,422 |
| | 2,203 |
| | 219 |
| | 10 | % |
| Total operating revenues | $ | 8,838 |
| | 8,753 |
| | 85 |
| | 1 | % |
Strategic Services |
| | | | | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2018 | | 2017 | | |
| | (Dollars in millions) | | |
| IP and Data Services | $ | 616 |
| | 634 |
| | (18 | ) | | (3 | )% |
| Transport and Infrastructure | 2,926 |
| | 3,006 |
| | (80 | ) |
| (3 | )% |
| Voice and Collaboration | 1,800 |
| | 1,980 |
| | (180 | ) |
| (9 | )% |
| IT and Managed Services | 6 |
| | — |
| | 6 |
|
| nm |
|
| Regulatory Services | 210 |
| | 211 |
| | (1 | ) | | — | % |
| Affiliate Services | 2,935 |
| | 2,719 |
| | 216 |
| | 8 | % |
| Total operating revenue | $ | 8,493 |
| | 8,550 |
| | (57 | ) | | (1 | )% |
nm - Percentages greater than 200% and comparisons between positive and negative values or to/from zero values are considered not meaningful.
Strategic services revenues increased
Total operating revenue decreased by $4$57 million, or less than 1%, for the year ended December 31, 20152018 as compared to the year ended December 31, 2014 and increased by $87 million, or 3%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013.2017. The increasechange in strategic services revenues for both periods was principally due to increases in the number of high-speed Internet subscribers, volume increases in our Ethernet services and from rate increases on various services. These increases were substantially offset by volume decreases in our private line services.
Legacy Services
Legacy services revenues decreased by $210 million, or 7%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014 and decreased by $221 million, or 7%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013. The decline in legacy services revenues for both periods was the result of lower local voice services revenues due to access line loss and reduced access services usage related to customer migration, competitive pressures and product substitution.
Affiliates and Other Services
Affiliates and other services revenues increased by $332 million, or 14%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014 and increased by $219 million, or 10%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013. The increase in affiliates and other services revenues for the year ended December 31, 2015operating revenue was primarily due to the additional revenue recorded under the FCC's CAF Phase 2 high-cost support programdeclines in voice and increases in volumecollaboration and in the rates we charge for our support services we provided to affiliates. During 2015, we recorded $95 million more revenue than we would have otherwise recorded during the same period under the interstate USF support program. Thetransport and infrastructure offset by an increase in affiliatesaffiliate services driven by new circuits. The decrease in voice and other services revenues for the year ended December 31, 2014collaboration was primarily due to increasesa continued decline in volumerevenue services from our local voice services. The reduction in transport and in the rates we charge for our supportinfrastructure revenue services we providedwas attributable to affiliates. For additional information about the CAF Phase 2 support program, see the discussion below in "Liquidityprivate line (including business data services) and Capital Resources—Connect America Fund."broadband.
Operating Expenses
The following tables summarize our consolidated operating expenses: | | | | Years Ended December 31, | | Increase / (Decrease) | | % Change | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2015 | | 2014 | | 2018 | | 2017 | |
| | (Dollars in millions) | | | (Dollars in millions) | | |
| Cost of services and products (exclusive of depreciation and amortization) | $ | 2,872 |
| | 2,879 |
| | (7 | ) | | — | % | $ | 2,767 |
| | 2,881 |
| | (114 | ) | | (4 | )% |
| Selling, general and administrative | 1,015 |
| | 1,086 |
| | (71 | ) | | (7 | )% | 799 |
| | 925 |
| | (126 | ) | | (14 | )% |
| Operating expenses-affiliates | 960 |
| | 756 |
| | 204 |
| | 27 | % | 831 |
| | 848 |
| | (17 | ) | | (2 | )% |
| Depreciation and amortization | 1,857 |
| | 2,005 |
| | (148 | ) | | (7 | )% | 1,436 |
| | 1,583 |
| | (147 | ) | | (9 | )% |
| Total operating expenses | $ | 6,704 |
| | 6,726 |
| | (22 | ) | | — | % | $ | 5,833 |
| | 6,237 |
| | (404 | ) | | (6 | )% |
|
| | | | | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2014 | | 2013 | | |
| | (Dollars in millions) | | |
| Cost of services and products (exclusive of depreciation and amortization) | $ | 2,879 |
| | 2,790 |
| | 89 |
| | 3 | % |
| Selling, general and administrative | 1,086 |
| | 1,062 |
| | 24 |
| | 2 | % |
| Operating expenses-affiliates | 756 |
| | 695 |
| | 61 |
| | 9 | % |
| Depreciation and amortization | 2,005 |
| | 2,128 |
| | (123 | ) | | (6 | )% |
| Total operating expenses | $ | 6,726 |
| | 6,675 |
| | 51 |
| | 1 | % |
These expense classifications may not be comparable to those of other companies.
Cost of Services and Products (exclusive of depreciation and amortization)
Cost of services and products (exclusive of depreciation and amortization) are expenses incurred in providing products and services to our customers. These expenses include: employee-related expenses directly attributable to operating and maintaining our network (such as salaries, wages, benefits and professional fees); facilities expenses (which include third-party telecommunications expenses we incur for using other carriers' networks to provide services to our customers); rents and utilities expenses; equipment sales expenses (such as modem expenses); payments tocosts incurred for universal service funds (which are federal and state funds that are established to promote the availability of telecommunications services to all consumers at reasonable and affordable rates, among other things, and to which we are often required to contribute); certain litigationlegal expenses associated with our operations; and other expenses directly related to our operations.
Cost of services and products (exclusive of depreciation and amortization) decreased by $7$114 million, or less than 1%4%, for the year ended December 31, 20152018 as compared to the year ended December 31, 2014 primarily2017. The decrease in our cost of services and products was due to decreasesa reduction in salaries and wages resulting from lowera decrease in headcount professional fees and contract labor. These decreases were substantially offset by an increase in allocated corporate costs from affiliates. Costs of services and products (exclusive of depreciation and amortization) increased by $89 million, or 3%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to increases in network expense and allocated corporate costs from affiliates.overtime accruals. The increasedecrease was partially offset by a decreaseincreases in employee-related expenses.USF rates and direct taxes driven by higher city franchise and state gross receipts.
Selling, General and Administrative
Selling, general and administrative expenses are expenses incurred in selling products and services to our customers, corporate overhead and other operating expenses. These expenses include: employee-related expenses (such as salaries, wages, internal commissions, benefits and professional fees) directly attributable to selling products or services and employee-related expenses for administrative functions; marketing and advertising;advertising expenses; property and other operating taxes and fees; external commissions; litigationlegal expenses associated with general matters; bad debt expense; and other selling, general and administrative expenses.
Selling, general and administrative expenses decreased by $71$126 million, or 7%14%, for the year ended December 31, 20152018 as compared to the year ended December 31, 20142017 primarily due to decreases in salaries and wages from lower headcount, marketing and advertising, insurance and fees, and an impairment charge related to an office building, which was sold in the fourth quarter of 2014. These decreases were partially offset by increases in professional fees and bad debt expense. Selling, general and administrative expenses increased by $24 million, or 2%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to an increase in employee-related expenses and from the above-noted impairment charge. These increases were partially offset by decreasesreductions in marketing and advertising expenses, and lowerdecreases in property and other operating taxes.taxes and reduced bad debt expenses.
In 2015, CenturyLink changed its allocation methodology related to pension and post-retirement costs. In 2015, we recorded $74 million of service costs allocated to us from CenturyLink's centrally managed pension and post-retirement benefit plans based upon our employees who are currently earning benefits under the plans. In 2014, we recorded combined net periodic benefit expense of $30 million for the qualified pension and post-retirement plans. In 2013, we recorded combined net periodic benefit income of $88 million. We expect to record service costs, allocated from CenturyLink, of approximately $60 million in 2016. Pension expense is allocated to cost of services and products (exclusive of depreciation and amortization) and to selling, general and administrative in our consolidated statements of operations. For additional information on CenturyLink's change in allocation methodology, see Note 1—Basis of Presentation and Summary of Significant Accounting Policies to our consolidated financial statements and for additional information on our participation in CenturyLink's pension and post-retirement benefit plans, see Note 7—Employee Benefits to our consolidated financial statements, both of which are in Item 8 of Part II of this Annual Report.
Non-recurring Operating Expenses Related to CenturyLink's Acquisition
We have incurred certain non-recurring operating expenses related to CenturyLink's indirect acquisition of us, which consist primarily of integration and severance expenses. The table below summarizes our acquisition-related expenses: |
| | | | | | | | | |
| | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 |
| | (Dollars in millions) |
| Acquisition-related expenses | $ | 4 |
| | 13 |
| | 24 |
|
The total amounts of these expenses are recognized in our cost of services and products and selling, general and administrative expenses in our consolidated statements of operations.
Operating Expenses-Affiliates
Since CenturyLink's acquisition of us, we have incurred affiliatesaffiliate expenses related to our use of telecommunication services, marketing and employee related support services provided by CenturyLink and its subsidiaries.
Operating expenses-affiliates increaseddecreased by $204$17 million, or 27%2%, for the year ended December 31, 20152018 as compared to the year ended December 31, 2014 and increased by $61 million, or 9%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013.2017. The increasedecrease in operating expenses-affiliates for both periods was primarily due to increasesthe decline in the rates we are charged for support services and higher levelslevel of services provided to us by our affiliates.
Depreciation and Amortization
The following tables provide detail of our depreciation and amortization expense: |
| | | | | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2015 | | 2014 | | |
| | (Dollars in millions) | | |
| Depreciation | $ | 986 |
| | 1,048 |
| | (62 | ) | | (6 | )% |
| Amortization | 871 |
| | 957 |
| | (86 | ) | | (9 | )% |
| Total depreciation and amortization | $ | 1,857 |
| | 2,005 |
| | (148 | ) | | (7 | )% |
| | | | Years Ended December 31, | | Increase / (Decrease) | | % Change | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2014 | | 2013 | | 2018 | | 2017 | |
| | (Dollars in millions) | | | (Dollars in millions) | | |
| Depreciation | $ | 1,048 |
| | 1,099 |
| | (51 | ) | | (5 | )% | $ | 855 |
| | 912 |
| | (57 | ) | | (6 | )% |
| Amortization | 957 |
| | 1,029 |
| | (72 | ) | | (7 | )% | 581 |
| | 671 |
| | (90 | ) | | (13 | )% |
| Total depreciation and amortization | $ | 2,005 |
| | 2,128 |
| | (123 | ) | | (6 | )% | $ | 1,436 |
| | 1,583 |
| | (147 | ) | | (9 | )% |
Annual depreciation expense is impacted by several factors, including changes in our depreciable cost basis, changes in our estimates of the remaining economic life of certain network assets and the addition of new plant. Depreciation expense decreased by $62$57 million, or 6%, for the year ended December 31, 20152018 as compared to the year ended December 31, 2014.2017. The depreciation expense related to our plant for the year ended December 31, 2015 was lower than the depreciation expense for the year ended December 31, 2014 due to full depreciation and retirement of certain plant placed in service prior to 2015. This2018 and 2017. The decrease was partially offset by an increase in depreciation expense attributable to new plant placed in service during the year ended December 31, 2015. Depreciationthese respective years.
Amortization expense decreased by $51$90 million, or 5%13%, for the year ended December 31, 20142018 as compared to the year ended December 31, 2013. The 2014 depreciation expense was lower than the respective prior period depreciation expense due to our plant aging and becoming fully depreciated or retired which was partially offset by new plant additions in 2014 and changes in the estimated lives of certain property, plant and equipment. During January 2014, we implemented changes in estimates that reduced the remaining economic lives of certain switch and circuit network equipment which resulted in increased 2014 annual depreciation expense.
Amortization expense decreased by $86 million, or 9%, for the year ended December 31, 2015 as compared to the year ended December 31, 2014 and amortization expense decreased by $72 million, or 7%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013.2017. The decrease in amortization expense was partially due to the use of accelerated amortization for both periodsa portion of our customer relationship assets. The effect of using an accelerated amortization method results in an incremental decline in expense each period as the intangible assets amortize. In addition, amortization of capitalized software was primarilylower due to software becoming fully amortized faster than new software was acquired or developed.
Other Consolidated Results
The following tables summarize our total other expense, net and income tax expense: |
| | | | | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2015 | | 2014 | | |
| | (Dollars in millions) | | |
| Interest expense | $ | (473 | ) | | (464 | ) | | 9 |
| | 2 | % |
| Interest expense-affiliates | (53 | ) | | (40 | ) | | 13 |
| | 33 | % |
| Other (expense) income, net | (1 | ) | | 1 |
| | (2 | ) | | nm |
|
| Total other expense, net | $ | (527 | ) | | (503 | ) | | 24 |
| | 5 | % |
| Income tax expense | $ | 659 |
| | 639 |
| | 20 |
| | 3 | % |
| | | | Years Ended December 31, | | Increase / (Decrease) | | % Change | Years Ended December 31, | | Increase / (Decrease) | | % Change |
| | 2014 | | 2013 | | 2018 | | 2017 | |
| | (Dollars in millions) | | | (Dollars in millions) | | |
| Interest expense | $ | (464 | ) | | (450 | ) | | 14 |
| | 3 | % | $ | (448 | ) | | (465 | ) | | (17 | ) | | (4 | )% |
| Interest expense-affiliates | (40 | ) | | (64 | ) | | (24 | ) | | (38 | )% | (57 | ) | | (63 | ) | | (6 | ) | | (10 | )% |
| Other income, net | 1 |
| | 2 |
| | (1 | ) | | (50 | )% | |
| Other income (expense), net | | 4 |
| | 6 |
| | (2 | ) | | (33 | )% |
| Total other expense, net | $ | (503 | ) | | (512 | ) | | (9 | ) | | (2 | )% | $ | (501 | ) | | (522 | ) | | (21 | ) | | (4 | )% |
| Income tax expense | $ | 639 |
| | 602 |
| | 37 |
| | 6 | % | $ | 494 |
| | 134 |
| | 360 |
| | nm |
|
nm-Percentagesnm - Percentages greater than 200% and comparisons between positive and negative values or to/from zero values are considered not meaningful.
Interest Expense
Interest expense increaseddecreased by $9$17 million, or 2%4%, for the year ended December 31, 20152018 as compared to the year ended December 31, 20142017 and interest expense increased by $14 million, or 3%, for the year ended December 31, 2014 as comparedwas attributable to the year ended December 31, 2013. The increase in interest expense for both periods was primarily due to a reductiondebt redemption of approximately $1.3 billion of senior notes in the amortizationthird quarter of debt premiums, which was partially offset by lower bond coupon rates.2018. See Note 3—4—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements in Item 8 of Part II of this Annual Reportreport and Liquidity and Capital Resources below for additional information about our debt.
Interest Expense-Affiliates, Net
Affiliate interest expense increaseddecreased by $13$6 million, or 33%10%, for the year ended December 31, 20152018 as compared to the year ended December 31, 2014 substantially2017. The decrease in affiliate interest expense was primarily due to an accounting adjustmenta decrease in 2014. Affiliatethe weighted average interest expenserate of 6.710% as of December 31, 2017 compared to 5.860% as of December 31, 2018.
Other Income (Expense), Net
Other income (expense), net reflects certain items not directly related to our core operations, including interest income, gains and losses from non-operating asset dispositions and components of net periodic pension and post-retirement benefit costs. Other income (expense), net decreased by $24$2 million, or 38%,33% for the year ended December 31, 20142018 as compared to the year ended December 31, 2013 substantially2017 primarily due to the above-noted accounting adjustment.$34 million loss on redemption of notes payable during the third quarter of 2018 partially offset by an increase in intercompany interest income due to the average interest rate for the year increasing to 1.774% in December 31, 2018 compared to 0.806% in December 31, 2017.
Income Tax Expense
Income tax expense for the year ended December 31, 2015,2018, was $659$494 million, or an effective tax rate of 38.0%22.9%, compared to $639$134 million, or an effective tax rate of 39.7%7.5%, for the year ended December 31, 2014.2017. For tax year ended December 31, 2017, the enactment of the Tax Cuts and Jobs Act in December 2017 resulted in a re-measurement of our deferred tax assets and liabilities at the new federal corporate tax rate of 21%. The decreasere-measurement resulted in a tax benefit of $555 million recorded in the 2015 effectivefourth quarter of 2017, which was the predominant factor contributing to our lower tax expense of $134 million for 2017. For tax year ended December 31, 2018, our tax rate is primarily duedriven by the lower federal statutory rate of 21%, as well as a tax benefit of $83 million generated by filing tax accounting method changes that accelerated significant tax deductions. These benefits are partially offset by an increase to a benefit from research and development credits, a smaller tax on a dividend from a foreign subsidiary and a smaller change toour state income taxes from changes in apportionment. Income tax expense for the year ended December 31, 2013 was $602 million, or an effective tax rate of 38.4%. The increase in the 2014 effective tax rate is primarily due to a change in the deferred state rate due to changes in apportionment and statutory rate changes and a change in the uncertain tax position as a result of audit settlements.rate.
For additional information on income taxes, see Note 11—Income Taxes to our consolidated financial statements in Item 8 of Part II of this Annual Report.report.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles that are generally accepted in the United States. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of our assets, liabilities, revenuesrevenue and expenses. We have identified certain policies and estimates as critical to our business operations and the understanding of our past or present results of operations related to (i) goodwill, customer relationships and other intangible assets; (ii) property, plant and equipment; (ii) affiliate transactions and (iii) pension and post-retirement benefits; (iv) affiliates transactions; (v) Connect America Fund support payments; and (vi) income taxes .taxes. These policies and estimates are considered critical because they had a material impact, or they have the potential to have a material impact, on our consolidated financial statements and because they require us to make significant judgments, assumptions or estimates. We believe that the estimates, judgments and assumptions made when accounting for the items described below were reasonable, based on information available at the time they were made. However, there can be no assurance that actual results will not differ from those estimates.
Our acquisition resulted in the assignment of the aggregate consideration to the assets acquired and liabilities assumed based on estimates of their acquisition date fair values. The fair value of the aggregate consideration transferred exceeded the acquisition date fair value of the recorded tangible and intangible assets and assumed liabilities by an estimated $9.354 billion, which has been recognized as goodwill. This goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and leveraged combined networks that we expect to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes. The aggregate consideration assignment is based on our final analysis of enterprise value of $18.639 billion
Goodwill, Customer Relationships and Other Intangible Assets
We amortize customer relationships primarily over estimated lives of ten years, using either the sum-of-the-years-digits or the straight-line methods, depending on the type of customer. We amortize capitalized software using the straight-line method over estimated lives ranging up to seven years. We annually review the estimated lives and methods used to amortize our other intangible assets, primarily capitalized software. The amount of future amortization expense may differ materially from current amounts, depending on the results of our annual reviews.
We are required to assess goodwill for impairment at least annually, or more frequently, if an event occurs or circumstances change that would indicate an impairment may have occurred. We are required to write-down the value of goodwill in periods in which the recorded amount of goodwill exceeds the implied fair value of goodwill. Our annual assessment date for testing goodwill impairment is October 31. The impairment assessment is done at the reporting unit level; in reviewing the criteria for reporting units when assigning the goodwill resulting from CenturyLink's acquisition of us, we determined that we are one reporting unit.
As of October 31, 2015, we performed our annual impairment assessment and concluded that our goodwill was not impaired and the estimated fair value of our equity was substantially in excess of our carrying value of equity as of that date.
We may be required to assess our goodwill for impairment before our next required assessment date of October 31, 2016 under certain circumstances, including any failure to meet our forecasted future operating results or any significant increases in our weighted average cost of capital. In addition, we cannot assure that adverse conditions will not trigger future goodwill impairment assessments or impairment charges. A number of factors, many of which we cannot control, could affect our financial condition, operating results and business prospects and could cause our actual results to differ from the estimates and assumptions we employed in our goodwill impairment assessment. These factors include, but are not limited to, (i) further weakening in the overall economy; (ii) a significant decline in our ultimate parent's, CenturyLink, stock price and resulting market capitalization as a result of an adverse change to our overall business operations; (iii) changes in the discount rate we use in our testing; (iv) successful efforts by our competitors to gain market share in our markets; (v) adverse changes as a result of regulatory or legislative actions; and (vi) a significant adverse change in our legal affairs or in the overall business climate. For additional information, see "Risk Factors" in Item 1A of Part I of this Annual Report. We will continue to monitor certain events that impact our operations to determine if an interim assessment of goodwill impairment should be performed prior to the next required assessment date of October 31, 2016.
Property, Plant and Equipment
As a result of our indirect acquisition by CenturyLink, property, plant and equipment owned at the time of acquisition was recorded based on its estimated fair value as of the acquisition date. Subsequently purchased and constructed property, plant and equipment isare recorded at cost. Renewals and betterments of plant and equipment are capitalized while repairs, as well as renewals of minor items, are charged to operating expense. Depreciation of property, plant and equipment is provided on the straight-line method using class or overall group rates. The group method provides for the recognition of the remaining net investment, less anticipated net salvage value, over the remaining useful life of the assets. This method requires the periodic revision of depreciation rates.
Normal retirements of property, plant and equipment are charged against accumulated depreciation, with no gain or loss recognized. We depreciate such property on the straight-line method over estimated service lives ranging from 45 to 45 years.
We perform annual internal reviews to evaluate the reasonableness of the depreciable lives for our property, plant and equipment. Our reviews utilize models that take into account actual usage, physical wear and tear, replacement history, assumptions about technology evolution and, in certain instances, actuarially determined probabilities to estimate the remaining life of our asset base.
Due to rapid changes in technology and the competitive environment, determining the estimated economic life of telecommunications plant equipment and softwareequipment requires a significant amount of judgment. We regularly review data on utilization of equipment, asset retirements and salvage values to determine adjustments to our depreciation rates. The effect of a hypothetical one year increase or decrease in the estimated remaining useful lives of our property, plant and equipment would have decreased depreciation expense by approximately $130$90 million annually or increased depreciation expense by approximately $170$120 million annually, respectively.
Pension and Post-retirement Benefits
A substantial amount of our employees participate in the CenturyLink pension and post-retirement benefit plans. CenturyLink allocates service costs relating to pension and post-retirement health care and life insurance benefits to us. Any amounts contributed by us through CenturyLink are not segregated or restricted to pay amounts due to our employees and may be used to provide benefits to employees of other CenturyLink affiliates. The allocation of service costs to us is based upon our employees who are currently earning benefits under the plans.
In computing the periodic pension and post-retirement benefits income and expense, the most significant assumptions CenturyLink makes are the discount rate and the expected rate of return on plan assets. Changes in either of these assumptions could significantly impact our general, administrative and other operating expenses. For further discussion of the qualified pension and post-retirement benefit plans and the critical accounting estimates, see CenturyLink's Annual Report on Form 10-K for the year ended December 31, 2015.
Affiliate Transactions
We recognize intercompany charges at the amounts billed to us by our affiliates and we recognize intercompany revenue for services we bill to our affiliates. Regulatory rules require certain expenses to be recorded at market price or fully distributed cost. Our compliance with regulations is subject to review by regulators. Adjustments to intercompany charges that result from these reviews are recorded in the period they become known.
Because of the significance of the services we provide to our affiliates and our other affiliatesaffiliate transactions, the results of operations, financial position and cash flows presented herein are not necessarily indicative of the results of operations, financial position and cash flows we would have achieved had we operated as a stand-alone entity during the periods presented. See Note 10—13—Affiliate Transactions to our consolidated financial statements in Item 8 of Part II of this Annual Reportreport for additional information.
Connect America Fund Support Payments
In 2015, CenturyLink accepted funding from the Connect America Fund ("CAF)" from the Federal Communications Commission ("FCC") of approximately $500 million per year for six years to fund the deployment of voice and high-speed Internet infrastructure for approximately 1.2 million rural households and businesses (living units) in 33 states under the CAF Phase 2 high-cost support program. Of these amounts, approximately $150 million is attributable to our service area, to provide service to approximately 0.3 million rural households and businesses in 13 states. This program provides a monthly high-cost subsidy similar to the support provided by the FCC’s previous cost reimbursement programs. Although we believe that there is no specific authoritative U.S. GAAP guidance for the treatment of government assistance, we identified three acceptable methods to account for these funds; 1) recognize revenue when entitled to receive cash, 2) defer cash received until the living units are enabled to receive the service at the FCC specified level, or 3) record the cash received as contra capital. After assessing these alternatives, we have determined that we will recognize CAF Phase 2 funds each month as revenue when we are entitled to receive the cash less a deferred amount. The amount of revenue deferred in 2015 was approximately $4 million. We believe our recognition methodology is consistent with other companies in our industry in the United States, but may not necessarily be consistent with companies outside the United States that receive similar government funding, and we cannot provide assurances to this effect.
In computing the amount of revenue to recognize, we assume that we will not be able to economically enable 100% of the required living units in every state with voice and high-speed Internet capabilities under the CAF Phase 2 program. We defer recognition of the funds related to potential living units that we estimate we will not enable until we can precisely determine that we can fully meet the enablement targets. As disclosed elsewhere herein, in some limited instances, a portion of the funds must be returned. The effect of a hypothetical 1% change in our estimate of living units we will not enable with voice and high-speed Internet capabilities under the CAF Phase 2 program would have increased or decreased our revenue up to $1 million or $3 million, respectively, in 2015.
For additional information about the CAF Phase 2 support program, see the discussion below in "Liquidity and Capital Resources—Connect America Fund."
Income Taxes
Until April 1, 2011, we were included in the consolidated federal income tax return of QCII. Since CenturyLink's acquisition of QCII on April 1, 2011, we
We are included in the consolidated federal income tax return of CenturyLink. Under CenturyLink's tax allocation policy, CenturyLink treats our consolidated results as if we were a separate taxpayer. The policy requires us to settle our tax liabilities through a change in our general intercompany obligation based upon our separate return taxable income. We are also included in the combined state tax returns filed by CenturyLink and the same payment and allocation policy applies. Our reported deferred tax assets and liabilities are primarily determined as a result of the application of the separate return allocation method and therefore the settlement of these amounts is dependent upon our parent, CenturyLink, rather than tax authorities. CenturyLink does have the right to change their policy regarding settlement of these assets and liabilities at any time.
Our provision for income taxes includes amounts for tax consequences deferred to future periods. We record deferred income tax assets and liabilities reflecting future tax consequences attributable to tax credit carryforwards and differences between the financial statement carrying value of assets and liabilities and the tax bases of those assets and liabilities. Deferred taxes are computed using enacted tax rates expected to apply in the year in which the differences are expected to affect taxable income. The effect on deferred income tax assets and liabilities of a change in tax rate is recognized in earnings in the period that includes the enactment date.
The measurement of deferred taxes often involves the exercise of considerable judgment related to the realization of tax basis. Our deferred tax assets and liabilities reflect our assessment that tax positions taken in filed tax returns and the resulting tax basis, are more likely than not to be sustained if they are audited by taxing authorities. Assessing tax rates that we expect to apply and determining the years when the temporary differences are expected to affect taxable income requires judgment about the future apportionment of our income among the states in which we operate. Any changes in our practices or judgments involved in the measurement of deferred tax assets and liabilities could materially impact our financial condition or results of operations. See Note 11—Income Taxes to our consolidated financial statements in Item 8 of Part II of this Annual Reportreport for additional information.
Liquidity and Capital Resources
Overview
We are an indirectly wholly-owned subsidiary of CenturyLink. As such, factors relating to, or affecting, CenturyLink's liquidity and capital resources could have material impacts on us, including impacts on our credit ratings, our access to capital markets and changes in the financial market's perception of us.
CenturyLink has cash management arrangements between certain of its subsidiaries that include lines of credit, affiliate advances and obligations, capital contributions and dividends. As part of these cash management arrangements, affiliates provide lines of credit to certain other affiliates. Amounts outstanding under these lines of credit and intercompany obligations vary from time to time. Under these arrangements, the majority of our cash balance is advanced on a daily basis tofor centralized management by CenturyLink. From time to time we may declare and pay dividends to our stockholder, QSC, sometimes in excess of our earnings to the extent permitted by applicable law, using cash owed to us under these advances, which has the net effect of reducing the amount of these advances. Our debt covenants do not currently limit the amount of dividends we can pay to QSC. Given our cash management arrangement with our ultimate parent, CenturyLink, and the resulting amounts due to us from CenturyLink, a significant component of our liquidity is dependent upon CenturyLink's ability to repay its obligation to us.
As of December 31, 2015,2018, we had a working capital deficit of $820$426 million, reflecting current liabilities of $2.422$2.3 billion and current assets of $1.602$1.8 billion, compared to a working capital deficit of $578$427 million as of December 31, 2014.2017. We have historically operated with a working capital deficit due to our practice of declaring and paying regular cash dividends to QSC. As long as we continue declaring and paying cash dividends to QSC, it is likely that we will continue to operate with a working capital deficit in the future. We anticipate that our future liquidity needs will be met through (i) our cash provided by our operating activities, (ii) amounts due to us from CenturyLink, (iii) our ability to refinance Qwest Corporation's debt securities at maturity and (iii)(iv) capital contributions, advances or loans from CenturyLink or its affiliates if and to the extent they have available funds or access to available funds that they are willing and able to contribute, advance or loan.
Capital Expenditures
We incur capital expenditures on an ongoing basis in order to enhance and modernize our networks, compete effectively in our markets and expand our service offerings. CenturyLink evaluates capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and the expected return on investment. The amount of CenturyLink's consolidated capital investment is influenced by, among other things, demand for CenturyLink's services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations (such as theour CAF Phase 2II infrastructure buildout requirements). Based on the type and volume of services we provide, approximately 38% to 43% of CenturyLink's annual consolidated capital expenditures have been attributed over the last couple of years to us for use in our operations. For more information on CenturyLink's total capital expenditures, please see its annual and quarterly reports filed with the SEC.
Our capital expenditures continue to be focused on our strategic services.
For more information on our capital spending, see "Business" and "Risk Factors" in Items 1 and 1A, respectively, of Part I of this Annual Report.report.
Debt and Other Financing Arrangements
CenturyLink has a revolving credit facility (the "Credit"2017 Revolving Credit Facility") maturing in 2022 that as of December 2019 that allows31, 2017 allowed CenturyLink to borrow up to $2 billion, including $400 million of letter of credit capacity, for the general corporate purposes of itself and its subsidiaries. On January 29, 2018, the 2017 Revolving Credit Facility was amended to increase CenturyLink's borrowing capacity thereunder to $2.16 billion. As of December 31, 2018, CenturyLink had $1.618 billion available for future use under the 2017 Revolving Credit Facility. CenturyLink also maintains a separate letter of credit arrangement with a financial institution amounting to $160$225 million to which we have access. As of December 31, 2015, CenturyLink had approximately $1.670 billion available for future use under the Credit Facility.
Under the Credit Facility, CenturyLink and we, must maintain a debt to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined in our Credit Facility) ratio of not more than 4.0:1.0 and 2.85:1.0, respectively, as of the last day of each fiscal quarter for the four quarters then ended. The Credit Facility also contains a negative pledge covenant, which generally requires CenturyLink to secure equally and ratably any advances under the Credit Facility if they pledge assets or permit liens on our property for the benefit of other debtholders. The Credit Facility also has a cross payment default provision, and the Credit Facility and certain of our debt securities also have cross acceleration provisions. When present, these provisions could have a wider impact on liquidity than might otherwise arise from a default or acceleration of a single debt instrument. Our debt to EBITDA ratios could be adversely affected by a wide variety of events, including unforeseen expenses or contingencies. This could reduce our financing flexibility due to potential restrictions on incurring additional debt under certain provisions of our debt agreements or, in certain circumstances, could result in a default under certain provisions of such agreements.
As of December 31, 2015, our long-term debt (including current maturities and excluding note payable to affiliate discussed in "Revolving Promissory Note") totaled $7.239 billion, compared to $7.269 billion outstanding as of December 31, 2014.
On February 20, 2015, we entered into a new credit agreement with several lenders that allows us to borrow up to $100 million under a term loan. Under this new credit agreement, we borrowed $100 million under a ten-year term note that expires on February 20, 2025.
Subject to market conditions, and to the extent feasible, we expect to continue to issue debt securities, under Qwest Corporation, from time to time in the future to refinance a substantial portion of our maturing debt. The availability, interest rate and other terms of any new borrowings will depend on the ratings assigned to usQwest Corporation by credit rating agencies, among other factors. For further information on ourWe have no debt maturities see below "Future Contractual Obligations."due in 2019.
We believe we were
Following CenturyLink's acquisition of Level 3 Communications, Inc. ("Level 3"), Qwest Corporation's current unsecured senior debt rating of Ba1 was downgraded to Ba2 with a negative outlook by Moody's Investors Service, Inc., and its current unsecured senior debt rating of BBB- was downgraded to BB+ with a stable outlook by Fitch Ratings. The downgrade of Qwest Corporation's rating by Fitch Ratings resulted in complianceQwest Corporation no longer being viewed as an "investment grade" issuer under the prevailing definition of that term. Standard and Poor's reaffirmed its rating of BBB- with all provisions and covenants of our debt agreements as of December 31, 2015. See Note 3—Long-Term Debt to our consolidated financial statements in Item 8 of Part II of this Annual Reporta stable outlook for additional information about our long-termQwest Corporation's current unsecured senior debt.
On February 14, 2019, Standard and Poor's revised its outlook on all credit ratings from negative to stable. As of the date of this Annual Report,report, the credit ratings for ourQwest Corporation's senior unsecured debt were as follows: |
| |
| Agency | QCCredit Ratings |
| Standard & Poor's | BBB- |
| Moody's Investors Service, Inc. | Baa3Ba2 |
| Fitch Ratings | BBB-BB+ |
Our
CenturyLink, Inc.'s and Qwest Corporation's credit ratings are reviewed and adjusted from time to time by the rating agencies, and downgrades could impactagencies. For additional information regarding CenturyLink's and our accessQwest Corporation's funding arrangements, see "Risk Factors—Risk Related to debt capital or further raise CenturyLink's Acquisition of Level 3" and our borrowing costs. Any such downgrades of CenturyLink's senior unsecured debt ratings could, under certain circumstances, incrementally increase the cost of CenturyLink's borrowing under its revolving credit facility, which could indirectly impact us. See "Risk Factors—Risks"Risks Affecting our Liquidity and Capital Resources" in Item 1A of Part I of this Annual Report.report.
Term Loan
In January 2016, we issued $235 million aggregate principal amount of 7% Notes due 2056, in exchange for net proceeds, after deducting underwriting discounts and other expenses, of approximately $227 million. All of the 7% Notes are unsecured obligations and may be redeemed by us, in whole or in part, on or after February 1, 2021, at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date.
Revolving Promissory Note
We are currently indebted to an affiliate of CenturyLink under a revolving promissory note that provides us with a funding commitment of up to $1.0 billion in aggregate principal amount through June 30, 2022, of which $855 million was outstanding as of December 31, 2015. The revolving promissory note is due on demand and ranks equally to our outstanding Senior Notes. Interest is accrued on the outstanding balance using a weighted average per annum interest rate of CenturyLink's outstanding borrowings for the interest period. As of December 31, 2015, the weighted average interest rate was 6.758%. As of December 31, 2015 and 2014, this revolving promissory note is reflected on our consolidated balance sheets as a current liability under note payable-affiliate. As of December 31, 2015, $5 million of accrued interest is reflected in other current liabilities on our consolidated balance sheet.
Dividends
We periodically pay dividends to our direct parent company. See Note 13—Stockholder's Equity to our consolidated financial statements in Item 8 of Part II of this Annual Report.
Future Contractual Obligations
The following table summarizes our estimated future contractual obligations as of December 31, 2015: |
| | | | | | | | | | | | | | | | | | | | | |
| | 2016 | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 and thereafter | | Total |
| | (Dollars in millions) |
Long-term debt (1) | $ | 242 |
| | 503 |
| | 3 |
| | 1 |
| | — |
| | 6,597 |
| | 7,346 |
|
Interest on long-term debt and capital leases(2) | 493 |
| | 467 |
| | 453 |
| | 453 |
| | 452 |
| | 10,303 |
| | 12,621 |
|
| Note payable-affiliate | 855 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 855 |
|
| Interest on note payable-affiliate | 5 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 5 |
|
| Operating leases | 56 |
| | 50 |
| | 45 |
| | 37 |
| | 32 |
| | 52 |
| | 272 |
|
Purchase commitments(3) | 73 |
| | 37 |
| | 16 |
| | 5 |
| | 1 |
| | — |
| | 132 |
|
Non-qualified pension obligations(4) | 2 |
| | 2 |
| | 1 |
| | 1 |
| | 1 |
| | 5 |
| | 12 |
|
Total future contractual obligations(5) | $ | 1,726 |
| | 1,059 |
| | 518 |
| | 497 |
| | 486 |
| | 16,957 |
| | 21,243 |
|
| |
(1)
| Includes current maturities and capital lease obligations but excludes unamortized discounts, net and unamortized debt issuance costs and excludes note payable-affiliate. |
| |
(2)
| Actual principal and interest paid in all years may differ due to future refinancing of outstanding debt or issuance of new debt. |
| |
(3)
| We have various long-term, non-cancelable purchase commitments for advertising and promotion services, including advertising and marketing at sports arenas and other venues and events. We also have service related commitments with various vendors for data processing, technical and software support services. Future payments under certain service contracts will vary depending on our actual usage. In the table above, we estimated payments for these service contracts based on estimates of the level of services we expect to receive. |
| |
(4)
| Reflects only the portion of total obligation that is contractual in nature. See Note 5 below. |
| |
(5)
| The table is limited to contractual obligations only and does not include: |
contingent liabilities;
our open purchase orders as of December 31, 2015. These purchase orders are generally issued at fair value, and are generally cancelable without penalty;
other long-term liabilities, such as accruals for legal matters and other taxes that are not contractual obligations by nature. We cannot determine with any degree of reliability the years in which these liabilities might ultimately settle;
affiliate cash funding requirements for qualified pension benefits payable to certain eligible current and future retirees allocated to us by CenturyLink. Benefits paid by CenturyLink’s qualified pension plan are paid through a trust. Cash funding requirements for this trust are not included in this table as CenturyLink is not able to reliably estimate required contributions to this trust. CenturyLink's cash funding projections are discussed further below;
affiliate post-retirement benefits payable to certain eligible current and future retirees. Not all of CenturyLink’s post-retirement benefit obligation amount is a contractual obligation and only the portion that we believe is a contractual obligation is reported in the table. See additional information on CenturyLink’s benefits plans in Note 7—Employee Benefits to the consolidated financial statements in Item 8 of Part II of CenturyLink’s Annual Report on Form 10-K for the year ended December 31, 2015;
contract termination fees. These fees are non-recurring payments, the timing and payment of which, if any, is uncertain. In the ordinary course of business and to optimize our cost structure, we enter into contracts with terms greater than one year to purchase other goods and services. Assuming we terminate these contracts in 2015, termination fees for these contracts to purchase goods and services would be approximately $97 million. In the normal course of business, we do not believe payment of these fees is likely; and
potential indemnification obligations to counterparties in certain agreements entered into in the normal course of business. The nature and terms of these arrangements vary.
Pension and Post-retirement Benefit Obligations
CenturyLink is subject to material obligations under its existing defined benefit pension plans and post-retirement benefit plans. At December 31, 2015, the accounting unfunded status of CenturyLink's qualified and non-qualified defined benefit pension plans and post-retirement benefit plans were $2.277 billion and $3.374 billion, respectively. See Note 7—Employee Benefits to our consolidated financial statements in Item 8 of Part II of this Annual Report and Note 7—Employee Benefits to the consolidated financial statements in Item 8 of Part II of CenturyLink's Annual Report on Form 10-K for the year ended December 31, 2015, for additional information about our and CenturyLink's pension and post-retirement benefit arrangements.
A substantial portion of our active and retired employees participate in CenturyLink's qualified Combined Pension Plan and post-retirement benefit plans. On December 31, 2014, the QCII pension plan and a pension plan of an affiliate were merged into the CenturyLink Retirement Plan, which was renamed the CenturyLink Combined Pension Plan. Our contributions are not segregated or restricted to pay amounts due to our employees and may be used to provide benefits to other employees of our affiliates. Prior to the pension plan merger, the above-noted employees participated in the QCII pension plan.
Benefits paid by CenturyLink's qualified pension plan are paid through a trust that holds all of the plan's assets. Based on current laws and circumstances, CenturyLink does not expect any contributions to be required for their qualified pension plan during 2016. The amount of required contributions to CenturyLink's qualified pension plan in 2017 and beyond will depend on a variety of factors, most of which are beyond their control, including earnings on plan investments, prevailing interest rates, demographic experience, changes in plan benefits and changes in funding laws and regulations. CenturyLink occasionally makes voluntary contributions in addition to required contributions.
Certain of CenturyLink's post-retirement health care and life insurance benefits plans are unfunded. Several trusts hold assets that are used to help cover the health care costs of certain retirees. As of December 31, 2015, the fair value of these trust assets was approximately $193 million; however, a portion of these assets is comprised of investments with restricted liquidity. CenturyLink estimates that the more liquid assets in these trusts will be adequate to provide continuing reimbursements for covered post-retirement health care costs for approximately one year. Thereafter, covered benefits will be paid either directly by CenturyLink or from these trusts as the remaining assets become liquid. This projected one year period could be shorter or longer depending on returns on plan assets, the timing of maturities of illiquid plan assets and future changes in benefits.
The affiliates obligations, net in current and noncurrent liabilities on our consolidated balance sheets represents the cumulative allocation of expense, net of payments, associated with QCII’s pension plans and post-retirement benefits plans prior to the plan mergers. In 2015, we agreed to a plan to settle the outstanding pension and post-retirement affiliate obligations, net balance with QCII over a 30 year term. Payments will be made on a monthly basis. For the year ended December 31, 2015, we made a settlement payment of $105 million to QCII on our affiliate obligations, net balance. Changes in the affiliates obligations, net are reflected in operating activities on our consolidated statements of cash flows. For the year ended December 31, 2016, we expect to make a settlement payment of $97 million to QCII on our affiliate obligations, net balance.
For 2016, CenturyLink's estimated annual long-term rate of return is 7.0% for both the pension plan trust assets and post-retirement plans trust assets, based on the assets currently held. However, actual returns could be substantially different.
For additional information, see "Risk Factors—Risks Affecting Our Liquidity and Capital Resources—Adverse changes in the value of assets or obligations associated with CenturyLink's qualified pension plan could negatively impact CenturyLink's liquidity, which may in turn affect our business and liquidity" in Item 1A of Part I of this Annual Report.
Connect America Fund
In August of 2015, CenturyLink accepted CAF funding from the FCC of approximately $500 million per year for six years to fund the deployment of voice and high-speed Internet infrastructure for approximately 1.2 million rural households and businesses in 33 states under the CAF Phase 2 support program. Of these amounts, approximately $150 million is attributable to our service area, to provide service to approximately 0.3 million rural households and businesses in 13 states. The funding from the CAF Phase 2 support program will substantially supplant the funding we previously received from the interstate USF program that we previously utilized to support voice services in high-cost rural markets in these 13 states. In September of 2015, we began receiving these payments from the FCC under the new CAF Phase 2 support program, which included (i) monthly support payments at a higher rate than under the interstate USF support program and (ii) a one-time cumulative catch-up payment representing the higher funding under the CAF Phase 2 support program over the interstate USF support program for the first seven months of 2015. During 2015, we received $92 million more cash than we would have otherwise received during the same period under the interstate USF support program.
CenturyLink and we declined annual funding of approximately $8 million in one state, and we expect the funding from the CAF Phase 2 support program for this one state will be auctioned by the FCC, perhaps in the latter part of 2016. In this one state, the interstate USF support we have historically received is expected to continue until the CAF Phase 2 auctions are completed.
As a result of accepting CAF Phase 2 support payments in 13 states, we will be obligated to make substantial capital expenditures to build infrastructure. See "Capital Expenditures" above.
In 2013, under the second round of the first phase of the CAF program, CenturyLink received $40 million in funding, $15 million attributed to our service areas, for deployment of high-speed Internet services in rural areas. The CAF Phase 2 support program overlaps certain eligible areas of the second round of CAF 1 funding, and CenturyLink is continuing to evaluate how much of the $40 million in funding they will utilize or return to the FCC. As of the date of this Annual Report, CenturyLink and we are past one of the benchmark deadlines for completing a portion of the broadband deployment. Due to the delays CenturyLink and we encountered in evaluating the eligible areas, we have requested relief and an extension of the deadline with the FCC. If the FCC does not grant us relief, we will be requested to refund a substantial portion of the $15 million in funding we received. This $15 million of CAF 1 Round 2 funding is included in other noncurrent liabilities on our consolidated balance sheet as of December 31, 2015.
For additional information on the FCC's CAF order and the USF program, see "Business—Regulation" in Item 1 of Part I of this Annual Report.
Historical Information
The following tables summarize our consolidated cash flow activities: |
| | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) |
| | 2015 | | 2014 | |
| | (Dollars in millions) |
| Net cash provided by operating activities | $ | 2,591 |
| | 2,801 |
| | (210 | ) |
| Net cash used in investing activities | (1,220 | ) | | (1,251 | ) | | (31 | ) |
| Net cash used in financing activities | (1,374 | ) | | (1,558 | ) | | (184 | ) |
|
| | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) |
| | 2014 | | 2013 | |
| | (Dollars in millions) |
| Net cash provided by operating activities | $ | 2,801 |
| | 2,713 |
| | 88 |
|
| Net cash used in investing activities | (1,251 | ) | | (1,381 | ) | | (130 | ) |
| Net cash used in financing activities | (1,558 | ) | | (1,326 | ) | | 232 |
|
Net cash provided by operating activities decreased by $210 million for the year ended December 31, 2015 as compared to the year ended December 31, 2014 primarily due to negative variances in the changes in affiliate obligations, net and accounts payable. During the year ended December 31, 2015, we made a settlement payment of $105 million to QCII on our affiliate obligations, net balance. Our net cash provided by operating activities in 2015 was also positively impacted by the cash received from the CAF Phase 2 support program, which was $92 million greater than the cash we would have otherwise received during the same period under the interstate USF support program. Net cash provided by operating activities increased by $88 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to a positive change in affiliate obligations, net, which was partially offset by less net income adjusted for non-cash items. For additional information about our operating results, see "Results of Operations" above.
Net cash used in investing activities decreased by $31 million for the year ended December 31, 2015 as compared to the year ended December 31, 2014 primarily due to a positive variance in the change in the amount of funds advanced to our affiliates, which was substantially offset by an increase in payments for property, plant and equipment. Net cash used in investing activities decreased by $130 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to a decrease in payments for property, plant and equipment and capitalized software.
Net cash used in financing activities decreased by $184 million for the year ended December 31, 2015 as compared to the year ended December 31, 2014 primarily due to decreases in the amount of net debt paydowns on long-term debt and dividend payments. Net cash used in financing activities increased by $232 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily due to an increase in the amount of net paydowns of long-term debt along with an increase in dividend payments. For additional information regarding our financing activities, see Note 3—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements in Item 8 of Part II of this Annual Report.
On October 13, 2015, we redeemed all $250 million of our 7.20% Notes due 2026, which resulted in an immaterial gain, and redeemed $150 million of our 6.875% Notes due 2033, which resulted in an immaterial loss.
On September 21, 2015, we issued $400 million aggregate principal amount of 6.625% Notes due 2055, in exchange for net proceeds, after deducting underwriting discounts and other expenses, of approximately $386 million. The underwriting agreement included an over-allotment option granting the underwriters for the offering an opportunity to purchase additional 6.625% Notes due 2055. On September 30, 2015, we issued an additional $10 million aggregate principal amount of the 6.625% Notes under this over-allotment option. All of the 6.625% Notes are unsecured obligations and may be redeemed by us, in whole or in part, on or after September 15, 2020, at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date.
On June 15, 2015, we paid at maturity the $92 million principal amount of our 7.625% Notes.
On February 20, 2015, weQwest Corporation entered into a term loan in the amount of $100 million with CoBank, ACB. The outstanding unpaid principal amount of this term loan plus any accrued and unpaid interest is due on February 20, 2025. Interest is paid monthly based upon either the London Interbank Offered Rate (“LIBOR”) or the base rate (as defined in the credit agreement) plus an applicable margin between 1.50% to 2.50% per annum for LIBOR loans and 0.50% to 1.50% per annum for base rate loans depending on our then current senior unsecured long-term debt rating. As ofAt both December 31, 2015,2018 and 2017, the outstanding principal balance on this term loan was $100 million.
Certain Matters Related to CenturyLink's Indirect Acquisition of Us
Since CenturyLink's 2011 indirect acquisition of us, we have been includedRevolving Promissory Note
On September 30, 2017, Qwest Corporation entered into an amended and restated revolving promissory note in the amount of $965 million with an affiliate of our ultimate parent company, CenturyLink, Inc. This note replaced and amended the original $1.0 billion revolving promissory note Qwest Corporation entered into on April 18, 2012 with the same affiliate. The outstanding principal balance of this new revolving promissory note and the accrued interest thereon shall be due and payable on demand, but if no demand is made, then on June 30, 2022. Interest is accrued on the outstanding balance during an interest period using a weighted average per annum interest rate on the consolidated federal income tax returnoutstanding debt of CenturyLink. CenturyLink is in the process of developing a post-acquisition intercompany agreement for allocation of consolidated income tax liabilities. Until that agreement is finalized, we will continue to account for income tax expense on a stand-alone basis. We are also included in certain combined state tax returns filed by CenturyLink and the same accounting will apply.
Throughits subsidiaries. As of December 31, 2015, we have paid certain costs that were associated with CenturyLink's indirect acquisition2018, the weighted average interest rate was 5.86%. As of us. These costs include compensation costs comprisedDecember 31, 2018 and December 31, 2017, the amended and restated revolving promissory note and the original revolving promissory note, respectively, are reflected on our consolidated balance sheets as a current liability under note payable - affiliate. As of retention bonusesDecember 31, 2018 and severance. December 31, 2017, $30 million and $16 million of accrued interest are reflected in other current liabilities on our consolidated balance sheets, respectively.
Dividends
We periodically pay dividends to our direct parent company. See Note 18—Stockholder's Equity to our consolidated financial statements in Item 8 of Part II of this report.
Future Contractual Obligations
The final amounts and timing of the compensation costs to be paid is partially dependent upon personnel decisions that continue to be made as part of the continuing integration. These amounts may be material.
In accounting for CenturyLink's indirect acquisition of us, we recordedfollowing table summarizes our debt securities at their estimated fair values, which totaled $8.498 billionfuture contractual obligations as of April 1, 2011. Our acquisition date fair value estimates were based primarily on quoted market prices in active markets and other observable inputs where quoted market prices were not available. We determined that the fair value of our debt securities exceeded their stated principal balances on the acquisition date by $530 million, which we recorded as a premium.
The table below summarizes the portions of this premium recognized as a reduction to interest expense or extinguished during the periods indicated:December 31, 2018: |
| | | | | | | | | | | | |
| | Years Ended December 31, | | From April 1, 2011
through
December 31, 2013 | | Total Since Acquisition |
| | 2015 | | 2014 | | |
| | (Dollars in millions) |
| Amortized | $ | 21 |
| | 42 |
| | 254 |
| | 317 |
|
Extinguished(1) | 1 |
| | — |
| | 187 |
| | 188 |
|
| Total | $ | 22 |
| | 42 |
| | 441 |
| | 505 |
|
|
| | | | | | | | | | | | | | | | | | | | | |
| | 2019 | | 2020 | | 2021 | | 2022 | | 2023 | | 2024 and thereafter | | Total |
| | (Dollars in millions) |
Long-term debt (1)(2) | $ | 11 |
| | 5 |
| | 951 |
| | — |
| | 1 |
| | 5,109 |
| | 6,077 |
|
Interest on long-term debt and capital leases(2) | 405 |
| | 405 |
| | 405 |
| | 341 |
| | 340 |
| | 8,474 |
| | 10,370 |
|
| Note payable-affiliate | 1,008 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 1,008 |
|
| Interest on note payable-affiliate | 30 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 30 |
|
| Operating leases | 35 |
| | 28 |
| | 27 |
| | 23 |
| | 19 |
| | 32 |
| | 164 |
|
| Right-of-way agreements | 19 |
| | 20 |
| | 20 |
| | 20 |
| | 19 |
| | 102 |
| | 200 |
|
Purchase commitments(3) | 15 |
| | 6 |
| | 4 |
| | — |
| | — |
| | — |
| | 25 |
|
Affiliate obligations, net(4) | 79 |
| | 65 |
| | 61 |
| | 56 |
| | 52 |
| | 512 |
| | 825 |
|
| Other | 3 |
| | 3 |
| | 3 |
| | 3 |
| | 2 |
| | 23 |
| | 37 |
|
Total future contractual obligations(5) | $ | 1,605 |
| | 532 |
| | 1,471 |
| | 443 |
| | 433 |
| | 14,252 |
| | 18,736 |
|
| |
| (1) | Includes current maturities and capital lease obligations, but excludes unamortized discounts, net and unamortized debt issuance costs and excludes note payable-affiliate. |
| |
| (2) | Actual principal and interest paid in all years may differ due to future refinancing of outstanding debt or issuance of new debt. |
| |
| (3) | We have various long-term, non-cancelable purchase commitments for advertising and promotion services, including advertising and marketing at sports arenas and other venues and events. We also have service-related commitments with various vendors for data processing, technical and software support services. Future payments under certain service contracts will vary depending on our actual usage. In the table above, we estimated payments for these service contracts based on estimates of the level of services we expect to receive. |
| |
| (4) | (1)
| Extinguished in connectionThe affiliate obligations, net primarily represents the cumulative allocation of expense attributable to our employees, net of payments, associated with the payment of Qwest debt securitiesQCII’s pension plans and post-retirement benefit plans prior to maturity.the plans being merged into CenturyLink's benefit plans. See additional information on CenturyLink’s employee benefit plans in Note 10—Employee Benefits to the consolidated financial statements in Item 8 of Part II of CenturyLink’s annual report on Form 10-K for the year ended December 31, 2018; |
| |
| (5) | The table is limited solely to contractual payment obligations and does not include: |
The remaining premium of $25 millioncontingent liabilities;
our open purchase orders as of December 31, 2015, will reduce interest expense2018. These purchase orders are generally issued at fair value, and are generally cancelable without penalty;
other long-term liabilities, such as accruals for legal matters and other taxes that are not contractual obligations by nature. We cannot determine with any degree of reliability the years in future periods, unless otherwise extinguished.which these liabilities might ultimately settle;
Other Matterscontract termination fees. These fees are non-recurring payments, the timing and payment of which, if any, is uncertain. In the ordinary course of business and to optimize our cost structure, we enter into contracts with terms greater than one year to purchase other goods and services. In the normal course of business, we do not believe payment of these fees is likely;
In February 2015,service level commitments to our customers, the FCC adopted new regulations that regulate Internet services as a public utilityviolation of which typically results in service credits rather than cash payments; and
potential indemnification obligations to counterparties in certain agreements entered into in the normal course of business. The nature and terms of these arrangements vary.
Pension and Post-retirement Benefit Obligations
CenturyLink is subject to material obligations under Titleits existing defined benefit pension plans and post-retirement benefit plans. At December 31, 2018, the accounting unfunded status of CenturyLink's qualified and non-qualified defined benefit pension plans and qualified post-retirement benefit plans was $1.6 billion and $3.0 billion, respectively. See Note 8—Employee Benefits to our consolidated financial statements in Item 8 of Part II of this report and Note 10—Employee Benefits to the Communications Act. Although it is prematureconsolidated financial statements in Item 8 of Part II of CenturyLink's annual report on Form 10-K for usthe year ended December 31, 2018, for additional information about our and CenturyLink's pension and post-retirement benefit arrangements.
A substantial portion of our active and retired employees participate in CenturyLink's qualified pension and post-retirement benefit plans. On December 31, 2014, the QCII pension plan and a pension plan of an affiliate were merged into the CenturyLink Retirement Plan, which was renamed the CenturyLink Combined Pension Plan. Our contributions are not segregated or restricted to determinepay amounts due to our employees and may be used to provide benefits to other employees of our affiliates. Prior to the ultimate impactpension plan merger, the above-noted employees participated in the QCII pension plan.
Benefits paid by CenturyLink's qualified pension plan are paid through a trust that holds all of the new regulationsplan's assets. Based on current laws and circumstances, CenturyLink does not expect any contributions to be required for their qualified pension plan during 2019. The amount of required contributions to CenturyLink's qualified pension plan in 2020 and beyond will depend on a variety of factors, most of which are beyond their control, including earnings on plan investments, prevailing interest rates, demographic experience, changes in plan benefits and changes in funding laws and regulations. CenturyLink occasionally makes voluntary contributions in addition to required contributions. CenturyLink made voluntary contributions of $500 million and $100 million to the trust for its qualified pension plan in 2018 and 2017, respectively. CenturyLink does not currently expect to make a voluntary contribution to the trust for its qualified pension plan in 2019.
Substantially all of CenturyLink's post-retirement health care and life insurance benefits plans are unfunded. Several trusts hold assets that have been used to help cover the health care costs of certain retirees. As of December 31, 2018, assets in the post-retirement trusts had been substantially depleted and had a fair value of $18 million (a portion of which was comprised of investments with restricted liquidity), which has significantly limited CenturyLink's ability to continue paying benefits from the trusts; however, CenturyLink plans to continue paying certain benefits from the trusts. Benefits not paid through the trusts are expected to be paid directly by CenturyLink with available cash.
The affiliate obligations, net in current and noncurrent liabilities on our operations,consolidated balance sheets primarily represents the cumulative allocation of expense, net of payments, associated with QCII’s pension plans and post-retirement benefits plans prior to the plan mergers. In 2015, we currentlyagreed to a plan to settle the outstanding pension and post-retirement affiliate obligations, net balance with QCII over a 30 year term. Under the plan, payments are scheduled to be made on a monthly basis. For the year ended December 31, 2018, we made settlement payments of $87 million to QCII in accordance with the plan. Changes in the affiliate obligations, net are reflected in operating activities on our consolidated statements of cash flows. For the year ended 2019, we expect that they will negatively impact our current operations. to make aggregate settlement payments of $79 million to QCII under the plan.
For 2018 and 2019, CenturyLink's estimated annual long-term rates of return are 6.5% and 4.0% for the pension plan trust assets and post-retirement plans' trust assets, respectively, based on the assets held. However, actual returns could be substantially different.
For additional information, see “Risk"Risk Factors—Risks Relating to LegalAffecting Our Liquidity and Regulatory Matters”Capital Resources—Adverse changes in the value of assets or obligations associated with CenturyLink's qualified pension plan could negatively impact CenturyLink's liquidity, which may in turn affect our business and liquidity" in Item 1A of Part I of this Annual Report.report.
Connect America Fund
50
As a result of accepting CAF II support payments, we must meet certain specified infrastructure buildout requirements in 13 states over the next several years. In order to meet these specified infrastructure buildout requirements, we may be obligated to make substantial capital expenditures. See "Capital Expenditures" above.
For additional information on the FCC's CAF order and the USF program, see "Business—Regulation" in Item 1 of Part I of this report.
Historical Information
The following tables summarize our consolidated cash flow activities:
|
| | | | | | | | | |
| | Years Ended December 31, | | Increase / (Decrease) |
| | 2018 | | 2017 | |
| | (Dollars in millions) |
| Net cash provided by operating activities | $ | 3,791 |
| | 2,435 |
| | 1,356 |
|
| Net cash used in investing activities | (1,153 | ) | | (1,436 | ) | | (283 | ) |
| Net cash used in financing activities | (2,634 | ) | | (1,003 | ) | | 1,631 |
|
Operating Activities
Net cash provided by operating activities increased by $1.4 billion for the year ended December 31, 2018 as compared to the year ended December 31, 2017 primarily due to an increase in net income adjusted for non-cash items, change in other noncurrent assets and liabilities, net, accounts payable and accounts receivable partially offset with a negative variance in the change in accrued income and other taxes and affiliate obligations. Cash provided by operating activities is subject to variability period over period as a result of the timing of the collection of receivables and payments related to interest expense, accounts payable and bonuses.For additional information about our operating results, see "Results of Operations" above.
Investing Activities
Net cash used in investing activities decreased by $283 million for the year ended December 31, 2018 as compared to the year ended December 31, 2017 primarily due to a decrease in capital expenditures and increased cash flow activity from advances to affiliates.
Financing Activities
Net cash used in financing activities increased by $1.6 billion for the year ended December 31, 2018 as compared to the year ended December 31, 2017 primarily due to an increase in dividends paid to affiliate and increase in payments of debt. Qwest Corporation redeemed $1.3 billion of notes payable during the three months ended September 30, 2018 which resulted in a total loss of $34 million. In the future, we may continue to retire debt, which could potentially result in the recognition of additional losses. These redemptions and repurchases were funded by cash payments and borrowings under CenturyLink's revolving credit facility.
See Note 4—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements in Item 8 of Part II of this report, for additional information on our outstanding debt securities.
Other Matters
Recent Tax Changes
On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was signed into law. The Act reduces the U.S. corporate income tax rate from a maximum of 35% to 21% for all corporations, effective January 1, 2018, and makes certain changes to U.S. taxation of income earned by foreign subsidiaries, capital expenditures, interest expense and various other items.
As a result of the reduction in the U.S. corporate income tax rate from 35% to 21%, we provisionally re-measured our net deferred tax liabilities at December 31, 2017 and recognized a tax benefit of $555 million in our consolidated statement of operations for the year ended December 31, 2017. Upon completion of our re-measurement during 2018 there was no material change to the provisional amount recorded in 2017.
For a more detailed description of the Act and its impact on us, please see Note 11—Income Taxes to our consolidated financial statements in Item 8 of Part II of this report.
CenturyLink and its affiliates are involved in several legal proceedings to which we are not a party that, if resolved against them, could have a material adverse effect on their business and financial condition. As a wholly-owned subsidiary of CenturyLink, our business and financial condition could be similarly affected. You can find descriptions of these legal proceedings in CenturyLink's quarterly and annual reports filed with the SEC. Because we are not a party to any of the matters, we have not accrued any liabilities for these matters as of December 31, 2015.2018.
Market Risk
We
As of December 31, 2018, we are exposed to market risk from changes in interest rates on our variable rate long-term debt obligationsterm loan and amended and restated revolving promissory note. We seek to maintain a favorable mix of fixed and variable rate debt in an effort to limit interest costs and cash flow volatility resulting from changes in rates.
Management periodically reviews our exposure to interest rate fluctuations and periodically implements strategies to manage the exposure. From time to time, we have used derivative instruments to (i) lock-in or swap our exposure to changing or variable interest rates for fixed interest rates or (ii) to swap obligations to pay fixed interest rates for variable interest rates. As of December 31, 2015,2018, we had no such instruments outstanding. We have established policies and procedures for risk assessment and the approval, reporting and monitoring of derivative instrument activities. We doAs of December 31, 2018, we did not hold or issue derivative financial instruments for trading or speculative purposes.
At December 31, 2015,2018, we had approximately $7.229$5.956 billion (excluding capital lease and other obligations) of long-term debt outstanding which bears interest at fixed rates and is therefore not exposed to interest rate risk. At December 31, 2015,2018, we had $100 million floating rate debt exposed to changes in the London InterBank Offered Rate (LIBOR). A hypothetical increase of 100 basis points in LIBOR relative to this debt would decrease our annual pre-tax earnings by $1 million. At December 31, 2015,2018, we had approximately $855 million$1.008 billion in debt, which was owed to an affiliate of our ultimate parent, CenturyLink. The note payable-affiliate bears interest at a variable rate, which is based on a weighted average per annum interest rate of CenturyLink's outstanding borrowings for the interest period and therefore is exposed to potential interest rate risk.
Certain shortcomings are inherent in the method of analysis presented in the computation of exposures to market risks. Actual values may differ materially from those disclosed by us from time to time if market conditions vary from the assumptions used in the analyses performed. These analyses only incorporate the risk exposures that existed at December 31, 2015.2018.
Off-Balance Sheet Arrangements
We
As of the date of this report, we have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support and we do not engage in leasing, hedging or other similar activities that expose us to any significant liabilities that are not (i) reflected on the face of the consolidated financial statements, (ii) disclosed in Note 15—Commitments, Contingencies and ContingenciesOther Items to our consolidated financial statements in Item 8 of Part II of this Annual Report,report, or in the Future Contractual Obligations table included in this Item 7 of Part II above, or (iii) discussed under the heading "Market Risk" above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Market Risk" in Item 7 of Part II of this Annual Reportreport is incorporated herein by reference.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholder
Qwest Corporation:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Qwest Corporation and subsidiaries (the Company) as of December 31, 20152018 and 2014, and2017, the related consolidated statements of operations, cash flows, and stockholder'sstockholder’s equity for each of the years in the three-yearthree year period ended December 31, 2015. 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. Anmisstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit includesof its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.
Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supportingregarding the amounts and disclosures in the consolidated financial statements. An auditOur audits also includes assessingincluded evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statement presentation.statements. We believe that our audits provide a reasonable basis for our opinion.
In our opinion the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for debt issuance costs effective January 1, 2014 due to the adoption of FASB ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. Additionally, as discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for deferred income taxes effective January 1, 2014 due to the adoption of FASB ASU 2015-17, Balance Sheet Classification of Deferred Taxes..
/s/ KPMG LLP
We have served as the Company’s auditor since 2002.
Shreveport, Louisiana
March 1, 201621, 2019
QWEST CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | | Years Ended December 31, | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| OPERATING REVENUES | | | | | | |
| Operating revenues | $ | 6,557 |
| | 6,676 |
| | 6,818 |
| |
| Operating revenues - affiliates | 2,407 |
| | 2,162 |
| | 1,935 |
| |
| Total operating revenues | 8,964 |
| | 8,838 |
| | 8,753 |
| |
| OPERATING REVENUE | | | | | | |
| Operating revenue | | $ | 5,558 |
| | 5,831 |
| | 6,247 |
|
| Operating revenue - affiliates | | 2,935 |
| | 2,719 |
| | 2,663 |
|
| Total operating revenue | | 8,493 |
| | 8,550 |
| | 8,910 |
|
| OPERATING EXPENSES | | | | | | | | | | |
| Cost of services and products (exclusive of depreciation and amortization) | 2,872 |
| | 2,879 |
| | 2,790 |
| 2,767 |
| | 2,881 |
| | 2,934 |
|
| Selling, general and administrative | 1,015 |
| | 1,086 |
| | 1,062 |
| 799 |
| | 925 |
| | 1,020 |
|
| Operating expenses - affiliates | 960 |
| | 756 |
| | 695 |
| 831 |
| | 848 |
| | 941 |
|
| Depreciation and amortization | 1,857 |
| | 2,005 |
| | 2,128 |
| 1,436 |
| | 1,583 |
| | 1,691 |
|
| Total operating expenses | 6,704 |
| | 6,726 |
| | 6,675 |
| 5,833 |
| | 6,237 |
| | 6,586 |
|
| OPERATING INCOME | 2,260 |
| | 2,112 |
| | 2,078 |
| 2,660 |
| | 2,313 |
| | 2,324 |
|
| OTHER (EXPENSE) INCOME | | | | | | | | | | |
| Interest expense | (473 | ) | | (464 | ) | | (450 | ) | (448 | ) | | (465 | ) | | (478 | ) |
| Interest expense - affiliates, net | (53 | ) | | (40 | ) | | (64 | ) | (57 | ) | | (63 | ) | | (59 | ) |
| Other (expense) income, net | (1 | ) | | 1 |
| | 2 |
| |
| Other income (expense), net | | 4 |
| | 6 |
| | (24 | ) |
| Total other expense, net | (527 | ) | | (503 | ) | | (512 | ) | (501 | ) | | (522 | ) | | (561 | ) |
| INCOME BEFORE INCOME TAX EXPENSE | 1,733 |
| | 1,609 |
| | 1,566 |
| 2,159 |
| | 1,791 |
| | 1,763 |
|
| Income tax expense | 659 |
| | 639 |
| | 602 |
| 494 |
| | 134 |
| | 678 |
|
| NET INCOME | $ | 1,074 |
| | 970 |
| | 964 |
| $ | 1,665 |
| | 1,657 |
| | 1,085 |
|
See accompanying notes to consolidated financial statements.
QWEST CORPORATION
CONSOLIDATED BALANCE SHEETS | | | | December 31, | December 31, |
| | 2015 | | 2014 | 2018 | | 2017 |
| | (Dollars in millions) | (Dollars in millions) |
| ASSETS | | | | | | |
| CURRENT ASSETS | | | | | | |
| Cash and cash equivalents | $ | 3 |
| | 6 |
| $ | 5 |
| | 1 |
|
| Accounts receivable, less allowance of $47 and $38 | 688 |
| | 740 |
| |
| Accounts receivable, less allowance of $41 and $47 | | 546 |
| | 646 |
|
| Advances to affiliates | 788 |
| | 812 |
| 1,148 |
| | 1,024 |
|
| Other | 123 |
| | 125 |
| 147 |
| | 98 |
|
| Total current assets | 1,602 |
| | 1,683 |
| 1,846 |
| | 1,769 |
|
| NET PROPERTY, PLANT AND EQUIPMENT | | | | | | |
| Property, plant and equipment | 12,182 |
| | 11,157 |
| 15,028 |
| | 14,316 |
|
| Accumulated depreciation | (4,808 | ) | | (3,956 | ) | (6,951 | ) | | (6,392 | ) |
| Net property, plant and equipment | 7,374 |
| | 7,201 |
| 8,077 |
| | 7,924 |
|
| GOODWILL AND OTHER ASSETS | | | | | | |
| Goodwill | 9,354 |
| | 9,354 |
| 9,360 |
| | 9,360 |
|
| Customer relationships, net | 2,435 |
| | 3,039 |
| 893 |
| | 1,362 |
|
| Other intangible assets, net | 613 |
| | 808 |
| 311 |
| | 379 |
|
| Other, net | 92 |
| | 100 |
| 96 |
| | 75 |
|
| Total goodwill and other assets | 12,494 |
| | 13,301 |
| 10,660 |
| | 11,176 |
|
| TOTAL ASSETS | $ | 21,470 |
| | 22,185 |
| $ | 20,583 |
| | 20,869 |
|
| LIABILITIES AND STOCKHOLDER'S EQUITY | | | | | | |
| CURRENT LIABILITIES | | | | | | |
| Current maturities of long-term debt | $ | 242 |
| | 117 |
| $ | 11 |
| | 17 |
|
| Accounts payable | 369 |
| | 464 |
| 441 |
| | 317 |
|
| Note payable - affiliate | 855 |
| | 796 |
| 1,008 |
| | 965 |
|
| Accrued expenses and other liabilities | | | | | | |
| Salaries and benefits | 211 |
| | 220 |
| 251 |
| | 238 |
|
| Income and other taxes | 189 |
| | 197 |
| 140 |
| | 174 |
|
| Interest | | 55 |
| | 77 |
|
| Other | 135 |
| | 140 |
| 75 |
| | 61 |
|
| Current affiliates obligations, net | 97 |
| | — |
| |
| Current affiliate obligations, net | | 79 |
| | 82 |
|
| Advance billings and customer deposits | 324 |
| | 327 |
| 212 |
| | 265 |
|
| Total current liabilities | 2,422 |
| | 2,261 |
| 2,272 |
| | 2,196 |
|
| LONG-TERM DEBT | 6,997 |
| | 7,152 |
| 5,948 |
| | 7,264 |
|
| DEFERRED CREDITS AND OTHER LIABILITIES | | | | | | |
| Deferred revenues | 137 |
| | 153 |
| |
| Deferred revenue | | 91 |
| | 128 |
|
| Deferred income taxes, net | 1,896 |
| | 2,085 |
| 1,098 |
| | 1,001 |
|
| Affiliates obligations, net | 1,051 |
| | 1,271 |
| |
| Affiliate obligations, net | | 759 |
| | 861 |
|
| Other | 60 |
| | 80 |
| 547 |
| | 82 |
|
| Total deferred credits and other liabilities | 3,144 |
| | 3,589 |
| 2,495 |
| | 2,072 |
|
| COMMITMENTS AND CONTINGENCIES (Note 15) |
| |
|
| |
|
| STOCKHOLDER'S EQUITY | | | | | | |
| Common stock - one share without par value, owned by Qwest Services Corporation | 10,050 |
| | 10,050 |
| 10,050 |
| | 10,050 |
|
| Accumulated deficit | (1,143 | ) | | (867 | ) | (182 | ) | | (713 | ) |
| Total stockholder's equity | 8,907 |
| | 9,183 |
| 9,868 |
| | 9,337 |
|
| TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY | $ | 21,470 |
| | 22,185 |
| $ | 20,583 |
| | 20,869 |
|
See accompanying notes to consolidated financial statements.
QWEST CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | Years Ended December 31, | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| OPERATING ACTIVITIES | | | | | | | | | | |
| Net income | $ | 1,074 |
| | 970 |
| | 964 |
| $ | 1,665 |
| | 1,657 |
| | 1,085 |
|
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | |
| Depreciation and amortization | 1,857 |
| | 2,005 |
| | 2,128 |
| 1,436 |
| | 1,583 |
| | 1,691 |
|
| Deferred income taxes | (189 | ) | | (228 | ) | | (152 | ) | 48 |
| | (773 | ) | | (123 | ) |
| Provision for uncollectible accounts | 78 |
| | 64 |
| | 65 |
| 60 |
| | 74 |
| | 80 |
|
| Net long-term debt issuance costs and premium amortization | (18 | ) | | (38 | ) | | (51 | ) | 1 |
| | (2 | ) | | (12 | ) |
| Accrued interest on affiliate note | 59 |
| | 42 |
| | — |
| 43 |
| | 51 |
| | 59 |
|
| Net loss on early retirement of debt | | 30 |
| | 5 |
| | 27 |
|
| Impairment of asset | — |
| | 17 |
| | — |
| — |
| | 1 |
| | 11 |
|
| Changes in current assets and liabilities: | | | | | | | | | | |
| Accounts receivable | (26 | ) | | (66 | ) | | (94 | ) | 40 |
| | (20 | ) | | (92 | ) |
| Accounts payable | (79 | ) | | (9 | ) | | (1 | ) | 69 |
| | (44 | ) | | 5 |
|
| Accrued income and other taxes | (8 | ) | | (9 | ) | | (9 | ) | (34 | ) | | (1 | ) | | (14 | ) |
| Other current assets and liabilities, net | 1 |
| | 34 |
| | 34 |
| 40 |
| | (36 | ) | | 47 |
|
| Other current assets and liabilities - affiliates | (4 | ) | | 9 |
| | — |
| 8 |
| | 11 |
| | — |
|
| Changes in other noncurrent assets and liabilities, net | (30 | ) | | 1 |
| | — |
| 473 |
| | 17 |
| | 1 |
|
| Changes in affiliate obligations, net | (123 | ) | | 8 |
| | (179 | ) | (105 | ) | | (88 | ) | | (117 | ) |
| Other, net | (1 | ) | | 1 |
| | 8 |
| 17 |
| | — |
| | 4 |
|
| Net cash provided by operating activities | 2,591 |
| | 2,801 |
| | 2,713 |
| 3,791 |
| | 2,435 |
| | 2,652 |
|
| INVESTING ACTIVITIES | | | | | | | | | | |
| Payments for property, plant and equipment and capitalized software | (1,247 | ) | | (1,165 | ) | | (1,264 | ) | (1,040 | ) | | (1,328 | ) | | (1,259 | ) |
| Changes in advances to affiliates | 24 |
| | (100 | ) | | (119 | ) | (119 | ) | | (152 | ) | | (84 | ) |
| Proceeds from sale of property | 3 |
| | 14 |
| | 2 |
| 6 |
| | 49 |
| | 9 |
|
| Cash paid for acquisition | | — |
| | (5 | ) | | — |
|
| Net cash used in investing activities | (1,220 | ) | | (1,251 | ) | | (1,381 | ) | (1,153 | ) | | (1,436 | ) | | (1,334 | ) |
| FINANCING ACTIVITIES | | | | | | | | | | |
| Net proceeds from issuance of long-term debt | 495 |
| | 483 |
| | 752 |
| — |
| | 638 |
| | 1,173 |
|
| Payments of long-term debt | (517 | ) | | (641 | ) | | (806 | ) | (1,359 | ) | | (641 | ) | | (1,189 | ) |
| Early retirement of debt costs | (2 | ) | | — |
| | — |
| |
| Dividends paid to Qwest Services Corporation | (1,350 | ) | | (1,400 | ) | | (1,325 | ) | (1,275 | ) | | (1,000 | ) | | (1,300 | ) |
| Changes in note payable - affiliate | — |
| | — |
| | 53 |
| |
| Net cash used in financing activities | (1,374 | ) | | (1,558 | ) | | (1,326 | ) | (2,634 | ) | | (1,003 | ) | | (1,316 | ) |
| Net (decrease) increase in cash and cash equivalents | (3 | ) | | (8 | ) | | 6 |
| |
| Cash and cash equivalents at beginning of period | 6 |
| | 14 |
| | 8 |
| |
| Cash and cash equivalents at end of period | $ | 3 |
| | 6 |
| | 14 |
| |
| Net increase (decrease) in cash, cash equivalents and restricted cash | | 4 |
| | (4 | ) | | 2 |
|
| Cash, cash equivalents and restricted cash at beginning of period | | 3 |
| | 7 |
| | 5 |
|
| Cash, cash equivalents and restricted cash at end of period | | $ | 7 |
| | 3 |
| | 7 |
|
| | | | | | | |
| Supplemental cash flow information: | | | | | | | | | | |
| Income taxes paid, net | $ | (848 | ) | | (861 | ) | | (750 | ) | |
| Interest paid (net of capitalized interest of $18, $17 and $17) | $ | (497 | ) | | (505 | ) | | (513 | ) | |
| Income taxes refunded (paid), net | | $ | 8 |
| | (907 | ) | | (801 | ) |
| Interest paid (net of capitalized interest of $24, $32 and $19) | | $ | (466 | ) | | (467 | ) | | (488 | ) |
| | | | | | | |
|
| | | | | | | | | |
| Cash, cash equivalents and restricted cash: | | | | | |
| Cash and cash equivalents | $ | 5 |
| | 1 |
| | 5 |
|
| Restricted cash - noncurrent | 2 |
| | 2 |
| | 2 |
|
| Total | $ | 7 |
| | 3 |
| | 7 |
|
See accompanying notes to consolidated financial statements.
QWEST CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
| | | | Years Ended December 31, | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| COMMON STOCK | | | | | | | | | | |
| Balance at beginning of period | $ | 10,050 |
| | 10,050 |
| | 10,050 |
| $ | 10,050 |
| | 10,050 |
| | 10,050 |
|
| Balance at end of period | 10,050 |
| | 10,050 |
| | 10,050 |
| 10,050 |
| | 10,050 |
| | 10,050 |
|
| ACCUMULATED DEFICIT | | | | | | | | | | |
| Balance at beginning of period | (867 | ) | | (437 | ) | | (76 | ) | (713 | ) | | (1,358 | ) | | (1,143 | ) |
| Net income | 1,074 |
| | 970 |
| | 964 |
| 1,665 |
| | 1,657 |
| | 1,085 |
|
Cumulative net effect of adoption of ASU 2014-09, Revenue from Contracts with Customers, net of ($49), $—, and $— taxes | | 141 |
| | — |
| | — |
|
| Dividends declared to Qwest Services Corporation | (1,350 | ) | | (1,400 | ) | | (1,325 | ) | (1,275 | ) | | (1,000 | ) | | (1,300 | ) |
| Dividend of equity interest in limited liability company to Qwest Services Corporation | | — |
| | (12 | ) | | — |
|
| Balance at end of period | (1,143 | ) | | (867 | ) | | (437 | ) | (182 | ) | | (713 | ) | | (1,358 | ) |
| TOTAL STOCKHOLDER'S EQUITY | $ | 8,907 |
| | 9,183 |
| | 9,613 |
| $ | 9,868 |
| | 9,337 |
| | 8,692 |
|
See accompanying notes to consolidated financial statements.
QWEST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unless the context requires otherwise, references in this annual report to "QC" refer to Qwest Corporation, references to "Qwest," "we," "us," and "our" refer to Qwest Corporation and its consolidated subsidiaries, references to "QSC" refer to our direct parent company, Qwest Services Corporation, and its consolidated subsidiaries, references to "QCII" refer to QSC's direct parent company and our indirect parent company, Qwest Communications International Inc., and its consolidated subsidiaries, and references to "CenturyLink" refer to QCII's direct parent company and our ultimate parent company, CenturyLink, Inc., and its consolidated subsidiaries.
| |
| (1) | Basis of PresentationBackground and Summary of Significant Accounting Policies |
Basis of Presentation
General
We are an integrated communications company engaged primarily in providing ana broad array of communications services to our residentialbusiness and businessresidential customers. Our communicationsspecific products and services include local voice, high-speed Internet, private line (including special access), network access, Ethernet, information technology, wireless, videoare detailed under the heading "Operations - Products and other ancillary services. In certain local and regional markets, we also provide local access and fiber transport services to competitive local exchange carriers.Services" in Item 1 of Part I of this report.
We generate the majority of our total consolidated operating revenuesrevenue from services provided in the 14-state region of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming. We refer to this region as our local service area.
On April 1, 2011, our indirect parent QCII became a wholly-owned subsidiary of CenturyLink, Inc. in a tax-free, stock-for-stock transaction.
Basis of Presentation
The accompanying consolidated financial statements include our accounts and the accounts of our subsidiaries. Intercompany amounts and transactions with our consolidated subsidiaries have been eliminated. Transactions with our non-consolidated affiliates (referred to herein as affiliates) have not been eliminated.
In 2015, our ultimate parent company, CenturyLink, Inc. ("CenturyLink"), changed their allocation methodology with respect
We reclassified certain prior period amounts to their now centrally managed pensionconform to the current period presentation. See Note 12—Products and post-retirement plans. Specifically, under this new methodology, CenturyLink will allocate current service costs to subsidiaries relative to employees which are currently earning benefits under the pension and post-retirement benefit plans. The net periodic benefit cost allocated to us is now paid on a monthly basis through CenturyLink’s intercompany cash management process. The change in methodology resulted in a decrease of $7 million to our net periodic benefit costServices Revenue for the year ended December 31, 2015.
Changes in Estimates
As a result of our annual reviews to evaluate the reasonableness of the depreciable lives for our property, plant and equipment, effective January 2014, we changed the estimates of the remaining economic lives of certain switch and circuit network equipment.additional information. These changes resulted in an increase in depreciation expense of approximately $20 million for the year ended December 31, 2014. This increase in depreciation expense, net of tax, reduced consolidatedhad no impact on total operating revenue, total operating expenses or net income by approximately $12 million for the year ended December 31, 2014.any period presented.
Connect America Fund
In August of 2015, CenturyLink accepted funding from the Federal Communications Commission's ("FCC") Connect America Fund ("CAF") of approximately $500 million per year for six years to fund the deployment of voice and high-speed Internet infrastructure for approximately 1.2 million rural households and businesses in 33 states under the CAF Phase 2 high-cost support program. The funding from the CAF Phase 2 support program in these 33 states will substantially supplant funding from the interstate Universal Service Fund ("USF") high-cost program that we previously utilized to support voice services in high-cost rural markets. Of these amounts, approximately $150 million is attributable to our service area, to provide service to approximately 0.3 million rural households and businesses in 13 states. In September of 2015, we began receiving these support payments from the FCC under the new CAF Phase 2 support program, which included (i) monthly support payments at a higher rate than under the interstate USF support program and (ii) a one-time cumulative catch-up payment representing the incrementally higher funding under the CAF Phase 2 support program over the interstate USF support program for the first seven months of 2015. During 2015, we recorded $95 million more revenue than we would have otherwise recorded during the same period under the interstate USF support program.
Summary of Significant Accounting Policies
Use of Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions we make when accounting for specific items and matters, including, but not limited to, revenue recognition, revenue reserves, network access costs, network access cost dispute reserves, investments, long-term contracts, customer retention patterns, allowance for doubtful accounts, depreciation, amortization, asset valuations, rates used for affiliate cost allocations, internal labor capitalization rates, recoverability of assets (including deferred tax assets), impairment assessments, pension, post-retirement and other post-employment benefits, taxes, certain liabilities and other provisions and contingencies, are reasonable, based on information available at the time they are made. Our accounting for CenturyLink's indirect acquisition of us required extensive use of estimates in determining the acquisition date fair values of our assets and liabilities. These estimates, judgments and assumptions can materially affect the reported amounts of assets, liabilities and components of stockholder's equity or deficit as of the dates of the consolidated balance sheets, as well as the reported amounts of revenues,revenue, expenses and components of cash flows during the periods presented in our other consolidated financial statements. We also make estimates in our assessments of potential losses in relation to threatened or pending tax and legal matters. See Note 11—Income Taxes and Note 15—Commitments, Contingencies and ContingenciesOther Items for additional information.
For matters not related to income taxes, if a loss is considered probable and the amount can be reasonably estimated, we recognize an expense for the estimated loss. If we have the potential to recover a portion of the estimated loss from a third party, we make a separate assessment of recoverability and reduce the estimated loss if recovery is also deemed probable.
For matters related to income taxes, if we determine that the impact of an uncertain tax position is more likely than not to be sustained upon audit by the relevant taxing authority, then we recognize a benefit for the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest is recognized on the amount of unrecognized benefit from uncertain tax positions.
For all of these and other matters, actual results could differ materially from our estimates.
Revenue Recognition
We earn most of our consolidated revenue from contracts with customers, primarily through the provision of telecommunications and other services. Revenue from contracts with customers is accounted for under Accounting Standards Codification ("ASC") 606. We also earn revenue from leasing arrangements and governmental subsidy payments, neither of which are accounted for under ASC 606.
Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to receive in exchange for those goods or services. Revenue is recognized based on the following five-step model:
Identification of the contract with a customer;
Identification of the performance obligations in the contract;
Determination of the transaction price;
Allocation of the transaction price to the performance obligations in the contract; and
Recognition of revenue when, or as, we satisfy a performance obligation.
We provide an array of communications services to residential and business customers, including local voice, VPN, Ethernet, data, broadband, private line (including special access), network access, transport, voice, information technology, video and other ancillary services. We provide these services to a wide range of businesses, including global/international, enterprise, wholesale, government, small and medium business customers. Certain contracts also include the sale of equipment, which is not significant to our business.
We recognize revenue for services when we provide the related services are provided.applicable service or when control is transferred. Recognition of certain payments received in advance of services being provided is deferred until the service is provided.deferred. These advance payments include certain activation and certain installation charges. If the activation and installation charges whichare not separate performance obligations, we recognize them as revenue over the actual or expected customer relationship period,contract term using historical experience, which ranges from eighteen monthsone year to over tenseven years depending on the service. We also defer costs for customer activations and installations. The deferral of customer activation and installation costs is limited to the amount of revenue deferred on advance payments. Costs in excess of advance payments are recorded as expense in the period such costs are incurred. Expected customer relationship periods are estimated using historical experience. In most cases, termination fees or other fees on existing contracts that are negotiated in conjunction with new contracts are deferred and recognized over the new contract term.
We offer bundle discounts
For access services, we generally bill fixed monthly charges one month in advance to our customers who receive certain groupings of services. These bundle discounts are recognized concurrentlyand recognize revenue as service is provided over the contract term in alignment with the associatedcustomer's receipt of service. For usage and other ancillary services, we generally bill in arrears and recognize revenue as usage or delivery occurs.
In certain cases, customers may be permitted to modify their contracts. We evaluate the change in scope or price to identify whether the modification should be treated as a separate contract, whether the modification is a termination of the existing contract and are allocatedcreation of a new contract, or if it is a change to the various services in the bundled offering based on the estimated selling price of services included in each bundled combination.existing contract.
Customer arrangements that include both equipment and servicescontracts are evaluated to determine whether the elementsperformance obligations are separable. If the elementsperformance obligations are deemed separable and separate earnings processes exist, the revenue associatedtotal transaction price that we expect to receive with the customer arrangement is allocated to each elementperformance obligation based on theits relative estimatedstandalone selling price of the separate elements. We have estimated the selling prices of each element by reference to vendor-specific objective evidence of selling prices when the elements are sold separately.price. The revenue associated with each elementperformance obligation is then recognized as earned. For example, if we receive an advance payment when we sell equipment and continuing service together, we immediately recognize as revenue the amount allocated to the equipment as long as all the conditions for revenue recognition have been satisfied. The portion of the advance payment allocated to the service based upon its relative selling price is recognized ratably over the longer of the contractual period or the expected customer relationship period.
We periodically transfersell optical capacity assets on our network to other telecommunications service carriers.network. These transactions are structured as indefeasible rights of use, commonly referred to as IRUs, which are the exclusive right to use a specified amount of capacity or fiber for a specified term, typically 10 to 20 years. Weyears. In most cases, we account for the cash consideration received on transfers of optical capacity assets and on allas ASC 606 revenue which we recognize ratably over the term of the other elements deliverable under an IRU,agreement. Cash consideration received on transfers of dark fiber is adjusted for the time value of money and is accounted for as non-ASC 606 lease revenue, which we also recognize ratably over the term of the agreement. We havedo not recognizedrecognize revenue on any contemporaneous exchanges of our optical capacity assets for other non-owned optical capacity assets.
In connection with offering products and services provided to the end user by third-party vendors, we review the relationship between us, the vendor and the end customeruser to assess whether revenue should be reported on a gross or net basis. In assessing whether revenue should be reported on a gross or net basis, we consider whether we act as a principal in the transaction take titleand control the goods and services used to fulfill the products,performance obligations associated with the transaction.
We have riskservice level commitments pursuant to contracts with certain of our customers. To the extent that such service levels are not achieved or are otherwise disputed due to performance or service issues or other service interruptions or conditions, we will estimate the amount of credits to be issued and rewards of ownership or act as an agent or broker. Basedrecord a corresponding reduction to revenue in the period that the service level commitment was not met.
Customer payments are made based on CenturyLink's agreements with DIRECTV and Verizon Wireless, we offer these services through sales agency relationshipsbilling schedules included in our customer contracts, which are reportedis typically on a netmonthly basis.
We defer (i.e. capitalize) incremental contract acquisition and fulfillment costs and recognize (or amortize) such costs over the average customer life. Our deferred contract costs for our customers have average amortization periods of approximately 30 months for consumer and up to 49 months for business. These deferred costs are monitored every period to reflect any significant change in assumptions.
See Note 3—Revenue Recognition for additional information.
Affiliate Transactions
We provide to our affiliates telecommunications services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support services. Services provided by us to our affiliates are recognized as operating revenue-affiliates in our consolidated statements of operations. We also purchase services from our affiliates including telecommunications services, marketing and employee-related support services. Services provided to us from our affiliates are recognized as operating expenses-affiliates on our consolidated statements of operations. Because of the significance of the services we provide to our affiliates and our affiliates provide to us, the results of operations, financial position and cash flows presented herein are not necessarily indicative of the results of operations, financial position and cash flows we would have achieved had we operated as a stand-alone entity during the periods presented.
We recognize intercompany charges at the amounts billed to us by our affiliates and we recognize intercompany revenue for services we bill to our affiliates. Regulatory rules require certain revenuesrevenue and expenses to be recorded at market price or fully distributed cost. Our compliance with regulations is subject to review by regulators. Adjustments to intercompany charges that result from these reviews are recorded in the period they become known.
CenturyLink has cash management arrangements between certain of its subsidiaries that include lines of credit, affiliate obligations, capital contributions and dividends. As part of these cash management arrangements, an affiliate provides lines of credit to certain other affiliates. Amounts outstanding under these lines of credit and intercompany obligations vary from time to time. Under these arrangements, the majority of our cash balance is transferred on a daily basis tofor centralized management by CenturyLink and most affiliate transactions are deemed to be settled at the time the transactions are recorded in our accounting records, with the resulting net balance at the end of each period reflected as advances to affiliates on the accompanying consolidated balance sheets. From time to time we declare and pay dividends to our parent, QSC, which are settled through the advances to affiliates, which has the net effect of reducing the amount of these advances. Dividends declared are reflected on our consolidated statements of stockholder's equity and the consolidated statements of cash flows reflects the changes in advances to affiliates as investing activities and changes in advances from affiliates as financing activities. Interest is assessed on the advances to/from affiliates on either the three-month U.S T-bill rate (for advances to affiliates) or CenturyLink’s weighted average borrowing rate (for advances from affiliates).
The affiliatesaffiliate obligations, net in current and noncurrent liabilities on our consolidated balance sheets primarily represents the cumulative allocation of expense, net of payments, associated with QCII’s pension plans and post-retirement benefits plans prior to the plan mergers. In 2015, we agreed to a plan to settle the outstanding affiliate obligations, net balance with QCII over a 30 year term. Payments willUnder the plan, payments are scheduled to be made on a monthly basis. For the yearyears ended December 31, 2015,2018 and 2017, we made a settlement paymentpayments of $105$87 million for both periods to QCII on our affiliate obligations, net balance.in accordance with the plan. Changes in the affiliatesaffiliate obligations, net are reflected in operating activities on our consolidated statements of cash flows.
In the normal course of business, we transfer assets to and from various affiliates through our parent, QSC, which are recorded through our equity. It is our policy to record asset transfers based on carrying values.
USF Surcharges, Gross Receipts Taxes and Other Surcharges
In determining whether to include in our revenuesrevenue and expenses the taxes and surcharges collected from customers and remitted to government authorities, including USF charges,surcharges, sales, use, value added and some excise taxes, we assess, among other things, whether we are the primary obligor or principal taxpayer for the taxes assessed in each jurisdiction where we do business. In jurisdictions where we determine that we are the principal taxpayer, we record the surcharges on a gross basis and include them in our revenuesrevenue and costs of services and products.
In jurisdictions where we determine that we are merely a collection agent for the government authority, we record the taxes on a net basis and do not include them in our revenuesrevenue and costs of services and products.
Advertising Costs
Costs related to advertising are expensed as incurred and included in selling, general and administrative expenses in our consolidated statements of operations. Our advertising expense was $84$58 million, $83$139 million and $88$91 million for the years ended December 31, 2015, 20142018, 2017 and 2013,2016, respectively.
Legal Costs
In the normal course of our business, we incur costs to hire and retain external legal counsel to advise us on regulatory, litigation and other matters. We expense these costs as the related services are received.
Income Taxes
Our results are included in the CenturyLink consolidated federal income tax return and certain combined state income tax returns. CenturyLink allocates income tax expense to us based upon a separate return allocation method which results in income tax expense that approximates the expense that would result if we were a stand-alone entity. Our reported deferred tax assets and liabilities, as discussed below and in Note 11—Income Taxes, are primarily determined as a result of the application of the separate return allocation method and therefore the settlement of these amounts is dependent upon our parent, CenturyLink, rather than tax authorities. Our current expectation is that the vast majority of deferred tax assets and liabilities will be settled through our general intercompany obligation based upon the current CenturyLink policy. CenturyLink has the right to change their policy regarding settlement of these assets and liabilities at any time.
The provision for income taxes consists of an amount for taxes currently payable, an amount for tax consequences deferred to future periods and adjustments to our liabilities for uncertain tax positions. We record deferred income tax assets and liabilities reflecting future tax consequences attributable to differences between the financial statement carrying value of assets and liabilities and the tax bases of those assets and liabilities. Deferred taxes are computed using enacted tax rates expected to apply in the year in which the differences are expected to affect taxable income. The effect on deferred income tax assets and liabilities of a change in tax rate is recognized in earnings in the period that includes the enactment date.
We establish valuation allowances when necessary to reduce deferred income tax assets to the amounts that we believe are more likely than not to be recovered. Each quarter we evaluate the need to retain all or a portion of the valuation allowance on our deferred tax assets. See Note 11—Income Taxes for additional information.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments that are readily convertible into cash and are not subject to significant risk from fluctuations in interest rates. As a result, the value at which cash and cash equivalents are reported in our consolidated financial statements approximates their fair value. Our cash collections are transferred to CenturyLink on a daily basis and our ultimate parent funds our cash disbursement needs. The net cash transferred to CenturyLink has been reflected as advances to affiliates in our consolidated balance sheets.
Book overdrafts occur when checks have been issued but have not been presented to our controlled disbursement bank accounts for payment. Disbursement bank accounts allow us to delay funding of issued checks until the checks are presented for payment. Until the issued checks are presented for payment, the book overdrafts are included in accounts payable on our consolidated balance sheet. This activity is included in the operating activities section in our consolidated statements of cash flows.
Restricted Cash and Securities
Restricted cash and securities consists primarily of cash and investments that serve to collateralize certain performance and operating obligations. Restricted cash and securities are recorded as current and non-current assets in the consolidated balance sheets depending on the duration of the restriction and the purpose for which the restriction exists. Restricted securities are stated at cost which approximates fair value as of December 31, 2018 and 2017.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recognized based upon the amount due from customers for the services provided or at cost for purchased and other receivables less an allowance for doubtful accounts. The allowance for doubtful accounts receivable reflects our best estimate of probable losses inherent in our receivable portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available evidence. We generally consider our accounts past due if they are outstanding over 30 days.days. Our collection process varies by the customer segment, amount of the receivable, and our evaluation of the customer's credit risk. Our past due accounts are written off against our allowance for doubtful accounts when collection is considered to be not probable. Any recoveries of accounts previously written off are generally recognized as a reduction in bad debt expense in the period received. The carrying value of accounts receivable, net of the allowance for doubtful accounts, approximates fair value.
Property, Plant and Equipment
As a result of our indirect acquisition by CenturyLink, property, plant and equipment acquired at the time of acquisition was recorded based on its estimated fair value as of the acquisition date. Subsequently purchased and constructed property, plant and equipment isare recorded at cost. Property, plant and equipment is depreciated primarily using the straight-line group method. Under the straight-line group method, assets dedicated to providing telecommunications services (which comprise the majority of our property, plant and equipment) that have similar physical characteristics, use and expected useful lives are pooled for purposes of depreciation and tracking. The equal life group procedure is used to establish each pool's average remaining useful life. Generally, under the straight-line group method, when an asset is sold or retired in the course of normal business activities, the cost is deducted from property, plant and equipment and charged to accumulated depreciation without recognition of a gain or loss. A gain or loss is recognized in our consolidated statements of operations only if a disposal is abnormal or unusual. Leasehold improvements are amortized over the shorter of the useful lives of the assets or the expected lease term. Expenditures for maintenance and repairs are expensed as incurred. Interest is capitalized during the construction phase of network and other internal-use capital projects. Employee-related costs for construction of network and other internal use assets are also capitalized during the construction phase. Property, plant and equipment supplies used internally are carried at average cost, except for significant individual items for which cost is based on specific identification.
We perform annual internal reviews to evaluate the reasonableness of the depreciable lives for our property, plant and equipment. Our reviews utilize models that take into account actual usage, physical wear and tear, replacement history, assumptions about technology evolution and, in certain instances, actuarially determined probabilities to estimate the remaining useful life of our asset base. Our remaining useful life assessments anticipate the loss in service value of assets that may precede the physical retirement. Assets shared among many customers may lose service value as those customers leave the network. However, the asset is not retired until all customers no longer utilize the asset and we determine there is no alternative use for the asset.
We review long-lived tangible assets for impairment whenever facts and circumstances indicate that the carrying amounts of the assets may not be recoverable. For assessment purposes, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities, absent a material change in operations. An impairment loss is recognized only if the carrying amount of the asset group is not recoverable and exceeds its estimated fair value. Recoverability of the asset group to be held and used is assessed by comparing the carrying amount of the asset group to the estimated undiscounted future net cash flows expected to be generated by the asset group. If the asset group's carrying value is not recoverable, we recognize an impairment charge is recognized for the amount by which the carrying amount of the asset group exceeds its estimated fair value. We determine fair values by using a combination of comparable market values and discounted cash flows, as appropriate.
Goodwill, Customer Relationships and Other Intangible Assets
Intangible assets arising from business combinations, such as goodwill, customer relationships and capitalized software are initially recorded at estimated fair value. We amortize customer relationships primarily over an estimated life of ten years, using either the sum-of-the-years-digits or the straight-line methods, depending on the type of customer. We amortize capitalized software using the straight-line method over estimated lives ranging up to seven years.years. Other intangible assets not arising from business combinations are initially recorded at cost.
Internally used software, whether purchased or developed by us, is capitalized and amortized using the straight-line method over its estimated useful life. We have capitalized certain costs associated with software such as costs of employees devoting time to the projects and external direct costs for materials and services. Costs associated with software to be used for internal purposes are expensed until the point at which the project has reached the development stage. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task it previously did not perform. Software maintenance, data conversion and training costs are expensed in the period in which they are incurred. We review the remaining economic lives of our capitalized software annually. Capitalized software is included in other intangible assets, net, in our consolidated balance sheets.
We are required to assess goodwill for impairment at least annually, or more frequently, if an event occurs or circumstances change that would indicate an impairment may have occurred. We are required to write-down the value of goodwill in periods in which the recordedcarrying amount of goodwillthe reporting unit equity exceeds the impliedestimated fair value of goodwill.the equity of the reporting unit limited to the goodwill balance. The impairment assessment is performed annually at the reporting unit level. We have determined that our operations consist of one reporting unit, consistent with our determination that our business consists of one operating segment. See Note 2—Goodwill, Customer Relationships and Other Intangible Assets for additional information.
Pension and Post-Retirement Benefits
A substantial portion of our active and retired employees participate in the CenturyLink Combined Pension Plan. On December 31, 2014, the QCII pension plan and a pension plan of an affiliate were merged into the CenturyLink Retirement Plan. The CenturyLink Retirement Plan was renamed the CenturyLink Combined Pension Plan. Prior to the pension plan merger, the above-noted employees participated in the QCII pension plan. In addition, certain of our employees may become eligible to participate in CenturyLink's post-retirement health care and life insurance benefit plans. CenturyLink allocates service costs relating to pension and post-retirement health care and life insurance benefits to us and its other affiliates. The amounts contributed by us through CenturyLink are not segregated or restricted to pay amounts due to our employees and may be used to provide benefits to other employees of CenturyLink. The allocation of the service costs to us is based upon our employees who are currently earning benefits under the plans.
For further information on qualified pension, post-retirement and other post-employment benefit plans, see CenturyLink's Annual Reportannual report on Form 10-K for the year ended December 31, 2015.2018.
Recently Adopted Accounting Pronouncements
In 2015,2018, we adopted Accounting Standards Update (“ASU”) 2015-03 “Simplifying the Presentation of Debt Issuance Costs” (ASU 2015-03) and ASU 2015-17 “Balance Sheet Classification of Deferred Taxes” (ASU 2015-17). Both ASUs are intended to simplify the presentation of financial information. ASU 2015-03 requires that debt issuance costs be presented as a reduction in the associated debt rather than as an other asset, net. ASU 2015-17 requires that deferred taxes be presented on a net basis by jurisdiction as either a net noncurrent asset or liability. The ASUs affect neither the timing of expense recognition related to the debt issuance costs nor the timing of income and expense recognition related to deferred income taxes.
We adopted both ASU 2015-03 and 2015-17 by retrospectively applying the requirements of the ASUs to our previously issued consolidated financial statements. The retrospective application had no impact on our net income for the years ended December 31, 2014 and 2013, but resulted in the following changes in our previously reported consolidated balance sheet as of December 31, 2014:
A decrease of $163 million in Total current assets;
A decrease of $109 million in Other assets, net;
A decrease of $110 million in Long-term debt; and
A decrease of $162 million in Deferred income taxes, net.
The adoption of the ASUs had no impact on our net cash provided by operating activities but did change the presentation of the adjustments to reconcile net income and changes in other noncurrent assets and liabilities, net for the years ended December 31, 2014 and 2013.
Recent Accounting Pronouncements
Leases
On February 25, 2016, the FASB issued ASU 2016-02, “2014-09, Leases” (“ASU 2016-02”). The core principle of ASU 2016-02 will require lessees to present right-of-use assets and lease liabilities on their balance sheets.
ASU 2016-02 is effective for annual and interim periods beginning January 1, 2019. Early adoption of ASU 2016-02 is permitted. Upon adoption of ASU 2016-02, we are required to recognize and measure leases at the beginning of the earliest period presented in our consolidated financial statements using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that we may elect to apply. We have not yet decided when we will adopt ASU 2016-02 or which practical expedient options we will elect. We are currently evaluating and assessing the impact ASU 2016-02 will have on us and our consolidated financial statements. As of the date of this Annual Report, we cannot provide any estimate of the impact of adopting ASU 2016-02.
“Revenue Recognition
On May 28, 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“, ASU 2014-09” or “new standard”2016-16, “Intra-Entity Transfers of Assets Other Than Inventory” and ASU 2017-04, "Simplifying the Test for Goodwill Impairment".
Each of these is described further below.
Revenue Recognition
In May 2014, the Financial Accounting Standards Board ("FASB"). The new standard issued Accounting Standards Update ("ASU") ASU 2014-09 which replaces virtually all existing generally accepted accounting principles (“GAAP”) on revenue recognition and replaces them with a principles-based approach for determining revenue recognition using a new five step model. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also includes new accounting principles related to the deferral and amortization of contract acquisition and fulfillment costs.
We currently do not defer any contract acquisition costs and defer contract fulfillment costs only up toadopted the extent of anynew revenue deferred.
On July 9, 2015, the FASB approved the deferral of the effective date of ASU 2014-09 by one year untilrecognition standard on January 1, 2018. Early adoption is permitted2018 using the modified retrospective transition method applying the rules to all open contracts existing as of January 1, 2017.2018. During the year ended December 31, 2018, we recorded a cumulative catch-up adjustment that increased our retained earnings by $141 million, net of $49 million of income taxes.
See Note 3—Revenue Recognition for additional information.
Income Taxes
In October 2016, the FASB issued ASU 2014-09 may2016-16, “Intra-Entity Transfers of Assets Other Than Inventory” ("ASU 2016-16"). ASU 2016-16 eliminates the current prohibition on the recognition of the income tax effects on the transfer of assets among our subsidiaries. After adoption of ASU 2016-16, the income tax effects associated with these asset transfers, except for the transfer of inventory, will be recognized in the period the asset is transferred versus the current deferral and recognition upon either the sale of the asset to a third party or over the remaining useful life of the asset. We adopted ASU 2016-16 on January 1, 2018. The adoption of ASU 2016-16 did not have a material impact to our consolidated financial statements.
Goodwill Impairment
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 simplifies the impairment testing for goodwill by applyingchanging the measurement for goodwill impairment. Under current rules, we are required to compute the fair value of goodwill to measure the impairment amount if the carrying value of a reporting unit exceeds its fair value. Under ASU 2017-04, the goodwill impairment charge will equal the excess of the reporting unit carrying value above fair value, limited to the amount of goodwill assigned to the reporting unit.
We elected to early adopt the provisions of ASU 2017-04 as of October 1, 2018.
Recently Issued Accounting Pronouncements
Financial Instruments
In June 2016, the new standardFASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). The primary impact of ASU 2016-13 for us is a retrospective basis to the periods includedchange in the financial statements or on a modified retrospective basis which would result inmodel for the recognition of credit losses related to our financial instruments from an incurred loss model, which recognized credit losses only if it was probable that a loss had been incurred, to an expected loss model, which requires our management team to estimate the total credit losses expected on the portfolio of financial instruments. We are currently reviewing the requirements of the standard and evaluating the impact on our consolidated financial statements.
We are required to adopt the provisions of ASU 2016-13 effective January 1, 2020, but could elect to early adopt the provisions as of January 1, 2019. We expect to adopt ASU 2016-13 on January 1, 2020 and recognize the impacts through a cumulative effectadjustment to retained earnings as of adoptingthe date of adoption.
Leases
In February 2016, the FASB issued ASU 2014-092016-02, “Leases” (“ASU 2016-02”), and associated ASUs related to ASU 842, Leases, which require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. In addition, the new guidance will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. For leases where we are a lessee, the presentation and measurement of the assets and liabilities will depend on each lease’s classification as either a finance or operating lease. For leases where we are a lessor, the accounting remains largely unchanged from current U.S. GAAP but does contain some targeted improvements to align with the new revenue recognition guidance issued in 2014 (ASC 606). The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.
We have a cross-functional team in place to evaluate and implement the new guidance and we have substantially completed the implementation of third-party software solutions to facilitate compliance with accounting and reporting requirements. The team continues to review existing lease arrangements and has collected and loaded a significant portion of our lease portfolio into the software. We continue to enhance accounting systems and update business processes and controls related to the new guidance for leases. Collectively, these activities are expected to facilitate our ability to meet the new accounting and disclosure requirements upon adoption in the first quarter of 2017, if adopting early, otherwise2019.
ASU 2016-02 requires a modified retrospective transition approach, applying the new standard to all leases existing at the date of initial adoption. An entity may choose to use either (1) the effective date or (2) the beginning of the earliest comparative period presented in the financial statements at the date of initial application. We will apply the transition requirements at the January 1, 2019 effective date by showing a cumulative effect adjustment in the first quarter of 2018. We have not yet decided which implementation method2019, rather than restating any prior periods. In addition, we will adopt. We are studyingelect the new standardpackage of practical expedients permitted under the transition guidance, which does not require reassessment of prior conclusions related to contracts containing a lease, lease classification and initial direct lease costs. As an accounting policy election, we will exclude short-term leases (term of 12 months or less) from the balance sheet presentation and will account for non-lease and lease components in a contract as a single lease component for most asset classes.
We are in the early stagesprocess of assessingcompleting our adoption of ASU 2016-02, including reviewing our lease portfolio, completing the implementation and testing of the third-party software solution and exercising internal controls over adoption and implementation of ASU 2016-02. Therefore, the estimated impact on our consolidated balance sheet cannot currently be determined. However, we expect the adoption of ASU 2016-02 will have a material impact on our consolidated balance sheet through the recognition of right of use assets and lease liabilities for our operating leases. The impact to our consolidated statements of operations and consolidated statements of cash flows is not expected to be material. We believe the new standard will have no impact on us and our consolidated financial statements. We cannot at this time, however, provide any estimate of the impact of adopting the new standard.debt covenant compliance under our current agreements.
| |
| (2) | Goodwill, Customer Relationships and Other Intangible Assets |
Goodwill, customer relationships and other intangible assets consisted of the following: | | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2018 | | 2017 |
| | (Dollars in millions) | (Dollars in millions) |
| Goodwill | $ | 9,354 |
| | 9,354 |
| $ | 9,360 |
| | 9,360 |
|
| Customer relationships, less accumulated amortization of $3,264 and $2,660 | 2,435 |
| | 3,039 |
| |
| Customer relationships, less accumulated amortization of $4,806 and $4,337 | | $ | 893 |
| | 1,362 |
|
| Other intangible assets subject to amortization: | | | | | | |
| Capitalized software, less accumulated amortization of $1,383 and $1,247 | 613 |
| | 808 |
| |
| Capitalized software, less accumulated amortization of $1,712 and $1,619 | | $ | 311 |
| | 379 |
|
As of December 31, 2015,2018, the gross carrying amount of goodwill, customer relationships and other intangible assets was $17.049$17.082 billion.
Total amortization expense for intangible assets was as follows:
|
| | | | | | | | | |
| | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 |
| | (Dollars in millions) |
| Amortization expense for intangible assets | $ | 871 |
| | 957 |
| | 1,029 |
|
|
| | | | | | | | | |
| | Years Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) |
| Amortization expense for intangible assets | $ | 581 |
| | 671 |
| | 767 |
|
We estimate that total amortization expense for intangible assets for the years ending December 31, 20162019 through 20202023 will be as follows: | | | | (Dollars in millions) | (Dollars in millions) |
| Year ending December 31, | | |
| 2016 | $ | 725 |
| |
| 2017 | 661 |
| |
| 2018 | 587 |
| |
| 2019 | 507 |
| $ | 517 |
|
| 2020 | 435 |
| 453 |
|
| 2021 | | 143 |
|
| 2022 | | 39 |
|
| 2023 | | 27 |
|
We annually review the estimated lives and methods used to amortize our other intangible assets. The actual amounts of amortization expense may differ materially from our estimates, depending on the results of our annual reviews.
Our
Substantially, all of our goodwill iswas derived from CenturyLink's acquisition of us where the purchase price exceeded the fair value of the net assets acquired.
We assess our goodwill for impairment annually, or, under certain circumstances, more frequently, such as when events or changes in circumstances indicate there may be impairment. We are required to write-down the value of goodwill only when our assessment determinesin periods in which the recordedcarrying value of equity exceeds the estimated fair value of equity, limited to the amount of goodwill exceeds the fair value.goodwill. Our annual impairment assessment date for goodwill is October 31, at which date we assessed goodwill at our reporting units. In reviewing the criteria for reporting units, we have determined that we are one reporting unit.
We compare our estimated fair value of equity to our carrying value of equity. If the estimated fair value of our equity is greater than the carrying value of our equity, we conclude that no impairment exists. If the estimated fair value of our equity is less than our carrying value of our equity, a second calculation is required in which the implied fair value of goodwill is compared to our carrying value of goodwill. If the implied fair value of goodwill is less than our carrying value of goodwill, goodwill must be written down to the implied fair value.
At October 31, 2015,2018, we estimated the fair value of our equity by considering both a market approach and a discounted cash flow method, which resulted in a Level 3 fair value measurement.method. The market approach method includes the use of comparable multiples of publicly traded companies whose services are comparable to ours. The discounted cash flow method is based on the present value of projected cash flows and a terminal value, which represents the expected normalized cash flows of the reporting unit beyond the cash flows from the discrete projection period. We discounted the estimated cash flows using a rate that represents our estimated weighted average cost of capital, which we determined to be approximately 6.0% as of the assessment date (which was comprised of an after-tax cost of debt of 3.3% and a cost of equity of 7.6%). Based on our assessment performed with respect to our reporting unit as described above, we concluded that our goodwill was not impaired as of that date. As of October 31, 2017, based on our assessments performed, we concluded that our goodwill was not impaired as of that date.
Comparative Results
The following tables present our reported results under ASC 606 and a reconciliation to results using the historical accounting method:
|
| | | | | | | | | |
| | Year Ended December 31, 2018 |
| | Reported Balances | | Impact of ASC 606 | | ASC 605 Historical Adjusted Amount |
| | (Dollars in millions) |
| Operating revenue | $ | 8,493 |
| | 6 |
| | 8,499 |
|
| Cost of services and products (exclusive of depreciation and amortization) | 2,767 |
| | 17 |
| | 2,784 |
|
| Selling, general and administrative | 799 |
| | — |
| | 799 |
|
| Income tax expense | 494 |
| | (3 | ) | | 491 |
|
| Net income | 1,665 |
| | (8 | ) | | 1,657 |
|
The following table presents a reconciliation of certain consolidated balance sheet captions under ASC 606 to the balance sheet results using the historical accounting method:
|
| | | | | | | | | |
| | As of December 31, 2018 |
| | Reported Balances | | Impact of ASC 606 | | ASC 605 Historical Adjusted Balances |
| | (Dollars in millions) |
| Other current assets | $ | 147 |
| | (119 | ) | | 28 |
|
| Other long-term assets, net | 96 |
| | (54 | ) | | 42 |
|
| Deferred revenue | 303 |
| | (13 | ) | | 290 |
|
| Deferred income taxes, net | 1,098 |
| | (53 | ) | | 1,045 |
|
| Other long-term liabilities | 547 |
| | 42 |
| | 589 |
|
| Accumulated deficit | (182 | ) | | (149 | ) | | (331 | ) |
Disaggregated Revenue by Service Offering
The following tables provide disaggregation of revenue from contracts with customers based on service offerings for the year ended December 31, 2018. It also shows the amount of revenue that is not subject to ASC 606, but is instead governed by other accounting standards.
|
| | | | | | | | | | |
| | Year Ended December 31, 2018 |
| | Total Revenue | | Adjustments for Non-ASC 606 Revenue (7) | | Total Revenue from Contracts with Customers |
| | (Dollars in millions) |
IP and data services (1) | $ | 616 |
| | — |
| | 616 |
|
Transport and infrastructure (2) | 2,926 |
| | (321 | ) | | 2,605 |
|
Voice and collaboration (3) | 1,800 |
| | — |
| | 1,800 |
|
IT and managed services (4) | 6 |
| | — |
| | 6 |
|
Regulatory revenue (5) | 210 |
| | (210 | ) | | — |
|
Affiliate revenue (6) | 2,935 |
| | — |
| | 2,935 |
|
| Total revenue | $ | 8,493 |
| | (531 | ) | | 7,962 |
|
| | | | | | |
| Timing of revenue | | | | | |
| Goods and services transferred at a point in time | | | | | $ | 69 |
|
| Services performed over time | | | | | 7,893 |
|
| Total revenue from contracts with customers | | | | | $ | 7,962 |
|
|
| | |
| (1 | ) | Includes primarily VPN data networks, Ethernet, IP and other ancillary services |
| (2 | ) | Includes primarily broadband, private line (including business data services) and other ancillary services. |
| (3 | ) | Includes local voice, including wholesale voice, and other ancillary services. |
| (4 | ) | Includes IT services and managed services revenue. |
| (5 | ) | Includes CAF II and federal and state USF support revenue. |
| (6 | ) | Includes telecommunications and data services we bill to our affiliates. |
| (7 | ) | Includes regulatory revenue, lease revenue, sublease rental income, which are not within the scope of ASC 606. |
Customer Receivables and Contract Balances
The following table provides balances of customer receivables, contract assets and contract liabilities as of December 31, 2018 and January 1, 2018:
|
| | | | | | |
| | December 31, 2018 | | January 1, 2018 |
| | (Dollars in millions) |
Customer receivables (1) | $ | 518 |
| | 631 |
|
| Contract liabilities | 207 |
| | 238 |
|
| Contract assets | 64 |
| | 68 |
|
| |
| (1) | Gross customer receivables of $554 million and $669 million, net of allowance for doubtful accounts of $36 million and $38 million, at December 31, 2018 and January 1, 2018, respectively. |
Contract liabilities are consideration we have received from our customers or billed in advance of providing goods and services promised in the future. We defer recognizing this consideration as revenue until we have satisfied the related performance obligation to the customer. Contract liabilities include recurring services billed one month in advance and installation and maintenance charges that are deferred and recognized over the actual or expected contract term, which ranges from one to seven years depending on the service. Contract liabilities are included within deferred revenue in our consolidated balance sheet.
The following table provides information about revenue recognized for the year ended December 31, 2018: |
| | | |
| | (Dollars in millions) |
| Revenue recognized in the period from: | |
| Amounts included in contract liability at the beginning of the period (January 1, 2018) | $ | 42 |
|
| Performance obligations satisfied during 2018 | — |
|
Performance Obligations
As of December 31, 2018, our estimated revenue expected to be recognized in the future related to performance obligations associated with customer contracts that are unsatisfied (or partially satisfied) is approximately $191 million. We expect to recognize approximately 100% of this revenue through 2021, with the balance recognized thereafter.
We do not disclose the value of unsatisfied performance obligations for contracts for which we recognize revenue at the amount to which we have a right to invoice for services performed (for example, uncommitted usage or non-recurring charges associated with professional or technical services to be completed), or contracts that are classified as leasing arrangements that are not subject to ASC 606.
Contract Costs
The following table provides changes in our contract acquisition costs and fulfillment costs:
|
| | | | | | |
| | Year Ended December 31, 2018 |
| | Acquisition Costs | | Fulfillment Costs |
| | (Dollars in millions) |
| Beginning of period balance | $ | 91 |
| | 61 |
|
| Costs incurred | 62 |
| | 27 |
|
| Amortization | (63 | ) | | (31 | ) |
| End of period balance | $ | 90 |
| | 57 |
|
Acquisition costs include commissions paid to employees as a result of obtaining contracts. Fulfillment costs include third party and internal costs associated with the provision, installation and activation of telecommunications services to customers, including labor and materials consumed for these activities.
Deferred acquisition and fulfillment costs are amortized based on the transfer of services on a straight-line basis over the average customer life of 30 months for consumer customers and up to 49 months for business customers and amortized fulfillment costs are included in cost of services and products and amortized acquisition costs are included in selling, general and administrative expenses in our consolidated statement of operations. The amount of acquisition costs included in these deferred costs that are anticipated to be amortized in the next twelve months are included in other current assets on our consolidated balance sheets. The amount of deferred costs expected to be amortized beyond the next twelve months is included in other non-current assets on our consolidated balance sheets. Deferred acquisition and fulfillment costs are assessed for impairment on an annual basis.
| |
| (4) | Long-Term Debt and Revolving Promissory Note |
Long-term debt, including unamortized premiums and discounts, unamortized debt issuance costs and note payable-affiliate, were as follows: | | | | | As of December 31, | | As of December 31, |
| | Interest Rates | | Maturities | | 2015 | | 2014 | Interest Rates | | Maturities | | 2018 | | 2017 |
| | | (Dollars in millions) | | (Dollars in millions) |
| Senior notes | 6.125% - 8.375% | | 2016 - 2055 | | $ | 7,229 |
| | 7,311 |
| 6.125% - 7.750% | | 2021 - 2057 | | $ | 5,956 |
| | 7,294 |
|
| Term loan | 2.180% | | 2025 | | 100 |
| | — |
| 4.530% | | 2025 | | 100 |
| | 100 |
|
| Capital lease and other obligations | Various | | Various | | 17 |
| | 32 |
| Various | | Various | | 21 |
| | 36 |
|
| Unamortized premiums, net | | 16 |
| | 36 |
| |
| Unamortized (discounts) premiums, net | | | (1 | ) | | 1 |
|
| Unamortized debt issuance costs | | (123 | ) | | (110 | ) | | (117 | ) | | (150 | ) |
| Total long-term debt | | 7,239 |
| | 7,269 |
| | 5,959 |
| | 7,281 |
|
| Less current maturities | | (242 | ) | | (117 | ) | | (11 | ) | | (17 | ) |
| Long-term debt, excluding current maturities | | $ | 6,997 |
| | 7,152 |
| | $ | 5,948 |
| | 7,264 |
|
| Note payable-affiliate | 6.758% | | 2022 | | $ | 855 |
| | 796 |
| 5.860% | | 2022 | | $ | 1,008 |
| | 965 |
|
New Issuances
2015
On September 21, 2015, weApril 27, 2017, Qwest Corporation issued $400$575 million aggregate principal amount of 6.625%6.75% Notes due 2055,2057 and, on May 5, 2017, issued an additional $85 million aggregate principal amount of such notes pursuant to an over-allotment option in exchange for aggregate net proceeds, after deducting underwriting discounts and other expenses, of approximately $386$638 million. The underwriting agreement included an over-allotment option granting the underwriters for the offering an opportunity to purchase additional 6.625% Notes due 2055. On September 30, 2015, we issued an additional $10 million aggregate principal amount of the 6.625% Notes under this over-allotment option. All of the 6.625%6.75% Notes are senior unsecured obligations and may be redeemed by us,Qwest Corporation, in whole or in part, on or after SeptemberJune 15, 2020,2022, at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date.
2014
On September 29, 2014,Repayments
During 2018, we issued $500retired approximately $1.3 billion in debt securities including approximately $164 million of Qwest Corporation 7.5% Notes due 2051, $925 million of Qwest Corporation 7.0% Notes due 2052, and $250 million of Qwest Corporation 7.25% Notes due 2035 and we recognized a loss of $34 million.
During 2017, Qwest Corporation redeemed $125 million aggregate principal amount of 6.875%the remaining $288 million of its 7.5% Notes due 2054, in exchange for net proceeds, after deducting underwriting discounts2051 and, other expenses, of $483 million. The Notes are senior unsecured obligations and may be redeemed, in whole or in part, on or after October 1, 2019, at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date.
Repayments
2015
On October 13, 2015, we redeemed all $250$500 million of our 7.20%its 6.5% Notes due 2026, which resulted in an immaterial gain, and redeemed $150 million of our 6.875% Notes due 2033,2017, which resulted in an immaterial loss.
On June 15, 2015, we paid at maturity the $92 million principal amount of our 7.625% Notes.
2014
On October 1, 2014, we paid at maturity the $600 million principal amount of our 7.50% Notes.
Term Loan
On February 20,
In 2015, weQwest Corporation entered into a term loan in the amount of $100 million with CoBank, ACB. The outstanding unpaid principal amount of this term loan plus any accrued and unpaid interest is due on February 20, 2025. Interest is paid monthly based upon either the applicable London Interbank Offered Rate (“LIBOR”) or the base rate (as defined in the credit agreement) plus an applicable margin between 1.50% to 2.50% per annum for LIBOR loans and 0.50% to 1.50% per annum for base rate loans depending on ourQwest Corporation's then current senior unsecured long-term debt rating. At both December 31, 2015,2018 and 2017, the outstanding principal balance on this term loan was $100 million.
Aggregate Maturities of Long-Term Debt
Set forth below is the aggregate principal amount of our long-term debt (excluding unamortized premiums and discounts net and unamortized debt issuance costs and other and excluding note payable-affiliate) maturing during the following years: |
| | | |
| | (Dollars in millions)(1) |
| 2016 | $ | 242 |
|
| 2017 | 503 |
|
| 2018 | 3 |
|
| 2019 | 1 |
|
| 2020 | — |
|
| 2021 and thereafter | 6,597 |
|
| Total long-term debt | $ | 7,346 |
|
|
| | | |
| | (Dollars in millions)(1) |
| 2019 | $ | 11 |
|
| 2020 | 5 |
|
| 2021 | 951 |
|
| 2022 | — |
|
| 2023 | 1 |
|
| 2024 and thereafter | 5,109 |
|
| Total long-term debt | $ | 6,077 |
|
(1)(1) Actual principal paid in all yearsany year may differ due to the possible future refinancing of outstanding debt or the issuance of new debt.
Revolving Promissory Note
We are currently indebted toOn September 30, 2017, Qwest Corporation entered into an amended and restated revolving promissory note in the amount of $965 million with an affiliate of our ultimate parent company, CenturyLink, under aInc. This note replaced and amended the original $1.0 billion revolving promissory note that provides usQwest Corporation entered into on April 18, 2012 with a funding commitmentthe same affiliate. The outstanding principal balance of up to $1.0 billion aggregate principal amount throughthis new revolving promissory note and the accrued interest thereon shall be due and payable on demand, but if no demand is made, then on June 30, 2022,2022. Interest is accrued on the outstanding balance during an interest period using a weighted average per annum interest rate on the consolidated outstanding debt of which $855 million was outstanding as of December 31, 2015.CenturyLink and its subsidiaries. As of December 31, 2015,2018, the weighted averageamended and restated revolving promissory note had an outstanding balance of $1.008 billion and bore interest at a weighted-average interest rate was 6.758%of 5.860%. As of December 31, 20152018 and 2014, this2017, the amended and restated revolving promissory note isand the original revolving promissory note, respectively, are reflected on our consolidated balance sheets as a current liability under “Note payable-affiliate”. In accordance with the terms of the amended and restated revolving promissory note, interest shall be assessed on June 30th and December 31st (an "Interest Period"). Any assessed interest for an Interest Period that remains unpaid on the last day of the subsequent Interest Period is to be capitalized on such date and is to begin accruing interest. Through December 31, 2018, $43 million of such interest has been capitalized. As of December 31, 2015, $52018, $30 million of accrued interest is reflected in other current liabilities on our consolidated balance sheet. In accordance with the note agreement, all accrued and unpaid interest is capitalized to the unpaid principal balance on June 1 and December 1 of each year.
Interest Expense
Interest expense includes interest on total long-term debt. The following table presents the amount of gross interest expense, net of capitalized interest and interest expense-affiliates, net: | | | | Years Ended December 31, | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| Interest expense: | | | | | | | | | | |
| Gross interest expense | $ | 491 |
| | 481 |
| | 467 |
| $ | 472 |
| | 497 |
| | 497 |
|
| Capitalized interest | (18 | ) | | (17 | ) | | (17 | ) | (24 | ) | | (32 | ) | | (19 | ) |
| Total interest expense | $ | 473 |
| | 464 |
| | 450 |
| $ | 448 |
| | 465 |
| | 478 |
|
| Interest expense-affiliates, net | $ | 53 |
| | 40 |
| | 64 |
| $ | 57 |
| | 63 |
| | 59 |
|
Covenants
The
Our senior notes were issued under indentures governing our notesdated April 15, 1990 and October 15, 1999. These indentures contain certain covenants including, but not limited to: (i) a prohibition on certain liens on our assets; and (ii) a limitation on mergers or sales of all, or substantially all, of our assets, which limitation requires that a successor assume the obligation with regard to these notes. These indentures do not contain any cross-default provisions.
Our senior notes were issued under indentures dated April 15, 1990 and October 15, 1999. These indentures restrictdo not contain any financial covenants or restrictions on our ability to (i) incur, issue new securities thereunder.
Under the Qwest Corporation term loan, Qwest Corporation must maintain a debt to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined in CenturyLink's Credit Facility) ratio of not more than 2.85:1.0, as of the last day of each fiscal quarter for the four quarters then ended. The term loan also contains a negative pledge covenant, which generally requires us to secure equally and ratably any advances under the term loan if we pledge assets or createpermit liens uponon our property for the benefit of other debtholders. The term loan also has a cross payment default and (ii) consolidate withcross acceleration provisions. When present, these provisions could have a wider impact on liquidity than might otherwise arise from a default or merge into, or transfer or lease all or substantially allacceleration of a single debt instrument. Our debt to EBITDA ratio could be adversely impacted by a wide variety of events, including unforeseen contingencies, many of which are beyond our control. This could reduce our financing flexibility due to potential restrictions on incurring additional debt under certain provisions of our assets to any other party.debt agreements or, in certain circumstances, could result in a default under certain provisions of such agreements.
Compliance
At December 31, 2015,2018 and 2017, we believe we were in compliance with all of the provisions andfinancial covenants contained in our debt agreements.agreements in all material respects.
Subsequent Event
In January 2016, we issued $235 million aggregate principal amount of 7% Notes due 2056, in exchange for net proceeds, after deducting underwriting discounts and other expenses, of approximately $227 million. All of the 7% Notes are unsecured obligations and may be redeemed by us, in whole or in part, on or after February 1, 2021, at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to the redemption date.
| |
(4)(5) | Accounts Receivable |
The following table presents details of our accounts receivable balances: | | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2018 | | 2017 |
| | (Dollars in millions) | (Dollars in millions) |
| Trade and purchased receivables | $ | 620 |
| | 649 |
| $ | 491 |
| | 591 |
|
| Earned and unbilled receivables | 111 |
| | 120 |
| 92 |
| | 99 |
|
| Other | 4 |
| | 9 |
| 4 |
| | 3 |
|
| Total accounts receivable | 735 |
| | 778 |
| 587 |
| | 693 |
|
| Less: allowance for doubtful accounts | (47 | ) | | (38 | ) | (41 | ) | | (47 | ) |
| Accounts receivable, less allowance | $ | 688 |
| | 740 |
| $ | 546 |
| | 646 |
|
We are exposed to concentrations of credit risk from residential and business customers within our local service area and from other telecommunications service providers. No customers individually represented more than 10% of our accounts receivable for all periods presented herein. We generally do not require collateral to secure our receivable balances. We have agreements with other telecommunications service providers whereby we agree to bill and collect on their behalf for services rendered by those providers to our customers within our local service area. We purchase accounts receivable from other telecommunications service providers primarily on a recourse basis and include these amounts in our accounts receivable balance. We have not experienced any significant loss associated with these purchased receivables.
The following table presents details of our allowance for doubtful accounts: |
| | | | | | | | | | | | |
| | Beginning Balance | | Additions | | Deductions | | Ending Balance |
| | (Dollars in millions) |
| 2015 | $ | 38 |
| | 78 |
| | (69 | ) | | 47 |
|
| 2014 | $ | 43 |
| | 64 |
| | (69 | ) | | 38 |
|
| 2013 | $ | 46 |
| | 65 |
| | (68 | ) | | 43 |
|
|
| | | | | | | | | | | | |
| | Beginning
Balance | | Additions | | Deductions | | Ending
Balance |
| | (Dollars in millions) |
| 2018 | $ | 47 |
| | 60 |
| | (66 | ) | | 41 |
|
| 2017 | $ | 53 |
| | 74 |
| | (80 | ) | | 47 |
|
| 2016 | $ | 47 |
| | 80 |
| | (74 | ) | | 53 |
|
| |
(5)(6) | Property, Plant and Equipment |
Net property, plant and equipment is composed of the following: | | | | Depreciable Lives | | As of December 31, | Depreciable Lives | | As of December 31, |
| | | 2015 | | 2014 | | 2018 | | 2017 |
| | | (Dollars in millions) | | (Dollars in millions) |
| Property, plant and equipment: | | | | | | | | |
| Land | N/A | | $ | 349 |
| | 350 |
| N/A | | $ | 332 |
| | 333 |
|
Fiber, conduit and other outside plant(1) | 15-45 years | | 5,362 |
| | 4,640 |
| 15-45 years | | 7,171 |
| | 6,639 |
|
Central office and other network electronics(2) | 4-10 years | | 3,614 |
| | 3,362 |
| 7-10 years | | 4,361 |
| | 4,250 |
|
Support assets(3) | 5-30 years | | 2,584 |
| | 2,496 |
| 5-30 years | | 2,656 |
| | 2,620 |
|
Construction in progress(4) | N/A | | 273 |
| | 309 |
| N/A | | 508 |
| | 474 |
|
| Gross property, plant and equipment | | 12,182 |
| | 11,157 |
| | 15,028 |
| | 14,316 |
|
| Accumulated depreciation | | (4,808 | ) | | (3,956 | ) | | (6,951 | ) | | (6,392 | ) |
| Net property, plant and equipment | | $ | 7,374 |
| | 7,201 |
| | $ | 8,077 |
| | 7,924 |
|
| |
(1) | Fiber, conduit and other outside plant consists of fiber and metallic cable, conduit, poles and other supporting structures. |
| |
(2) | Central office and other network electronics consists of circuit and packet switches, routers, transmission electronics and electronics providing service to customers. |
| |
(3) | Support assets consist of buildings, computers and other administrative and support equipment. |
| |
(4) | Construction in progress includes inventory held for construction and property of the aforementioned categories that has not been placed in service as it is still under construction. |
We recorded depreciation expense of $986$855 million, $1.048 billion$912 million and $1.099 billion$924 million for the years ended December 31, 2015, 20142018, 2017 and 2013,2016, respectively.
In 2014, we recorded an impairment charge of $17 million in connection with a sale-leaseback transaction involving an office building which closed in the fourth quarter of 2014. This impairment charge is included in selling, general and administrative expense in our consolidated statement of operations for the year ended December 31, 2014.
Periodically, we have reductions inreduce our workforce and have accruedaccrue liabilities for the related severance costs. These workforce reductions resultedresult primarily from the progression or completion of our post-acquisition integration plans related to CenturyLink's indirect acquisition of us, increased competitive pressures, cost reduction initiatives, process improvements through automation and reduced workload demands due to the loss of customers purchasing certain legacy services.
We report severance liabilities within accrued expenses and other liabilities-salaries and benefits in our consolidated balance sheets and report severance expenses in cost of services and products and selling, general and administrative expenses in our consolidated statements of operations.
Changes in our accrued liability for severance expenses were as follows: | | | | Severance | Severance |
| | (Dollars in millions) | (Dollars in millions) |
| Balance at December 31, 2013 | $ | 5 |
| |
| Balance at December 31, 2016 | | $ | 52 |
|
| Accrued to expense | 44 |
| 14 |
|
| Payments, net | (39 | ) | (58 | ) |
| Balance at December 31, 2014 | $ | 10 |
| |
| Balance at December 31, 2017 | | 8 |
|
| Accrued to expense | 51 |
| 85 |
|
| Payments, net | (55 | ) | (60 | ) |
| Balance at December 31, 2015 | $ | 6 |
| |
| Balance at December 31, 2018 | | $ | 33 |
|
Pension and Post-Retirement Benefits
We are required to disclose the amount of our contributions to CenturyLink relative to the CenturyLink qualified pension plans and post-retirement benefit plans and the amount of income or expense from these plans allocated by CenturyLink to us and their other affiliates.
QCII's post-retirement benefit plans were merged into CenturyLink's post-retirement benefit plans on January 1, 2012 and on December 31, 2014, QCII's qualified pension plan and a pension plan of an affiliate were merged into the CenturyLink Retirement Plan, which was renamed the CenturyLink Combined Pension Plan. Prior to the plan mergers, a substantial portion of our active and retired employees participated in QCII's pension and post-retirement plans. Based on current laws and circumstances, (i) CenturyLink was not required to make a cash contribution to the CenturyLink Combined Pension Plan in 20152018 and (ii) CenturyLink does not expect it will be required to make a contribution in 2016.2019. The amount of required contributions to the CenturyLink Combined Pension Plan in 20172019 and beyond will depend on earnings on plan investments, prevailing discount rates, demographic experience, changes in plan benefits and changes in funding laws and regulations. CenturyLink occasionally makes voluntary contributions in addition to required contributions, and CenturyLink made such a voluntary cash contributioncontributions of $500 million and $100 million to the CenturyLink Combined Pension Plan during the third quarter of 2015. No contributions were made to the post-retirement occupational health care trust in 2015 or 20142018 and 2017, respectively. CenturyLink does not currently expect to make a voluntary contribution to the trust for our qualified pension plan in 2016.2019.
The unfunded status of CenturyLink's qualified pension plan for accounting purposes was $2.207$1.6 billion and $2.402$2.0 billion as of December 31, 20152018 and 2014,2017, respectively, which includes the merged QCII qualified pension plan. The unfunded status of CenturyLink's post-retirement benefit plans for accounting purposes was $3.374$3.0 billion and $3.477$3.4 billion as of December 31, 20152018 and 2014,2017, respectively.
In 2015, our ultimate parent company, CenturyLink, changed their allocation methodology with respect to their now centrally managed pension and post-retirement plans. Specifically, under this new methodology, CenturyLink will allocate current service costs to subsidiaries relative to employees whichwho are currently earning benefits under the pension and post-retirement benefit plans. The net periodic benefit cost allocated to us is now paid on a monthly basis through CenturyLink’s intercompany cash management process. The change in methodology resulted in a decrease of $7 million to our net periodic benefit cost for the year ended December 31, 2015.
The affiliatesaffiliate obligations, net in current and noncurrent liabilities on the consolidated balance sheets primarily represents the cumulative allocation of expense, net of payments, associated with QCII's pension plans and post-retirement benefits plans prior to the plan mergers. In 2015, we agreed to a plan to settle the outstanding pension and post-retirement affiliate obligations, net balance with QCII over a 30 year term. Payments willUnder the plan, payments are scheduled to be made on a monthly basis. For the yearyears ended December 31, 2015,2018 and 2017, we made a settlement paymentpayments in the aggregate of $105$87 million for both periods to QCII on our affiliate obligations, net balance.under the plan. Changes in the affiliatesaffiliate obligations, net are reflected in operating activities on our consolidated statements of cash flows.
We were allocated $57$46 million of pension service costs and $17$11 million of post-retirement service costs during the year ended December 31, 2015,2018, which represented 69%70% of CenturyLink's total pension and post-retirement service costs for the year. The combined net pension and post-retirement service costs is included in cost of services and products and selling, general and administrative expenses on our consolidated statement of operations for the year ended December 31, 2015.2018.
We were allocated $98$44 million of pension service costs and $178$12 million in pension incomeof post-retirement service costs during the yearsyear ended December 31, 2014 and 2013, respectively. Our allocated post-retirement benefit expense for the years ended December 31, 2014 and 2013 was $128 million and $88 million, respectively. These allocated amounts represent our share2017, which represented 70% of theCenturyLink's total pension and post-retirement benefit expenses based on the actuarially determined amounts. Prior to the plan mergers, our allocated portion of QCII's pension and post-retirement benefit income and expense was 92% and 91%service costs for the years ended December 31, 2014 and 2013, respectively.year. The combined net pension and post-retirement benefits (income) expensesservice costs is included in cost of services and products and selling, general and administrative expenses on our consolidated statementsstatement of operations for the yearsyear ended December 31, 20142017.
We were allocated $45 million of pension service costs and 2013.$14 million of post-retirement service costs during the year ended December 31, 2016, which represented 70% of CenturyLink's total pension and post-retirement service costs for the year. The combined net pension and post-retirement service costs is included in cost of services and products and selling, general and administrative expenses on our consolidated statement of operations for the year ended December 31, 2016.
CenturyLink sponsors a noncontributory qualified defined benefit pension plan that covers substantially allcertain of our eligible employees. As noted above, on December 31, 2014, QCII's pension plan was merged into the CenturyLink Retirement Plan, which was renamed the CenturyLink Combined Pension Plan. The plan also provides survivor and disability benefits to certain employees. In November 2009, and prior to the plan merger, the pension plan was amended to no longer provide pension benefit accruals for active non-represented employees after December 31, 2009. In addition, non-represented employees hired after January 1, 2009 are not eligible to participate in the plans. Active non-represented employees who participate in these plans retain their accrued pension benefit earned as of December 31, 2009 and certain participants will continue to earn interest credits on their benefit after December 31, 2009. Employees are eligible to receive their vested accrued benefit when they separate from CenturyLink. The plans also provided a death benefit for eligible beneficiaries of certain retirees; however, the plan was amended to eliminate this benefit effective March 1, 2010 for retirees who retired prior to January 1, 2004 and whose deaths occur after February 28, 2010 and eliminate the death benefit for eligible beneficiaries of certain retirees who retired after December 31, 2003.
CenturyLink maintains post-retirement benefit plans that provide health care and life insurance benefits for certain eligible retirees. The QCII post-retirement benefit plans were merged into CenturyLink's post-retirement benefit plans on January 1, 2012. The benefit obligation for the occupational health care and life insurance post-retirement plans is estimated based on the terms of benefit plans. In calculating this obligation, CenturyLink considers numerous assumptions, estimates and judgments, including but not limited to, discount rates, health care cost trend rates and plan amendments. In October 2013,June 2017, we renewed a four-year collective bargaining agreement for three years which covers approximately 11,0008,400 of our unionized employees. Effective January 1, 2014,with the renewal, there were no significant changes to the existing benefits for the approximately 11,0008,400 active employees and eligible post-1990 retirees who are former represented employees, have changes to their health and welfare benefits including: (i) changes to align the coverage and benefits for these active employees and non-Medicare eligible post-1990 retirees with the health and welfare coverage and benefits offered to all other CenturyLink employees and other CenturyLink retirees (with some exceptions) (ii) increased out-of-pocket health care costs through plan design changes effective January 1, 2014 and the elimination of Class II dependent coverage and (iii) elimination of the group medical plan coverage and benefits for Medicare-eligible post-1990 retirees and the establishment of a health reimbursement account and assistance to this population with their transition effective May 1, 2014 to their own purchase of individual policies through the Medicare Exchange market place using the health reimbursement account. In order to maintain their eligibility, post-1990 retirees continue to be obligated to contribute to the cost of health care benefitsemployees. This agreement expires in excess of specified limits on the company-funded portion of retiree health care costs (also referred to as the "caps"), as they have since January 1, 2009.March 2020.
The terms of the post-retirement health care and life insurance plans between CenturyLink and its eligible non-represented employees and its eligible post-1990 non-represented retirees are established by CenturyLink and are subject to change at its discretion. CenturyLink has a practice of sharing some of the cost of providing health care benefits with its non-represented employees and post-1990 non-represented retirees. The benefit obligation for the non-represented post-retirement health care benefits is based on the terms of the current written plan documents and is adjusted for anticipated continued cost sharing with non-represented employees and post-1990 non-represented retirees. However, CenturyLink's contribution under its post-1990 non-represented retirees' health care plan is capped at a specific dollar amount.
Medicare Prescription Drug, Improvement and Modernization Act of 2003
CenturyLink sponsors post-retirement health care plans with several benefit options that provide prescription drug benefits that CenturyLink deems actuarially equivalent to or exceeding Medicare Part D. CenturyLink recognizes the impact of the federal subsidy received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 in the calculation of its post-retirement benefit obligation and net periodic post-retirement benefit expense.
Other Benefit Plans
Health Care and Life Insurance
We provide health care and life insurance benefits to essentially all of our active employees. We are largely self-funded for the cost of the health care plan. Our health care benefit expense for current employees was $217$211 million, $204 million and $223$241 million for the years ended December 31, 2015, 20142018, 2017 and 2013,2016, respectively. Union-represented employee benefits are based on negotiated collective bargaining agreements. Employees' group basic life insurance plans are fully insured and the premiums are paid by CenturyLink.
401(k) PlanPlans
CenturyLink sponsors qualified defined contribution plans covering substantially all of our employees. Under these plans, employees may contribute a percentage of their annual compensation up to certain maximums, as defined by the plans and by the Internal Revenue Service ("IRS"). Currently, we match a percentage of our employees' contributions in cash. We recognized $43$45 million, $47$42 million and $49$42 million in expense related to these plans for the years ended December 31, 2015, 20142018, 2017 and 2013,2016, respectively.
Deferred
(9) Share-based Compensation Plans
CenturyLink sponsors non-qualified unfunded deferred compensation plans for various groups that includes certain of our current and former highly compensated employees. The plans are frozen and participants can no longer defer compensation to these plans. The value of the assets and liabilities related to these plans is not significant.
| |
(8) | Share-based Compensation |
Share-based compensation expenses are included in cost of services and products, and selling, general, and administrative expenses in our consolidated statements of operations. We recognized compensation expense for options and awards granted to our employees under CenturyLink's equity incentive plans, including plans assumed in connection with us being indirectly acquired. We record share-based compensation expense that is allocated to us from CenturyLink, which is included in operating expenses-affiliates in our consolidated statements of operations. Based on many factors that affect the allocation, the amount of share-based compensation expense recorded at CenturyLink and ultimately allocated to us may fluctuate. We settle the share-based compensation expense allocated to us from CenturyLink through affiliate transactions.
For the years ended December 31, 2015, 20142018, 2017 and 2013,2016, we were allocated arecorded share-based compensation expense of approximately $21$24 million, $21$27 million and $17$22 million, respectively. We recognized an income tax benefit from our compensation expense of approximately $8$6 million, $8$7 million and $7$8 million, respectively, during the years ended December 31, 2015, 20142018, 2017 and 2013,2016, respectively.
| |
(9) | Products and Services Revenues |
We are an integrated communications company engaged primarily in providing an array of communications services, including local voice, high-speed Internet, private line (including special access), network access, Ethernet, information technology, video, wireless and other ancillary services. We strive to maintain our customer relationships by, among other things, bundling our service offerings to provide our customers with a complete offering of integrated communications services. We currently categorize our products, services and revenues among the following three categories:
Strategic services, which include primarily high-speed Internet, private line (including special access), Ethernet, Verizon Wireless and other ancillary services;
Legacy services, which include primarily local voice, Integrated Services Digital Network ("ISDN") services (which use regular telephone lines to support voice, video and data applications), switched access and traditional wide area network ("WAN") services (which allow a local communications network to link to networks in remote locations); and
Affiliates and other services, which consist primarily of CAF support payments, USF support payments, USF surcharges and services we provide to our affiliates. We receive federal support payments from both CAF Phase 1 and CAF Phase 2 programs, and support payments from both federal and state USF programs. These support payments are government subsidies designed to reimburse us for various costs related to certain telecommunications services, including the costs of deploying, maintaining and operating voice and high-speed Internet infrastructure in high-cost rural areas where we are not able to recover our costs from our customers. USF surcharges are the amounts we collect based on specific items we list on our customers' invoices to fund the FCC's universal service programs. We provide to our affiliates, telecommunication services that we also provide to external customers. In addition, we provide to our affiliates, computer system development and support services, network support and technical services.
Our operating revenues for our products and services consisted of the following categories for the years ended December 31, 2015, 2014 and 2013: |
| | | | | | | | | |
| | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 |
| | (Dollars in millions) |
| Strategic services | $ | 3,433 |
| | 3,429 |
| | 3,342 |
|
| Legacy services | 2,777 |
| | 2,987 |
| | 3,208 |
|
| Affiliates and other services | 2,754 |
| | 2,422 |
| | 2,203 |
|
| Total operating revenues | $ | 8,964 |
| | 8,838 |
| | 8,753 |
|
We do not have any single external customer that provides more than 10% of our total consolidated operating revenues. Substantially all of our consolidated revenues come from customers located in the United States.
We recognize revenues in our consolidated statements of operations for certain USF surcharges and transaction taxes that we bill to our customers. Our consolidated statements of operations also reflect the related expense for the amounts we remit to the government agencies. The total amount of such surcharges that we included in revenues, aggregated approximately $147 million, $151 million and $154 million for the years ended December 31, 2015, 2014 and 2013, respectively. Those USF surcharges, where we record revenue, are included in "other" operating revenues and transaction tax surcharges are included in "legacy services" revenues. We also act as a collection agent for certain other USF and transaction taxes that we are required by government agencies to include in our bills to customers, for which we do not record any revenue or expense because we only act as a pass-through agent.
Our operations are integrated into and reported as part of the consolidated segment data of CenturyLink. CenturyLink's chief operating decision maker ("CODM") is our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the Securities and Exchange Commission. Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such, we believe we have one reportable segment.
| |
| (10) | Affiliate Transactions |
We provide to our affiliates, telecommunications services that we also provide to external customers. In addition, we provide to our affiliates, computer system development and support services and network support and technical services.
Below are details of the services we provide to our affiliates:
Telecommunications services. Data, Internet and voice services in support of our affiliates' service offerings;
Computer system development and support services. Information technology services primarily include the labor cost of developing, testing and implementing the system changes necessary to support order entry, provisioning, billing, network and financial systems, as well as the cost of improving, maintaining and operating our operations support systems and shared internal communications networks; and
Network support and technical services. Network support and technical services relate to forecasting demand volumes and developing plans around network utilization and optimization, developing and implementing plans for overall product development, provisioning and customer care.
We charge our affiliates for services based on market price or fully distributed cost ("FDC"). We charge our affiliates market price for services that we also provide to external customers, while other services that we provide only to our affiliates are priced by applying an FDC methodology. FDC rates include salaries and wages, payroll taxes, employee related benefits, miscellaneous expenses, and charges for the use of our buildings, computing and software assets. Whenever possible, costs are directly assigned to our affiliates for the services they use. If costs cannot be directly assigned, they are allocated among all affiliates based upon cost causative measures; or if no cost causative measure is available, these costs are allocated based on a general allocator. These cost allocation methodologies are reasonable. From time to time, we adjust the basis for allocating the costs of a shared service among affiliates. Such changes in allocation methodologies are generally billed prospectively.
We also purchase services from our affiliates including telecommunication services, insurance, flight services and other support services such as legal, regulatory, finance and accounting, tax, human resources and executive support. Our affiliates charge us for these services based on market price or FDC.
We were included in the consolidated federal income tax returns and the combined state income tax returns of QCII until CenturyLink's April 1, 2011 acquisition of QCII and the consolidated federal income tax returns and certain combined state income tax returns of CenturyLink subsequent to the acquisition. Both CenturyLink and QCII treat our consolidated results as if we were a separate taxpayer. The policy requires us to settle our tax liabilities through a change in our general intercompany obligation based upon our separate return taxable income, which is reflected in advances to affiliates on our consolidated balance sheets and the changes in advances to affiliates are reflected as investing activities on our consolidated statements of cash flows. Because we are included in the consolidated federal income tax returns and the combined state income tax returns of CenturyLink (and previously with QCII), any tax audits involving CenturyLink or QCII will also involve us. The IRS previously examined all of QCII's federal income tax returns prior to 2008 because they were included in its coordinated industry case program and now examines all of QCII's federal income tax returns as included in the consolidated federal return of the ultimate parent company, CenturyLink.
In 2013, CenturyLink filed an amended 2009 consolidated federal income tax return primarily to report the carryforward impact of prior year settlements. The refund for the 2009 amended return filed in 2013 was received in 2014. In 2014, CenturyLink filed an amended consolidated federal income tax return for 2010. The refund claim filed for 2010 was accepted by the IRS, and the refund was received in 2015. The 2010 amended return released certain general business credits that were required to be carried back to 2009. As a result, a subsequent 2009 federal amended return was filed in 2014 to reflect the carrybacks from 2010. The 2009 refund claim filed in 2014 was accepted by the IRS and the refund was received in 2015. Beginning with the 2012 tax year, CenturyLink's federal consolidated returns are subject to annual examination by the IRS.
Our open income tax years by major jurisdiction are as follows at December 31, 2015: |
| | |
Jurisdiction | | Open Tax Years |
Federal | | 2012—current |
State | | |
Arizona | | 2010—current |
Florida | | 2010—current |
Other states | | 2011—current |
Since the period for assessing additional liability typically begins upon the filing of a return, it is possible that certain jurisdictions could assess tax for years prior to the open tax years disclosed above. Additionally, it is possible that certain jurisdictions in which we do not believe we have an income tax filing responsibility, and accordingly did not file a return, may attempt to assess a liability, or other jurisdictions to which we pay taxes may attempt to assert that we owe additional taxes.
As of December 31, 2015, 2014, and 2013, we had no liability for interest related to uncertain tax positions. We did not record a liability for interest related to uncertain tax positions for the year ended December 31, 2015. We made no accrual for penalties related to income tax positions.
Income Tax Expense
The components of the income tax expense from continuing operations are as follows: |
| | | | | | | | | |
| Years Ended December 31, |
| 2015 | | 2014 | | 2013 |
| (Dollars in millions) |
| Income tax expense: |
|
|
|
|
|
| Current tax provision: |
|
|
|
|
|
| Federal and foreign | $ | 734 |
|
| 738 |
| | 653 |
|
| State and local | 114 |
|
| 129 |
| | 101 |
|
| Total current tax provision | 848 |
|
| 867 |
|
| 754 |
|
| Deferred tax expense: |
|
|
|
|
|
| Federal and foreign | (170 | ) |
| (209 | ) | | (125 | ) |
| State and local | (19 | ) |
| (19 | ) | | (27 | ) |
| Total deferred tax expense | (189 | ) |
| (228 | ) |
| (152 | ) |
| Income tax expense | $ | 659 |
|
| 639 |
|
| 602 |
|
The effective income tax rate for continuing operations differs from the statutory tax rate as follows: |
| | | | | | | | |
| | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 |
| | (in percent) |
| Effective income tax rate: | | | | | |
| Federal statutory income tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
| State income taxes-net of federal effect | 3.6 | % | | 4.0 | % | | 3.1 | % |
| Other | (0.6 | )% | | 0.7 | % | | 0.3 | % |
| Effective income tax rate | 38.0 | % | | 39.7 | % | | 38.4 | % |
Deferred Tax Assets and Liabilities
The components of the deferred tax assets and liabilities are as follows: |
| | | | | | |
| | As of December 31, |
| | 2015 | | 2014 |
| | (Dollars in millions) |
| Deferred tax assets and liabilities: | | | |
| Deferred tax liabilities: | | | |
| Property, plant and equipment | $ | (1,431 | ) | | (1,380 | ) |
| Intangibles assets | (1,153 | ) | | (1,449 | ) |
| Receivable from an affiliate due to pension plan participation | (460 | ) | | (500 | ) |
| Other | (59 | ) | | (52 | ) |
| Total deferred tax liabilities | (3,103 | ) | | (3,381 | ) |
| Deferred tax assets: | | | |
| Payable to affiliate due to post-retirement benefit plan participation | 921 |
| | 998 |
|
| Debt premiums | 21 |
| | 36 |
|
| Other | 277 |
| | 274 |
|
| Total deferred tax assets | 1,219 |
| | 1,308 |
|
| Valuation allowance on deferred tax assets | (12 | ) | | (12 | ) |
| Net deferred tax assets | 1,207 |
| | 1,296 |
|
| Net deferred tax liabilities | $ | (1,896 | ) | | (2,085 | ) |
At December 31, 2015, we have established a valuation allowance of $12 million as it is not more likely than not that this amount of deferred tax assets will be realized.
Other Income Tax Information
We paid $848 million, $861 million and $750 million to QSC related to income taxes in the years ended December 31, 2015, 2014 and 2013, respectively.
| |
(12) | Fair Value Disclosure |
Our financial instruments consist of cash and cash equivalents, accounts receivable, advances to affiliates, accounts payable, note payable-affiliate and long-term debt, excluding capital lease and other obligations. Due to their short-term nature, the carrying amounts of our cash and cash equivalents, accounts receivable, advances to affiliates, accounts payable and note payable-affiliate approximate their fair values.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between independent and knowledgeable parties who are willing and able to transact for an asset or liability at the measurement date. We use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs when determining fair value and then we rank the estimated values based on the reliability of the inputs used following the fair value hierarchy set forth by the FASB. We determined the fair values of our long-term debt, including the current portion, based on quoted market prices where available or, if not available, based on discounted future cash flows using current market interest rates.
The three input levels in the hierarchy of fair value measurements are defined by the FASB generally as follows: |
| | |
| Input Level | | Description of Input |
| | |
| Level 1 | | Observable inputs such as quoted market prices in active markets. |
| Level 2 | | Inputs other than quoted prices in active markets that are either directly or indirectly observable. |
| Level 3 | | Unobservable inputs in which little or no market data exists. |
The following table presents the carrying amounts and estimated fair values of our long-term debt, excluding capital lease and other obligations, and unamortized debt issuance costs, as well as the input levels used to determine the fair values: |
| | | | | | | | | | | | | | |
| | | | As of December 31, 2015 | | As of December 31, 2014 |
| | Input Level | | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
| | | | (Dollars in millions) |
| Liabilities-Long-term debt (excluding capital lease and other obligations) | 2 | | $ | 7,222 |
| | 7,456 |
| | 7,237 |
| | 7,702 |
|
|
| | | | | | | | | | | | | | |
| | | | As of December 31, 2018 | | As of December 31, 2017 |
| | Input Level | | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
| | | | (Dollars in millions) |
| Liabilities-Long-term debt (excluding capital lease and other obligations) | 2 | | $ | 5,938 |
| | 5,118 |
| | 7,245 |
| | 7,080 |
|
On December 22, 2017, the Tax Cuts and Jobs Act (the "Act") was signed into law. The Act reduces the U.S. corporate income tax rate from a maximum of 35% to 21% for all corporations, effective January 1, 2018, and makes certain changes to U.S. taxation of income earned by foreign subsidiaries, capital expenditures, interest expense and various other items.
As a result of the reduction in the U.S. corporate income tax rate from 35% to 21%, we re-measured our net deferred tax liabilities at December 31, 2017 and recognized a provisional tax benefit of $555 million in our consolidated statement of operations for the year ended December 31, 2017. Upon completion of our re-measurement during 2018 there was no material change to the provisional amount recorded in 2017.
With few exceptions, we are no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2010. The Internal Revenue Service and state and local taxing authorities reserve the right to audit any period where net operating loss carryforwards are available.
A reconciliation of the change in our gross unrecognized tax benefits (excluding both interest and any related federal benefit) from January 1 to December 31 for 2018 and 2017 are as follows:
|
| | | | | | |
| | 2018 | | 2017 |
| | (Dollars in millions) |
| Unrecognized tax benefits at December 31, 2017 | $ | — |
| | — |
|
| Increase due to tax positions taken in a prior year | 433 |
| | — |
|
| Unrecognized tax benefits at December 31, 2018 | $ | 433 |
| | — |
|
The total amount of unrecognized tax benefits (including interest and net of federal benefit) that, if recognized, would impact the effective income tax rate was $435 million at December 31, 2018. As of December 31, 2017, there was no impact on the effective income tax rate.
Our policy is to reflect interest expense associated with unrecognized tax benefits in income tax expense. We had accrued interest (presented before related tax benefits) of approximately $21 million at December 31, 2018. We made no accrual as of December 31, 2017 for interest.
Based on our current assessment of various factors, including (i) the potential outcomes of these ongoing examinations, (ii) the expiration of statute of limitations for specific jurisdictions, (iii) the negotiated settlement of certain disputed issues, and (iv) the administrative practices of applicable taxing jurisdictions, it is reasonably possible that the related unrecognized tax benefits for uncertain tax positions previously taken maynot change in the next 12 months. The actual amount of changes, if any, will depend on future developments and events, many of which are outside our control.
Income Tax Expense
The components of the income tax expense (benefit) from continuing operations are as follows: |
| | | | | | | | | |
| Years Ended December 31, |
| 2018 | | 2017 | | 2016 |
| (Dollars in millions) |
| Income tax expense (benefit): |
|
|
|
|
|
| Current: |
|
|
|
|
|
| Federal and foreign | $ | (39 | ) |
| 777 |
| | 686 |
|
| State and local | 31 |
|
| 130 |
| | 115 |
|
| Total current | (8 | ) |
| 907 |
|
| 801 |
|
| Deferred: |
|
|
|
|
|
| Federal and foreign | 408 |
|
| (736 | ) | | (103 | ) |
| State and local | 94 |
|
| (37 | ) | | (20 | ) |
| Total deferred | 502 |
|
| (773 | ) |
| (123 | ) |
| Income tax expense (benefit) | $ | 494 |
|
| 134 |
|
| 678 |
|
The effective income tax rate for continuing operations differs from the statutory tax rate as follows: |
| | | | | | | | |
| | Years Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (in percent) |
| Effective income tax rate: | | | | | |
| Federal statutory income tax rate | 21.0 | % | | 35.0 | % | | 35.0 | % |
| State income taxes-net of federal effect | 6.1 | % | | 3.4 | % | | 3.5 | % |
| Tax reform | — | % | | (31.0 | )% | | — | % |
| Accounting method changes | (3.9 | )% | | — | % | | — | % |
| Other | (0.3 | )% | | 0.1 | % | | — | % |
| Effective income tax rate | 22.9 | % | | 7.5 | % | | 38.5 | % |
The effective tax rate for the year ended December 31, 2017 reflects the benefit of $555 million from the re-measurement of deferred taxes as noted above.
Deferred Tax Assets and Liabilities
The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows: |
| | | | | | |
| | As of December 31, |
| | 2018 | | 2017 |
| | (Dollars in millions) |
| Deferred tax assets and liabilities: | | | |
| Deferred tax liabilities: | | | |
| Property, plant and equipment | $ | (1,026 | ) | | (933 | ) |
| Intangibles assets | (419 | ) | | (553 | ) |
| Total deferred tax liabilities | (1,445 | ) | | (1,486 | ) |
| Deferred tax assets: | | | |
| Payable to affiliate due to post-retirement benefit plan participation | 297 |
| | 366 |
|
| Other | 58 |
| | 127 |
|
| Gross deferred tax assets | 355 |
| | 493 |
|
| Less valuation allowance on deferred tax assets | (8 | ) | | (8 | ) |
| Net deferred tax assets | 347 |
| | 485 |
|
| Net deferred tax liabilities | $ | (1,098 | ) | | (1,001 | ) |
At December 31, 2018, we have established a valuation allowance of $8 million as it is not more likely than not that this amount of deferred tax assets will be realized.
Other Income Tax Information
We received $8 million from QSC and paid $907 million and $801 million to QSC related to income taxes in the years ended December 31, 2018, 2017 and 2016, respectively.
| |
| (12) | Products and Services Revenue |
We are an integrated communications company engaged primarily in providing an array of communications services, including local voice, broadband, private line (including business data services), Ethernet, network access, information technology and other ancillary services. We strive to maintain our customer relationships by, among other things, bundling our service offerings to provide our customers with a complete offering of integrated communications services.
We categorize our products, services and revenue among the following six categories:
IP and Data Services, which include primarily VPN data networks, Ethernet, IP and other ancillary services;
Transport and Infrastructure, which include broadband, private line (including business data services) and other ancillary services;
Voice and Collaboration, which includes primarily local voice, including wholesale voice, and other ancillary services;
IT and Managed Services, which include information technology services and managed services, which may be purchased in conjunction with our other network services;
Regulatory Revenue, which consist of Universal Service Fund ("USF") and Connect America Fund ("CAF") support payments and other operating revenue. We receive federal support payments from both federal and state USF programs and from the federal CAF program. These support payments are government subsidies designed to reimburse us for various costs related to certain telecommunications services including the costs of deploying, maintaining and operating voice and broadband infrastructure in high-cost rural areas where we are not able to fully recover our costs from our customers; and
Affiliate services, we provide to our affiliates, telecommunication services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support services, network support and technical services.
From time to time, we may change the categorization of our products and services.
Our operating revenue for our products and services consisted of the following categories for the years ended December 31, 2018, 2017 and 2016: |
| | | | | | | | | |
| | Years Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) |
| IP and Data Services | $ | 616 |
| | 634 |
| | 667 |
|
| Transport and Infrastructure | 2,926 |
| | 3,006 |
| | 3,109 |
|
| Voice and Collaboration | 1,800 |
| | 1,980 |
| | 2,252 |
|
| IT and Managed Services | 6 |
| | — |
| | 2 |
|
| Regulatory Services | 210 |
| | 211 |
| | 217 |
|
| Affiliate Services | 2,935 |
| | 2,719 |
| | 2,663 |
|
| Total operating revenue | $ | 8,493 |
| | 8,550 |
| | 8,910 |
|
We do not have any single external customer that provides more than 10% of our total consolidated operating revenue. Substantially all of our consolidated revenue comes from customers located in the United States.
We recognize revenue in our consolidated statements of operations for certain USF surcharges and transaction taxes that we bill to our customers. Our consolidated statements of operations also reflect the offsetting expense for the amounts we remit to the government agencies. The total amount of such surcharges and transaction taxes that we included in revenue aggregated to $124 million, $134 million and $149 million for the years ended December 31, 2018, 2017 and 2016, respectively. These USF surcharges are assigned to the products and services categories based on the underlying revenue. We also act as a collection agent for certain other USF and transaction taxes that we are required by government agencies to bill our customers, for which we do not record any revenue or expense because we only act as a pass-through agent.
Our operations are integrated into and reported as part of the consolidated segment data of CenturyLink. CenturyLink's chief operating decision maker ("CODM") is our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the Securities and Exchange Commission. Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such, we believe we have one reportable segment.
| |
| (13) | Stockholder's EquityAffiliate Transactions |
Common Stock
We have one share of common stock (no par value) issued and outstanding, which is owned by QSC.
provide to our affiliates, telecommunications services that we also provide to external customers. In addition, we provide to our affiliates, computer system development and support services and network support and technical services.
Below are details of the services we provide to our affiliates:
Telecommunications services. Data, broadband and voice services in support of our affiliates' service offerings;
Computer system development and support services. Information technology services primarily include the normal courselabor cost of business,developing, testing and implementing the system changes necessary to support order entry, provisioning, billing, network and financial systems, as well as the cost of improving, maintaining and operating our operations support systems and shared internal communications networks; and
Network support and technical services. Network support and technical services relate to forecasting demand volumes and developing plans around network utilization and optimization, developing and implementing plans for overall product development, provisioning and customer care.
We charge our affiliates for services that we transfer assetsalso provide to external customers, while other services that we provide only to our affiliates are priced by applying a fully distributed cost ("FDC") methodology. FDC rates include salaries and liabilitieswages, payroll taxes, employee related benefits, miscellaneous expenses, and charges for the use of our buildings, computing and software assets. Whenever possible, costs are directly assigned to and from QSC and itsour affiliates whichfor the services they use. If costs cannot be directly assigned, they are recorded through our equity. Itallocated among all affiliates based upon cost causative measures; or if no cost causative measure is our policy to recordavailable, these asset transferscosts are allocated based on carrying values.a general allocator. These cost allocation methodologies are reasonable. From time to time, we adjust the basis for allocating the costs of a shared service among affiliates. Such changes in allocation methodologies are generally billed prospectively.
Dividends
We declared the following cash dividend to QSC:also purchase services from our affiliates including telecommunication services, insurance, flight services and other support services such as legal, regulatory, finance and accounting, tax, human resources and executive support. Our affiliates charge us for these services based on FDC. |
| | | | | | | | | |
| | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 |
| | (Dollars in millions) |
| Cash dividend declared to QSC | $ | 1,350 |
| | 1,400 |
| | 1,325 |
|
| Cash dividend paid to QSC | 1,350 |
| | 1,400 |
| | 1,325 |
|
The timing of cash payments for declared dividends to QSC is at our discretion in consultation with QSC. We may declare and pay dividends to QSC in excess of our earnings to the extent permitted by applicable law. Our debt covenants do not limit the amount of dividends we can pay to QSC.
| |
| (14) | Quarterly Financial Data (Unaudited) |
| | | | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Total | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Total |
| | (Dollars in millions) | (Dollars in millions) |
| 2015 | | | | | | | | | | |
| Operating revenues | $ | 2,217 |
| | 2,222 |
| | 2,287 |
| | 2,238 |
| | 8,964 |
| |
| 2018 | | | | | | | | | | |
| Operating revenue | | $ | 2,130 |
| | 2,101 |
| | 2,149 |
| | 2,113 |
| | 8,493 |
|
| Operating income | 545 |
| | 521 |
| | 572 |
| | 622 |
| | 2,260 |
| 632 |
| | 626 |
| | 717 |
| | 685 |
| | 2,660 |
|
| Income tax expense | 167 |
| | 152 |
| | 171 |
| | 169 |
| | 659 |
| 130 |
| | 81 |
| | 111 |
| | 172 |
| | 494 |
|
| Net income | 247 |
| | 238 |
| | 268 |
| | 321 |
| | 1,074 |
| 380 |
| | 427 |
| | 453 |
| | 405 |
| | 1,665 |
|
|
| | | | | | | | | | | | | | | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Total |
| | (Dollars in millions) |
| 2014 | | | | | | | | | |
| Operating revenues | $ | 2,211 |
| | 2,206 |
| | 2,198 |
| | 2,223 |
| | 8,838 |
|
| Operating income | 542 |
| | 546 |
| | 528 |
| | 496 |
| | 2,112 |
|
| Income tax expense | 160 |
| | 162 |
| | 156 |
| | 161 |
| | 639 |
|
| Net income | 253 |
| | 256 |
| | 245 |
| | 216 |
| | 970 |
|
|
| | | | | | | | | | | | | | | |
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Total |
| | (Dollars in millions) |
| 2017 | | | | | | | | | |
| Operating revenue | $ | 2,162 |
| | 2,133 |
| | 2,141 |
| | 2,114 |
| | 8,550 |
|
| Operating income | 580 |
| | 573 |
| | 560 |
| | 600 |
| | 2,313 |
|
| Income tax expense (benefit) | 174 |
| | 170 |
| | 168 |
| | (378 | ) | | 134 |
|
| Net income | 278 |
| | 268 |
| | 265 |
| | 846 |
| | 1,657 |
|
During the third quarter of 2015, we recognized an incremental $64 million of revenue associated with the FCC's CAF Phase 2 support program, and an additional incremental $31 million inIn the fourth quarter of 2015.2017, we recognized a tax benefit of $555 million due to the change in the federal corporate tax rate from 35% to 21%.
| |
| (15) | Commitments, Contingencies and ContingenciesOther Items |
Legal Matters
We are subject to various claims, legal proceedings and other contingent liabilities, including the matters described below, which individually or in the aggregate could materially affect our financial condition, future results of operations or cash flows. As a matter of course, we are prepared to both litigate these matters to judgment as needed, as well as to evaluate and consider reasonable settlement opportunities.
Irrespective of its merits, litigation may be both lengthy and disruptive to our operations and could cause significant expenditure and diversion of management attention. We review our litigation accrual liabilities on a quarterly basis, but in accordance with applicable accounting guidelines only establish accrual liabilities when losses are deemed probable and reasonably estimable and only revise previously-established accrual liabilities when warranted by changes in circumstances, in each case based on then-available information. As such, as of any given date we could have exposure to losses under proceedings as to which no liability has been accrued or as to which the accrued liability is inadequate. Amounts accrued for our litigation and non-income tax contingencies at December 31, 2018 aggregated to approximately $17 million and are included in “Other” current liabilities and “Other Liabilities” in our consolidated balance sheet as of such date. The establishment of an accrual does not mean that actual funds have been set aside to satisfy a given contingency. Thus, the resolution of a particular contingency for the amount accrued could have no effect on our results of operations but nonetheless could have an adverse effect on our cash flows.
In this Note, when we refer to a class action as "putative" it is because a class has been alleged, but not certified in that matter.
Switched Access Disputes
Subsidiaries of CenturyLink, Inc., including us, are among hundreds of companies involved in an industry-wide dispute, raised in nearly 100 federal lawsuits (filed between 2014 and 2016) that have been consolidated in the United States District Court for the Northern District of Texas for pretrial procedures. The disputes relate to switched access charges that local exchange carriers ("LECs") collect from interexchange carriers ("IXCs") for IXCs' use of LEC's access services. In the lawsuits, IXCs, including Sprint Communications Company L.P. ("Sprint") and various affiliates of Verizon Communications Inc. ("Verizon"), assert that federal and state laws bar LECs from collecting access charges when IXCs exchange certain types of calls between mobile and wireline devices that are routed through an IXC. Some of these IXCs have asserted claims seeking refunds of payments for access charges previously paid and relief from future access charges.
In November 2015, the federal court agreed with the LECs and rejected the IXCs' contention that federal law prohibits these particular access charges, and also allowed the IXCs to refile state-law claims. Since then, many of the LECs and IXCs have filed revised pleadings and additional motions, which remain pending. Separately, some of the defendants, including us, have petitioned the FCC to address these issues on an industry-wide basis.
The outcome of these disputes and lawsuits, as well as any related regulatory proceedings that could ensue, are currently not predictable.
Billing Practices Suits
In June 2017, a former employee of CenturyLink filed an employment lawsuit against CenturyLink claiming that she was wrongfully terminated for alleging that CenturyLink charged some of its retail customers for products and services they did not authorize. Starting shortly thereafter and continuing since then, and based in part on the allegations made by the former employee, several legal proceedings have been filed.
In June 2017, McLeod v. CenturyLink, a putative consumer class action, was filed against CenturyLink in the U.S. District Court for the Central District of California alleging that it charged some of its retail customers for products and services they did not authorize. A number of other complaints asserting similar claims have been filed in other federal and state courts, as well. The lawsuits assert claims including fraud, unfair competition, and unjust enrichment. Also, in June 2017, Craig. v. CenturyLink, Inc., et al., a putative securities investor class action, was filed in U.S. District Court for the Southern District of New York, alleging that it failed to disclose material information regarding improper sales practices, and asserting federal securities law claims. A number of other cases asserting similar claims have also been filed.
Beginning June 2017, CenturyLink received several shareholder derivative demands addressing related topics. In August 2017, CenturyLink's Board of Directors formed a special litigation committee of outside directors to address the allegations of impropriety contained in the shareholder derivative demands. In April 2018, the special litigation committee concluded its review of the derivative demands and declined to take further action. Since then, derivative cases were filed. Two of these cases, Castagna v. Post and Pinsly v. Post, were filed in Louisiana state court in the Fourth Judicial District Court for the Parish of Ouachita. The remaining derivative cases were filed in federal court in Louisiana and Minnesota. These cases have been brought on behalf of CenturyLink against certain current and former officers and directors of the Company and seek damages for alleged breaches of fiduciary duties.
The consumer putative class actions, the securities investor putative class actions, and the federal derivative actions described above have been transferred to the U.S. District Court for the District of Minnesota for coordinated and consolidated pretrial proceedings as In Re: CenturyLink Sales Practices and Securities Litigation.
In July 2017, the Minnesota state attorney general filed State of Minnesota v. CenturyTel Broadband Services LLC, et al. in the Anoka County Minnesota District Court, alleging claims of fraud and deceptive trade practices relating to improper consumer sales practices. The suit seeks an order of restitution on behalf of all CenturyLink customers, civil penalties, injunctive relief, and costs and fees. Additionally, CenturyLink has received and responded to information requests and inquiries from other states.
Other Proceedings, Disputes and Contingencies
From time to time, we are involved in other proceedings incidental to our business, including patent infringement allegations, administrative hearings of state public utility commissions relating primarily to our rates or services, actions relating to employee claims, various tax issues, environmental law issues, grievance hearings before labor regulatory agencies and miscellaneous third partythird-party tort actions.
We are currently defending several patent infringement lawsuits asserted against us by non-practicing entities, many of whomwhich are seeking substantial recoveries. These cases have progressed to various stages and one or more may go to trial in the coming 24 months if they are not otherwise resolved. Where applicable, we are seeking full or partial indemnification from our vendors and suppliers. As with all litigation, we are vigorously defending these actions and, as a matter of course, we are prepared both to litigate these matters to judgment, as well as to evaluate and consider all reasonable settlement opportunities.
We are among hundreds of defendants nationwide in dozens of lawsuits filed by Sprint Communications Company and affiliates of Verizon Communications Inc. The plaintiffs in these suits have challenged the right of local exchange carriers to bill interexchange carriers for switched access charges for certain calls between mobile and wireline devices that are routed through an interexchange carrier. In the lawsuits, the plaintiffs are seeking refunds of access charges previously paid and relief from future access charges. In addition, these and some other interexchange carriers have ceased paying switched access charges on these calls. These lawsuits involving us and many other carriers have been consolidated for pretrial purposes in the United States District Court for the District of Northern Texas. In November 2015, the Court dismissed the plaintiffs' federal law claims and granted them leave to file state law claims, if any. Some of the defendants, including us, have petitioned the Federal Communications Commission to address these issues on an industry-wide basis.
The outcome of these disputes and suits, as well as any related regulatory proceedings that could ensue, are currently not predictable. If we are required to stop assessing these charges or to pay refunds of any such charges, our financial results could be negatively affected.
CenturyLink and its affiliates are involved in several legal proceedings to which we are not a party that, if resolved against them, could have a material adverse effect on their business and financial condition. As an indirect wholly-owned subsidiary of CenturyLink, our business and financial condition could be similarly affected. You can find descriptions of these legal proceedings in CenturyLink's quarterly and annual reports filed with the Securities and Exchange Commission. Because we are not a party to any of the matters, we have not accrued any liabilities for the matters.
We are subject to various federal, state and local environmental protection and health and safety laws. From time to time, we are subject to judicial and administrative proceedings brought by various governmental authorities under these laws. Several such proceedings are currently pending, but none is reasonably expected to exceed $100,000 in fines and penalties.
The outcome of these other proceedings described under this heading is not predictable. However, based on current circumstances, we do not believe that the ultimate resolution of these other proceedings, after considering available defenses and any insurance coverage or indemnification rights, will have a material adverse effect on us.
The ultimate outcome of the above-described matters may differ materially from the outcomes anticipated, estimated, projected or implied by us in certain of our financial position, results of operations or cash flows.statements appearing above in this Note, and proceedings currently viewed as immaterial by us may ultimately materially impact us.
Capital Leases
We lease certain facilities and equipment under various capital lease arrangements. Depreciation of assets under capital leases is included in depreciation and amortization expense in our consolidated statements of operations. Payments on capital leases are included in repayments of long-term debt, including current maturities in our consolidated statements of cash flows.
The tables below summarize our capital lease activity: | | | | Years Ended December 31, | Years Ended December 31, |
| | 2015 | | 2014 | | 2013 | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) | (Dollars in millions) |
| Assets acquired through capital leases | $ | 10 |
| | 3 |
| | — |
| $ | 2 |
| | 19 |
| | 10 |
|
| Depreciation expense | 19 |
| | 32 |
| | 42 |
| 14 |
| | 9 |
| | 5 |
|
| Cash payments towards capital leases | 20 |
| | 32 |
| | 40 |
| 12 |
| | 8 |
| | 6 |
|
| | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2018 | | 2017 |
| | (Dollars in millions) | (Dollars in millions) |
| Assets included in property, plant and equipment | $ | 66 |
| | 137 |
| $ | 50 |
| | 57 |
|
| Accumulated depreciation | 55 |
| | 108 |
| 28 |
| | 24 |
|
The future annual minimum payments under capital lease arrangements as of December 31, 20152018 were as follows: | | | | Future Minimum Payments | Future Minimum Payments |
| | (Dollars in millions) | (Dollars in millions) |
| Capital lease obligations: | | |
| 2016 | $ | 8 |
| |
| 2017 | 4 |
| |
| 2018 | 4 |
| |
| 2019 | 2 |
| $ | 10 |
|
| 2020 | — |
| 6 |
|
| 2021 and thereafter | 5 |
| |
| 2021 | | 2 |
|
| 2022 | | 1 |
|
| 2023 | | 1 |
|
| 2024 and thereafter | | 4 |
|
| Total minimum payments | 23 |
| 24 |
|
| Less: amount representing interest and executory costs | (7 | ) | (5 | ) |
| Present value of minimum payments | 16 |
| 19 |
|
| Less: current portion | (6 | ) | (12 | ) |
| Long-term portion | $ | 10 |
| $ | 7 |
|
Operating LeasesLease Income
Qwest leases various IRUs, office facilities, switching facilities and other network sites to third parties under operating leases. Lease and sublease income is included in operating revenue in the consolidated statements of operations.
For the years ended December 31, 2018, 2017 and 2016, our gross rental income was $522 million, $555 million and $594 million, respectively.
Right-of-Way and Operating Lease Expense
We lease various equipment, office facilities, retail outlets, switching facilities and other network sites. These leases, with few exceptions, provide for renewal options and escalations that are either fixed or based on the consumer price index. Any rent abatements, along with rent escalations, are included in the computation of rent expense calculated on a straight-line basis over the lease term. The lease term for most leases includes the initial non-cancelable term plus any term under renewal options that are reasonably assured. For the years ended December 31, 2015, 20142018, 2017 and 2013,2016, our gross rental expense was $75$64 million, $79$70 million and $83$72 million, respectively. We also received sublease rental income for the years ended December 31, 2015, 20142018, 2017 and 20132016 of $4$2 million, $4$2 million and $4 million, respectively.
At December 31, 2015,2018, our future rental commitments for Right-of-Way agreements and operating leases were as follows: |
| | | |
| | Future Minimum Payments |
| | (Dollars in millions) |
| Operating leases: | |
| 2016 | $ | 56 |
|
| 2017 | 50 |
|
| 2018 | 45 |
|
| 2019 | 37 |
|
| 2020 | 32 |
|
| 2021 and thereafter | 52 |
|
Total future minimum payments(1) | $ | 272 |
|
|
| | | | | | | | | |
| | Right-of-Way Agreements | Operating Leases | Total |
| | (Dollars in millions) |
| 2019 | $ | 19 |
| $ | 35 |
| $ | 54 |
|
| 2020 | 20 |
| 28 |
| 48 |
|
| 2021 | 20 |
| 27 |
| 47 |
|
| 2022 | 20 |
| 23 |
| 43 |
|
| 2023 | 19 |
| 19 |
| 38 |
|
| 2024 and thereafter | 102 |
| 32 |
| 134 |
|
Total future minimum payments(1) | $ | 200 |
| $ | 164 |
| $ | 364 |
|
| |
(1) | Minimum payments have not been reduced by minimum sublease rentals of $30$22 million due in the future under non-cancelable subleases. |
Purchase Commitments
We have several commitments primarily for marketing activities and support services from a variety of vendors to be used in the ordinary course of business totaling $132$25 million at December 31, 2015.2018. Of this amount, we expect to purchase $73 million in 2016, $53 million in 2017 through 2018, $6$15 million in 2019 and $10 million in 2020 through 2020 and none in 2021 and thereafter.2021. These amounts do not represent our entire anticipated purchases in the future, but represent only those items for which we were contractually committed as of December 31, 2015.2018.
| |
| (16) | Other Financial Information |
Other Current Assets
The following table presents details of other current assets in our consolidated balance sheets: | | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2018 | | 2017 |
| | (Dollars in millions) | (Dollars in millions) |
| Prepaid expenses | $ | 46 |
| | 45 |
| $ | 37 |
| | 42 |
|
| Contract acquisition costs | | 52 |
| | — |
|
| Contract fulfillment costs | | 27 |
| | 49 |
|
| Other | 77 |
| | 80 |
| 31 |
| | 7 |
|
| Total other current assets | $ | 123 |
| | 125 |
| $ | 147 |
| | 98 |
|
Selected Current Liabilities
Current liabilities reflected in our consolidated balance sheets include accounts payable: |
| | | | | | |
| | As of December 31, |
| | 2015 | | 2014 |
| | (Dollars in millions) |
| Accounts payable | $ | 369 |
| | 464 |
|
Included in accounts payable at December 31, 2015 and 2014, were $29 million and $44 million, respectively, associated with capital expenditures.
| |
| (17) | Labor Union Contracts |
Approximately 11,000,
As of December 31, 2018, approximately 8,400, or 50%,44% of our employees arewere members of various bargaining units represented by the CommunicationsCommunication Workers of America ("CWA") orand the International Brotherhood of Electrical Workers ("IBEW"). We believe that relations with our employees continue to be generally good.
Common Stock
We have one share of common stock (no par value) issued and outstanding, which is owned by QSC.
In addition, in the normal course of business, we transfer assets and liabilities to and from QSC and its affiliates, which are subjectrecorded through our equity. It is our policy to collective bargaining agreementsrecord these asset transfers based on carrying values.
Dividends
We declared the following cash dividend to QSC: |
| | | | | | | | | |
| | Years Ended December 31, |
| | 2018 | | 2017 | | 2016 |
| | (Dollars in millions) |
| Cash dividend declared to QSC | $ | 1,275 |
| | 1,000 |
| | 1,300 |
|
| Cash dividend paid to QSC | 1,275 |
| | 1,000 |
| | 1,300 |
|
The timing of cash payments for declared dividends to QSC is at our discretion in consultation with QSC. We may declare and pay dividends to QSC in excess of our earnings to the extent permitted by applicable law. Our debt covenants do not limit the amount of dividends we can pay to QSC.
On March 31, 2017, we distributed our equity interest valued at $12 million in a limited liability company to QSC. The limited liability company's sole asset was a building that expire in 2017.was being utilized by an affiliate.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure
Disclosure controls and procedures (as defined in Rule 13a-15(e) ofpromulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) are designed to provide reasonable assurance that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is(i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These include controlsforms and procedures designed to ensure that this information is(ii) accumulated and communicated to the Company’s management, including itsour Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Management with the participation of our Chief Executive Officer, Glen F. Post, III, and our Chief Financial Officer, R. Stewart Ewing, Jr., evaluated the effectiveness of the Company’s disclosurerecognizes that any controls and procedures, asno matter how well designed and operated, can provide only reasonable assurance of December 31, 2015. achieving their objectives, and management necessarily applies its judgment in evaluating the cost benefit relationship of possible controls and procedures.
Based on thistheir most recent evaluation, the Company’sour Chief Executive Officer and Chief Financial Officer have concluded that, theas of December 31, 2018, our Company’s disclosure controls and procedures were not effective as a result of the material weaknesses in our internal control over financial reporting described below.
Notwithstanding the material weaknesses described below, our management, including our chief executive officer and chief financial officer, believes that the audited consolidated financial statements contained in this Annual Report on Form 10-K fairly present, in all material respects, our financial condition, results of operations and cash flows for the fiscal years presented in conformity with U.S. generally accepted accounting principles. In addition, the material weaknesses described below did not result in the restatements of any of our audited or unaudited consolidated financial statements or disclosures for any previously reported periods.
Changes in Internal Control over Financial Reporting
During the fourth quarter 2018, we identified a deficiency that existed earlier in the year in the design of process controls over manual journal entries. Specifically, we had not designed and implemented controls to ensure all manual journal entries were reviewed. Although this control deficiency did not result in a misstatement in our consolidated financial statements, it created a reasonable possibility that a material misstatement would not have
been prevented or detected on a timely basis. Therefore we concluded the deficiency represented a material weakness in our internal control over financial reporting.
Upon identification of the deficiency, management designed and implemented a new journal entry module into our enterprise resource planning (ERP) system with certain configuration and automated workflow controls that we believe, together with newly-designed and implemented monitoring controls, sufficiently remediated the material weakness prior to December 31, 2015, at2018.
Except for the reasonable assurance level.
The effectivenessremediation of our or any system of disclosure controls and procedures is subject to certain limitations, including the exercise of judgment in designing, implementing and evaluating the controls and procedures, the assumptions used in identifying the likelihood of future eventsmanual journal entry material weakness discussed above, and the inabilityadditional material weakness disclosed below, there were no changes in our internal control over financial reporting during the quarter ended December 31, 2018 that materially affected, or that we believe are reasonably likely to eliminate misconduct completely. As a result, there can be no assurance thatmaterially affect, our disclosure controls and procedures will detect all errors or fraud. By their nature, our or any system of disclosure controls and procedures can provide only reasonable assurance regarding management'sinternal control objectives.over financial reporting.
Internal Control Overover Financial Reporting
Management’s Report on Internal Control Overover Financial Reporting
Management of the Company
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act), a process. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. UnderOur system of internal control over financial reporting includes policies and procedures that (1) pertain to the supervisionmaintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles and that receipts and expenditures are being made only in accordance with authorizations of our management; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our consolidated financial statements.
Our management, under the participationoversight of management, including our principal executive officer and principal financial officer, we conducted an evaluation ofand Audit Committee, assessed the effectiveness of our internal control over financial reporting based onas of December 31, 2018 using the frameworkcriteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integratedcontrol - An Integrated Framework (2013) issued by the COSO. Based(“2013 Framework”). In connection with this assessment, we identified a material weakness in internal control over financial reporting as of December 31, 2018. A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on our evaluation under the frameworka timely basis. As a result of COSO,this assessment, management concluded a material weakness existed related to the ineffective design and operation of certain process level internal controls over the existence and accuracy of revenue transactions. The deficiency arose because we did not conduct an effective risk assessment to identify risks of material misstatement related to the existence and accuracy of revenue transactions.
The deficiency led to immaterial misstatements that were not corrected in revenue. However, the control deficiency created a reasonable possibility that a material misstatement to the consolidated financial statements would not be prevented or detected on a timely basis. Therefore, we concluded that the deficiency represented a material weakness in internal control over financial reporting and our internal control over financial reporting was not effective atas of December 31, 2015.2018.
Pursuant to Regulation S-K 308(b), this Annual Report on Form 10-K does not include an attestation report of our company’s registered public accounting firm regarding internal control over financial reporting.
Remediation Plans
We are taking several steps to remediate the material weakness identified above. These steps include the following:
We plan to implement continuous risk assessment processes that are designed to identify and assess changes that could significantly impact our internal control over financial reporting environment and risks of material misstatement related to the revenue recognition process.
We plan to design and implement sufficient additional process level control activities over the existence and accuracy of revenue transactions.
We plan to execute our plans to remediate the material weakness identified above as soon as feasible. We will test the ongoing effectiveness of the new controls and will consider the material weakness remediated after the new controls operate effectively for a sufficient period of time. There is no assurance, however, that these measures will remediate the material weakness or ensure that our internal controls over financial reporting will be effective in the future.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We have omitted this information
Omitted pursuant to General Instruction I.I (2).
ITEM 11. EXECUTIVE COMPENSATION
We have omitted this information
Omitted pursuant to General Instruction I.I (2).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
We have omitted this information
Omitted pursuant to General Instruction I.I (2).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
We have omitted this information
Omitted pursuant to General Instruction I.I (2).
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Pre-Approval Policies and Procedures
The Audit Committee of CenturyLink's Board of Directors is responsible for the appointment, compensation and oversight of the work of our independent registered public accounting firm. Under the Audit Committee's charter, the Audit Committee pre-approves all audit and permissible non-audit services provided by our independent registered public accounting firm. The approval may be given as part of the Audit Committee's approval of the scope of the engagement of our independent registered public accounting firm or on an individual basis. The pre-approval of non-audit services may be delegated to one or more of the Audit Committee's members, but the decision must be reported to the full Audit Committee. Our independent registered public accounting firm may not be retained to perform the non-audit services specified in Section 10A(g) of the Exchange Act.
Fees Paid to the Independent Registered Public Accounting Firm
QCII first engaged KPMG LLP to be our independent registered public accounting firm in May 2002. The aggregate
audit fees billed or allocated to us
was $2.2 million and $2.6 million for the years ended December 31,
20152018 and
20142017, respectively, for professional accounting services, including KPMG's audit of our annual consolidated financial
statements, are set forth in the table below.statements. |
| | | | | | |
| | Years Ended December 31, |
| | 2015 | | 2014 |
| | (Dollars in thousands) |
| Audit fees | $ | 2,910 |
| | 2,825 |
|
| Audit-related fees | — |
| | — |
|
| Total fees | $ | 2,910 |
| | 2,825 |
|
KPMG did not provide to us any professional services for tax compliance, tax advice or tax planning in 2015 or 2014.
For purposes of the preceding table, the professional fees are classified as follows:
Audit fees: Thesefees are fees billed for the year shown for professional services performed for the audit of the consolidated financial statements included in our Form 10-K filing for that year, the review of condensed consolidated financial statements included in our Form 10-Q filings made during that year, comfort letters, consents and assistance with and review of documents filed with the SEC. Audit fees for each year shown include amounts that have been billed through the date of this filing and any additional amounts that are expected to be billed thereafter.
Audit-related fees: These are fees billed for assurance and related services that were performed in the year shown and that are traditionally performed by our independent registered public accounting firm. More specifically, these services include regulatory filings. Audit-related fees for each year shown include amounts that have been billed through the date of this filing.
The Audit Committee of CenturyLink, Inc. approved in advance all of the services performed by KPMG described above.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Exhibits identified in parentheses below are on file with the SEC and are incorporated herein by reference. All other exhibits are provided as part of this electronic submission.(1) |
| | | |
Exhibit Number | | Description |
| 3.1 |
| | Restated Articles of Incorporation of Qwest Corporation (incorporated by reference to Exhibit 3(a) of Qwest Corporation's Annual Report on Form 10-K for the year ended December 31, 1997 (File No. 001-03040) filed with the Securities |
3.2 |
| | Articles of Amendment to therestated Articles of Incorporation of Qwest Corporation (incorporated by reference to Exhibit 3.1 of Qwest Corporation's Quarterly Report on Form 10-Q for the period ended June 30, 2000March 31, 2013 (File No. 001-03040) filed with the Securities and Exchange Commission on August 11, 2000)May 13, 2013). |
3.33.2 |
| | |
| 4.1 |
| | |
| |
| a. | |
| 4.2 |
| | |
| | a. | |
| 4.3 |
| | Indenture, dated as of October 15, 1999, by and between U S West Communications, Inc. (currently named Qwest Corporation) and Bank One Trust Company, N.A., as trustee (incorporated by reference to Exhibit 4(b) of Qwest Corporation's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 001-03040) filed with the Securities and Exchange Commission on March 3, 2000). |
| | a. | Fifth Supplemental Indenture, dated as of May 16, 2007, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.1 of Qwest Corporation's Current Report on Form 8-K (File No. 001-03040) filed with the Securities and Exchange Commission on May 18, 2007). |
| b. | Sixth Supplemental Indenture, dated as of April 13, 2009, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.1 of Qwest Corporation's Current Report on Form 8-K (File No. 001-03040) filed with the Securities and Exchange Commission on April 13, 2009). |
| c. | Seventh Supplemental Indenture, dated as of June 8, 2011, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.8 of Qwest Corporation's Form 8-A (File No. 001-03040) filed with the Securities and Exchange Commission on June 7, 2011). |
| d. | |
| | e.b. | |
| f. | Tenth Supplemental Indenture, dated as of April 2, 2012, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Qwest Corporation's Form 8-A (File No. 001-03040) filed with the Securities and Exchange Commission on March 30, 2012). |
| g. | Eleventh Supplemental Indenture, dated as of June 25, 2012, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Qwest Corporation's Form 8-A (File No. 001-03040) filed with the Securities and Exchange Commission on June 22, 2012). |
| h. | Twelfth Supplemental Indenture, dated as of May 23, 2013, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.13 of Qwest Corporation's Form 8-A (File No. 001-03040) filed with the Securities and Exchange Commission on May 22, 2013). |
| i. | Thirteenth Supplemental Indenture, dated as of September 29, 2014, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.14 of Qwest Corporation's Form 8-A (File No. 001-03040) filed with the Securities and Exchange Commission on September 26, 2014). |
| j. | Fourteenth Supplemental Indenture, dated as of September 21, 2015, by and between Qwest Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.15 of Qwest Corporation's Form 8-A (File No. 001-03040) filed with the Securities and Exchange Commission on September 21, 2015). |
| |
(1) | Certain of the items in Sections 4.1 through 4.3 (i)(j) omit supplemental indentures or other instruments governing debt that has been retired, or (ii) refer to trustees who may have been replaced, acquired or affected by similar changes. In accordance with Item 601(b) (4) (iii) (A) of Regulation S-K, copies of certain instruments defining the rights of holders of certain of our long-term debt are not filed herewith. Pursuant to this regulation, we hereby agree to furnish a copy of any such instrument to the SEC upon request. |
|
| | | |
Exhibit Number | | Description |
| | k.c. | |
| d. | |
| e. | |
| f. | |
| g. | |
| h. | |
| i. | |
| j. | |
| 4.4 |
| | Revolving Promissory Note, dated as of April 18, 2012, pursuant to which Qwest Corporation may borrow from an affiliate of CenturyLink, Inc. up to $1.0 billion on a revolving basis (incorporated by reference to Exhibit 4.7(b) of CenturyLink, Inc.'s Quarterly Report on Form 10-Q for the period ended June 30, 2012 (File No 001-07784) filed with the Securities and Exchange Commission on August 9, 2012), as amended by the Amended and Restated Revolving Promissory Note, dated as of September 30, 2017, by and between Qwest Corporation and an affiliate of CenturyLink, Inc. (incorporated by reference to Exhibit 4.9(b) of CenturyLink, Inc.'s Quarterly Report on Form 10-Q for the period ended September 30, 2017 (File No. 001-077884) filed with the Securities and Exchange Commission on November 9, 2017). |
| 4.5 |
| | |
12* |
| | Calculation of Ratio of Earnings to Fixed Charges. |
23* |
| | Independent Registered Public Accounting Firm Consent. |
| 31.1* |
| | |
| 31.2* |
| | |
| 32* |
| | |
| 101* |
| | Financial statements from the Annual Report on Form 10-K of Qwest Corporation for the period ended December 31, 2015,2018, formatted in XBRL: (i) the Consolidated Statements of Operations, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statements of Cash Flows, (iv) the Consolidated Statements of Stockholder's Equity and (v) the Notes to the Consolidated Financial Statements. |
ITEM 16. SUMMARY OF BUSINESS AND FINANCIAL INFORMATION
Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Reportreport to be signed on its behalf by the undersigned, thereunto duly authorized on March 1, 2016.21, 2019.
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| | |
| | QWEST CORPORATION |
| | By: | /s/ David D. ColeEric J. Mortensen |
| | | David D. ColeEric J. Mortensen |
| | | ExecutiveSenior Vice President - Controller
(Principal Accounting Officer) and Operations SupportDirector (Chief Accounting Officer and Duly Authorized Officer)
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Reportreport has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
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| | | | |
| Signature | | Title | | Date |
| | | | |
/s/ Glen F. Post, IIIJeff K. Storey | | Chief Executive Officer and President (Principal Executive Officer) | | March 21, 2019 |
Glen F. Post, IIIJeff K. Storey | | | |
| | | | | |
/s/ R. Stewart Ewing, Jr.Indraneel Dev | | Director, Executive Vice President and Chief Financial Officer (Principal Financial Officer)
| | March 21, 2019 |
R. Stewart Ewing, Jr.Indraneel Dev | | | |
| | | | |
| /s/ Stacey W. Goff | | Executive Vice President, General Counsel & Secretary and Director | | March 21, 2019 |
| Stacey W. Goff | | | |
| | | | |
| /s/ Eric J. Mortensen | | Senior Vice President - Controller (Principal Accounting Officer) and Director
| | March 21, 2019 |
| Eric J. Mortensen | | | |