See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
LEVEL 3 PARENT, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
References in the Notes to “Level 3 Communications, Inc.,” "Level 3," “we,” “us,” "its," the “Company” and “our”, unless the context otherwise requires, refer to Level 3 Parent, LLC and its consolidated subsidiaries.
(1) Background
General
We are an international facilities-based communications company engaged in providingprovider of a broad arrayrange of integrated communication services to our business customers. We created our communications network by constructing our own assets and through a combination of purchasing other companies and purchasing or leasing facilities from others.services. We designed our network to provide communications services that employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.
On October 31, 2016, we entered into an agreement and plan of merger (the "Merger Agreement") with CenturyLink, Inc., a Louisiana corporation ("CenturyLink"), Wildcat Merger Sub 1 LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink ("Merger Sub 1"), and WWG Merger Sub LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink ("Merger Sub 2"), pursuant to which, effectiveEffective November 1, 2017, we were acquired by CenturyLink in a cash and stock transaction, including the assumption of our debt (the "CenturyLink Merger"). See Note 2 - CenturyLink Merger.
Basis of Presentation
Our consolidated balance sheet as of December 31, 2017,2018, which was derived from our audited consolidated financial statements, and our unaudited interim consolidated financial statements provided herein have been prepared in accordance with the instructions for Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission ("SEC"); however, in our opinion, the disclosures made are adequate to make the information presented not misleading. We believe that these consolidated financial statements include all normal recurring adjustments necessary to fairly present the results for the interim periods. The consolidated results of operations and cash flows for the first nine months of the year are not necessarily indicative of the consolidated results of operations and cash flows that might be expected for the entire year. These consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our annual report on Form 10-K for the year ended December 31, 2017.2018.
On November 1, 2017, we became a wholly owned subsidiary of CenturyLink. On the date of the acquisition, our assets and liabilities were recognized at CenturyLink's preliminary estimates of fair value. This revaluation has been reflected in our financial statements and, therefore, has resulted in a new basis of accounting for the successor period beginning on November 1, 2017. This new basis of accounting means that our financial statements for the successor periods are not comparable to our previously reported financial statements, including the predecessor period financial statements in this report.
The accompanying consolidated financial statements include our accounts and the accounts of our subsidiaries in which we have a controlling interest. All significant intercompany accountsIntercompany amounts and transactions with our consolidated subsidiaries have been eliminated. Transactions with our non-consolidated affiliates (CenturyLink and its other subsidiaries, referred to herein as affiliates) have not been eliminated. As part of our consolidation policy, we consider our controlled subsidiaries, investments in businesses in which we are not the primary beneficiary or do not have effective control but have the ability to significantly influence operating and financial policies, and variable interests resulting from economic arrangements that give us rights to economic risks or rewards of a legal entity. We do not have variable interests in a variable interest entity where we are required to consolidate the entity as the primary beneficiary. Due to exchange restrictions and other conditions, effective at the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiary.subsidiary and began accounting for our investment in our Venezuelan subsidiary using the cost method of accounting. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the third quarter of 2018.2019.
In conjunction with our acquisition on November 1, 2017, we changed the definitions we use to classify expenses as cost of services and products and selling, general and administrative, and as a result, weWe reclassified previously reportedcertain prior period amounts to conform to the current period presentation. We revisedpresentation, including the categorization of our definitions so that our expense classifications are more consistent with the expense classifications used by our new ultimate parent company, CenturyLink. These revisions resulted in the reclassification of $70 million from depreciationrevenue for three and amortization to cost of services and products for the predecessor nine months ended September 30, 2017. Although we continued as a surviving corporation2019 and legal entity after the acquisition, the accompanying consolidated statements of operations, comprehensive income, member's/stockholders' equity and cash flows are presented for two periods: predecessor and successor, which relates to the period preceding the acquisition and the period succeeding the acquisition. Our current definitions are as follows:2018.
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 are third-party telecommunications expenses we incur for using other carriers' networks to provide services to our customers); rents and utilities expenses; costs for universal service funds ("USF") (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); taxes (such as property and other taxes); and other expenses directly related to our network.
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; taxes (such as state and local franchise taxes and sales and use taxes) and fees; external commissions; bad debt expense; and other selling, general and administrative expenses.
Segments
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.SEC. Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such, we have one1 reportable segment.
Recently Adopted Accounting Pronouncements
We adopted Accounting Standards Update ("ASU") 2016-02, "Leases (ASC 842)", as of September 30, 2018,January 1, 2019, using the non-comparative transition option pursuant to ASU 2018-11. Therefore, we hadhave not completedrestated comparative period financial information for the effects of ASC 842, and we will not make the new required lease disclosures for comparative periods beginning before January 1, 2019. Instead, we have recognized ASC 842's cumulative effect transition adjustment (discussed below) as of January 1, 2019. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things (i) allowed us to carry forward the historical lease classification; (ii) did not require us to reassess whether any expired or existing contracts are or contain leases under the new definition of a lease; and (iii) did not require us to reassess whether previously capitalized initial direct costs for any existing leases would qualify for capitalization under ASC 842. We also elected the practical expedient related to land easements, allowing us to carry forward our accounting treatment for land easements on existing agreements. We did not elect the tax effectshindsight practical expedient regarding the likelihood of the Tax Cuts and Jobs Act (the "Act"), which was signed into law in late December 2017. In order to complete our accountingexercising a lessee purchase option or assessing any impairment of right-of-use assets for the impact of the Act, we continue to obtain, analyze and interpret additional guidance as such guidance becomes available from the U.S. Treasury Department, the Internal Revenue Service (“IRS”), state taxing jurisdictions,existing leases.
On March 5, 2019, the Financial Accounting Standards Board ("FASB") issued ASU 2019-01, "Leases (ASC 842): Codification Improvements", and other standard-setting and regulatory bodies. Guidance issued by these bodies to date does not allow us to definitively calculateeffective for public companies for fiscal years beginning after December 15, 2019. The new ASU aligns the tax effectsguidance in ASC 842 for determining fair value of the Act. New guidanceunderlying asset by lessors that are not manufacturers or interpretationsdealers, with that of existing guidance. As a result, the fair value of the underlying asset at lease commencement is its cost, reflecting any volume or trade discounts that may apply. However, if there has been a significant lapse of time between when the underlying asset is acquired and when the lease commences, the definition of fair value (in ASC 820, "Fair ValueMeasurement") should be applied. More importantly, the ASU also exempts both lessees and lessors from having to provide certain interim disclosures in the fiscal year in which a company adopts the new leases standard. Early adoption permits public companies to adopt concurrent with the transition to ASC 842 on leases. We adopted ASU 2019-01 as of January 1, 2019.
Adoption of the new standards resulted in the recording of operating lease assets and operating lease liabilities of approximately $1.3 billion and $1.4 billion, respectively, as of January 1, 2019. The standards did not materially impact our provisionconsolidated net earnings and had no impact on cash flows. Our financial position for income taxes in future periods.
Additional information that is needed to complete the analysis but is currently unavailable includes, but is not limited to, the amount of earnings of foreign subsidiaries, the final determination of certain net deferred tax assets subject to remeasurement due to purchase accounting adjustments and other matters and the tax treatment of such provisions of the Act by various state tax authorities. We have provisionally recognized the tax impacts related to the remeasurement of deferred tax assets and liabilities. The ultimate impact may differ from our current provisional estimate due to additional analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, and actions we may take as a result of the Act. The change from our current provisional estimates will be reflected in our fourth quarter 2018 statement of operations and could be material. We expect to complete the accounting in the fourth quarter of 2018.
The Act reduced the U.S. corporate income tax rate from a maximum of 35% to 21% for all C corporations, effective January 1, 2018, introduced further limitationsreporting periods beginning on the deductibility of interest expense, made certain changes to capital expenditures and various other items, and imposed a one-time repatriation tax on certain earnings of certain foreign subsidiaries. In addition, the Tax Act introduces additional base-broadening measures, including Global Intangible Low-Taxed Income and the Base-Erosion Anti-Abuse Tax. 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 assets at December 31, 2017 and recognized a tax expense of $195 million in our consolidated statement of operations for the year ended December 31, 2017. During the first nine months of 2018, we increased the tax expense from tax reform by $83 million due to changes in certain purchase accounting adjustments related to CenturyLink’s acquisition of us.
During the third quarter of 2018, we continued to evaluate and analyze the tax impacts of the Act. While we have not finalized our analysis, we do not expect the provisions of the Act, exclusive of the rate reduction, to materially impact us in 2018. However, we cannot provide any assurance that, upon completion of our analysis, the impact will not be material or that there will not be material tax impacts in future years. Accordingly, we have not made any additional adjustments related to the Act in our financial statements.
Based on current circumstances, we do not expect to experience a material near term reduction in the amount of cash income taxes paid by us from the Act due to utilization of net operating loss carryforwards. However, we anticipate that the provisions of the Act may reduce our cash income taxes in future years.
Recently Adopted Accounting Pronouncements
In the first quarter of 2018, we adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”, ASU 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory” and ASU 2018-02, “Income Statement-Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”.
Each of these is described further below.
Revenue Recognition
In May 2014, the FASB issued ASU 2014-09 which replaces virtually all existing generally accepted accounting principles 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 adopted the new revenue recognition standard under the modified retrospective transition method. On January 1, 2018, we recorded a cumulative catch-up adjustment that increased our retained earnings by $9 million, net of $3 million of income taxes.
Under ASU 2014-09, we are now deferring (i.e. capitalizing) incremental contract acquisition and fulfillment costs and are recognizing (or amortizing) such costs over either the initial contract (plus and anticipated renewal contracts to which the costs relate) or the average customer life. Our deferred contract costs for our customers have average amortization periods of approximately 30 months. These deferred costs are monitored every period to reflect any significant change in assumptions.
See Note 4 - Revenue Recognition for additional information.
Comprehensive Income
ASU 2018-02 provides an option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Act (or portion thereof) is recorded. If an entity elects to reclassify the income tax effects of the Act, the amount of that reclassification shall include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of enactment of the Act related to items remaining in accumulated other comprehensive income. The effect of the change in the U.S. federal corporate income tax rate on gross valuation allowances that were originally charged to income from continuing operations shall not be included. ASU 2018-02 is effectiveafter January 1, 2019 but early adoption is permittedpresented under the new guidance, as discussed above, while prior period amounts are not adjusted and shouldcontinue to be applied eitherreported in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Act is recognized. We early adopted ASU 2018-02 in the first quarter of 2018 and applied it in the period of adoption. The adoption of ASU 2018-02 resulted in a $6 million decrease to member's equity and increase to accumulated other comprehensive income. See Note 11 - Accumulated Other Comprehensive Loss for additional information.accordance with previous guidance.
Income Taxes
On October 24, 2016, FASB issued ASU 2016-16, “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.
Recently Issued Accounting Pronouncements
Goodwill Impairment
On January 26, 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 changing the measurement for goodwill impairment. Under current rules, we are required to compute the implied 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 its fair value, limited to the amount of goodwill assigned to the reporting unit.
We are required to adopt the provisions of ASU 2017-04 for any goodwill impairment tests, including our required annual test, occurring after January 1, 2020, but have the option to early adopt for any impairment test that we are required to perform. We have not determined if we will elect to early adopt the provisions of ASU 2017-04. The provisions of ASU 2017-04 would not have affected our last goodwill impairment assessment, but no assurance can be provided that the simplified testing methodology will not affect our goodwill impairment assessment in the future.
Financial Instruments
OnIn June 16, 2016, the FASB 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 change in the model 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 reviewingevaluating the requirementspotential impact ASU 2016-13 will have on our financial assets measured at amortized cost including, but not limited to, customer receivables and contract asset balances.
Over the fourth quarter we will complete our evaluation of the standardimpact to our accounting and evaluating the impact on our consolidatedinternal controls over financial statements.
ASU 2016-13. We are requiredexpect to adopt the provisions of ASU 2016-13 effectiveon January 1, 2020 but could elect to early adopt the provisions as of January 1, 2019. We expect toand recognize the impacts of adopting ASU 2016-13 through a cumulative adjustment to retained earningsaccumulated deficit as of the date of adoption.
Subsequent Event
As of the date of this report, we have not yet determined the date we will adopt ASU 2016-13.
Leases
In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”). The core principle$250 million of ASU 2016-02 will require lesseesdistributions were declared and $225 million were paid to present right-of-use assets and lease liabilities on their balance sheets for operating leases, which are currently not reflected on their balance sheets.
ASU 2016-02 is effective for annual and interim periods beginning January 1, 2019. Upon adoption of ASU 2016-02, we are required to recognize and measure leases at the beginning of the earliest period presentedour parent in our consolidated financial statements using a modified retrospective approach. The modified retrospective transition approach includes a number of optional practical expedients that we may elect to apply.
In January 2018, the FASB issued ASU 2018-01, “Leases: Land Easement Practical Expedient for Transition to ASU 2016-02". ASU 2018-01 permits the election of an optional transition practical expedient to not evaluate land easements that exist or expired before the entity’s adoption of ASC 2016-02 and that were not previously accounted for as leases. We plan to adopt ASU 2018-01 at the same time we adopt ASU 2016-02.
In July 2018, the FASB issued ASU 2018-11, "Leases: Targeted Improvements" ("ASU 2018-11"). ASU 2018-11 provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We have not yet determined whether we will use ASU 2018-11's newly permitted adoption method.
We are in the process of implementing a new lease administration and accounting system. We plan to adopt ASU 2016-02 and ASU 2018-01 effective January 1, 2019. The adoption of ASU 2016-02 and ASU 2018-01 will result in our recognition of right of use assets and lease liabilities that we have not previously recorded. Although we believe it is premature as of the date of this report to provide any estimate of the impact of adopting ASU 2016-02 and ASU 2018-01, we do expect that it will have a material impact on our consolidated financial statements.
(2) CenturyLink Merger
On November 1, 2017, CenturyLink acquired us through successive merger transactions, including a merger of Level 3 with and into a merger subsidiary, which survived such merger as CenturyLink's indirect wholly-owned subsidiary under the name of Level 3 Parent, LLC. Our results of operations have been included in the consolidated results of operations of CenturyLink since November 1, 2017.
As of September 30, 2018, the preliminary estimated amount of aggregate consideration was $19.6 billion.
The U.S. Department of Justice approved the acquisition subject to conditions of a consent decree on October 2, 2017, which required the combined company to divest (i) certain Level 3 metro network assets in the markets located in Albuquerque, New Mexico; Boise, Idaho; and Tucson, Arizona and (ii) 24 strands of dark fiber connecting 30 specified city-pairs across the United States in the form of an indefeasible right of use agreement.
During the second quarter of 2018, we sold network assets in Boise, Idaho and Albuquerque, New Mexico that we were required to divest as a condition of the merger. The proceeds from these sales were included in the proceeds from sale of property, plant and equipment in our consolidated statements of cash flows. No gain or loss was recognized with these transactions. All of the metro network assets were classified as assets held for sale on our consolidated balance sheet as of December 31, 2017. The Tucson, Arizona assets continued to be classified as assets held for sale on our consolidated balance sheet as of September 30, 2018. In October 2018, we sold the Tucson, Arizona assets for its net book value.
CenturyLink recognized our assets and liabilities based on CenturyLink’s preliminary estimates of the fair value of the acquired tangible and intangible assets and assumed liabilities of us as of November 1, 2017, the consummation date of the acquisition, with the excess aggregate consideration recorded as goodwill. The final determination of the allocation of the aggregate consideration paid by CenturyLink in the combination is based on the fair value of such assets and liabilities as of the acquisition date with any excess aggregate consideration to be recorded as goodwill. The estimation of such fair values and the estimation of lives of depreciable tangible assets and amortizable intangible assets require significant judgment. CenturyLink is reviewing its valuation analysis along with the related allocation to goodwill. CenturyLink expects to complete its final fair value determinations during the fourth quarter of 2018. CenturyLink is also reviewing its calculations of the estimates of the fair value of Level 3’s deferred tax assets acquired and liabilities assumed and performing related final controls. CenturyLink’s final fair value determinations may be different than those reflected in our consolidated financial statements at September 30, 2018, however we do not expect that any subsequent modifications to the preliminary purchase price allocation will be material. The recognition of assets and liabilities at fair value are reflected in our financial statements and result in a new basis of accounting for the “successor period” beginning on November 1, 2017. This new basis of accounting means that our financial statements for the successor periods will not be comparable to our previously reported financial statements, including the financial statements in this report.2019.
Based solely on CenturyLink’s preliminary estimates through September 30, 2018, the aggregate consideration exceeds the aggregate estimated fair value of the acquired assets and assumed liabilities by $11.2 billion, which we have recognized as goodwill. The goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and leveraged combined networks that CenturyLink expects to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes.
As of September 30, 2018, the following is our updated assignment of the preliminary estimated aggregate consideration:
|
| | | | | | | | | |
| | Adjusted November 1, 2017 Balance as of December 31, 2017 | | Purchase Price Adjustments(3) | | Adjusted November 1, 2017 Balance as of September 30, 2018 |
| | (Dollars in millions) |
Cash, accounts receivable and other current assets (1) | $ | 3,317 |
| | (25 | ) | | 3,292 |
|
| Property, plant and equipment | 9,311 |
| | 86 |
| | 9,397 |
|
Identifiable intangible assets (2) | | | | |
|
|
| Customer relationships | 8,964 |
| | (476 | ) | | 8,488 |
|
| Other | 391 |
| | (13 | ) | | 378 |
|
| Other noncurrent assets | 782 |
| | 203 |
| | 985 |
|
| Current liabilities, excluding current maturities of long-term debt | (1,461 | ) | | (31 | ) | | (1,492 | ) |
| Current maturities of long-term debt | (7 | ) | | — |
| | (7 | ) |
| Long-term debt | (10,888 | ) | | — |
| | (10,888 | ) |
| Deferred revenue and other liabilities | (1,613 | ) | | (102 | ) | | (1,715 | ) |
| Goodwill | 10,837 |
| | 353 |
| | 11,190 |
|
| Total estimated aggregate consideration | $ | 19,633 |
| | (5 | ) | | 19,628 |
|
(1) Includes accounts receivable, which had a gross contractual value of $884 million on November 1, 2017 and September 30, 2018.
(2) The preliminary estimate of the weighted-average amortization period for the acquired intangible assets is approximately 12.0 years.
(3) All purchase price adjustments occurred during the nine months ended September 30, 2018.
Acquisition-Related Expenses
We have incurred acquisition-related expenses related to our activities surrounding the CenturyLink Merger. The table below summarizes our acquisition-related expenses, which consist of integration-related expenses, including severance and retention compensation expenses, and transaction-related expenses:
|
| | | | | | | | | | | |
| | Successor | | | Predecessor |
| | Three Months Ended September 30, 2018 | Nine Months Ended September 30, 2018 | | | Three Months Ended September 30, 2017 | Nine Months Ended September 30, 2017 |
| | (Dollars in millions) |
| Transaction-related expenses | $ | — |
| — |
| | | 7 |
| 12 |
|
| Integration-related expenses | 16 |
| 94 |
| | | 24 |
| 62 |
|
| Total acquisition-related expenses | $ | 16 |
| 94 |
| | | 31 |
| 74 |
|
(3) Goodwill, Customer Relationships and Other Intangible Assets
Goodwill, customer relationships and other intangible assets consisted of the following:
|
| | | | | | |
| | September 30, 2019 | | December 31, 2018 |
| | (Dollars in millions) |
| Goodwill | $ | 7,389 |
| | 11,119 |
|
| Customer relationships, less accumulated amortization of $1,355 and $833 | $ | 7,026 |
| | 7,567 |
|
| Other intangible assets subject to amortization: | | | |
| Trade names, less accumulated amortization of $50 and $30 | 80 |
| | 100 |
|
| Developed technology, less accumulated amortization of $121 and $67 | 378 |
| | 310 |
|
| Total other intangible assets, net | $ | 458 |
| | 410 |
|
|
| | | | | | |
| | September 30, 2018 | | December 31, 2017 |
| | (Dollars in millions) |
| Goodwill | $ | 11,132 |
| | 10,837 |
|
| Customer relationships, less accumulated amortization of $659 and $126 | $ | 7,801 |
| | 8,845 |
|
| Other intangible assets subject to amortization: | | | |
| Trade names, less accumulated amortization of $24 and $4 | 106 |
| | 126 |
|
| Developed technology, less accumulated amortization of $51 and $9 | 295 |
| | 252 |
|
| Total other intangible assets, net | $ | 401 |
| | 378 |
|
Our goodwill balance at Decemberwas derived from CenturyLink's acquisition of us where the purchase price exceeded the fair value of the net assets acquired.
We are required to perform an impairment test related to our goodwill annually, which we perform as of October 31, 2017 includes $16 millionor sooner if an indicator of goodwill that was allocated to us from CenturyLink associated with differencesimpairment occurs. The decline in CenturyLink's stock price triggered impairment testing in the deferred state income taxes that CenturyLink expectsfirst quarter of 2019. Due to realize duethis impairment indicator, we evaluated our goodwill as of March 31, 2019. There was not an additional triggering event during the third quarter of 2019.
When we performed our October 31, 2018 annual impairment test, we estimated the fair value of equity by considering both a market approach and a discounted cash flow method. The market approach method includes the use of multiples of publicly traded companies whose services are comparable to its consolidationours. 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 beyond the cash flows from the discrete projection period. Because CenturyLink's low stock price was a trigger for impairment testing, we estimated the fair value of our operations using only the market approach in the quarter ended March 31, 2019. Applying this approach, we utilized company comparisons and analyst reports within the telecommunications industry which have historically supported a range of fair values of annualized revenue and EBITDA multiples between 2.1x and 4.9x and 4.9x and 9.8x, respectively. We selected a revenue and EBITDA multiple within this range. For the three months ended March 31, 2019, based on our assessments performed as described above, we concluded that the estimated fair value was less than our carrying value of equity as of the date of our triggering event during the first quarter. As a result, we recorded a non-cash, non-tax-deductible goodwill impairment charge aggregating to $3.7 billion in the first quarter of 2019.
The market multiples approach that we used incorporates significant estimates and assumptions related to the forecasted results for the remainder of operations into its state tax returns.the year, including revenues, expenses, and the achievement of other cost synergies. In developing the market multiple, we also considered observed trends of our industry participants. Our failure to attain these forecasted results or changes in trends could result in future impairments. Our assessment included many qualitative factors that required significant judgment. Alternative interpretations of these factors could have resulted in different conclusions regarding the size of our impairments. Continued declines in our profitability or cash flows or the continued sustained low trading prices of CenturyLink's common stock may result in further impairment.
Total amortization expense for intangible assets for the successor three months ended September 30, 2019 and 2018, was $206 million and $204 million, respectively,and for the nine months ended September 30, 2019 and 2018, was $204$604 million and $595 million, respectively, and the predecessor three and nine months ended September 30, 2017 was $49 million and $153$595 million, respectively. As of the successor date of September 30, 2018,2019, the gross carrying amount of goodwill, customer relationships, indefinite-life and other intangible assets was $20.1$16.4 billion.
We estimate that total amortization expense for intangible assets for the successor years ending December 31, 20182019 through 20222023 will be as follows:
|
| | | |
| | (Dollars in millions) |
| 2019 (remaining three months) | $ | 205 |
|
| 2020 | 825 |
|
| 2021 | 825 |
|
| 2022 | 764 |
|
| 2023 | 743 |
|
|
| | | |
| | (Dollars in millions) |
| 2018 (remaining three months) | $ | 202 |
|
| 2019 | 805 |
|
| 2020 | 805 |
|
| 2021 | 805 |
|
| 2022 | 794 |
|
The following table shows the rollforward of goodwill from December 31, 20172018 through September 30, 2018:2019: |
| | | |
| | (Dollars in millions) |
| As of December 31, 2018 | $ | 11,119 |
|
| Effect of foreign currency rate change and other | (22 | ) |
| Impairment | (3,708 | ) |
| As of September 30, 2019 | $ | 7,389 |
|
|
| | | |
| | (Dollars in millions) |
| As of December 31, 2017 | $ | 10,837 |
|
| Purchase accounting and other adjustments | 353 |
|
| Effect of foreign currency rate change | (58 | ) |
| As of September 30, 2018 | $ | 11,132 |
|
(4)
(3) Revenue Recognition
We earn mostRefer to the Revenue Recognition section of Note 1—Background and Summary of Significant Accounting Policies and Note 4—Revenue Recognition in our consolidated revenue from contracts with customers, primarily throughannual report on Form 10-K for the provisionyear ended December 31, 2018 for further information regarding our application of telecommunications and other services. Revenue from contracts with customers is accounted for under Accounting Standards Codification ("ASC") 606, which we adopted on January 1, 2018 using the modified retrospective approach. We also earn revenues from leasing arrangements (primarily fiber capacity agreements) and governmental subsidy payments, neither of which are accounted for under ASC 606.
Under ASC 606, revenues are recognized when control of“Revenue from Contracts with Customers”, including practical expedients and judgments applied in determining 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;amounts and
Recognition of revenue when, or as, we satisfy a performance obligation.
We provide an array of communications services, including local voice, VPN, Ethernet, data, broadband, private line (including special access), network access, Ethernet, 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.
For access services, we generally bill fixed monthly charges one month in advance to customers and recognize revenue as service is provided over the contract term in alignment with the customer's receipt of service. For usage, installation and other ancillary services, we generally bill in arrears and recognize revenue as usage or delivery occurs. In most cases, the amount invoiced for our service offerings constitutes the price that would be billed on a standalone basis.
Under ASC 606, we recognize revenue for services when we provide the 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. These advance payments include certain activation and certain installation charges. If the activation and installation charges are not separate performance obligations, we recognize them as revenue over the actual or expected contract term using historical experience, which ranges from one year to seven years depending on the service. A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer. We recognize revenue for services when we satisfy our performance obligation. 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.
A performance obligation is a promise in a contract with a customer to provide a good or service to the customer. We recognize revenue for services when we satisfy our performance obligation.
Promotional or performance-based incentive payments are estimated at contract inception (and updated on a periodic basis as needed) and accounted for as variable consideration. In certain cases, customers may be permitted to modify their contracts without incurring a penalty. 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 creation of a new contract, or if it is a change to the existing contract. The impact of contract modifications has not been significant to our results in 2018.
Customer contracts are evaluated to determine whether the performance obligations are separable. If the performance obligations are deemed separable and separate earnings processes exist, the total transaction price that we expect to receive with the customer is allocated to each performance obligation based on its relative standalone selling price. The standalone selling price is the price we sell to similar customers. The revenue associated with each performance obligation is then recognized as earned. The portion of any advance payment allocated to the service based upon its relative selling price is recognized ratably over the contract term.
We periodically sell optical capacity on our 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 - 20 years. In most cases, we account for the cash consideration received on transfers of optical capacity as ASC 606 revenue which we recognize ratably over the term of the agreement. Cash consideration received on transfers of dark fiber is accounted for as non-ASC 606 lease revenue, which we also recognize ratably over the term of the agreement. We do not recognize 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 user 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 and control the goods and services used to fulfill the performance obligations associated with the transaction.
We have service 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 record a corresponding reduction to revenues in the period that the service level commitment was not met.
Customer payments are made based on billing schedules included in our customer contracts, which is typically on a monthly basis. For certain products or services and customer types, payment is required before products or services are provided.
Comparative Results
The following tables present our reported results under ASC 606 and a reconciliation to results using the historical accounting method:
|
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, 2018 | | Nine Months Ended September 30, 2018 |
| | (Dollars in millions) |
| | Reported Balances as of September 30, 2018 | | Impact of ASC 606 | | ASC 605 Historical Adjusted Balances | | Reported Balances as of September 30, 2018 | | Impact of ASC 606 | | ASC 605 Historical Adjusted Balances |
| Operating revenues | $ | 2,010 |
| | (4 | ) | | 2,006 |
| | 6,149 |
| | (4 | ) | | 6,145 |
|
| Cost of services and products (exclusive of depreciation and amortization) | 976 |
| | — |
| | 976 |
| | 2,954 |
| | — |
| | 2,954 |
|
| Selling, general and administrative | 311 |
| | 12 |
| | 323 |
| | 1,043 |
| | 32 |
| | 1,075 |
|
| Interest expense | 137 |
| | (7 | ) | | 130 |
| | 381 |
| | (7 | ) | | 374 |
|
| Income tax expense | 38 |
| | (2 | ) | | 36 |
| | 184 |
| | (8 | ) | | 176 |
|
| Net income | 88 |
| | (7 | ) | | 81 |
| | 190 |
| | (21 | ) | | 169 |
|
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:
|
| | | | | | | | | |
| | September 30, 2018 |
| | (Dollars in millions) |
| | Reported Balances as of September 30, 2018 | | Impact of ASC 606 | | ASC 605 Historical Adjusted Balances |
| Other current assets | $ | 290 |
| | (22 | ) | | 268 |
|
| Other long-term assets, net | 132 |
| | (22 | ) | | 110 |
|
| Deferred revenue | 1,469 |
| | (3 | ) | | 1,466 |
|
| Deferred income tax assets, net | 274 |
| | 10 |
| | 284 |
|
| Member's equity | 18,312 |
| | (31 | ) | | 18,281 |
|
Disaggregated Revenue by Service Offering
The following table provides disaggregation timing of revenue from contracts with customers based on service offering for the three and nine months ended September 30, 2018, respectively. It also showscustomers.
Reconciliation of Total Revenue to Revenue from Contracts with Customers
The following table provides the amount of revenue that is not subject to ASC 606, but is instead governed by other accounting standards.standards:
|
| | | | | | | | | | | | | | | | | | | | |
| | Successor | | Successor |
| | Three Months Ended September 30, 2018 | | Nine Months Ended September 30, 2018 |
| | (Dollars in millions) | | (Dollars in millions) |
| | Total Revenues | | Adjustments(7) | | Total Revenue from Contracts with Customers | | Total Revenues | | Adjustments(7) | | Total Revenue from Contracts with Customers |
IP & Data Services (1) | $ | 969 |
| | — |
| | 969 |
| | 2,959 |
| | — |
| | 2,959 |
|
Transport & Infrastructure (2) | 664 |
| | (45 | ) | | 619 |
| | 2,012 |
| | (140 | ) | | 1,872 |
|
Voice & Collaboration (3) | 349 |
| | — |
| | 349 |
| | 1,093 |
| | — |
| | 1,093 |
|
IT and Managed Services (4) | 1 |
| | — |
| | 1 |
| | 3 |
| | — |
| | 3 |
|
Other revenues (5) | 1 |
| | (1 | ) | | — |
| | 4 |
| | (3 | ) | | 1 |
|
Affiliate revenues (6) | 26 |
| | (26 | ) | | — |
| | 78 |
| | (78 | ) | | — |
|
| Total revenues | $ | 2,010 |
| | (72 | ) | | 1,938 |
| | 6,149 |
| | (221 | ) | | 5,928 |
|
| | | | | | | | | | | | |
| Timing of revenue | | | | |
|
| | | | | |
|
|
| Goods transferred at a point in time | | | | | $ | — |
| | | | | | $ | — |
|
| Services performed over time | | | | | 1,938 |
| | | | | | 5,928 |
|
| Total revenue from contracts with customers |
|
| |
|
| | $ | 1,938 |
| | | | | | $ | 5,928 |
|
|
| | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2019 | | 2018 | | 2019 | | 2018 |
| | (Dollars in millions) |
| Total revenue | $ | 2,064 |
| | 2,010 |
| | 6,124 |
| | 6,149 |
|
Adjustments for non-ASC 606 revenue (1) | (94 | ) | | (72 | ) | | (288 | ) | | (221 | ) |
| Total revenue from contracts with customers | $ | 1,970 |
| | 1,938 |
| | 5,836 |
| | 5,928 |
|
_____________________________________________________________________
(1) Includes primarily VPN data network, Ethernet, IP, video and ancillary revenues.
(2) Includes primarily broadband and equipment sales and professional services revenues.
(3) Includes local, long-distance and other ancillary revenues.
(4) Includes IT services and managed services revenues.
(5) Includes sublease rental income.
(6) Includes telecommunications and data services we bill to our affiliates.
(7) Includes sublease rental income and revenue from fiber capacity lease arrangements which are not within the scope of ASC 606.
| |
(1) | Includes sublease rental income and revenue from fiber capacity lease arrangements 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 September 30, 20182019 and January 1,December 31, 2018: | | | | Successor | | | | | |
| | September 30, 2018 | | January 1, 2018 | September 30, 2019 | | December 31, 2018 |
| | (Dollars in millions) | (Dollars in millions) |
Customer receivables (1) | $ | 715 |
| | 748 |
| $ | 737 |
| | 712 |
|
| Contract assets | | 31 |
| | 19 |
|
| Contract liabilities | 413 |
| | 353 |
| 412 |
| | 393 |
|
| |
| (1) | Gross customer receivables of $725$751 million and $751,$723 million, net of allowance for doubtful accounts of $10$14 million and $3,$11 million, at September 30, 20182019 and January 1,December 31, 2018, respectively. |
Contract liabilities are consideration we have received from our customers or billed in advance of providing the goods or services promised in the contract.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.sheets.
The following table provides information about revenuesrevenue recognized for the three and nine months ended September 30, 2019 and 2018:
|
| | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2019 | | 2018 | | 2019 | | 2018 |
| | (Dollars in millions) |
| Revenue recognized in the period from: | | | | | | | |
| Amounts included in contract liability at the beginning of the period (January 1, 2019 and 2018, respectively) | $ | 27 |
| | 22 |
| | 146 |
| | 135 |
|
| Performance obligations satisfied in previous periods | — |
| | — |
| | — |
| | — |
|
|
| | | | | | |
| | Three Months Ended September 30, 2018 | | Nine Months Ended September 30, 2018 |
| | (Dollars in millions) |
| Revenue recognized in the period from: | | | |
| Amounts included in contract liability at the beginning of the period (January 1, 2018) | $ | 22 |
| | 135 |
|
| Performance obligations satisfied in previous periods | — |
| | — |
|
Performance Obligations
As of September 30, 2018,2019, our estimated revenue expected to be recognized in the future related to performance obligations associated with customer contracts (including affiliates) that are unsatisfied (or partially satisfied) is approximately $6.3$5.2 billion. We expect to recognize approximately 67%69% of this revenue through 2020,2021, with the balance recognized thereafter.
We do not disclose the amountvalue of unsatisfied performance obligations for contracts underfor which we are contractually entitled to bill pre-determined amounts for future services (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 606.606.
Contract Costs
The following table providestables provide changes in our contract acquisition costs and fulfillment costs for the three and nine months ended September 30, 2018:costs:
|
| | | | | | | | | | | | |
| | Three Months Ended September 30, |
| | 2019 | | 2018 |
| | (Dollars in millions) |
| | Acquisition Costs | | Fulfillment Costs | | Acquisition Costs | | Fulfillment Costs |
| Beginning of period balance | $ | 73 |
| | 106 |
| | 34 |
| | 52 |
|
| Costs incurred | 13 |
| | 26 |
| | 16 |
| | 22 |
|
| Amortization | (12 | ) | | (17 | ) | | (5 | ) | | (8 | ) |
| End of period balance | $ | 74 |
| | 115 |
| | 45 |
| | 66 |
|
| | | | Successor | Nine Months Ended September 30, |
| | Three Months Ended September 30, 2018 | | Nine Months Ended September 30, 2018 | 2019 | | 2018 |
| | (Dollars in millions) | (Dollars in millions) |
| | Acquisition Costs | | Fulfillment Costs | | Acquisition Costs | | Fulfillment Costs | Acquisition Costs | | Fulfillment Costs | | Acquisition Costs | | Fulfillment Costs |
| Beginning of period balance | $ | 34 |
| | 52 |
| | 13 |
| | 14 |
| $ | 64 |
| | 84 |
| | 13 |
| | 14 |
|
| Costs incurred | 16 |
| | 22 |
| | 42 |
| | 70 |
| 42 |
| | 77 |
| | 42 |
| | 69 |
|
| Amortization | (5 | ) | | (8 | ) | | (10 | ) | | (18 | ) | (32 | ) | | (46 | ) | | (10 | ) | | (17 | ) |
| End of period balance | $ | 45 |
| | 66 |
| | 45 |
| | 66 |
| $ | 74 |
| | 115 |
| | 45 |
| | 66 |
|
Acquisition costs include commission fees 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. Acquisition