QWEST CORPORATION
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
December 31,
2012
|
|
December 31,
2011
|
|
|
|
(Dollars in millions,
except per share amounts)
|
|
ASSETS
|
|
|
|
|
|
|
|
CURRENT ASSETS
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
8
|
|
|
3
|
|
Accounts receivable, less allowance of $46 and $42
|
|
|
709
|
|
|
707
|
|
Advances to affiliates
|
|
|
593
|
|
|
198
|
|
Deferred income taxes, net
|
|
|
149
|
|
|
162
|
|
Other
|
|
|
114
|
|
|
98
|
|
|
|
|
|
|
|
Total current assets
|
|
|
1,573
|
|
|
1,168
|
|
|
|
|
|
|
|
NET PROPERTY, PLANT AND EQUIPMENT
|
|
|
|
|
|
|
|
Property, plant and equipment
|
|
|
9,242
|
|
|
8,420
|
|
Accumulated depreciation
|
|
|
(2,011
|
)
|
|
(914
|
)
|
|
|
|
|
|
|
Net property, plant and equipment
|
|
|
7,231
|
|
|
7,506
|
|
|
|
|
|
|
|
GOODWILL AND OTHER ASSETS
|
|
|
|
|
|
|
|
Goodwill
|
|
|
9,369
|
|
|
9,369
|
|
Customer relationships, net
|
|
|
4,379
|
|
|
5,101
|
|
Other intangible assets, net
|
|
|
1,212
|
|
|
1,460
|
|
Other
|
|
|
181
|
|
|
205
|
|
|
|
|
|
|
|
Total goodwill and other assets
|
|
|
15,141
|
|
|
16,135
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
23,945
|
|
|
24,809
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDER'S EQUITY
|
|
|
|
|
|
|
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
Current maturities of long-term debt
|
|
$
|
804
|
|
|
64
|
|
Accounts payable
|
|
|
456
|
|
|
656
|
|
Accounts payableaffiliates, net
|
|
|
|
|
|
180
|
|
Note payableaffiliate
|
|
|
701
|
|
|
|
|
Dividends payableQwest Services Corporation
|
|
|
|
|
|
310
|
|
Accrued expenses and other liabilities
|
|
|
|
|
|
|
|
Salaries and benefits
|
|
|
253
|
|
|
256
|
|
Other taxes
|
|
|
215
|
|
|
221
|
|
Other
|
|
|
102
|
|
|
133
|
|
Advance billings and customer deposits
|
|
|
301
|
|
|
265
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
2,832
|
|
|
2,085
|
|
|
|
|
|
|
|
LONGTERM DEBT
|
|
|
6,821
|
|
|
8,261
|
|
|
|
|
|
|
|
DEFERRED CREDITS AND OTHER LIABILITIES
|
|
|
|
|
|
|
|
Deferred revenue
|
|
|
130
|
|
|
55
|
|
Deferred income taxes, net
|
|
|
2,629
|
|
|
2,842
|
|
Affiliates obligations, net
|
|
|
1,442
|
|
|
1,572
|
|
Other
|
|
|
117
|
|
|
129
|
|
|
|
|
|
|
|
Total deferred credits and other liabilities
|
|
|
4,318
|
|
|
4,598
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES (Note 16)
|
|
|
|
|
|
|
|
STOCKHOLDER'S EQUITY
|
|
|
|
|
|
|
|
Common stockone share without par value, owned by Qwest Services Corporation
|
|
|
10,050
|
|
|
9,950
|
|
Retained Earnings (Accumulated deficit)
|
|
|
(76
|
)
|
|
(85
|
)
|
|
|
|
|
|
|
Total stockholder's equity
|
|
|
9,974
|
|
|
9,865
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY
|
|
$
|
23,945
|
|
|
24,809
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
58
Table of Contents
QWEST CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
849
|
|
|
543
|
|
|
|
|
299
|
|
1,082
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
2,290
|
|
|
1,866
|
|
|
|
|
451
|
|
1,873
|
|
Deferred income taxes (benefits)
|
|
|
(201
|
)
|
|
150
|
|
|
|
|
76
|
|
241
|
|
Provision for uncollectible accounts
|
|
|
74
|
|
|
44
|
|
|
|
|
17
|
|
70
|
|
Long-term debt (premium) discount amortization
|
|
|
(65
|
)
|
|
(133
|
)
|
|
|
|
3
|
|
11
|
|
Net loss on early retirement of debt
|
|
|
47
|
|
|
8
|
|
|
|
|
|
|
|
|
Changes in current assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(76
|
)
|
|
(71
|
)
|
|
|
|
18
|
|
(22
|
)
|
Accounts payable
|
|
|
(58
|
)
|
|
(47
|
)
|
|
|
|
(20
|
)
|
51
|
|
Accounts receivable and
payableaffiliates, net
|
|
|
|
|
|
(108
|
)
|
|
|
|
93
|
|
(81
|
)
|
Accrued income and other taxes
|
|
|
(9
|
)
|
|
(36
|
)
|
|
|
|
50
|
|
(16
|
)
|
Other current assets and other current liabilities, net
|
|
|
(17
|
)
|
|
(6
|
)
|
|
|
|
(89
|
)
|
11
|
|
Changes in other noncurrent assets and
liabilities
|
|
|
61
|
|
|
11
|
|
|
|
|
(36
|
)
|
15
|
|
Changes in other noncurrent assets and liabilitiesaffiliates
|
|
|
(130
|
)
|
|
(53
|
)
|
|
|
|
|
|
7
|
|
Other, net
|
|
|
9
|
|
|
33
|
|
|
|
|
7
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
2,774
|
|
|
2,201
|
|
|
|
|
869
|
|
3,235
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments for property, plant and equipment and capitalized software
|
|
|
(1,266
|
)
|
|
(1,036
|
)
|
|
|
|
(341
|
)
|
(1,240
|
)
|
Changes in interest in investments managed by Qwest Services Corporation
|
|
|
|
|
|
|
|
|
|
|
4
|
|
(17
|
)
|
Changes in advances to affiliates
|
|
|
(395
|
)
|
|
(157
|
)
|
|
|
|
|
|
|
|
Proceeds from sale of property
|
|
|
133
|
|
|
|
|
|
|
|
|
|
|
|
Other, net
|
|
|
|
|
|
2
|
|
|
|
|
2
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(1,528
|
)
|
|
(1,191
|
)
|
|
|
|
(335
|
)
|
(1,256
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net proceeds from issuance of long-term debt
|
|
|
896
|
|
|
2,126
|
|
|
|
|
|
|
|
|
Payments of long-term debt
|
|
|
(1,430
|
)
|
|
(2,368
|
)
|
|
|
|
(14
|
)
|
(534
|
)
|
Early retirement of debt costs
|
|
|
(178
|
)
|
|
|
|
|
|
|
|
|
|
|
Dividends paid to Qwest Services Corporation
|
|
|
(1,150
|
)
|
|
(900
|
)
|
|
|
|
(530
|
)
|
(2,260
|
)
|
Changes in note payableaffiliate
|
|
|
701
|
|
|
|
|
|
|
|
|
|
|
|
Changes in advances to affiliates
|
|
|
(80
|
)
|
|
|
|
|
|
|
|
|
|
|
Other, net
|
|
|
|
|
|
(66
|
)
|
|
|
|
19
|
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in financing activities
|
|
|
(1,241
|
)
|
|
(1,208
|
)
|
|
|
|
(525
|
)
|
(2,801
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
5
|
|
|
(198
|
)
|
|
|
|
9
|
|
(822
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
3
|
|
|
201
|
|
|
|
|
192
|
|
1,014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
8
|
|
|
3
|
|
|
|
|
201
|
|
192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes (paid) refunded, net
|
|
$
|
(607
|
)
|
|
(327
|
)
|
|
|
|
116
|
|
(677
|
)
|
Interest (paid) (net of capitalized interest of $18, $8, $3 and $12)
|
|
|
(513
|
)
|
|
(464
|
)
|
|
|
|
(149
|
)
|
(603
|
)
|
See accompanying notes to consolidated financial statements.
59
Table of Contents
QWEST CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
COMMON STOCK
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
9,950
|
|
|
9,951
|
|
|
|
|
11,425
|
|
|
11,346
|
|
Asset transfers
|
|
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
79
|
|
Tax benefit of pension deduction
|
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
|
10,050
|
|
|
9,950
|
|
|
|
|
11,425
|
|
|
11,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ACCUMULATED DEFICIT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
|
(85
|
)
|
|
|
|
|
|
|
(12,256
|
)
|
|
(11,034
|
)
|
Net income
|
|
|
849
|
|
|
543
|
|
|
|
|
299
|
|
|
1,082
|
|
Dividends declared to Qwest Services Corporation
|
|
|
(840
|
)
|
|
(628
|
)
|
|
|
|
(1,000
|
)
|
|
(2,300
|
)
|
Change in other comprehensive income
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
|
(76
|
)
|
|
(85
|
)
|
|
|
|
(12,956
|
)
|
|
(12,256
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL STOCKHOLDER'S EQUITY (DEFICIT)
|
|
$
|
9,974
|
|
|
9,865
|
|
|
|
|
(1,531
|
)
|
|
(831
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
60
Table of Contents
QWEST CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unless the context requires otherwise, references in this 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 Presentation and Summary of Significant Accounting Policies
Basis of Presentation
We are an integrated communications company engaged primarily in providing an array of communications services to our residential,
business, governmental and wholesale customers. Our communications services include local and long-distance, network access, private line (including special access), broadband, data,
wireless and video services. In certain local and regional markets, we also provide local access and fiber transport services to competitive local exchange carriers.
We
generate the majority of our 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.
On
April 1, 2011, our indirect parent QCII became a wholly owned subsidiary of CenturyLink, Inc. in a tax-free, stock-for-stock
transaction. Although we have continued as a surviving corporation and legal entity since the acquisition, the accompanying consolidated statements of operations, comprehensive income, cash flows and
stockholder's equity (deficit) are presented for two periods: predecessor and successor, which relate to the period preceding the acquisition and the period succeeding the acquisition, respectively.
On the date of the acquisition, April 1, 2011, our assets and liabilities were recognized at their fair value. This revaluation has been reflected in our consolidated financial statements and,
therefore, has resulted in a new basis of accounting for the "successor period". This new basis of accounting means that our consolidated financial statements for the successor periods are not
comparable to our consolidated financial statements relating to periods prior to the acquisition, including the predecessor period consolidated financial statements in this report.
The
accompanying consolidated financial statements include our accounts and the accounts of our subsidiaries over which we exercise control. All intercompany amounts and transactions
with our consolidated subsidiaries have been eliminated.
We
provide to our affiliates telecommunications services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support
services. We also purchase services from our affiliates including telecommunications services, marketing and employee-related support services. In the normal course of business, we transfer assets and
liabilities to and from our ultimate parent, CenturyLink, and its affiliates based on their respective carrying values. Dividends declared are reflected on our consolidated statements of stockholder's
equity.
Effective
January 1, 2012, in connection with post-acquisition systems integration activities, we adopted the affiliate expense allocation methodology used by our
ultimate parent. This methodology results in certain overhead costs incurred by us and by our direct parent that were previously assessed to us on a net basis now being assessed on a gross basis both
to and from our ultimate parent, resulting in both higher affiliate revenues and expenses for us. This change resulting from systems integration activities did not have a significant impact to our
consolidated net income for the successor year ended December 31, 2012.
61
Table of Contents
During
the first quarter of 2012, we reclassified certain operating expenses from our selling, general and administrative expenses to our cost of services and products (exclusive of
depreciation and amortization) to better reflect our expenses related to providing services to our affiliates. As a result, we reclassified previously reported amounts to conform to the current period
presentation. For the successor nine months ended December 31, 2011 and the predecessor three months ended March 31, 2011, this reclassification resulted in a reduction of selling,
general and administrative expenses of $338 million and $116 million, respectively.
During
the first quarter of 2012, in connection with post-acquisition systems integration activities, CenturyLink changed certain cash management processes applicable to us.
Therefore, we now present the balances related to these cash management transactions on a net basis with our other affiliate transactions.
Effective
January 1, 2012, we changed our rates of capitalized labor as we transitioned certain legacy systems to the historical systems of our ultimate parent, CenturyLink. This
transition resulted in an estimated $40 million to $55 million increase in the amount of labor capitalized as an asset compared to the amount that would have been capitalized if we had
continued to use our legacy systems and a corresponding estimated $40 million to $55 million decrease in operating expenses for the successor year ended December 31, 2012. The
reduction in expenses described above, net of tax, increased net income approximately $25 million to $34 million for the successor year ended December 31, 2012.
Effective
January 1, 2012, we changed our estimates of the remaining useful lives of certain telecommunications equipment. These changes resulted in a decrease to depreciation
expense of approximately $52 million for the successor year ended December 31, 2012. This decrease in depreciation expense, net of tax, had the effect of increasing net income by
approximately $32 million for the successor year ended December 31, 2012.
During
the first quarter of 2012, we recognized a $100 million equity contribution for the tax benefit associated with a deduction for pension funding. Since we are the employer
of a significant percentage of the participants and none of the 2011 QCII pension funding was allocated to us, a tax deduction will be recognized on our separate company tax return and, therefore, we
recognized an equity contribution for the tax benefits associated with this deduction.
On
April 2, 2012, we sold an office building for net proceeds of $133 million. As part of the transaction, we agreed to lease a portion of the building from the new owner.
As a result, the $16 million gain from the sale was deferred and will be recognized as a reduction to rent expense over the 10 year lease term.
We
also have reclassified certain other prior period amounts to conform to the current period presentation. These changes had no impact on total operating expenses or net income for any
period.
Summary of Significant Accounting Policies
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 made when accounting for items and matters such as, but not
limited to, long-term contracts, customer retention patterns, allowance for doubtful accounts, depreciation, amortization, asset valuations, 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 were made. Our accounting for CenturyLink's indirect acquisition of us required extensive use of
estimates
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in
determining the acquisition date fair values of our assets and liabilities. These estimates, judgments and assumptions can 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 revenue, expenses and components of cash flows during the periods presented in
our consolidated statements of operations, our consolidated statements of comprehensive income and our consolidated statements of cash flows. We also make estimates in our assessments of potential
losses in relation to threatened or pending tax and legal matters. See Note 12Income Taxes and Note 16Commitments and Contingencies 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 from our estimates.
We recognize revenue for services when the related services are provided. Recognition of certain payments received in advance of
services being provided is deferred until the service is provided. These advance payments include activation and installation charges, which we recognize as revenue over the expected customer
relationship period, which ranges from eighteen months to over ten years depending on the service. We also defer procurement costs related to customer activation and installations. The deferral of
customer activation and installation costs is limited to the amount of revenue deferred for such items. Costs in excess of deferred revenue are recorded as expense in the period such costs are
incurred. Expected customer relationship periods are estimated using historical experience. 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 to our customers who receive certain groupings of services. These bundle discounts are recognized concurrently with the associated revenues and are allocated to
the various services in the bundled offering based on the estimated selling price of services included in each bundled combination.
Customer
arrangements that include both equipment and services are evaluated to determine whether the elements are separable. If the elements are deemed separable and separate earnings
processes exist, the revenue associated with each element is allocated to each element based on the relative estimated 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. The revenue associated with each element 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
have periodically transferred the rights to use optical capacity assets on our network to other telecommunications service carriers. These transactions are structured as indefeasible
rights of use,
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commonly
referred to as IRUs, which are the exclusive right to use a specified amount of capacity or fiber for a specified term, typically 20 years. We account for the cash consideration
received on transfers of optical capacity assets and on all of the other elements deliverable under an IRU, as revenue ratably over the term of the agreement. We have not recognized revenue on any
contemporaneous exchanges of our optical capacity assets for other optical capacity assets during all periods presented in these financial statements.
We
offer some products and services that are provided by third-party vendors. We review the relationship between us, the vendor and the end customer 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 title to the products,
have risk and rewards of ownership or act as an agent or broker. Based on our agreements with DIRECTV and Verizon Wireless, we offer these services through sales agency relationships which are
reported on a net basis.
We record intercompany charges at the amounts billed to us by our affiliates. Regulatory rules require certain expenses to be recorded
at market price or fully distributed cost. Our compliance with regulations is subject to review by regulators. Adjustments to intercompany charges that result from these reviews are recorded in the
period they become known.
Because
of the significance of the services we provide to our affiliates and our other affiliates transactions, the results of operations, financial position and cash flows presented
herein are not necessarily indicative of the results of operations, financial position and cash flows we would have achieved had we operated as a stand-alone entity during the periods presented.
In
the normal course of business, we transfer assets to and from our parent, QSC, which are recorded through our equity. It is our policy to record asset transfers based on carrying
values. We recorded $28 million of noncash dividends associated with asset transfers to QSC during the successor nine months ended December 31, 2011.
USF, Gross Receipts Taxes and Other Surcharges
In determining whether to include in our revenue and expenses the taxes and surcharges collected from customers and remitted to
governmental authorities, including Universal Service Fund ("USF") charges, 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 revenue 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 revenue and
costs of services and products.
Costs related to advertising are expensed as incurred. Our advertising expense was $90 million for the successor year ended
December 31, 2012, $174 million for the successor nine months ended December 31, 2011, $65 million for the predecessor three months ended March 31, 2011 and
$292 million for the predecessor year ended December 31, 2010. This expense is included in selling, general and administrative expenses in our consolidated statements of operations.
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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.
Effective April 1, 2011, 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 12Income 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 does have 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, adjustments to our liabilities for uncertain
tax positions and amortization of investment tax credits. 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. As of the successor date of December 31, 2012, we 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. See Note 12Income Taxes for additional information.
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. Subsequent to
CenturyLink's indirect acquisition of us, 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 short-term affiliate loans in our consolidated balance sheets. As a result, cash and cash equivalents in the successor period are comprised of demand
deposits with financial institutions. During the predecessor periods, in evaluating investments for classification as cash equivalents, we required that individual securities have original maturities
of ninety days or less and that individual investment funds have dollar-weighted average maturities of ninety days or less. To preserve capital and maintain liquidity, we invest with financial
institutions we deem to be of sound financial condition and in high quality and relatively risk-free investment products. Our cash investment policy limits the concentration of investments
with specific financial institutions or among certain products and includes criteria related to credit worthiness of any particular financial institution.
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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. 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 CenturyLink's indirect acquisition of us, the purchase price was allocated to the assets acquired and liabilities
assumed based on their estimated fair values at the date of acquisition. Therefore, the allocated fair values of the assets represent their new basis of accounting in our consolidated financial
statements. This resulted in adjustments to our property, plant and equipment accounts, including accumulated depreciation at the acquisition date. The adjustments related to CenturyLink's indirect
acquisition of us are described in Note 2Acquisition of QCII by CenturyLink and Note 6Property, Plant and Equipment.
Property,
plant and equipment acquired since the acquisition date is stated at original cost plus the estimated value of any associated legally or contractually required retirement
obligations. 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 categorized in the year
acquired on the basis of equal life groups for purposes of depreciation and tracking. 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 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 life of our asset
base.
We
have asset retirement obligations associated with the legally or contractually required removal of a limited group of property, plant and equipment assets from leased properties and
the disposal of certain hazardous materials present in our owned properties. When an asset retirement obligation is identified, usually in association with the acquisition of the asset, we record the
fair value of the obligation as a liability. The fair value of the obligation is also capitalized as property, plant and equipment and then amortized over the estimated remaining useful life of the
associated asset. Where the removal obligation is not legally binding, the net cost to remove assets is expensed in the period in
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which
the costs are actually incurred. As a result of CenturyLink's acquisition of us, our asset retirement obligations were adjusted to fair value as of the acquisition date. The asset retirement
obligation was $21 million and $22 million as of December 31, 2012 and 2011.
We
review property, plant and equipment for impairment whenever facts and circumstances indicate that the carrying amounts of the assets may not be recoverable. For measurement purposes,
property, plant and equipment is 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 fair value. Recoverability of
the asset group to be held and used is measured 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, an impairment charge is recognized for the amount by which the carrying amount of the asset group exceeds its 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, capitalized software, trademarks and
trade names are initially recorded at estimated fair value. We amortize customer relationships primarily over an estimated life of 10 years, using either the
sum-of-the-years-digits or
straight-line methods, depending on the type of customer. We amortize capitalized software using the straight-line method over estimated lives ranging up to seven years and
amortize our trademark and trade name assets using the sum-of-the-years digits method over an estimated life of four years. In the predecessor period, we amortized
capitalized software using the straight-line group method. In the predecessor period, trade names and trademarks were not amortized as they had an indefinite life. Other intangible assets
not arising from business combinations are initially recorded at cost. Where there are no legal, regulatory, contractual or other factors that would reasonably limit the useful life of an intangible
asset, we classify the intangible asset as indefinite lived and such intangible assets are not amortized.
As
a result of CenturyLink's indirect acquisition of us, the software used by us for internal use was adjusted to fair value as of the acquisition date. During the predecessor and
successor periods, 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
test customer relationships for impairment whenever facts and circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized only if the
carrying amount is not recoverable and exceeds its fair value. Recoverability of the our customer relationships is measured by comparing the carrying amount to the estimated undiscounted future net
cash flows expected to be generated by them. If the customer relationship's carrying value is not recoverable, an impairment charge is recognized for the amount by which the carrying amount exceeds
its fair value. We determine fair values by using a combination of comparable market values and discounted cash flows, as appropriate.
We
are required to test goodwill for impairment at least annually, or more frequently if events or a change in circumstances indicate that an impairment may have occurred. We are
required to
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write-down
the value of goodwill only in periods in which the recorded amount of goodwill exceeds the fair value. Our annual measurement date for testing goodwill impairment is
September 30. The impairment testing is at the reporting unit level, and in reviewing the criteria for reporting units when allocating the goodwill resulting from CenturyLink's indirect
acquisition of us, 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 3Goodwill, Customer Relationships and Other Intangible Assets for additional information.
A substantial portion of our employees participate in the QCII pension plan. QCII also maintains a non-qualified pension
plan for certain of our eligible highly compensated employees. In addition, certain employees may become eligible to participate in QCII's post-retirement health care and life insurance
benefit plans. QCII allocates the expense relating to pension, non-qualified pension, and post-retirement health care and life insurance benefits and the associated obligations
and assets to us and determines our cash contribution. The amounts contributed by us through QCII are not segregated or restricted to pay amounts due to our employees and may be used to provide
benefits to other employees of QCII's affiliates. Historically, QCII has only required us to pay our portion of its required pension contribution. The allocation of expense to us is based upon the
demographics of our employees and retirees compared to all the remaining participants. However, significant year over year changes in QCII's funded status affecting accumulated other comprehensive
income may not have a significant initial impact on the affiliate receivable or payable that is allocated to us.
For
further information on QCII pension, non-qualified pension, post-retirement and other post-employment benefit plans, see QCII's Annual Report on
Form 10-K for the year ended December 31, 2012.
(2) Acquisition of QCII by CenturyLink
On April 1, 2011, our indirect parent QCII became a wholly owned subsidiary of CenturyLink.
Since
April 1, 2011, our consolidated results of operations have been included in the consolidated results of operations of CenturyLink. CenturyLink has accounted for its
acquisition of QCII and us under the acquisition method of accounting, which resulted in the assignment of the purchase price to the assets acquired and liabilities assumed based on their acquisition
date fair values. In the first quarter of 2012, we completed our valuation of the assets acquired and liabilities assumed, along with the related allocations to goodwill and intangible assets.
The
aggregate consideration exceeded the aggregate estimated fair value of the assets acquired and liabilities assumed by $9.369 billion, which we have recognized as goodwill.
This goodwill is attributable to strategic benefits, including enhanced financial and operational scale, market diversification and
leveraged combined networks that we expect to realize. None of the goodwill associated with this acquisition is deductible for income tax purposes.
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The
following is our assignment of the aggregate consideration:
|
|
|
|
|
|
|
April 1, 2011
|
|
|
|
(Dollars in millions)
|
|
Cash, accounts receivable and other current assets*
|
|
$
|
1,091
|
|
Property, plant and equipment
|
|
|
7,460
|
|
Identifiable intangible assets:
|
|
|
|
|
Customer relationships
|
|
|
5,699
|
|
Capitalized software
|
|
|
1,702
|
|
Other noncurrent assets
|
|
|
209
|
|
Current liabilities, excluding current maturities of long-term debt
|
|
|
(2,446
|
)
|
Current maturities of long-term debt
|
|
|
(2,378
|
)
|
Long-term debt
|
|
|
(6,310
|
)
|
Deferred credits and other liabilities
|
|
|
(4,445
|
)
|
Goodwill
|
|
|
9,369
|
|
|
|
|
|
Aggregate consideration
|
|
$
|
9,951
|
|
|
|
|
|
-
*
-
Includes
estimated fair value of $674 million for accounts receivable, excluding affiliate accounts receivable, which had gross contractual value of
$722 million on April 1, 2011. The $48 million difference between the gross contractual value and the estimated fair value assigned represents our best estimate as of
April 1, 2011 of contractual cash flows that would not be collected.
During the first quarter of 2012, we retrospectively adjusted our reported assignment of the aggregate consideration for changes to our original
estimates of the fair value of certain items at the acquisition date. These changes are the result of additional information obtained since the filing of our Form 10-K for the year
ended December 31, 2011. Due to these revisions of our estimates, (i) property, plant and equipment decreased by $36 million primarily from a revision to our valuation of our
buildings and (ii) deferred credits and other liabilities increased by $89 million primarily from a revision to one of our lease valuations and changes in tax liabilities. Among other
minor revisions, goodwill decreased by $84 million as an offset to the above-mentioned changes. The depreciation impact of the adjustments to property, plant and equipment valuations did not
result in a material change to previously-reported amounts.
Acquisition-Related Expenses
We have incurred 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
Combined
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Twelve Months
Ended
December 31,
2011
|
|
Acquisition-related expenses
|
|
$
|
39
|
|
|
146
|
|
|
|
|
2
|
|
|
148
|
|
The total amounts of these expenses are recognized in our cost of services and products and selling, general and administrative expenses.
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(3) Goodwill, Customer Relationships and Other Intangible Assets
Goodwill, customer relationships and other intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Weighted
Average of
Remaining Lives
|
|
December 31,
2012
|
|
December 31,
2011
|
|
Goodwill
|
|
|
N/A
|
|
$
|
9,369
|
|
|
9,369
|
|
|
|
|
|
|
|
|
|
|
Customer relationships, less accumulated amortization of $1,320 and $598
|
|
|
8.3 years
|
|
$
|
4,379
|
|
|
5,101
|
|
|
|
|
|
|
|
|
|
|
Other intangible assets subject to amortization Capitalized software, less accumulated amortization of $704 and $354
|
|
|
3.1 years
|
|
$
|
1,212
|
|
|
1,460
|
|
|
|
|
|
|
|
|
|
|
As of the successor date of December 31, 2012, the gross carrying amounts of goodwill, customer relationships and other intangible assets
were $16.984 billion. These assets were recorded at fair value on April 1, 2011 as a result of CenturyLink's indirect acquisition of us.
Total
amortization expense for intangible assets was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
Amortization expense for intangible assets
|
|
$
|
1,114
|
|
|
952
|
|
|
|
|
58
|
|
|
221
|
|
We amortize customer relationships primarily over an estimated life of 10 years, using either the
sum-of-the-years-digits or straight-line methods, depending on the type of customer. We amortize capitalized software using the
straight-line method over estimated lives ranging up to seven years. The estimated future amortization expense for intangible assets is as follows:
|
|
|
|
|
|
|
(Dollars in millions)
|
|
Year ending December 31,
|
|
|
|
|
2013
|
|
$
|
988
|
|
2014
|
|
|
917
|
|
2015
|
|
|
827
|
|
2016
|
|
|
737
|
|
2017
|
|
|
652
|
|
2018 and thereafter
|
|
|
1,470
|
|
We periodically review the estimated lives and methods used to amortize our other intangible assets. The actual amounts of amortization expense
may differ materially from our estimates, depending on the results of our periodic reviews.
We
have accounted for CenturyLink's acquisition of us under the acquisition method of accounting, which resulted in the assignment of the aggregate consideration to the assets acquired
and liabilities assumed based on 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 $9.369 billion, which has been recognized as goodwill. The impairment testing is done at the reporting unit level; in reviewing the criteria for reporting units when
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allocating
the goodwill resulting from our acquisition by CenturyLink, we have determined that we are one reporting unit. We are required to test goodwill recorded in business combinations for
impairment at least annually, or more frequently if events or circumstances indicate there may be impairment. Our annual measurement date for testing goodwill impairment is September 30. We are
required to write-down the value of goodwill only in periods in which the recorded amount of goodwill exceeds the fair value.
We
adopted the provisions of ASU 2011-08 in the third quarter of 2011, Testing Goodwill for Impairment, which permits us to make a qualitative assessment of whether it
is more likely than not that a reporting unit's estimated fair value is less than its carrying amount before applying the two step goodwill impairment test, which requires us (i) in step one,
to identify potential impairments by comparing the estimated fair value of a reporting unit against its carrying value and (ii) in step two, to quantify any impairment identified in step one.
At September 30, 2012, as a result of changes in our estimate of future cash flows we did not perform a qualitative assessment. Therefore, we determined the estimated fair value of Qwest using
an equal weighting based on a market approach and a discounted cash flow method. The market approach 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 Qwest beyond the cash flows
from the discrete nine-year projection period. We discounted the estimated cash flows using a rate that represents a market participant's weighted average cost of capital, which we
determined to be approximately 6.0% as of the measurement date (which was comprised of an after-tax cost of debt of 3.2% and a cost of equity of 8.4%). Based on our analysis performed with
respect to our reporting unit described above, we concluded that our goodwill was not impaired.
(4) Long-Term Debt and Revolving Promissory Note
Long-term debt, including unamortized discounts and premiums, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Interest Rates
|
|
Maturities
|
|
December 31,
2012
|
|
December 31,
2011
|
|
|
|
|
|
|
|
(Dollars in millions)
|
|
Senior notes
(1)
|
|
3.558 - 8.375%
|
|
2013 - 2052
|
|
$
|
7,386
|
|
|
7,829
|
|
Capital lease and other obligations
|
|
Various
|
|
Various
|
|
|
112
|
|
|
176
|
|
Unamortized premiums, net
|
|
|
|
|
|
|
127
|
|
|
320
|
|
|
|
|
|
|
|
|
|
|
|
Total long-term debt
|
|
|
|
|
|
|
7,625
|
|
|
8,325
|
|
Less current maturities
|
|
|
|
|
|
|
(804
|
)
|
|
(64
|
)
|
|
|
|
|
|
|
|
|
|
|
Long-term debt, excluding current maturities
|
|
|
|
|
|
$
|
6,821
|
|
|
8,261
|
|
|
|
|
|
|
|
|
|
|
|
-
(1)
-
Our
$750 million Notes due 2013 are floating rate notes, with rates that reset every three months. As of the most recent measurement date of
December 17, 2012, the rate for these notes was 3.558%.
New Issuances
On June 25, 2012, we issued $400 million aggregate principal amount of 7.00% Notes due 2052 in exchange for net proceeds,
after deducting underwriting discounts and expenses, of $387 million. The Notes are unsecured obligations and may be redeemed, in whole or in part, on or after July 1, 2017 at a
redemption price equal to 100% of the principal amount redeemed plus accrued interest.
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Table of Contents
In connection with consummating the April 18, 2012 tender offer described below under "Repayments", we borrowed from a CenturyLink affiliate approximately
$580 million under a revolving promissory note, payable upon demand. The promissory note is unsecured and ranked equally to our senior notes.
On
April 2, 2012, we issued $525 million aggregate principal amount of 7.00% Notes due 2052 in exchange for net proceeds, after deducting underwriting discounts and
expenses, of $508 million. The Notes are unsecured obligations and may be redeemed, in whole or in part, on or after April 1, 2017 at a redemption price equal to 100% of the principal
amount redeemed plus accrued interest.
On October 4, 2011, we issued $950 million aggregate principal amount of our 6.75% Notes due 2021 in exchange for net
proceeds, after deducting underwriting discounts and expenses, of $927 million. The notes are our senior unsecured obligations and may be redeemed, in whole or in part, at a redemption price
equal to the greater of their principal amount or the present value of the remaining principal and interest payments discounted at a U.S. Treasury interest rate specified in the indenture agreement
plus 50 basis points.
On
September 21, 2011, we issued $575 million aggregate principal amount of our 7.50% Notes due 2051 in exchange for net proceeds, after deducting underwriting discounts
and expenses, of $557 million. The notes are our senior unsecured obligations and may be redeemed, in whole or in part, on or after September 15, 2016 at a redemption price equal to 100%
of the principal amount redeemed plus accrued and unpaid interest to the redemption date.
On
June 8, 2011, we issued $661 million aggregate principal amount of our 7.375% Notes due 2051 in exchange for net proceeds, after deducting underwriting discounts and
expenses, of $642 million. The notes are our unsecured obligations and may be redeemed, in whole or in part, on or after June 1, 2016 at a redemption price equal to 100% of the principal
amount redeemed plus accrued and unpaid interest to the redemption date.
CenturyLink
has a revolving credit facility (the "Credit Facility") maturing April 2017 that allows CenturyLink to borrow up to $2 billion for the general corporate purposes of
itself and its subsidiaries. Up to $400 million of the Credit Facility can be used for letters of credit, which reduce the amount available for other extensions of credit. Interest is assessed
on borrowings using the London Interbank Offered Rate ("LIBOR") plus an applicable margin between 0.5% and 2.5% per annum depending on the type of loan and CenturyLink's then-current
senior unsecured long-term debt rating. CenturyLink also maintains a separate letter of credit arrangement with a financial institution amounting to $160 million to which we have
access. As of the successor date of December 31, 2012, CenturyLink had approximately $820 million and $120 million outstanding under the Credit Facility and the separate letter of
credit arrangement, respectively. CenturyLink also had approximately $277 million and $129 million outstanding under the Credit Facility and the separate letter of credit arrangement,
respectively, for the successor date of December 31, 2011. We are not guarantors of the Credit Facility or any other debt obligations of our affiliates.
Repayments
On July 20, 2012, we redeemed all $484 million of our 7.50% Notes due 2023, which resulted in an immaterial loss.
On
April 18, 2012, we completed a cash tender offer to purchase a portion of our $811 million of 8.375% Notes due 2016 and our $400 million of 7.625% Notes due 2015.
With respect to our 8.375% Notes due 2016, we received and accepted tenders of approximately $575 million aggregate principal
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amount
of these notes, or 71%, for $722 million including a premium, fees and accrued interest. With respect to our 7.625% Notes due 2015, we received and accepted tenders of approximately
$308 million aggregate principal amount of these notes, or 77%, for $369 million including a premium, fees and accrued interest. The completion of this tender offer resulted in a loss of
$46 million.
2011
In October 2011, we used the net proceeds of $927 million from the October 4, 2011 debt issuance, together with the
$557 million of net proceeds received from the September 21, 2011 debt issuance described above and available cash, to redeem the $1.5 billion aggregate principal amount of our
8.875% Notes due 2012 and to pay all related fees and expenses, which resulted in a loss of $6 million.
In
June 2011, we used the net proceeds of $642 million from the June 8, 2011 debt issuance, together with available cash, to redeem $825 million aggregate principal
amount of our 7.875% Notes due 2011 and to pay related fees and expenses, which resulted in an immaterial loss.
Aggregate
maturities of our long-term debt (excluding unamortized premiums, discounts, and other):
|
|
|
|
|
|
|
(Dollars in millions)
|
|
2013
|
|
$
|
804
|
|
2014
|
|
|
634
|
|
2015
|
|
|
112
|
|
2016
|
|
|
236
|
|
2017
|
|
|
500
|
|
2018 and thereafter
|
|
|
5,212
|
|
|
|
|
|
Total long-term debt
|
|
$
|
7,498
|
|
|
|
|
|
Revolving Promissory Note
On April 18, 2012, we entered into a revolving promissory note with an affiliate of CenturyLink that provides us with a funding
commitment with an aggregate principle amount available to $1.0 billion through June 30, 2022, of which $701 million was outstanding as of the successor date of
December 31, 2012. The revolving promissory note is payable on demand and ranked equally to our 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 the successor date of December 31, 2012, the weighted average interest rate was 6.706%. The accrued interest
and outstanding principle balance are payable on demand, or no later than June 30, 2022. This revolving promissory note is reflected on our consolidated balance sheets under "Note
payableaffiliate".
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Interest Expense
Interest expense includes interest on long-term debt. The following table presents the amount of gross interest expense,
net of capitalized interest and interest expense (income)affiliates:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross interest expense
|
|
$
|
461
|
|
|
305
|
|
|
|
|
153
|
|
|
627
|
|
Capitalized interest
|
|
|
(18
|
)
|
|
(5
|
)
|
|
|
|
(3
|
)
|
|
(12
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense
|
|
$
|
443
|
|
|
300
|
|
|
|
|
150
|
|
|
615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense (income)affiliates
|
|
$
|
24
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
Covenants
The indentures governing our notes 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. As of the successor date of December 31, 2012, we believe we were in compliance with the provisions and covenants of our
debt agreements.
(5) Accounts Receivable
The following table presents details of our accounts receivable balances:
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
December 31,
2012
|
|
December 31,
2011
(1)
|
|
|
|
(Dollars in millions)
|
|
Trade and purchased receivables
|
|
$
|
661
|
|
|
660
|
|
Earned and unbilled receivables
|
|
|
82
|
|
|
81
|
|
Other
|
|
|
12
|
|
|
8
|
|
|
|
|
|
|
|
Total accounts receivable
|
|
|
755
|
|
|
749
|
|
Less: allowance for doubtful accounts
|
|
|
(46
|
)
|
|
(42
|
)
|
|
|
|
|
|
|
Accounts receivable, less allowance
|
|
$
|
709
|
|
|
707
|
|
|
|
|
|
|
|
-
(1)
-
We
have reclassified prior period amounts of purchased receivables from other to trade and purchased receivables to conform to the current period
presentation.
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
74
Table of Contents
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:
|
|
|
|
|
|
|
Allowance for Doubtful
Accounts
|
|
|
|
(Dollars in millions)
|
|
Balance at January 1, 2010 (Predecessor)
|
|
$
|
53
|
|
Charged to expensenet
|
|
|
70
|
|
Deductions
|
|
|
(75
|
)
|
|
|
|
|
Balance at December 31, 2010 (Predecessor)
|
|
|
48
|
|
Charged to expensenet
|
|
|
17
|
|
Deductions
|
|
|
(18
|
)
|
|
|
|
|
Balance at March 31, 2011(Predecessor)
|
|
$
|
47
|
|
|
|
|
|
Fair value adjustment
|
|
|
(47
|
)
|
|
|
|
|
Balance at April 1, 2011 (Successor)
|
|
$
|
|
|
Charged to expensenet
|
|
|
44
|
|
Deductions
|
|
|
(2
|
)
|
|
|
|
|
Balance at December 31, 2011 (Successor)
|
|
|
42
|
|
Charged to expensenet
|
|
|
74
|
|
Deductions
|
|
|
(70
|
)
|
|
|
|
|
Balance at December 31, 2012 (Successor)
|
|
$
|
46
|
|
|
|
|
|
As a result of CenturyLink's indirect acquisition of us, the allowance for doubtful accounts as of the acquisition date of $47 million was
reduced to zero and our gross accounts receivable were reduced by $47 million to reflect its estimated acquisition date fair value.
(6) Property, Plant and Equipment
CenturyLink accounted for its indirect acquisition of us under the acquisition method of accounting, which requires the assignment of the purchase price to the
assets acquired based on their fair values at the acquisition date.
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Table of Contents
Net
property, plant and equipment is composed of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Depreciable
Lives
|
|
December 31,
2012
|
|
December 31,
2011
|
|
|
|
|
|
(Dollars in millions)
|
|
Property, plant and equipment:
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
N/A
|
|
$
|
356
|
|
|
368
|
|
Fiber, conduit and other outside plant
(1)
|
|
|
15-45 years
|
|
|
3,475
|
|
|
3,247
|
|
Central office and other network electronics
(2)
|
|
|
5-10 years
|
|
|
2,611
|
|
|
2,155
|
|
Support assets
(3)
|
|
|
5-30 years
|
|
|
2,428
|
|
|
2,449
|
|
Construction in progress
(4)
|
|
|
N/A
|
|
|
372
|
|
|
201
|
|
|
|
|
|
|
|
|
|
|
Gross property, plant and equipment
|
|
|
|
|
|
9,242
|
|
|
8,420
|
|
|
|
|
|
|
|
|
|
|
Accumulated depreciation
|
|
|
|
|
|
(2,011
|
)
|
|
(914
|
)
|
|
|
|
|
|
|
|
|
|
Net property, plant and equipment
|
|
|
|
|
$
|
7,231
|
|
|
7,506
|
|
|
|
|
|
|
|
|
|
|
-
(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.
Effective January 1, 2012, we changed our rates of capitalized labor as we transitioned certain legacy systems to the historical systems of
our ultimate parent, CenturyLink. This transition resulted in an estimated $40 million to $55 million increase in the amount of labor capitalized as an asset compared to the amount that
would have been capitalized if we had continued to use our legacy systems and a corresponding estimated $40 million to $55 million decrease in operating expenses for the successor year
ended December 31, 2012. The reduction in expenses described above, net of tax, increased net income approximately $25 million to $34 million for the successor year ended
December 31, 2012.
Effective
January 1, 2012, we changed our estimates of the remaining useful lives of certain telecommunications equipment. These changes resulted in a decrease to depreciation
expense of approximately $52 million for the successor year ended December 31, 2012. This decrease in depreciation expense, net of tax, had the effect of increasing net income by
approximately $32 million for the successor year ended December 31, 2012.
During
the first quarter of 2012, we retrospectively adjusted our previously reported assignment of the aggregate Qwest consideration for changes to our original estimates of the fair
value of buildings at the acquisition date. This retrospective adjustment decreased the previously reported December 31, 2011 support assets by $36 million. Also, we reclassified certain
prior period amounts of inventory held for construction to conform to the current period presentation. This reclassification increased construction in progress at December 31, 2011 by
$38 million with an offsetting decrease to fiber, conduit and other outside plant and central office and other network electronics by $8 million and $30 million, respectively.
We
recorded depreciation expense of $1.176 billion, $914 million, $393 million and $1.652 billion for the successor year ended December 31, 2012, the
successor nine months ended December 31, 2011,
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Table of Contents
the
predecessor three months ended March 31, 2011 and the predecessor year ended December 31, 2010, respectively.
(7) Severance
Periodically, we have implemented reductions in our workforce and have accrued liabilities for related severance costs. These workforce reductions resulted
primarily from the progression or completion of our integration plans related to CenturyLink's indirect acquisition of us, increased competitive pressures and reduced workload demands due to the loss
of access lines.
We
report severance liabilities within "accrued expenses and other liabilitiessalaries 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
|
|
|
|
(Dollars in millions)
|
|
Balance at December 31, 2010 (Predecessor)
|
|
$
|
28
|
|
Accrued to expense
|
|
|
3
|
|
Payments, net
|
|
|
(11
|
)
|
Reversals and adjustments
|
|
|
(1
|
)
|
Balance at March 31, 2011 (Predecessor)
|
|
$
|
19
|
|
|
|
|
|
Fair value adjustment
|
|
|
(2
|
)
|
|
|
|
|
Balance at April 1, 2011 (Successor)
|
|
$
|
17
|
|
Accrued to expense
|
|
|
118
|
|
Payments, net
|
|
|
(97
|
)
|
Reversals and adjustments
|
|
|
(9
|
)
|
|
|
|
|
Balance at December 31, 2011 (Successor)
|
|
|
29
|
|
Accrued to expense
|
|
|
64
|
|
Payments, net
|
|
|
(85
|
)
|
Reversals and adjustments
|
|
|
(1
|
)
|
|
|
|
|
Balance at December 31, 2012 (Successor)
|
|
$
|
7
|
|
|
|
|
|
Our severance expenses for the successor nine months ended December 31, 2011 also included $12 million of share-based compensation
associated with the accelerated vesting of stock awards that occurred in connection with workforce reductions relating to CenturyLink's indirect acquisition of us.
(8) Employee Benefits
Pension and Post-Retirement Benefits
We are required to disclose the amount of our contributions to QCII relative to the QCII pension and post-retirement
benefit plans. QCII was not required and did not make contributions to the pension plan trust in 2012. Based on current laws and circumstances, (i) QCII will not be required to make a cash
contribution to this plan in 2013 and (ii) QCII does not expect it will be required to make a contribution in 2014. The amount of required contributions to the plan in 2014 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. No contributions were made
to the post-retirement occupational health care trust in 2012 or 2011 and QCII does not expect to make a contribution in 2013.
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Table of Contents
The
unfunded status of QCII's pension plan for accounting purposes was $948 million and $627 million as of the successor dates of December 31, 2012 and
December 31, 2011, respectively. The unfunded
status of its post-retirement benefit plans for accounting purposes was $2.866 billion and $2.706 billion as of the successor dates of December 31, 2012 and
December 31, 2011, respectively. QCII allocates its pension, non-qualified pension and post-retirement benefit obligations to us using the amount of its funded or
unfunded status and its related accumulated other comprehensive income balance. Therefore, significant year over year changes in QCII's funded status affecting accumulated other comprehensive income
may not have a significant initial impact on the assets or obligations that are allocated to us.
We
recognized an allocated $117 million in pension income during the successor year ended December 31, 2012 and $51 million for the successor nine months ended
December 31, 2011, as well as $11 million and $53 million in pension expense for the predecessor three months ended March 31, 2011 and the predecessor year ended
December 31, 2010, respectively. Our allocated post-retirement benefit expense for the successor year ended December 31, 2012, the successor nine months ended
December 31, 2011, the predecessor three months ended March 31, 2011 and the predecessor year ended December 31, 2010 was $106 million, $84 million,
$16 million and $72 million, respectively. These allocated amounts represent our share of the pension and post-retirement benefit expenses based on the actuarially determined
amounts. Our allocated portion of QCII's total pension and post-retirement benefit expenses were 91%, 96%, 102% and 101% for the successor year ended December, 31, 2012, the successor nine
months ended December 31, 2011, the predecessor three months ended March 31, 2011 and the predecessor year ended December 31, 2010, respectively. QCII allocates the expenses of
these plans to us and its other affiliates. The allocation of expense to us is based upon demographics of our employees compared to all remaining participants. The combined net pension and
post-retirement benefits (income) expenses is included in cost of services and products and selling, general and administrative expenses.
QCII
sponsors a noncontributory qualified defined benefit pension plan (referred to as QCII's pension plan) for substantially all of our employees. In addition to this tax qualified
pension plan, QCII also maintains a non-qualified pension plan for certain eligible highly compensated employees. These plans also provide survivor and disability benefits to certain
employees. In November 2009, QCII amended the pension plan and the non-qualified pension plans 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, QCII has eliminated this benefit effective March 1, 2010 for retirees who retired prior to January 1, 2004 and whose deaths occur
after February 28, 2010. QCII previously eliminated the death benefit for eligible beneficiaries of certain retirees who retired after December 31, 2003.
QCII
maintains post-retirement benefit plans that provide health care and life insurance benefits for certain eligible retirees. The benefit obligation for QCII's
occupational health care and life insurance post-retirement plans is estimated based on the terms of QCII's written benefit plans. In calculating this obligation, QCII considers numerous
assumptions, estimates and judgments, including but not limited to, discount rates, health care cost trend rates and plan amendments. In October 2012, our current four-year collective
bargaining agreements
expired which covered approximately 100% of our unionized employees as of the successor date of December 31, 2012. In 2008, the plan was amended to reflect changes affecting eligible
post-1990 retirees who are former represented employees, including: (i) a Letter of Agreement that states such post-1990 retirees will begin contributing to the cost of
health care benefits in excess of specified limits on the company-funded portion of retiree
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Table of Contents
health
care costs (also referred to as "caps") beginning January 1, 2009 and (ii) a provision that such post-1990 retirees will pay increased
out-of-pocket costs through plan design changes starting January 1, 2009, including the elimination of Medicare Part B premium reimbursements for
post-1990 retirees who are former represented employees. These changes have been considered in calculating the benefit obligation under QCII's occupational health care plan.
The
terms of the post-retirement health care and life insurance plans between QCII and its eligible non-represented employees and its eligible
post-1990 non-represented retirees are established by QCII and are subject to change at its discretion. QCII 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, QCII's contribution under its post-1990 non-represented retirees' health care plan is capped
at a specific dollar amount. Effective January 1, 2009, QCII amended its post-1990 non-represented retiree plan to, among other things, (i) require retirees to
pay increased out-of-pocket costs and (ii) eliminate the reimbursement of Medicare Part B premiums.
Medicare Prescription Drug, Improvement and Modernization Act of 2003
QCII sponsors post-retirement health care plans with several benefit options that provide prescription drug benefits that
QCII deems actuarially equivalent to or exceeding Medicare Part D. QCII 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
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 active health care benefit expenses were $221 million, $167 million, $57 million, and $224 million for the successor year ended
December 31, 2012, the successor nine months ended December 31, 2011, the predecessor three months ended March 31, 2011 and the predecessor year ended December 31, 2010,
respectively. Represented employee benefits are based on negotiated collective bargaining agreements. Employees are required to partially fund the health care benefits provided by us, in addition to
paying their own out-of-pocket costs. Our group life insurance plan is fully insured and the premiums are paid by us.
No
contributions were made to the post-retirement occupational health care trust in 2012, 2011 or 2010 and we do not expect to make a contribution in 2013.
CenturyLink sponsors a qualified defined contribution benefit plan covering substantially all of our employees. Under this plan,
employees may contribute a percentage of their annual compensation to the plan up to certain maximums, as defined by the plan and by the Internal Revenue Service ("IRS"). Currently, QCII, on our
behalf, matches a percentage of our employees' contributions in cash. We recognized $46 million, $36 million, $12 million and $51 million in expense related to this plan
for the successor year ended December 31, 2012, the successor nine months ended December 31, 2011, the predecessor three months ended March 31, 2011 and the predecessor year ended
December 31, 2010, respectively.
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QCII sponsored a non-qualified unfunded deferred compensation plan for various groups that include certain of our current
and former highly compensated employees. The plan is frozen and participants can no longer defer compensation to the plan. The value of the assets and liabilities related to this plan is not
significant.
(9) Stock-Based Compensation
During the predecessor year ended December 31, 2010, our employees participated in QCII's Equity Incentive Plan ("EIP") and Employee Stock Purchase Plan
("ESPP"). Due to CenturyLink's acquisition of QCII and the purchasing of its outstanding stock, QCII no longer offers these plans.
Stock-Based Compensation Expense
Stock-based compensation expenses are included in cost of services and products, and selling, general, and administrative expenses in
our consolidated statements of operations. During our predecessor years, we recognized compensation expense relating to awards granted to our employees under the EIP using the
straight-line method over the applicable vesting periods. We also recognized compensation expense when our employees purchased QCII's common stock under the ESPP for the difference between
the employees' purchase price and the fair value of QCII's stock.
For
the successor year ended December 31, 2012, we were allocated a stock based compensation expense of $18.3 million from CenturyLink. For the successor nine months ended
December 31, 2011, the predecessor three months ended March 31, 2011 and the predecessor year ended December 31, 2010, our total stock-based compensation expense was approximately
$19 million, $3 million and $121 million, respectively. We recognized an income tax benefit of $7 million, $7 million, $1 million and $30 million
associated with our stock compensation expense during the successor year ended December 31, 2012,
the successor nine months ended December 31, 2011, the predecessor three months ended March 31, 2011 and the predecessor year ended December 31, 2010, respectively.
On
December 21, 2010, QCII accelerated the vesting of certain restricted stock and performance share awards issued under our previous Equity Incentive Plan in order to preserve
certain economic benefits to employees that otherwise would have been lost in connection with CenturyLink's acquisition of QCII. As the vast majority of affected employees are employed by us, QCII
allocated substantially all of the $63 million expense associated with this accelerated vesting to us.
Due
to CenturyLink's acquisition of QCII, we now record the stock-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 stock-based compensation expense recorded at CenturyLink and ultimately allocated to us
may fluctuate. We cash settle the stock-based compensation expense allocated to us from CenturyLink.
(10) Products and Services Revenues
We are an integrated communications company engaged primarily in providing an array of communications services, including local and long-distance,
network access, private line (including special access), broadband, Ethernet, data, wireless and video services. We strive to maintain our customer relationships by, among other things, bundling our
service offerings to provide our customers with a complete offering of integrated communications services. We categorize our products and services into the following three
categories:
-
-
Strategic services
, which include primarily private line (including
special access), broadband, video (including resold satellite video services) and Verizon Wireless services;
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Table of Contents
-
-
Legacy services,
which include primarily local, long-distance,
integrated services digital network (which uses regular telephone lines to support voice, video and data applications), switched access and traditional wide area network services (which allows a local
communications network to link to networks in remote locations); and
-
-
Affiliates and other services
, which consist primarily of USF revenues and
surcharges and services we provide to our non-consolidated affiliates. 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.
During
the first quarter of 2012, we reclassified certain prior period revenues between the aforementioned three categories to conform to the current period presentation.
Since
the April 1, 2011 closing of CenturyLink's indirect acquisition of us, our operations have been integrated into and reported as part of the segments of CenturyLink.
CenturyLink's chief operating decision maker ("CODM") has become our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we
file with the 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 now have one reportable
segment and have reclassified our prior period results to conform to our current view.
Operating
revenues for our products and services are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
Strategic services
|
|
$
|
3,265
|
|
|
2,406
|
|
|
|
|
|
792
|
|
|
3,059
|
|
Legacy services
|
|
|
3,471
|
|
|
2,796
|
|
|
|
|
|
1,003
|
|
|
4,323
|
|
Affiliates and other services
|
|
|
2,112
|
|
|
1,433
|
|
|
|
|
|
473
|
|
|
1,889
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
$
|
8,848
|
|
|
6,635
|
|
|
|
|
|
2,268
|
|
|
9,271
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We do not have any single customer that provides more than 10% of our total revenue. Substantially all of our revenue comes from customers located
in the United States.
The
table below presents the aggregate USF surcharges recognized on a gross basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
Taxes and surcharges included in operating revenues and expenses
|
|
$
|
171
|
|
|
122
|
|
|
|
|
|
43
|
|
|
186
|
|
(11) Related Party 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.
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Table of Contents
Below
are details of the services we provided 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 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.
(12) Income Taxes
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. 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
years prior to 2011, QCII filed amended federal income tax returns for 2002-2007 to make protective claims with respect to items reserved in our audit settlements and to
correct items not addressed in prior audits. The examination of those amended federal income tax returns by the IRS was completed in 2012. In 2012, QCII filed an amended 2008 federal income tax return
primarily to report the carryforward impact of prior year settlements. Such amended filing is subject to adjustment by the IRS.
QCII
also files combined income tax returns in many states, and these combined returns remain open for adjustments to its federal income tax returns. In addition, certain combined state
income tax returns filed since 1996 are still open for state specific adjustments.
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Table of Contents
As of the successor dates of December 31, 2012 and December 31, 2011, we had no amounts accrued for unrecognized tax benefits for each
aforementioned year.
Effective
on April 1, 2011 in conjunction with CenturyLink's indirect acquisition of us, we changed our accounting policy to recognize interest expense and penalties related to
income taxes as income tax expense. Prior to April 1, 2011, interest expense and penalties related to income taxes were included in the other income (expense) line of our consolidated
statements of operations. As of the successor dates of December 31, 2012 and December 31, 2011, we had recorded liabilities for interest related to uncertain tax positions in the amounts
of $5 million for each aforementioned year. 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
Income tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current tax provision:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
638
|
|
|
173
|
|
|
|
|
|
104
|
|
|
470
|
|
State and local
|
|
|
105
|
|
|
26
|
|
|
|
|
|
11
|
|
|
80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current tax provision
|
|
|
743
|
|
|
199
|
|
|
|
|
|
115
|
|
|
550
|
|
Deferred tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(175
|
)
|
|
128
|
|
|
|
|
|
61
|
|
|
208
|
|
State and local
|
|
|
(26
|
)
|
|
22
|
|
|
|
|
|
15
|
|
|
33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax expense (benefit)
|
|
|
(201
|
)
|
|
150
|
|
|
|
|
|
76
|
|
|
241
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
$
|
542
|
|
|
349
|
|
|
|
|
|
191
|
|
|
791
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The effective income tax rate for continuing operations differs from the statutory tax rate as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(in percent)
|
|
Effective income tax rate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal statutory income tax rate
|
|
|
35.0%
|
|
|
35.0%
|
|
|
|
|
35.0%
|
|
|
35.0%
|
|
State income taxesnet of federal effect
|
|
|
3.7
|
|
|
3.5
|
|
|
|
|
3.4
|
|
|
3.9
|
|
Medicare subsidiary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.7
|
|
Excess compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.0
|
|
Other
|
|
|
0.3
|
|
|
0.6
|
|
|
|
|
0.6
|
|
|
(0.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate
|
|
|
39.0%
|
|
|
39.1%
|
|
|
|
|
39.0%
|
|
|
42.2%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Table of Contents
Deferred Tax Assets and Liabilities
The components of the deferred tax assets and liabilities are as follows:
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
December 31,
2012
|
|
December 31,
2011
|
|
|
|
(Dollars in millions)
|
|
Deferred tax assets and liabilities:
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
Property, plant and equipment
|
|
$
|
(1,046
|
)
|
|
(1,279
|
)
|
Intangibles assets
|
|
|
(2,226
|
)
|
|
(2,274
|
)
|
Receivable from an affiliate due to pension plan participation
|
|
|
(398
|
)
|
|
(359
|
)
|
Other
|
|
|
(39
|
)
|
|
(148
|
)
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(3,709
|
)
|
|
(4,060
|
)
|
|
|
|
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
Payable to affiliate due to post-retirement benefit plan
participation
|
|
|
932
|
|
|
920
|
|
Debt premiums
|
|
|
70
|
|
|
164
|
|
Other
|
|
|
239
|
|
|
304
|
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
1,241
|
|
|
1,388
|
|
|
|
|
|
|
|
Valuation allowance on deferred tax assets
|
|
|
(12
|
)
|
|
(8
|
)
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
1,229
|
|
|
1,380
|
|
|
|
|
|
|
|
Net deferred tax liabilities
|
|
$
|
(2,480
|
)
|
|
(2,680
|
)
|
|
|
|
|
|
|
At December 31, 2012, 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 $607 million, $211 million and $677 million to QSC related to income taxes in the successor years ended
2012 and 2011 and the predecessor year ended 2010, respectively. As of the successor date of December 31, 2011, we had an approximate $19 million receivable from QSC relating to income
taxes reflected in advances to affiliates on our consolidated balance sheets.
Income
tax expense for the combined year ended December 31, 2011, as compared to the predecessor year ended December 31, 2010, decreased by $251 million as a result
of the March 2010 enactments of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. Income tax expense also decreased due to the 2010
tax treatments of the expenses allocated to
us when QCII accelerated the vesting of certain stock-based compensation and certain expenses associated with CenturyLink's acquisition of us.
In
the predecessor year ended December 31, 2010, we increased our state tax rate based on a review of our state apportionment factors and the current tax rate of the states where
we conduct business. This change resulted in a $2 million state deferred tax expense, net of federal effect.
We
had unamortized investment tax credits of $1 million, $2 million and $61 million as of the successor dates of December 31, 2012 and December 31,
2011 and the predecessor date of December 31, 2010, respectively, which are included in other long-term liabilities on our consolidated balance sheets. These investment credits are
amortized over the lives of the related assets. Amortization of investment tax credits was immaterial in 2012 and 2011. Amortization of investment
84
Table of Contents
tax
credits of $8 million is included in the provision for income taxes for the predecessor year ended December 31, 2010.
(13) Fair Value Disclosure
Our financial instruments consist of cash and cash equivalents, accounts receivable, advances to affiliates, accounts payable, accounts
payableaffiliates, note payableaffiliate and long-term debt excluding capital lease obligations. Due to their short-term nature, the carrying amounts
of our cash and cash equivalents, accounts receivable, advances to affiliates, accounts payable, accounts payableaffiliates and note payableaffiliate 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. 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 Financial Accounting Standards Board 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
obligations, as well as the input levels used to determine the fair values:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
|
|
December 31, 2012
|
|
December 31, 2011
|
|
|
|
Input
Level
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
|
|
|
|
|
(Dollars in millions)
|
|
LiabilitiesLong-term debt excluding capital lease obligations
|
|
|
2
|
|
$
|
7,513
|
|
|
8,019
|
|
|
8,149
|
|
|
8,352
|
|
For the assets and liabilities measured at fair value on our acquisition date, we employed a variety of methods to determine these fair values,
including quoted market price, observable market values of comparable assets, current replacement costs and discounted cash flow analysis. The factors that most significantly impact our estimate of
fair value included forecasted cash flows and a market participant discount rate. The applicable market participant discount rate is impacted by the market risk free rate of return and risk premium
associated with a group of peer telecommunication companies which have been deemed to be market participants for determining the fair value. The discount rates used in our valuations ranged from 7.5%
of 9.5% depending upon the asset or liability valued and relative risk associated with the cash flows.
85
Table of Contents
(14) Stockholder's Equity
Common Stock
We have one share of common stock (no par value) issued and outstanding, which is owned by QSC.
Other Net Asset Transfers
During 2012, we recognized a $100 million equity contribution for the tax benefit associated with a deduction for pension
funding. Since we are the employer of a significant percentage of the participants and none of the 2011 QCII pension funding was allocated to us, a tax deduction will be recognized on our separate
company tax return and, therefore, we recognized an equity contribution for the tax benefits associated with this deduction.
During
2010, we recorded a $56 million equity transaction for excess tax deductions, the difference between the acceleration of stock-based compensation expense for both
performance and restricted shares and the tax deduction.
In
addition, in the normal course of business, we transfer assets and liabilities to and from QSC and its affiliates, which are recorded through our equity. It is our policy to record
these asset transfers based on carrying values.
Dividends
We declared the following cash and non-cash dividends to QSC:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31
2010
|
|
|
|
(Dollars in millions)
|
|
Non-cash dividend to QSC
(1)
|
|
$
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
Cash dividend declared to QSC
|
|
|
840
|
|
|
600
|
|
|
|
|
|
1,000
|
|
|
2,300
|
|
Cash dividend paid to QSC
|
|
|
1,150
|
|
|
900
|
|
|
|
|
|
530
|
|
|
2,260
|
|
-
(1)
-
This
was a non-cash transaction whereby we transferred assets via dividends to our parent company, QSC.
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.
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Table of Contents
(15) Quarterly Financial Data (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarterly Financial Data
|
|
|
|
Successor
|
|
|
|
First
Quarter
|
|
Second
Quarter
|
|
Third
Quarter
|
|
Fourth
Quarter
|
|
Twelve
Months
Total
|
|
|
|
(Dollars in millions)
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
$
|
2,260
|
|
|
2,195
|
|
|
2,183
|
|
|
2,210
|
|
|
8,848
|
|
Operating income
|
|
|
466
|
|
|
455
|
|
|
459
|
|
|
525
|
|
|
1,905
|
|
Income tax expense (benefit)
|
|
|
136
|
|
|
113
|
|
|
133
|
|
|
160
|
|
|
542
|
|
Net income (loss)
|
|
|
218
|
|
|
178
|
|
|
212
|
|
|
241
|
|
|
849
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarterly Financial Data
|
|
|
|
Predecessor
|
|
|
|
Successor
|
|
|
|
First
Quarter
|
|
|
|
Second
Quarter
|
|
Third
Quarter
|
|
Fourth
Quarter
|
|
Nine
Months
Total
|
|
|
|
(Dollars in millions)
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenues
|
|
$
|
2,268
|
|
|
|
|
2,231
|
|
|
2,190
|
|
|
2,214
|
|
|
6,635
|
|
Operating income
|
|
|
638
|
|
|
|
|
370
|
|
|
412
|
|
|
417
|
|
|
1,199
|
|
Income tax expense (benefit)
|
|
|
191
|
|
|
|
|
116
|
|
|
118
|
|
|
115
|
|
|
349
|
|
Net income (loss)
|
|
|
299
|
|
|
|
|
165
|
|
|
199
|
|
|
179
|
|
|
543
|
|
Second Quarter 2011
We recognized $123 million of certain expenses associated with activities related to CenturyLink's indirect acquisition of us
during the successor three months ended June 30, 2011. These expenses were comprised primarily of severance of $98 million, retention bonuses of $12 million, share-based
compensation of $11 million allocated to us by QCII and system integration consulting of $1 million.
(16) Commitments 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 rate making, actions relating to employee claims, various tax issues, environmental law issues, grievance hearings before labor regulatory agencies,
and miscellaneous third party tort actions. The outcome of these other proceedings is not predictable. However, we do not believe that the ultimate resolution of
these other proceedings, after considering available insurance coverage, will have a material adverse effect on our financial position, results of operations or cash flows.
CenturyLink
and QCII 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 and QCII, our business and financial condition could be similarly affected. You can find descriptions of these legal proceedings in
CenturyLink's and QCII'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.
87
Table of Contents
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. Payments on capital leases are included in repayments of long-term debt, including current maturities in the consolidated statements of
cash flows.
The
tables below summarize our capital lease activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
Predecessor
|
|
|
|
Year
Ended
December 31,
2012
|
|
Nine Months
Ended
December 31,
2011
|
|
|
|
Three Months
Ended
March 31,
2011
|
|
Year
Ended
December 31,
2010
|
|
|
|
(Dollars in millions)
|
|
Assets acquired through capital leases
|
|
$
|
|
|
|
2
|
|
|
|
|
16
|
|
|
116
|
|
Depreciation expense
|
|
|
50
|
|
|
41
|
|
|
|
|
11
|
|
|
28
|
|
Cash payments towards capital leases
|
|
|
41
|
|
|
35
|
|
|
|
|
11
|
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
Successor
|
|
|
|
December 31,
2012
|
|
December 31,
2011
|
|
Assets included in property, plant and equipment
|
|
$
|
188
|
|
|
192
|
|
Accumulated depreciation
|
|
|
85
|
|
|
41
|
|
The future annual minimum payments under capital lease arrangements as of December 31, 2012 were as follows:
|
|
|
|
|
|
|
Future
Minimum
Payments
|
|
|
|
(Dollars in
millions)
|
|
Capital lease obligations:
|
|
|
|
|
2013
|
|
$
|
46
|
|
2014
|
|
|
35
|
|
2015
|
|
|
21
|
|
2016
|
|
|
2
|
|
2017
|
|
|
1
|
|
2018 and thereafter
|
|
|
6
|
|
|
|
|
|
Total minimum payments
|
|
|
111
|
|
Less: amount representing interest and executory costs
|
|
|
(14
|
)
|
|
|
|
|
Present value of minimum payments
|
|
|
97
|
|
Less: current portion
|
|
|
(40
|
)
|
|
|
|
|
Long-term portion
|
|
$
|
57
|
|
|
|
|
|
88
Table of Contents
Operating Leases
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 successor year ended December 31, 2012 and the successor nine months ended December 31, 2011, our gross rental expense was $93 million
and $125 million, respectively. Also, gross rental expense was $58 million and $200 million for the predecessor three months ended March 31, 2011 and the predecessor year
ended December 31, 2010, respectively. We also received sublease rental income for the same periods of $8 million, $10 million, $4 million and $15 million,
respectively.
At
December 31, 2012, our future minimum payments under operating leases were as follows:
|
|
|
|
|
|
|
Future
Minimum
Payments
|
|
|
|
(Dollars in
millions)
|
|
Operating leases:
|
|
|
|
|
2013
|
|
$
|
55
|
|
2014
|
|
|
36
|
|
2015
|
|
|
30
|
|
2016
|
|
|
25
|
|
2017
|
|
|
20
|
|
2018 and thereafter
|
|
|
39
|
|
|
|
|
|
Total future minimum payments
(1)
|
|
$
|
205
|
|
|
|
|
|
-
(1)
-
Minimum
payments have not been reduced by minimum sublease rentals of $32 million due in the future under non-cancelable subleases.
Purchase Obligations
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 $179 million as of December 31, 2012. Of this amount, we expect to purchase $47 million in 2013, $63 million in 2014 through 2015,
$56 million in 2016 through 2017 and $13 million in 2018 and thereafter. These amounts do not represent our entire anticipated purchases in the future, but represent only those items for
which we are contractually committed.
89
Table of Contents
(17) Other Financial Information
Other Current Assets
Other current assets reflected on our balance sheets consisted of the following:
|
|
|
|
|
|
|
|
|
|
Other Current Assets
|
|
|
|
December 31,
2012
|
|
December 31,
2011
|
|
|
|
(Dollars in millions)
|
|
Prepaid expenses
|
|
$
|
64
|
|
|
57
|
|
Other
|
|
|
50
|
|
|
41
|
|
|
|
|
|
|
|
Total other current assets
|
|
$
|
114
|
|
|
98
|
|
|
|
|
|
|
|
(18) Labor Union Contracts
Approximately 56% or 12,000 of our employees are members of bargaining units represented by the Communications Workers of America and the International
Brotherhood of Electrical Workers. These employees are subject to collective bargaining agreements that expired October 6, 2012. Our parent company, CenturyLink, is currently negotiating the
terms of new agreements. In the meantime, the predecessor agreements have been extended, and the unions have agreed to provide at least a twenty-four hour advance notice before terminating
those predecessor agreements. Any strikes or other changes in our labor relations could have a significant impact on our business. 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. To help mitigate this potential risk, we have established contingency plans in which we would assign trained, non-represented employees to cover jobs for represented
employees in the event of a work stoppage to provide continuity for our customers.
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Table of Contents