QWEST CORP 10-Q

ITEM 1. FINANCIAL STATEMENTS QWEST CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended March 31, 2020 2019 (Dollars in millions) OPERATING REVENUE Operating revenue (1) $ 1,235 1,308 Operating revenue - affiliates 683 722 Total operating revenue (1) 1,918 2,030 OPERATING EXPENSES Cost of services and products (exclusive of depreciation and amortization) (1) 473 582 Selling, general and administrative 143 157 Operating expenses - affiliates 195 195 Depreciation and amortization 328 336 Total operating expenses (1) 1,139 1,270 OPERATING INCOME 779 760 OTHER (EXPENSE) INCOME Interest expense ( 75 ) ( 95 ) Interest expense - affiliates, net ( 16 ) ( 16 ) Other (expense) income, net ( 8 ) 9 Total other expense, net ( 99 ) ( 102 ) INCOME BEFORE INCOME TAXES 680 658 Income tax expense 177 171 NET INCOME $ 503 487 _______________________________________________________________________________ (1) Reclassifications were made within certain 2019 comparative figures due to the retrospective application of an accounting policy election during the first quarter of 2020. Refer to Note 1—Background and our Form 8-K filing dated May 7, 2020 for further information. See accompanying notes to consolidated financial statements. 7 Table of Contents QWEST CORPORATION CONSOLIDATED BALANCE SHEETS March 31, 2020 (Unaudited) December 31, 2019 (Dollars in millions) ASSETS CURRENT ASSETS Cash and cash equivalents $ 8 2 Accounts receivable, less allowance of $37 and $39 470 514 Advances to affiliates 695 1,842 Other 151 128 Total current assets 1,324 2,486 Property, plant and equipment, net of accumulated depreciation of $7,900 and $7,746 8,211 8,170 GOODWILL AND OTHER ASSETS Goodwill 9,360 9,360 Operating lease assets 102 105 Customer relationships, net 369 468 Other intangible assets, net 313 311 Other, net 94 99 Total goodwill and other assets 10,238 10,343 TOTAL ASSETS $ 19,773 20,999 LIABILITIES AND STOCKHOLDER'S EQUITY CURRENT LIABILITIES Current maturities of long-term debt $ 3 1,105 Accounts payable 347 403 Note payable - affiliate 1,100 1,069 Accrued expenses and other liabilities Salaries and benefits 178 276 Income and other taxes 157 94 Interest 49 55 Other 100 134 Current affiliate obligations, net 72 72 Current portion of deferred revenue 200 201 Total current liabilities 2,206 3,409 LONG-TERM DEBT 4,851 4,846 DEFERRED CREDITS AND OTHER LIABILITIES Deferred revenue 110 108 Deferred income taxes, net 1,195 1,198 Noncurrent operating lease liabilities 84 89 Affiliate obligations, net 691 717 Other 518 515 Total deferred credits and other liabilities 2,598 2,627 COMMITMENTS AND CONTINGENCIES (Note 8) STOCKHOLDER'S EQUITY Common stock - one share without par value, owned by Qwest Services Corporation 10,050 10,050 Retained earnings 68 67 Total stockholder's equity 10,118 10,117 TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 19,773 20,999 See accompanying notes to consolidated financial statements. 8 Table of Contents QWEST CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended March 31, 2020 2019 (Dollars in millions) OPERATING ACTIVITIES Net income $ 503 487 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 328 336 Deferred income taxes ( 11 ) ( 33 ) Provision for uncollectible accounts 13 14 Accrued interest on affiliate note 31 30 Net loss on early retirement of debt 12 — Changes in current assets and liabilities: Accounts receivable 36 ( 7 ) Accounts payable ( 20 ) ( 2 ) Accrued income and other taxes 67 30 Other current assets and liabilities, net ( 154 ) ( 95 ) Other current assets and liabilities - affiliates, net ( 16 ) ( 15 ) Changes in other noncurrent assets and liabilities, net 10 15 Changes in affiliate obligations, net ( 18 ) ( 23 ) Other, net 4 ( 5 ) Net cash provided by operating activities 785 732 INVESTING ACTIVITIES Capital expenditures ( 317 ) ( 288 ) Changes in advances to affiliates 1,147 ( 110 ) Proceeds from sale of property, plant and equipment and other assets — 23 Net cash provided by (used in) investing activities 830 ( 375 ) FINANCING ACTIVITIES Payments of long-term debt ( 1,109 ) ( 3 ) Dividends paid to Qwest Services Corporation ( 500 ) ( 350 ) Net cash used in financing activities ( 1,609 ) ( 353 ) Net increase in cash, cash equivalents and restricted cash 6 4 Cash, cash equivalents and restricted cash at beginning of period 4 7 Cash, cash equivalents and restricted cash at end of period $ 10 11 Supplemental cash flow information: Income taxes paid, net $ ( 179 ) ( 197 ) Interest paid (net of capitalized interest of $10 and $6) ( 81 ) ( 92 ) Cash, cash equivalents and restricted cash: Cash and cash equivalents $ 8 9 Restricted cash included in other noncurrent assets 2 2 Total $ 10 11 See accompanying notes to consolidated financial statements. 9 Table of Contents QWEST CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (UNAUDITED) Three Months Ended March 31, 2020 2019 (Dollars in millions) COMMON STOCK Balance at beginning of period $ 10,050 10,050 Balance at end of period 10,050 10,050 RETAINED EARNINGS (ACCUMULATED DEFICIT) Balance at beginning of period 67 ( 182 ) Net income 503 487 Cumulative effect of adoption of ASU 2016-02, Leases — 22 Cumulative effect of adoption of ASU 2016-13, Measurement of Credit losses, net $1 tax 3 — Dividends declared to Qwest Services Corporation ( 500 ) ( 350 ) Other ( 5 ) — Balance at end of period 68 ( 23 ) TOTAL STOCKHOLDER'S EQUITY $ 10,118 10,027 See accompanying notes to consolidated financial statements. 10 Table of Contents QWEST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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, and references to "CenturyLink" refer to our ultimate parent company, CenturyLink, Inc. and its consolidated subsidiaries including Level 3 Parent, LLC, referred to as "Level 3". (1) Background General We are an integrated communications company engaged primarily in providing a broad array of communications services to our residential and business customers. Our specific products and services are detailed in Note 7—Products and Services Revenue of this report. We generate the majority of our total consolidated operating revenue 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. Basis of Presentation Our consolidated balance sheet as of December 31, 2019 , which was derived from our audited consolidated financial statements, and our unaudited interim consolidated financial statements provided herein have been prepared in accordance with the instructions for Form 10-Q. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to rules and regulations of the SEC; however, in our opinion, the disclosures made are adequate to make the information presented not misleading. We believe that these consolidated financial statements include all normal recurring adjustments necessary to fairly present the results for the interim periods. The consolidated results of operations and cash flows for the first three months of the year are not necessarily indicative of the consolidated results of operations and cash flows that might be expected for the entire year. These consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our annual report on Form 10-K for the year ended December 31, 2019 . The accompanying consolidated financial statements include our accounts and the accounts of our subsidiaries. Intercompany amounts and transactions with our consolidated subsidiaries have been eliminated. Transactions with our non-consolidated affiliates (referred to herein as affiliates) have not been eliminated. We reclassified certain prior period amounts to conform to the current period presentation, including the categorization of our revenue and expenses for the three months ended March 31, 2020 and 2019 . Segments Our operations are integrated into and reported as part of CenturyLink. CenturyLink's chief operating decision maker ("CODM") is our CODM but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the SEC. Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such, we have one reportable segment. Change in Accounting Policy During the first quarter of 2020, we elected to change the presentation for taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, including federal and certain state Universal Service Fund ("USF") regulatory fees, to present all such taxes on a net basis in our statement of operations. Prior to the first quarter of 2020, we assessed whether we were the primary obligor or principal taxpayer for the taxes assessed in each jurisdiction where we do business. The previous policy resulted in presenting such USF fees on a gross basis within operating revenue and cost of services and products, and all other significant taxes on a net basis. This change in accounting policy was applied retrospectively and decreased 11 Table of Contents both operating revenue and cost of services and products by $ 25 million for both quarters ended March 31, 2020 and March 31, 2019 . The change had no impact on operating income or net income in the consolidated statements of operations. We changed our policy to present such taxes on the net basis and believe the new policy is preferable because of the historical and potential future regulatory rate changes outside of our control resulting in significant variability in tax and fee revenue that are not indicative of our operating performance. We believe that net presentation provides the most useful and transparent financial information and improves comparability and consistency of financial results. Operating Lease Income Qwest leases various data transmission capacity, office facilities, switching facilities and other network sites to third parties under operating leases. Lease and sublease income are included in operating revenue in the consolidated statements of operations. For the three months ended March 31, 2020 and 2019 , our gross rental income was $ 79 million and $ 81 million , respectively, which represents approximately 4 % of our operating revenue for both the three months ended March 31, 2020 and 2019 . Recently Adopted Accounting Pronouncements Financial Instruments In June 2016, the FASB issued ASU 2016-13, " Measurement of Credit Losses on Financial Instruments ". The primary impact of ASU 2016-13 for us is a change in the model for the recognition of credit losses related to our financial instruments from an incurred loss model, which recognized credit losses only if it was probable that a loss had been incurred, to an expected loss model, which requires our management team to estimate the total credit losses expected on the portfolio of financial instruments. We adopted ASU 2016-13 on January 1, 2020 and recognized a cumulative adjustment to our retained earnings as of the date of adoption of $ 3 million net of tax effect. Please refer to Note 4—Credit Losses on Financial Instruments for more information. Recently Issued Accounting Pronouncements In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes (Topic 740 ). ASU 2019-12 removes certain exceptions for investments, intra-period allocations and interim calculations, and adds guidance to reduce complexity in accounting for income taxes. ASU 2019-12 will become effective for us in the first quarter of fiscal 2021 and early adoption is permitted. We are evaluating the impact the adoption will have on our consolidated financial statements. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU is intended to help stakeholders during the global market-wide reference rate transition period. Therefore, it will be in effect for a limited time through December 31, 2022. We are evaluating the optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued and the related impact on our consolidated financial statements. 12 Table of Contents (2) Goodwill, Customer Relationships and Other Intangible Assets Goodwill, customer relationships and other intangible assets consisted of the following: March 31, 2020 December 31, 2019 (Dollars in millions) Goodwill $ 9,360 9,360 Customer relationships, less accumulated amortization of $5,330 and $5,231 $ 369 468 Other intangible assets, less accumulated amortization of $1,802 and $1,780 $ 313 311 Substantially, all of our goodwill was derived from CenturyLink's acquisition of us where the purchase price exceeded the fair value of the net assets acquired. We assess our goodwill for impairment annually, or, under certain circumstances, more frequently, such as when events or changes in circumstances indicate there may be impairment. We are required to write-down the value of goodwill in periods in which the carrying value of equity exceeds the estimated fair value of equity, limited to the amount of goodwill. Our annual impairment assessment date for goodwill is October 31, at which date we assessed goodwill at our reporting unit. In reviewing the criteria for reporting units, we have determined that we are one reporting unit. Because CenturyLink's low stock price was a trigger for impairment testing, we estimated the fair value of our operations using only the market approach in the quarter ended March 31, 2019. Applying this approach, we utilized company comparisons and analyst reports within the telecommunications industry, which have historically supported a range of fair values of annualized revenue and EBITDA multiples between 2.1x and 4.9x and 4.9x and 9.8x, respectively. We selected a revenue and EBITDA multiple within this range. As of March 31, 2019, based on our assessments performed as described above, we concluded that our goodwill was not impaired as of that date. The market multiples approach that we used in the quarter ended March 31, 2019 incorporated significant estimates and assumptions related to the forecasted results for the remainder of the year, including revenues, expenses, and the achievement of certain cost synergies. In developing the market multiple, we also considered observed trends of our industry participants. Our assessment included many qualitative factors that required significant judgment. Alternative interpretations of these factors could have resulted in different conclusions regarding the size of our impairments. During the first quarter of 2020, we observed a decline in CenturyLink's stock price as a result of events occurring after the end of 2019, including the COVID-19 pandemic. We evaluated whether such events would indicate the fair value of our reporting unit was below its carrying value. We believe these events have impacted the global economy more directly than us, and when considered with other factors, we have concluded it is not more likely than not that the fair value of our reporting unit was less than its carrying value as of the quarter ended March 31, 2020. In light of the negative impacts of COVID-19 on the global economy, we will continue to evaluate the general economic trends which could have an impact on our assessment of whether it is more likely than not that the fair value of our reporting unit is less than its carrying amount. Future changes could cause our reporting unit fair value to be less than its carrying value, resulting in potential impairments of our goodwill which could have a material effect on our results of operations and financial condition. The extent of the impact, if any, will depend on future developments including actions taken to contain the coronavirus and its long-term impacts on the overall economy. As of March 31, 2020 , the gross carrying amount of goodwill, customer relationships and other intangible assets was $ 17.2 billion . The total amortization expense for intangible assets for the three months ended March 31, 2020 and 2019 totaled $ 124 million and $ 137 million , respectively. 13 Table of Contents We estimate that total amortization expense for intangible assets for the years ending December 31, 2020 through 2024 will be as follows: (Dollars in millions) 2020 (remaining nine months) $ 359 2021 154 2022 52 2023 42 2024 33 (3) Revenue Recognition Reconciliation of Total Revenue to Revenue from Contracts with Customers The following table provides the amount of revenue that is not subject to ASC 606, but is instead governed by other accounting standards: Three Months Ended March 31, 2020 2019 (Dollars in millions) Total revenue (1) $ 1,918 2,030 Adjustments for non-ASC 606 revenue (2) ( 121 ) ( 127 ) Total revenue from contracts with customers $ 1,797 1,903 ______________________________________________________________________ (1) Reclassifications were made within certain 2019 comparative figures due to the retrospective application of an accounting policy election during the first quarter of 2020. Refer to Note 1—Background and our Form 8-K filing dated May 7, 2020 for further information. (2) Includes regulatory revenue, lease revenue, sublease rental income and revenue from fiber capacity lease arrangements which are not within the scope of ASC 606. Customer Receivables and Contract Balances The following table provides balances of customer receivables, contract assets and contract liabilities as of March 31, 2020 and December 31, 2019 : March 31, 2020 December 31, 2019 (Dollars in millions) Customer receivables (1) $ 415 430 Contract liabilities 337 338 Contract assets 15 18 ______________________________________________________________________ (1) Gross customer receivables of $ 444 million and $ 462 million , net of allowance for doubtful accounts of $ 29 million and $ 32 million , at March 31, 2020 and December 31, 2019 , respectively. Contract liabilities consist of consideration we have received from our customers or billed in advance of providing goods or services promised in the future. We defer recognizing this consideration as revenue until we have satisfied the related performance obligation to the customer. Contract liabilities include recurring services billed one month in advance and installation and maintenance charges that are deferred and recognized over the actual or expected contract term, which ranges from one to five years depending on the service. Contract liabilities are included within deferred revenue in our consolidated balance sheets. During the three months ended March 31, 2020 and March 31, 2019 , we recognized $ 184 million and $ 261 million , respectively, of revenue that was included in contract liabilities as of January 1, 2020 and January 1, 2019 , respectively. Performance Obligations 14 Table of Contents As of March 31, 2020 , our estimated revenue expected to be recognized in the future related to performance obligations associated with customer contracts that are unsatisfied (or partially satisfied) is approximately $ 163 million . We expect to recognize approximately 99 % of this revenue through 2022 , with the balance recognized thereafter. We do not disclose the value of unsatisfied performance obligations for contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed (for example, uncommitted usage or non-recurring charges associated with professional or technical services to be completed), or contracts that are classified as leasing arrangements that are not subject to ASC 606 . Contract Costs The following table provides changes in our contract acquisition costs and fulfillment costs: Three Months Ended March 31, 2020 Three Months Ended March 31, 2019 Acquisition Costs Fulfillment Costs Acquisition Costs Fulfillment Costs (Dollars in millions) Beginning of period balance $ 86 64 90 57 Costs incurred 14 6 16 4 Amortization ( 16 ) ( 9 ) ( 16 ) ( 4 ) End of period balance $ 84 61 90 57 Acquisition costs include commission fees paid to employees as a result of obtaining contracts. Fulfillment costs include third party and internal costs associated with the provision, installation and activation of communications services to customers, including labor and materials consumed for these activities. Deferred acquisition and fulfillment costs are amortized based on the transfer of services on a straight-line basis over the average customer life of 30 months for consumer customers and average contract life of 29 months for business customers. Amortized fulfillment costs are included in cost of services and products and amortized acquisition costs are included in selling, general and administrative expenses in our consolidated statements of operations. The amount of these deferred costs that are anticipated to be amortized in the next twelve months are included in other current assets on our consolidated balance sheets. The amount of deferred costs expected to be amortized beyond the next twelve months is included in other non-current assets on our consolidated balance sheets. Deferred acquisition and fulfillment costs are assessed for impairment on an annual basis. (4) Credit Losses on Financial Instruments In accordance with ASC 326, "Financial Instruments - Credit Losses" ("ASC 326") we aggregate financial assets with similar risk characteristics such that expected credit losses reflect the credit quality or deterioration over the life of the asset. We monitor certain risk characteristics within our aggregated financial assets and revise their composition accordingly, to the extent internal and external risk factors change each reporting period. Financial assets that do not share risk characteristics with other financial assets are evaluated separately. Our financial assets measured at amortized cost primarily consist of accounts receivable. In developing our accounts receivable portfolio, we pooled certain assets with similar credit risk characteristics based on the nature of our customers, their industry, policies used to grant credit terms and their historical and expected credit loss patterns. Prior to the adoption of the new credit loss standard, the allowance for doubtful accounts receivable reflected our best estimate of probable losses inherent in our receivable portfolio determined based on historical experience, specific allowances for known troubled accounts, and other currently available evidence. We implemented the new standard, using a loss rate method to estimate our allowance for credit losses. Our current expected credit loss rate begins with the use of historical loss experience as a percentage of accounts receivable. We measure our historical loss period based on the average days to move accounts receivable to credit loss. When asset specific characteristics and current conditions change from those in the historical period, due to 15 Table of Contents changes in our credit and collections strategy or credit loss and recovery policies, we perform a qualitative and quantitative assessment to update our current loss rate, which as noted below has increased due to an increase in historic loss experience and weakening economic forecasts. We use regression analysis to develop an expected loss rate using historical experience and economic data over a forecast period. We measure our forecast period based on the average days to collect payment on billed accounts receivable. The historical, current, and expected credit loss rates are combined and applied to period end accounts receivable, which results in our allowance for credit losses. If there is a deterioration of a customer's financial condition or if future default rates in general, including impacts of COVID-19, differ from those currently anticipated, we may have to adjust the allowance for credit losses, which would affect earnings in the period that adjustments are made. The assessment of the correlation between historical observed default rates, current conditions, and forecast economic conditions requires judgment. Alternative interpretations of these factors could have resulted in different conclusions regarding the allowance for credit losses. The amount of credit loss is sensitive to changes in circumstances and forecasted economic conditions. Our historical credit loss experience, current conditions, and forecast of economic conditions may also not be representative of the customer's actual default in the future. The following table presents the activity of our allowance for credit losses by accounts receivable portfolio: (Dollars in millions) Beginning balance at January 1, 2020 (1) $ 35 Current period provision for expected losses 13 Write-offs charged against the allowance ( 16 ) Recoveries collected 5 Ending Balance at March 31, 2020 $ 37 ______________________________________________________________________ (1) The beginning balance includes the cumulative effect of the adoption of new credit loss standard For the three months ended March 31, 2020, our allowance for credit losses for our business and consumer accounts receivable portfolio increased due to an increase in historical loss experience and weakening economic forecasts, partially offset by recoveries. (5) Long-Term Debt and Note Payable - Affiliate The following chart reflects (i) the consolidated long-term debt of Qwest Corporation and its subsidiaries, including finance lease and other obligations, unamortized premiums, net, unamortized debt issuance costs and (ii) note payable - affiliate: Interest Rates Maturities March 31, 2020 December 31, 2019 (Dollars in millions) Senior notes 6.125% - 7.750% 2021 - 2057 $ 4,856 5,956 Term loan (1) LIBOR + 2.00% 2025 100 100 Finance lease and other obligations Various Various 8 10 Unamortized premiums, net 4 — Unamortized debt issuance costs ( 114 ) ( 115 ) Total long-term debt 4,854 5,951 Less current maturities ( 3 ) ( 1,105 ) Long-term debt, excluding current maturities $ 4,851 4,846 Note payable - affiliate 5.561 % 2022 $ 1,100 1,069 _______________________________________________________________________________ 16 Table of Contents (1) Qwest Corporation's Term Loan had an interest rate of 2.990 % as of March 31, 2020 and 3.800 % as of December 31, 2019 Redemption of Senior Notes On January 15, 2020 , Qwest Corporation fully redeemed all $ 850 million aggregate principal amount of its outstanding 6.875 % senior notes due 2033 and all $ 250 million aggregate principal amount of its outstanding 7.125 % senior notes due 2043 which resulted in a loss of $ 12 million . Note Payable - Affiliate On September 30, 2017, Qwest Corporation entered into an amended and restated revolving promissory note in the amount of $ 965 million with an affiliate of our ultimate parent company, CenturyLink, Inc. This note replaced and amended the original $ 1.0 billion revolving promissory note Qwest Corporation entered into on April 18, 2012 with the same affiliate. The outstanding principal balance owed by Qwest Corporation under this revolving promissory note and the accrued interest thereon is due and payable on demand, but if no demand is made, then on June 30, 2022. Interest is accrued on the outstanding balance during an interest period using a weighted average per annum interest rate on the consolidated outstanding debt of CenturyLink and its subsidiaries. As of March 31, 2020 , the amended and restated revolving promissory note had an outstanding balance of $ 1.100 billion and bore interest at a weighted-average interest rate of 5.561 % . As of March 31, 2020 and December 31, 2019 , the amended and restated revolving promissory note is reflected on our consolidated balance sheets as a current liability under "Note payable - affiliate". In accordance with the terms of the amended and restated revolving promissory note, interest shall be assessed on June 30th and December 31st (an "Interest Period"). Any assessed interest for an Interest Period that remains unpaid on the last day of the subsequent Interest Period is to be capitalized on such date and is to begin accruing interest. Through March 31, 2020 , $ 136 million of such interest has been capitalized. As of March 31, 2020 , $ 15 million of accrued interest is reflected in other current liabilities on our consolidated balance sheet. Aggregate Maturities of Long-Term Debt Set forth below is the aggregate principal amount of our long-term debt (excluding unamortized premiums and discounts and unamortized debt issuance costs and excluding note payable-affiliate) maturing during the following years: (Dollars in millions) 2020 (remaining nine months) $ 3 2021 951 2022 1 2023 — 2024 1 2025 and thereafter 4,008 Total long-term debt $ 4,964 Compliance As of March 31, 2020 , we believe we were in compliance with the financial covenants contained in our material debt agreements in all material respects. Other For additional information on our long-term debt and credit facilities, see Note 5—Long-Term Debt and Revolving Promissory Note to our consolidated financial statements in Item 8 of Part II of our annual report on Form 10-K for the year ended December 31, 2019 . (6) Fair Value Disclosure Our financial instruments consist of cash and cash equivalents, restricted cash, accounts receivable, advances to affiliates, accounts payable, note payable-affiliate and long-term debt, excluding finance lease and 17 Table of Contents other obligations. Due to their short-term nature, the carrying amounts of our cash, cash equivalents and restricted cash, accounts receivable, advances to affiliates, accounts payable and note-payable-affiliate approximate their fair values. The three input levels in the hierarchy of fair value measurements are defined by the Fair Value Measurement and Disclosure framework 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 finance lease and other obligations, as well as the input level used to determine the fair values indicated below: March 31, 2020 December 31, 2019 Input Level Carrying Amount Fair Value Carrying Amount Fair Value (Dollars in millions) Liabilities—Long-term debt (excluding finance lease and other obligations) 2 $ 4,846 4,397 5,941 6,258 (7) Products and Services Revenue We are an integrated communications company engaged primarily in providing an array of communications services, including local voice, broadband, private line (including business data services), Ethernet, network access, information technology and other ancillary services. We strive to maintain our customer relationships by, among other things, bundling our service offerings to provide our customers with a complete offering of integrated communications services. We categorize our products, services and revenue among the following six categories: • IP and Data Services , which include primarily VPN data networks, Ethernet, IP and other ancillary services; • Transport and Infrastructure , which include broadband, private line (including business data services) and other ancillary services; • Voice and Collaboration , which includes primarily local voice, including wholesale voice, and other ancillary services; • IT and Managed Services, which include information technology services and managed services, which may be purchased in conjunction with our other network services; • Regulatory Revenue, which consist of Connect America Fund ("CAF") support payments and other operating revenue. We receive federal support payments from the federal CAF program. These support payments are government subsidies designed to reimburse us for various costs related to certain telecommunications services including the costs of deploying, maintaining and operating voice and broadband infrastructure in high-cost rural areas where we are not able to fully recover our costs from our customers; and • Affiliate Services, which are telecommunication services that we also provide to external customers. In addition, we provide to our affiliates computer system development and support services, network support and technical services. From time to time, we may change the categorization of our products and services. 18 Table of Contents Our operating revenue for our products and services consisted of the following categories: Three Months Ended March 31, 2020 2019 (1) (Dollars in millions) IP and Data Services $ 136 140 Transport and Infrastructure 657 701 Voice and Collaboration 395 418 IT and Managed Services 1 1 Regulatory Revenue 46 48 Affiliate Services 683 722 Total operating revenue $ 1,918 2,030 _______________________________________________________________________________ (1) Reclassifications were made within certain 2019 comparative figures due to the retrospective application of an accounting policy election during the first quarter of 2020, in addition to product reclassification changes. Refer to Note 1—Background and our Form 8-K filing dated May 7, 2020 for further information. (8) Commitments, Contingencies and Other Items We are subject to various claims, legal proceedings and other contingent liabilities, including the matters described below, which individually or in the aggregate could materially affect our financial condition, future results of operations or cash flows. As a matter of course, we are prepared to both litigate these matters to judgment as needed, as well as to evaluate and consider reasonable settlement opportunities. Irrespective of its merits, litigation may be both lengthy and disruptive to our operations and could cause significant expenditure and diversion of management attention. We review our litigation accrual liabilities on a quarterly basis, but in accordance with applicable accounting guidelines only establish accrual liabilities when losses are deemed probable and reasonably estimable and only revise previously-established accrual liabilities when warranted by changes in circumstances, in each case based on then-available information. As such, as of any given date we could have exposure to losses under proceedings as to which no liability has been accrued or as to which the accrued liability is inadequate. Amounts accrued for our litigation and non-income tax contingencies at March 31, 2020 aggregated to approximately $ 26 million and are included in “Other” current liabilities and “Other Liabilities” in our consolidated balance sheet as of such date. The establishment of an accrual does not mean that actual funds have been set aside to satisfy a given contingency. Thus, the resolution of a particular contingency for the amount accrued could have no effect on our results of operations but nonetheless could have an adverse effect on our cash flows. In this Note, when we refer to a class action as "putative" it is because a class has been alleged, but not certified in that matter. Principal Proceedings Switched Access Disputes Subsidiaries of CenturyLink, Inc., including us, are among hundreds of companies involved in an industry-wide dispute, raised in nearly 100 federal lawsuits (filed between 2014 and 2016) that have been consolidated in the United States District Court for the Northern District of Texas for pretrial procedures. The disputes relate to switched access charges that local exchange carriers ("LECs") collect from interexchange carriers ("IXCs") for IXCs' use of LEC's access services. In the lawsuits, IXCs, including Sprint Communications Company L.P. ("Sprint") and various affiliates of Verizon Communications Inc. ("Verizon"), assert that federal and state laws bar LECs from collecting access charges when IXCs exchange certain types of calls between mobile and wireline devices that are routed through an IXC. Some of these IXCs have asserted claims seeking refunds of payments for access charges previously paid and relief from future access charges. 19 Table of Contents In November 2015, the federal court agreed with the LECs and rejected the IXCs' contention that federal law prohibits these particular access charges, and also allowed the IXCs to refile state-law claims. Since then, many of the LECs and IXCs have filed revised pleadings and additional motions, which remain pending. Separately, some of the defendants, including us, have petitioned the FCC to address these issues on an industry-wide basis. The outcome of these disputes and lawsuits, as well as any related regulatory proceedings that could ensue, are currently not predictable. Billing Practices Suits In June 2017, a former employee of CenturyLink filed an employment lawsuit against CenturyLink claiming that she was wrongfully terminated for alleging that CenturyLink charged some of its retail customers for products and services they did not authorize. Starting shortly thereafter and continuing since then, and based in part on the allegations made by the former employee, several legal proceedings have been filed. In June 2017, McLeod v. CenturyLink, a putative consumer class action, was filed against CenturyLink in the U.S. District Court for the Central District of California alleging that it charged some of its retail customers for products and services they did not authorize. Other complaints asserting similar claims have been filed in other federal and state courts, as well. The lawsuits assert claims including fraud, unfair competition, and unjust enrichment. Also, in June 2017, Craig. v. CenturyLink, Inc., et al., a putative securities investor class action, was filed in U.S. District Court for the Southern District of New York, alleging that it failed to disclose material information regarding improper sales practices, and asserting federal securities law claims. A number of other cases asserting similar claims have also been filed. Beginning June 2017, CenturyLink received several shareholder derivative demands addressing related topics. In August 2017, CenturyLink's Board of Directors formed a special litigation committee of outside directors to address the allegations of impropriety contained in the shareholder derivative demands. In April 2018, the special litigation committee concluded its review of the derivative demands and declined to take further action. Since then, derivative cases were filed in Louisiana state court in the Fourth Judicial District Court for the Parish of Ouachita and in federal court in Louisiana and Minnesota. These cases have been brought on behalf of CenturyLink against certain current and former officers and directors of the Company and seek damages for alleged breaches of fiduciary duties. The consumer putative class actions, the securities investor putative class actions, and the federal derivative actions have been transferred to the U.S. District Court for the District of Minnesota for coordinated and consolidated pretrial proceedings as In Re: CenturyLink Sales Practices and Securities Litigation. Subject to confirmatory discovery and court approval, CenturyLink agreed to settle the consumer putative class actions for payments of $ 15.5 million to compensate class members and of up to $ 3.5 million for administrative costs. In the second quarter of 2019, CenturyLink accrued for these obligations, and a portion of the administrative costs has been expended in 2020. Certain class members may elect to opt out of the class settlement and pursue the resolution of their individual claims against us on these issues through various dispute resolution processes, including individual arbitration. One law firm claims to represent more than 22,000 potential class members. To the extent that a substantial number of class members, including many of the law firm’s alleged clients, meet the contractual requirements to arbitrate, elect to opt out of the settlement (or otherwise successfully exclude their individual claims), and actually pursue arbitrations, CenturyLink and we could incur a material amount of filing and other arbitrations fees in relation to the administration of those claims. In July 2017, the Minnesota state attorney general filed State of Minnesota v. CenturyTel Broadband Services LLC, et al. in the Anoka County Minnesota District Court, alleging claims of fraud and deceptive trade practices relating to improper consumer sales practices. CenturyLink has engaged in discussions regarding potential resolutions of these claims with a number of state attorneys general, and have entered into agreements settling the Minnesota suit and certain of the consumer practices claims asserted by state attorneys general. While CenturyLink does not agree with allegations raised in these matters, it has been willing to consider reasonable settlements where appropriate. Locate Service Investigations 20 Table of Contents In June 2019, Minnesota and Arizona initiated investigations related to the timeliness of responses by certain of our vendors to requests for marking the location of underground telecommunications facilities. We, along with CenturyLink and its other subsidiaries are cooperating with the investigations. In February 2020, the Minnesota claims were settled. The terms of the settlement were not material to our consolidated results of operations or financial position. Other Proceedings, Disputes and Contingencies From time to time, we are involved in other proceedings incidental to our business, including patent infringement allegations, administrative hearings of state public utility commissions relating primarily to our rates or services, actions relating to employee claims, various tax issues, environmental law issues, grievance hearings before labor regulatory agencies and miscellaneous third-party tort actions. We are currently defending several patent infringement lawsuits asserted against us by non-practicing entities, many of which are seeking substantial recoveries. These cases have progressed to various stages and one or more may go to trial during 2020 if they are not otherwise resolved. Where applicable, we are seeking full or partial indemnification from our vendors and suppliers. As with all litigation, we are vigorously defending these actions and, as a matter of course, are prepared to litigate these matters to judgment, as well as to evaluate and consider all reasonable settlement opportunities. We are subject to various federal, state and local environmental protection and health and safety laws. From time to time, we are subject to judicial and administrative proceedings brought by various governmental authorities under these laws. Several such proceedings are currently pending, but none is reasonably expected to exceed $ 100,000 in fines and penalties. The outcome of these other proceedings described under this heading is not predictable. However, based on current circumstances, we do not believe that the ultimate resolution of these other proceedings, after considering available defenses and any insurance coverage or indemnification rights, will have a material adverse effect on us. The matters listed above in this Note do not reflect all of our contingencies. For additional information on our contingencies, see Note 16—Commitments, Contingencies and Other Items to the financial statements included in Item 8 of Part II of our annual report on Form 10-K for the year ended December 31, 2019. The ultimate outcome of the above-described matters may differ materially from the outcomes anticipated, estimated, projected or implied by us in certain of our statements appearing above in this Note, and proceedings currently viewed as immaterial by us may ultimately materially impact us. (9) Dividends From time to time we may declare and pay dividends to our direct parent company, QSC, sometimes in excess of our earnings to the extent permitted by applicable law. Our debt covenants do not currently limit the amount of dividends we can pay to QSC. During the three months ended March 31, 2020 and 2019 , we declared and paid dividends of $ 500 million and $ 350 million , respectively, to QSC. Dividends paid are reflected on our consolidated statements of cash flows as financing activities. 21 Table of Contents (10) Other Financial Information Other Current Assets The following table presents details of other current assets reflected in our consolidated balance sheets: March 31, 2020 December 31, 2019 (Dollars in millions) Prepaid expenses $ 64 41 Contract acquisition costs 50 50 Contract fulfillment costs 28 28 Other 9 9 Total other current assets $ 151 128 (11) Labor Union Contracts As of March 31, 2020 , approximately 46 % of our employees were represented by the Communication Workers of America ("CWA") or the International Brotherhood of Electrical Workers ("IBEW"). During the third quarter of 2019, we reached new agreements with the CWA and IBEW, which represented all of the above noted represented employees. Therefore, there are no collective bargaining agreements that are scheduled to expire over the next 12 months. We believe relations with our employees continue to be generally good. 22 Table of Contents