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Leases

9 Months Ended

Sep. 30, 2019

Our financial position for reporting periods beginning on or after January 1, 2019 is presented under the new accounting guidance, while prior periods amounts are not adjusted and continue to be reported in accordance with previous guidance, as discussed in Note 1—Background.

We primarily lease various office facilities, switching and colocation facilities, equipment and dark fiber. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.

We determine if an arrangement is a lease at inception and whether that lease meets the classification criteria of a finance or operating lease. Lease-related assets, or right-of-use assets, are recognized at the lease commencement date at amounts equal to the respective lease liabilities. Lease-related liabilities are recognized at the present value of the remaining contractual fixed lease payments, discounted using our incremental borrowing rates. As part of the present value calculation for the lease liabilities, we use an incremental borrowing rate as the rates implicit in the leases are not readily determinable. The incremental borrowing rates used for lease accounting are based on our unsecured rates, adjusted to approximate the rates at which we could borrow on a collateralized basis over a term similar to the recognized lease term. We apply the incremental borrowing rates to lease components using a portfolio approach based upon the length of the lease term and the reporting entity in which the lease resides. Operating lease expense is recognized on a straight-line basis over the lease term, while variable lease payments are expensed as incurred.

Some of our lease arrangements contain lease components (including fixed payments, such as, rent, real estate taxes and insurance costs) and non-lease components (including common-area maintenance costs). We generally account for each component separately based on the estimated standalone price of each component. For colocation leases, we account for the lease and non-lease components as a single lease component.

Many of our lease agreements contain renewal options; however, we do not recognize right-of-use assets or lease liabilities for renewal periods unless it is determined that we are reasonably certain of renewing the lease at inception or when a triggering event occurs. Certain leases also include options to purchase the leased property. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option reasonably certain to be exercised. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Lease expense consisted of the following:



	Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
	(Dollars in millions)
Operating and short-term lease cost	$	8	24
Finance lease cost:
Amortization of right-of-use assets	2		7
Interest on lease liability	1		1
Total finance lease cost	3		8
Total lease cost	$	11	32

Supplemental unaudited consolidated balance sheet information and other information related to leases:



Leases (millions)	Classification on the Balance Sheet	September 30, 2019
Assets
Operating lease assets	Operating lease assets	$	117
Finance lease assets	Property, plant and equipment, net of accumulated depreciation	16
Total leased assets		$	133

Liabilities
Current
Operating	Other current liabilities	$	29
Finance	Current portion of long-term debt	7
Noncurrent
Operating	Noncurrent operating lease liabilities	90
Finance	Long-term debt	5
Total lease liabilities		$	131

Weighted-average remaining lease term (years)
Operating leases		5.4
Finance leases		4.9
Weighted-average discount rate
Operating leases		6.71		%
Finance leases		5.26		%

Supplemental unaudited consolidated cash flow statement information related to leases:



	Nine Months Ended September 30, 2019
	(Dollars in millions)
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	27
Financing cash flows from finance leases	8

As of September 30, 2019, maturities of lease liabilities were as follows:



	Operating Leases			Finance Leases
	(Dollars in millions)
2019 (remaining three months)	$	8		2
2020	32			5
2021	30			1
2022	27			1
2023	22			1
Thereafter	36			4
Total lease payments	155			14
Less: interest	(36		)	(2	)
Total	119			12
Less: current portion	(29		)	(7	)
Long-term portion	$	90		5

As of September 30, 2019, we had no material operating or finance leases that had not yet commenced.

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 is included in operating revenue in the consolidated statements of operations.

For the three and nine months ended September 30, 2019, our gross rental income was $79 million and $242 million, respectively, which represents 4% of our operating revenue for both periods. For the three and nine months ended September 30, 2018, our gross rental income was $83 million and $249 million, respectively which represents 4% of our operating revenue for both periods.

Disclosures under ASC 840

We adopted ASU 2016-02 on January 1, 2019 as noted above, and as required, the following disclosure is provided for periods prior to adoption.

The future annual minimum payments under capital lease agreements as of December 31, 2018 were as follows:



	Capital Lease Obligations
	(Dollars in millions)
2019	$	10
2020	6
2021	2
2022	1
2023	1
2024 and thereafter	4
Total minimum payments	24
Less: amount representing interest and executory costs	(5		)
Present value of minimum payments	19
Less: current portion	(12		)
Long-term portion	$	7

At December 31, 2018, our future rental commitments for operating leases were as follows:



	Operating Leases
	(Dollars in millions)
2019	$	35
2020	28
2021	27
2022	23
2023	19
2024 and thereafter	32
Total future minimum payments⁽¹⁾	$	164

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(1)	Minimum payments have not been reduced by minimum sublease rentals of $22 million due in the future under non-cancelable subleases.

Leases