10-Q 1 csal-10q_20150930.htm 10-Q csal-10q_20150930.htm

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission File Number: 001-36708

 

Communications Sales & Leasing, Inc.

(Exact name of registrant as specified in its charter)

 

 

Maryland

46-5230630

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

 

10802 Executive Center Drive

Benton Building Suite 300

Little Rock, Arkansas

72211

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (501) 850-0820

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  o  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  x      No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

¨

  

Accelerated filer

 

¨

 

 

 

 

Non-accelerated filer

 

x  (Do not check if a small reporting company)

  

Small reporting company

 

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  o    No  x

As of November 10, 2015, the registrant had 150,549,266 shares of common stock, $0.0001 par value per share, outstanding.

 

 

 


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EXPLANATORY NOTE

Prior to April 24, 2015, Communications Sales & Leasing, Inc. (the “Company,” “CS&L,” “we,” “us” or “our”) was a wholly-owned subsidiary of Windstream Services, LLC (“Windstream Services”), a wholly owned subsidiary of Windstream Holdings, Inc. (“Windstream Holdings,” and together with its subsidiaries, “Windstream”). On April 24, 2015, Windstream contributed certain telecommunications network assets, including fiber and copper networks and other real estate (the “Distribution Systems”) and a small consumer competitive local exchange carrier (“CLEC”) business (the “Consumer CLEC Business”), to CS&L. In exchange, CS&L issued to Windstream Services (i) approximately 149.8 million shares of its common stock, par value $0.0001 per share, (ii) $400.0 million aggregate principal amount of 6.00% Senior Secured Notes due April 15, 2023 (the “Secured Notes”), (iii) $1.11 billion aggregate principal amount of 8.25% Senior Notes due October 15, 2023 (the “Senior Notes” and together with the Secured Notes, the “Notes”), (iv) $990 million of term loans under CS&L’s senior credit facilities and (v) approximately $1.04 billion in cash obtained from borrowings under CS&L’s senior credit facilities. The contribution of the Distribution Systems and the Consumer CLEC Business and the related issuance of cash, debt and equity securities are referred to herein as the “Spin-Off.” The Spin-Off was effective on April 24, 2015.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements as defined under U.S. federal securities law. Forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations, including, but not limited to, statements regarding: the benefits and tax treatment of the Spin-Off; future financing plans, business strategies, growth prospects and operating and financial performance; expectations regarding the making of distributions and the payment of dividends; and compliance with and changes in governmental regulations.

Words such as “anticipate(s),” “expect(s),” “intend(s),” “plan(s),” “believe(s),” “may,” “will,” “would,” “could,” “should,” “seek(s)” and similar expressions, or the negative of these terms, are intended to identify such forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of risks and uncertainties that could lead to actual results differing materially from those projected, forecasted or expected. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Factors which could have a material adverse effect on our operations and future prospects or which could cause actual results to differ materially from our expectations include, but are not limited to:

 

·

our ability to achieve some or all the benefits that we expect to achieve from the Spin-Off;

 

·

the ability and willingness of Windstream and future customers to meet and/or perform their obligations under any contractual arrangements entered into with us, including master lease arrangements, and any of their obligations to indemnify, defend and hold us harmless from and against various claims, litigation and liabilities;

 

·

the ability of Windstream and future customers to comply with laws, rules and regulations in the operation of the assets we lease to them;

 

·

the ability and willingness of Windstream and our future customers to renew their leases with us upon their expiration, and the ability to reposition our properties on the same or better terms in the event of nonrenewal or in the event we replace an existing tenant;

 

·

the availability of and our ability to identify suitable acquisition opportunities and our ability to acquire and lease the respective properties on favorable terms;

 

·

our ability to generate sufficient cash flows to service our outstanding indebtedness;

 

·

our ability to access debt and equity capital markets;

 

·

credit rating downgrades;

 

·

fluctuating interest rates;

 

·

our ability to retain our key management personnel;

 

·

our ability to qualify or maintain our status as a real estate investment trust (“REIT”);

 

·

changes in the U.S. tax law and other state, federal or local laws, whether or not specific to REITs;

 

·

covenants in our debt agreements that may limit our operational flexibility;

 

·

other risks inherent in the communications industry and in the ownership of communications distribution systems, including potential liability relating to environmental matters and illiquidity of real estate investments; and

 

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·

additional factors discussed in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q and in Part II, Item 1A “Risk Factors” of our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2015, as well as those described from time to time in our future reports filed with the SEC. 

Forward-looking statements speak only as of the date of this Quarterly Report. Except in the normal course of our public disclosure obligations, we expressly disclaim any obligation to release publicly any updates or revisions to any forward-looking statements to reflect any change in our expectations or any change in events, conditions or circumstances on which any such statement is based.

 

 

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Communications Sales & Leasing, Inc.

Table of Contents

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

5

 

Communication Sales & Leasing, Inc.

 

 

Condensed Consolidated Balance Sheet

5

 

Condensed Consolidated Statement of Income

6

 

Condensed Consolidated Statements of Comprehensive Income (Loss)

7

 

Condensed Consolidated Statements of Shareholders’ Deficit

8

 

Condensed Consolidated Statement of Cash Flows

9

 

Notes to Condensed Consolidated Financial Statements

10

 

CLEC Business

 

 

Statement of Assets Contributed and Liabilities Assumed

25

 

Statement of Revenue and Direct Expenses

26

 

Notes to Financial Statements

27

 

Distribution Systems

 

 

Combined Balance Sheet

30

 

Notes to Combined Balance Sheet

31

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

40

Item 4.

Controls and Procedures

40

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

42

Item 1A.

Risk Factors

42

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

Item 3.

Defaults Upon Senior Securities

42

Item 4.

Mine Safety Disclosures

42

Item 5.

Other Information

42

Item 6.

Exhibits

43

 

 

 

Signatures

44

 

 

Exhibit Index

45

 

 

 

 

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

Communications Sales & Leasing, Inc.

Condensed Consolidated Balance Sheet

(unaudited)

(Thousands, except par value)

 

September 30, 2015

 

Assets:

 

 

 

 

Real estate investments

 

$

6,026,679

 

Accumulated depreciation - real estate investments

 

 

(3,637,594

)

Net real estate investments

 

 

2,389,085

 

Cash and cash equivalents

 

 

209,998

 

Accounts receivable, net

 

 

1,651

 

Customer list intangible assets, net

 

 

11,494

 

Straight-line rent receivable

 

 

7,497

 

Other assets

 

 

3,054

 

Total Assets

 

$

2,622,779

 

 

Liabilities and Shareholders' Deficit:

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

97,411

 

Derivative liability

 

 

13,993

 

Dividends payable

 

 

90,404

 

Deferred income taxes

 

 

6,252

 

Notes and other debt

 

 

3,506,905

 

      Total liabilities

 

 

3,714,965

 

 

 

 

 

 

Commitments and contingencies (Note 12)

 

 

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value, 50,000 shares authorized, no shares issued and outstanding

 

 

-

 

Common stock, $0.0001 par value, 500,000 shares authorized, 149,836 shares issued and outstanding

 

 

15

 

Additional paid-in capital

 

 

601

 

Accumulated other comprehensive income (loss)

 

 

(13,993

)

Distributions in excess of accumulated earnings

 

 

(1,078,809

)

      Total shareholders' deficit

 

 

(1,092,186

)

Total Liabilities and Shareholders' Deficit

 

$

2,622,779

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Communications Sales & Leasing, Inc.

Condensed Consolidated Statements of Income

(unaudited)

 

 

 

Three Months Ended

 

 

Period from

 

(Thousands, except per share data)

 

September 30, 2015

 

 

April 24 - September 30, 2015

 

Revenues:

 

 

 

 

 

 

 

 

Rental revenues

 

$

166,959

 

 

$

291,131

 

Consumer CLEC

 

 

6,675

 

 

 

11,251

 

Total revenues

 

 

173,634

 

 

 

302,382

 

Costs and Expenses:

 

 

 

 

 

 

 

 

Interest expense

 

 

66,511

 

 

 

115,307

 

Depreciation and amortization

 

 

87,271

 

 

 

151,715

 

General and administrative expense

 

 

4,229

 

 

 

7,390

 

CLEC operating expense

 

 

5,148

 

 

 

8,889

 

Acquisition and transaction related costs

 

 

804

 

 

 

877

 

Total costs and expenses

 

 

163,963

 

 

 

284,178

 

Income before income taxes

 

 

9,671

 

 

 

18,204

 

Income tax expense

 

 

268

 

 

 

500

 

Net income

 

 

9,403

 

 

 

17,704

 

Participating securities' share in earnings

 

 

(430

)

 

 

(755

)

Net income applicable to common shareholders

 

$

8,973

 

 

$

16,949

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

Basic

 

$

0.06

 

 

$

0.11

 

Diluted

 

$

0.06

 

 

$

0.11

 

 

 

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding

 

 

 

 

 

 

 

 

Basic

 

 

149,834

 

 

 

149,831

 

Diluted

 

 

149,834

 

 

 

149,831

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.60

 

 

$

1.04

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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Communications Sales & Leasing, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

 

 

 

Three Months Ended

 

 

Period from

 

(Thousands)

 

September 30, 2015

 

 

April 24 - September 30, 2015

 

Net income

 

$

9,403

 

 

$

17,704

 

Other comprehensive income:

 

 

 

 

 

 

 

 

Unrealized loss on derivative contracts

 

 

(42,544

)

 

 

(13,993

)

Comprehensive (loss) income

 

$

(33,141

)

 

$

3,711

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.


 

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Communications Sales & Leasing, Inc.

Condensed Consolidated Statement of Shareholders’ Deficit

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred Stock

 

 

Common Stock

 

 

Additional Paid-in Capital

 

 

Accumulated Other Comprehensive Loss

 

 

Distributions in Excess of Accumulated Earnings

 

 

Total Shareholders' Deficit

 

(Thousands, except share data)

 

Shares

 

 

Amount

 

 

Shares

 

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at April 24, 2015

 

 

-

 

 

$

-

 

 

 

149,827,214

 

 

$

15

 

 

$

-

 

 

$

-

 

 

$

2,508,405

 

 

$

2,508,420

 

Net income

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

17,704

 

 

 

17,704

 

Distributions to Windstream related to Spin-Off

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(3,447,879

)

 

 

(3,447,879

)

Other comprehensive loss

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(13,993

)

 

 

-

 

 

 

(13,993

)

Common stock dividends

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(156,926

)

 

 

(156,926

)

Equity issuance cost

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

(516

)

 

 

-

 

 

 

(113

)

 

 

(629

)

Stock-based compensation

 

 

-

 

 

 

-

 

 

 

8,413

 

 

 

-

 

 

 

1,117

 

 

 

-

 

 

 

-

 

 

 

1,117

 

Balance at September 30, 2015

 

 

-

 

 

$

-

 

 

 

149,835,627

 

 

$

15

 

 

$

601

 

 

$

(13,993

)

 

$

(1,078,809

)

 

$

(1,092,186

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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Communications Sales & Leasing, Inc.

Condensed Consolidated Statement of Cash Flows

(unaudited)

 

 

 

Period from

 

(Thousands)

 

April 24 - September 30, 2015

 

Cash flow from operating activities

 

 

 

 

Net income

 

$

17,704

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

Depreciation and amortization

 

 

151,715

 

Amortization of deferred financing costs

 

 

3,039

 

Amortization of debt discount

 

 

3,253

 

Deferred income taxes

 

 

(672

)

Straight-line rental revenues

 

 

(7,497

)

Stock-based compensation

 

 

1,117

 

Changes in:

 

 

 

 

Accounts receivable

 

 

217

 

Other assets

 

 

(1,664

)

Accounts payable, accrued expenses and other liabilities

 

 

54,047

 

Net cash provided by operating activities

 

 

221,259

 

 

 

 

 

 

Cash flow from investing activities

 

 

 

 

Consideration paid to Windstream Services, LLC

 

 

(1,035,029

)

Capital expenditures

 

 

(712

)

Net cash used in investing activities

 

 

(1,035,741

)

 

 

 

 

 

Cash flow from financing activities

 

 

 

 

Proceeds from issuance of Term Loans

 

 

1,127,000

 

Deferred financing costs

 

 

(30,018

)

Principal payment on debt

 

 

(5,350

)

Common stock issuance costs

 

 

(629

)

Dividends paid

 

 

(66,522

)

Cash in-lieu of fractional shares

 

 

(19

)

Net cash provided by financing activities

 

 

1,024,462

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

 

209,980

 

Cash and cash equivalents at beginning of period

 

 

18

 

Cash and cash equivalents at end of period

 

$

209,998

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

Cash paid for interest

 

$

58,600

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

Issuance of notes and other debt to Windstream Services, LLC, net of deferred financing costs ($34,681)

 

$

2,412,829

 

Tenant capital improvements

 

$

41,289

 

Accrual of dividends declared

 

$

90,404

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements

.

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements

Note 1. Organization and Description of Business and Basis of Presentation

Communications Sales & Leasing, Inc. (the “Company,” “CS&L,” “we,” “us” or “our”) was incorporated in the state of Delaware in February 2014 and reorganized in the state of Maryland on September 4, 2014 as a subsidiary of Windstream Holdings, Inc. (“Windstream Holdings” and, together with its consolidated subsidiaries “Windstream”). On April 24, 2015, in connection with the separation and spin-off of CS&L from Windstream (the “Spin-Off”), Windstream contributed certain telecommunications network assets, including fiber and copper networks and other real estate (the “Distribution Systems”) and a small consumer competitive local exchange carrier (“CLEC”) business (the “Consumer CLEC Business”) to CS&L in exchange for certain consideration paid to Windstream. The assets and liabilities of the Distribution Systems and Consumer CLEC Business were recorded in our Condensed Consolidated Financial Statements on a carryover basis as of the date of the Spin-Off.

CS&L is an independent, internally managed triple-net-lease real estate investment trust engaged in the acquisition and construction of mission critical infrastructure in the communications industry. We generate revenues primarily by leasing communications distribution systems to telecommunications operators in triple-net lease arrangements, under which the tenant is primarily responsible for costs relating to the distribution systems (including property taxes, insurance, and maintenance and repair costs). We intend to elect on our U.S. federal income tax return for the taxable year ending December 31, 2015 to be treated as a real estate investment trust (“REIT”).

The Consumer CLEC Business, which historically has been reported as an integrated operation within Windstream, offers voice, broadband, long-distance, and value-added services to residential customers located primarily in rural locations. Substantially all of the network assets used to provide these services to customers are contracted through interconnection agreements with other telecommunications carriers. We have elected to treat the Consumer CLEC Business as a “taxable REIT subsidiary” effective on the first day of the first taxable year that CS&L qualifies as a REIT.

 

 

Note 2. Basis of Presentation

The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information set forth in the Accounting Standards Codification (“ASC”), as published by the Financial Accounting Standards Board (“FASB”), and with the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement of results for the interim period have been included. Operating results from any interim period are not necessarily indicative of the results that may be expected for the full fiscal year. The accompanying Consolidated Financial Statements and related notes should be read in conjunction with the audited consolidated financial statements and notes thereto included in our information statement on Form 10 filed as Exhibit 99.1 to our Current Report on Form 8-K filed with the SEC on March 26, 2015. All material intercompany balances and transactions have been eliminated.

 

 

Note 3. Summary of Significant Accounting Policies

Use of Estimates—The preparation of financial statements, in accordance with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from the estimates and assumptions used in preparing the accompanying financial statements, and such differences could be material.

Real Estate Investments—Real estate investments are stated at original cost, less accumulated depreciation and consists of land and central office buildings, copper and fiber optic cable lines, telephone poles, underground conduits, concrete pads, pedestals, guy wires, anchors, and attachment hardware. Costs of maintenance and repairs to real estate investments are the responsibility of our tenant under triple-net leasing arrangements.

Certain real estate investments are depreciated using a group composite depreciation method. Under this method, when property is retired, the original cost, net of salvage value, is charged against accumulated depreciation and no immediate gain or loss is recognized on the disposition of the property. For all other property, depreciation is computed using the straight-line method over the estimated useful life of the respective property. When the property is retired or otherwise disposed of, the related cost and accumulated depreciation are written-off, with the corresponding gain or loss reflected in operating results.

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

Tenant Capital ImprovementsOur lease with Windstream provides that tenant funded capital improvements (“TCIs”), defined as maintenance, repair, overbuild, upgrade or replacements to the leased network, including, without limitation, the replacement of copper distribution systems with fiber distribution systems, automatically become property of CS&L upon their construction by Windstream. We receive non-monetary consideration related to the TCIs as they automatically become our property, and we recognize the cost basis of TCIs that are capital in nature as real estate investments and deferred revenue. Deferred revenue is recorded within accounts payable, accrued expenses and other liabilities. We depreciate the real estate investments over their estimated useful lives and amortize the deferred revenue as additional leasing revenues over the same depreciable life of the TCI assets. At September 30, 2015, the net book value of TCIs recorded as a component of real estate investments on our Condensed Consolidated Balance Sheet was $41.1 million.

Impairment of Long-Lived Assets—We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset group may not be recoverable from future undiscounted net cash flows we expect the asset group to generate. If the asset group is not fully recoverable, an impairment loss would be recognized for the difference between the carrying value of the asset group and its estimated fair value based on discounted net future cash flows.

 

 

Cash and Cash Equivalents—Cash and cash equivalents include all non-restricted cash held at financial institutions and other non-restricted highly liquid short-term investments with original maturities of three months or less.

Derivative Instruments and Hedging Activities—We account for our derivatives in accordance with FASB ASC 815, Derivatives and Hedging, in which we reflect all derivative instruments at fair value as either assets or liabilities on our Condensed Consolidated Balance Sheet. For derivative instruments that are designated and qualify as hedging instruments, we record the effective portion of the gain or loss on the hedge instruments as a component of accumulated other comprehensive income. Any ineffective portion of a derivative’s change in fair value is immediately recognized within net income. For derivatives that do not meet the criteria for hedge accounting, changes in fair value are immediately recognized within net income. See Note 5.

Customer List Intangible Assets—Customer list intangible assets are presented in the financial statements at cost less accumulated amortization and are amortized using the sum-of-the-digits method over their estimated useful lives.

Revenue Recognition—We recognize leasing revenues on a straight-line basis over the applicable lease term when collectability is reasonably assured. Recognizing leasing income on a straight-line basis generally results in recognized revenues during the first half of the lease term in excess of cash amounts contractually due from our tenants, creating a straight-line rent receivable.

We evaluate the collectability of straight-line rent receivables and record a provision for doubtful accounts if management believes the receivables to be uncollectible. At September 30, 2015 no allowance was recorded related to our straight-line rent receivable.

Consumer CLEC Business revenues are primarily derived from providing access to or usage of leased networks and facilities, and are recognized over the period that the corresponding services are rendered to customers. Revenues derived from other telecommunications services, including broadband, long distance and enhanced service revenues are recognized monthly as services are provided. Sales of customer premise equipment and modems are recognized when products are delivered to and accepted by customers.

Stock-Based Compensation—We account for stock-based compensation using the fair value method of accounting. We have determined that our stock-based payment awards granted in exchange for employee services qualify as equity classified awards, which are measured based on the fair value of the award on the date of the grant. The fair value of restricted stock-based payments is based on the market value of our common stock on the date of grant. The fair value of performance-based awards, which have performance conditions, is based on a Monte Carlo simulation. The fair value of all stock-based compensation is recognized over the period during which an employee is required to provide services in exchange for the award.

Income Taxes—We intend to elect on our U.S. federal income tax return for the taxable year ending December 31, 2015 to be treated as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a REIT, we must distribute at least 90% of our annual REIT taxable income to shareholders, and meet certain organizational and operational requirements, including asset holding requirements. As a REIT, we will generally not be subject to U.S. federal income tax on income that we distribute as dividends to our shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to U.S. federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate income tax rates, and we could not deduct dividends paid to our shareholders in computing taxable income. Any resulting corporate liability could be substantial and

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

could materially and adversely affect our net income and net cash available for distribution to shareholders. Unless we were entitled to relief under certain Code provisions, we also would be disqualified from re-electing to be taxed as a REIT for the four taxable years following the year in which we failed to qualify as a REIT.

To maintain REIT status, we must distribute a minimum of 90% of our taxable income. We intend to make regular quarterly dividend payments of all or substantially all of our income to holders of our common stock, and therefore no provision is required in the accompanying Condensed Consolidated Financial Statements for federal income taxes related to the activities of the REIT and its pass-through subsidiaries. We are subject to the statutory requirements of the locations in which we conduct business, and state and local income taxes are accrued as deemed required in the best judgment of management based on analysis and interpretation of respective tax laws.

We have elected to treat certain subsidiaries as taxable REIT subsidiaries (“TRS”). Certain activities that we undertake must be conducted by a TRS, such as our Consumer CLEC Business, that we could otherwise not perform as a REIT, such as holding certain assets directly. A TRS is subject to both corporate level federal and state income taxes.

Deferred income taxes are recognized in certain taxable entities. Deferred tax assets and liabilities are recognized under the asset and liability method for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax balances are adjusted to reflect tax rates based on currently enacted tax laws, which will be in effect in the years in which the temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period of the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized.

We currently have no liabilities for uncertain income tax positions. We have not yet filed our initial corporate tax return and therefore are not yet subject to examination.

The Company will be subject to a federal corporate level tax rate (currently 35%) on any gain recognized from the sale of assets occurring within a specified period (generally 10 years) after the Spin-Off up to the amount of the built in gain that existed on April 24, 2015, which is based on the fair market value of the assets in excess of the Company’s tax basis as of such date.

Earnings per Share—Basic earnings per share includes only the weighted average number of common shares outstanding during the period. Dilutive earnings per share includes the weighted average number of common shares and the dilutive effect of restricted stock and performance-based awards outstanding during the period, when such awards are dilutive.

Outstanding restricted stock awards that contain rights to non-forfeitable dividends are deemed to be participating securities, requiring the application of the two-class method of computing basic and dilutive earnings per share.

Fair Value of Financial Instruments—FASB ASC 820, Fair Value Measurements, establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring assets and liabilities at fair values. This hierarchy establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are as follows:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the assessment date

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly

Level 3 – Unobservable inputs for the asset or liability

Our financial instruments consist of cash and cash equivalents, accounts and other receivables, derivative assets, our outstanding notes and other debt, accounts payable and interest payable.

The following table summarizes the valuation of our financial instruments at September 30, 2015:

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

(Thousands)

 

Total

 

Quoted Prices in Active Markets

(Level 1)

 

Prices with Other Observable Inputs

(Level 2)

 

Prices with Unobservable Inputs (Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

209,998

 

$

209,998

 

$

-

 

$

-

 

Accounts and other receivables

 

 

1,651

 

 

1,651

 

 

-

 

 

-

 

Total

 

$

211,649

 

$

211,649

 

$

-

 

$

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Senior secured notes - 6.00% , due April 15, 2023

 

$

355,000

 

$

-

 

$

355,000

 

$

-

 

Senior unsecured notes - 8.25%, due October 15, 2023

 

 

946,275

 

 

-

 

 

946,275

 

 

-

 

Senior secured term loan B - variable rate, due October 24, 2022

 

 

2,016,950

 

 

-

 

 

2,016,950

 

 

-

 

Derivative liability

 

 

13,993

 

 

 

 

 

13,993

 

 

 

 

Accounts and interest payable

 

 

97,411

 

 

97,411

 

 

-

 

 

-

 

Total

 

$

3,429,629

 

$

97,411

 

$

3,332,218

 

$

-

 

The carrying value of cash and cash equivalents, accounts and other receivables, accounts payable and interest payable approximate fair values due to the short-term nature of these financial instruments.

The total principal balance of our Notes and other debt was $3.64 billion at September 30, 2015, with a fair value of $3.32 billion. The estimated fair value of Notes and other debt was based on available external pricing data and current market rates for similar debt instruments, among other factors, which are classified as Level 2 inputs within the fair value hierarchy. Derivative liabilities are carried at fair value. The Company has determined that the majority of the inputs used to value its derivative liabilities fall within Level 2 of the fair value hierarchy; however the associated credit valuation adjustments utilized Level 3 inputs, such as estimates of credit spreads, to evaluate the likelihood of default by the Company and its counterparties. As of September 30, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall value of the derivatives. As such, the Company classifies its derivative liabilities valuation in Level 2 of the fair value hierarchy.

Concentration of Credit Risks—In connection with the Spin-Off, we entered into a long-term exclusive triple-net lease agreement with Windstream (the “Master Lease”), pursuant to which all real property currently owned by CS&L is leased to Windstream and from which all of CS&L’s rental revenues are currently derived. Windstream is a publicly traded company and is subject to the periodic filing requirements of the Securities Exchange Act of 1934, as amended. Windstream filings can be found at www.sec.gov. Windstream filings are not incorporated by reference in this Quarterly Report on Form 10-Q.

Because substantially all of our revenue is derived from lease payments by Windstream pursuant to the Master Lease, there could be a material adverse impact on our consolidated results of operations, liquidity and/or financial condition if Windstream experiences operating difficulties and becomes unable to generate sufficient cash to make payments to us. In recent years, Windstream has experienced annual declines in its total revenue and sales. Accordingly, we monitor the credit quality of Windstream through numerous methods, including by (i) reviewing the credit ratings of Windstream by nationally recognized credit rating agencies, (ii) reviewing the financial statements of Windstream that are publicly available and that are required to be delivered to us pursuant to the Master Lease, (iii) monitoring news reports regarding Windstream and its businesses, (iv) conducting research to ascertain industry trends potentially affecting Windstream, and (v) monitoring the timeliness of its lease payments.

Recently Issued Accounting Standards—In April 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU 2015-15 "Interest - Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements" ("ASU 2015-15"). This amendment provides additional guidance within ASU 2015-03 for debt issuance costs related to line of credit arrangements. The recognition and measurement guidance for debt issuance costs are not affected. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015; however, early adoption is permitted. We have adopted ASU 2015-03 effective April 24, 2015, and therefore have presented debt issuance costs as a direct deduction from the carrying amount of our debt on our Condensed Consolidated Balance Sheet. See Note 7.

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). This update outlines a single comprehensive revenue recognition model for entities to follow in accounting for revenue from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity should recognize revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to receive for those goods or services. ASU 2014-09 is effective for annual periods beginning after December 15, 2017 and interim periods within those annual periods. Early adoption is permitted for public companies for annual periods beginning after December 15, 2016. Management is in the process of determining the method of adoption and assessing the impact of ASU 2014-09 on our financial statements.

 

 

Note 4. Real Estate Investments

The carrying value of real estate investments is as follows:

 

(Thousands)

 

Depreciable Lives

 

September 30, 2015

 

Land

 

 

 

$

33,065

 

Building and improvements

 

3 - 40 years

 

 

310,591

 

Poles

 

13 - 40 years

 

 

226,899

 

Fiber

 

7 - 40 years

 

 

1,890,317

 

Copper

 

7 - 40 years

 

 

3,469,232

 

Conduit

 

13 - 47 years

 

 

89,460

 

Construction in progress

 

 

 

 

7,115

 

 

 

 

 

 

6,026,679

 

Less accumulated depreciation

 

 

 

 

(3,637,594

)

Net real estate investments

 

 

 

$

2,389,085

 

 

Depreciation expense for the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015 was $86.2 million and $150.0 million, respectively.

 

Construction in progress represents in process capital projects that were transferred to us at the time of the Spin-Off. As Windstream completes these projects, amounts are reclassified to depreciable assets. We currently do not engage in any construction or development activities.

 

 

Note 5. Derivative Instruments and Hedging Activities

The Company uses derivative instruments to mitigate the effects of interest rate volatility inherent in our variable rate debt, which could unfavorably impact our future earnings and forecasted cash flows. The Company does not use derivative instruments for speculative or trading purposes.

On April 27, 2015, we entered into interest rate swap agreements to mitigate the interest rate risk inherent in our variable rate Senior Secured Term Loan B facility. These interest rate swaps are designated as cash flow hedges and have a notional value of $2.13 billion and mature on October 24, 2022. The weighted average fixed rate paid is 2.105%, and the variable rate received resets monthly to the one-month LIBOR subject to a minimum rate of 1.0%. The Company does not currently have any master netting arrangements related to its derivative contracts.

The following table summarizes the fair value and the presentation in our Condensed Consolidated Balance Sheet:

(Thousands)

 

Location on Condensed Consolidated Balance Sheet

 

September 30, 2015

 

Interest rate swaps

 

Derivative liability

 

$

13,993

 

 

As of September 30, 2015, all of the interest rate swaps were valued in net unrealized loss positions and recognized as liability balances within the derivative liability balance. For the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, the amount recorded in other comprehensive income related to the unrealized loss on derivative

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

instruments was $36.5 million and $3.7 million, respectively. The amount reclassified out of other comprehensive income into interest expense on our Condensed Consolidated Statement of Income for the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015 was $6.0 million and $10.3 million, respectively. For the period from April 24, 2015 to September 30, 2015, there was no ineffective portion of the change in fair value derivatives.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, beginning October 1, 2015, we estimate that $24.1 million will be reclassified as an increase to interest expense.

 

 

Note 6. Customer List Intangible Assets

The carrying value of the customer list intangible assets is as follows:

 

 

September 30, 2015

 

 

 

Gross

 

 

Accumulated

 

 

Net Carrying

 

(Thousands)

 

Cost

 

 

Amortization

 

 

Value

 

Customer lists

 

$

34,501

 

 

$

(23,007

)

 

$

11,494

 

 

Amortization expense for the customer list intangible assets was $1.6 million for the period from April 24, 2015 to September 30, 2015. Amortization expense is estimated to be $2.6 million for the full year of 2015, $3.3 million in 2016, $2.6 million in 2017, $2.0 million in 2018 and $1.4 million in 2019.

 

Note 7. Notes and Other Debt

Notes and other debt is as follows:

(Thousands)

 

September 30, 2015

 

Principal amount

 

$

3,644,650

 

Less unamortized discount and debt issuance costs

 

 

(137,745

)

Notes and other debt less unamortized discount and debt issuance costs

 

$

3,506,905

 

 

Notes and other debt at September 30, 2015 consisted of the following:

(Thousands)

 

Principal

 

 

Unamortized Discount and Debt Issuance Costs

 

Senior secured notes - 6.00% , due April 15, 2023

(discount is based on imputed interest rate of 6.29%)

 

$

400,000

 

 

$

(6,948

)

Senior unsecured notes - 8.25%, due October 15, 2023

(discount is based on imputed interest rate of 9.06%)

 

 

1,110,000

 

 

 

(51,262

)

Senior secured term loan B - variable rate, due October 24, 2022

(discount is based on imputed interest rate of 5.66%)

 

 

2,134,650

 

 

 

(79,535

)

Senior secured revolving credit facility, variable rate, due April 24, 2020

 

 

-

 

 

 

-

 

Total

 

$

3,644,650

 

 

$

(137,745

)

 

 

On April 24, 2015 we, along with our wholly owned subsidiary CSL Capital, LLC (“CSL Capital”), co-issued $400 million aggregate principal amount of 6.00% Senior Secured Notes due April 15, 2023 (the “Secured Notes”) and $1.11 billion aggregate principal amount of 8.25% Senior Unsecured Notes due October 15, 2023 (the “Senior Notes” and together with the Secured Notes, the “Notes”). The Secured Notes were issued at an issue price of 100% of par value, while the Senior Notes were issued at an issue price of 97.055% of par value. The Notes are guaranteed by each of CS&L’s wholly-owned domestic subsidiaries that guarantee indebtedness under CS&L’s senior credit facilities. The Notes were issued to Windstream Services as partial consideration for the contribution of the Distribution Systems and the Consumer CLEC Business in connection with the Spin-Off. As such, CS&L did not receive any proceeds from the issuance of the Notes. The issuance of the Notes and their exchange by Windstream Services for certain of its outstanding indebtedness were not registered under the Securities Act of 1933, as amended (the “Securities Act”), but were exempt from registration under Rule 144A, Regulation S and other applicable exemptions of the Securities Act. Pursuant to a

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

registration rights agreement entered into by the Company in connection with the sale of the Senior Notes, the Company subsequently filed with the SEC a registration statement relating to an exchange offer pursuant to which 8.25% Senior Notes due 2023 (the “Exchange Notes”) that were registered with the SEC, were offered in exchange for Senior Notes tendered by the holders of those notes. The terms of the Exchange Notes are substantially identical to the terms of the Senior Notes in all material respects, except that the Exchange Notes are registered under the Securities Act of 1933, as amended, and the transfer restrictions, registration rights and additional interest provision applicable to the Senior Notes do not apply to the Exchange Notes. The exchange offer was launched on August 5, 2015, and completed on September 2, 2015, with all outstanding Senior Notes being tendered and exchanged for Exchange Notes.

The Notes contain customary high yield covenants limiting our ability to incur or guarantee additional indebtedness; incur or guarantee secured indebtedness; pay dividends or distributions on, or redeem or repurchase, capital stock; make certain investments or other restricted payments; sell assets; enter into transactions with affiliates; merge or consolidate or sell all or substantially all of our assets; and create restrictions on the ability of CS&L, CSL Capital and our restricted subsidiaries to pay dividends. The covenants are subject to a number of important and significant limitations, qualifications and exceptions. As of September 30, 2015, we were in compliance with all of the covenants under the Notes.

In addition, on April 24, 2015 the Company and CSL Capital entered into a credit agreement (the “Credit Agreement”), which provides for a $2.14 billion Senior Secured Term Loan B facility due October 24, 2022 (the “Term Loan Facility”) and a $500 million senior secured revolving credit facility maturing April 24, 2020 (the “Revolving Credit Facility” and, together with the Term Loan Facility, the “Facilities”). The term loans under the Facilities were issued at an issue price of 98.00% of par value, bear interest at a rate equal to a Eurodollar rate, subject to a 1.0% floor, plus an applicable margin equal to 4.00%, and are subject to amortization of 1.0% per annum. The loans have been incurred by the Company and CSL Capital, are guaranteed by certain of CS&L’s wholly-owned subsidiaries (the “Guarantors”), and are secured by substantially all of the assets of CS&L, CSL Capital and the Guarantors, subject to certain exceptions, which assets also secure the Secured Notes. The Revolving Credit Facility bears interest at a rate equal to LIBOR plus 1.75% to 2.25% based on our consolidated secured leverage ratio, as defined in the Credit Agreement.

We are subject to customary covenants under the Credit Agreement, including an obligation to maintain a consolidated secured leverage ratio, as defined in the Credit Agreement, not to exceed 5.00 to 1.00. We are permitted, subject to customary conditions, to incur incremental term loan borrowings and/or increased commitments under the Credit Agreement in an aggregate amount equal to $150 million plus, an unlimited amount, so long as, on a pro forma basis after giving effect to any such increases, our consolidated total leverage ratio, as defined in the Credit Agreement, does not exceed 6.50 to 1.00 and our consolidated secured leverage ratio, as defined in the Credit Agreement, does not exceed 4.00 to 1.00. As of September 30, 2015, we were in compliance with all of the covenants under the Credit Agreement.

The Company transferred $1.04 billion of cash proceeds under the Facilities to Windstream Services, the Company’s parent immediately preceding the Spin-Off, as partial consideration for the contribution of the Distribution Systems and the Consumer CLEC Business in connection with the Spin-Off. After giving effect to the borrowings under the Facilities, the issuance of the Notes and the transfer of cash to Windstream Services, the Company retained net borrowing proceeds of $62.2 million, which are available to us for general corporate purposes.

Deferred financing costs were incurred in connection with the issuance of the Notes and the Facilities. These costs are amortized using the effective interest method over the term of the related indebtedness, and are included in interest expense in our Condensed Consolidated Statement of Income. For the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, we recognized $1.8 million and $3.0 million, respectively, of non-cash interest expense related to the amortization of deferred financing costs.

 

 

Note 8. Stock-Based Compensation

The Company’s Board of Directors has adopted the 2015 Equity Incentive Plan (the “Equity Plan”), which is administered by the Compensation Committee of the Board of Directors. Awards issuable under the Equity Plan include incentive stock options, “non-qualified” stock options, stock appreciation rights, performance units and performance shares, restricted shares, and restricted stock units.

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

In connection with the Spin-Off, the Company issued 538,819 restricted shares and 70,889 performance-based restricted stock units to employees of Windstream in accordance with the terms of the Employee Matters Agreement between the Company and Windstream. Under the Employee Matters Agreement, which governs the compensation and employee benefit obligations of CS&L and Windstream with respect to the current and former employees of each company, employees of Windstream who held equity awards as of the date of the Spin-Off were entitled to receive equity awards of CS&L in the same proportion as if the equity awards had been common shares on the date of the Spin-Off. The CS&L awards issued have the same form and vesting requirements as the underlying Windstream awards. For the purposes of vesting in the CS&L awards, continued service with Windstream is deemed to be continued service with CS&L. We do not recognize any compensation expense in our Condensed Consolidated Statement of Income related to these awards, as none of the employees granted awards provide service to CS&L. At September 30, 2015, 487,111 restricted shares and 58,395 performance-based restricted stock units issued to Windstream employees remained outstanding.

Certain employees of CS&L have retained their unvested Windstream awards that were held prior to the Spin-Off. Unrecognized compensation expense related to these awards was $0.2 million at September 30, 2015, and will be amortized to compensation expense in our Condensed Consolidated Statement of Income on a straight-line basis over the vesting period. For the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, we recognized $72,000 and $125,000 of compensation expense, respectively, related to these awards, which is recorded in general and administrative expense on our Condensed Consolidated Statement of Income.

Restricted Awards

During the period from April 24, 2015 to September 30, 2015, the Company granted 229,080 shares of restricted stock to employees, which had a fair value of $5.9 million as of the date of grant. The restricted stock awards are amortized on a straight-line basis to expense over the vesting period. The following table sets forth the number of unvested restricted stock awards and the weighted-average fair value of these awards at the date of grant:

 

 

 

Restricted Awards

 

 

Weighted Average Fair Value at Grant Date

 

Unvested balance April 24, 2015

 

 

-

 

 

$

-

 

Granted

 

 

229,080

 

 

$

26.13

 

Forfeited

 

 

-

 

 

$

-

 

Vested

 

 

-

 

 

$

-

 

Unvested balance, September 30, 2015

 

 

229,080

 

 

$

26.13

 

 

As of September 30, 2015, total unrecognized compensation expense on restricted awards was approximately $5.1 million, and the weighted average vesting period was 2.1 years.

Performance Awards

The Company grants long-term incentives to members of management in the form of performance-based restricted stock units (“PSUs”) under the Equity Plan. The number of PSUs earned is based on the Company’s achievement of specified performance goals, over a specified performance period, and may range from 0% to 150% of the target shares. The PSUs have a service condition that will expire at the end of the three-year performance period provided that the holder continues to be employed by the Company at the end of the performance period. Holders of PSUs are entitled to dividend equivalents, which will be accrued quarterly and paid in cash upon the vesting of a PSU. Dividend equivalents are forfeited to the extent that the underlying PSU is forfeited.

On May 29, 2015, we issued 60,970 PSUs equal to 100% of the target amount, with an aggregate value of $1.3 million on the grant date. The PSUs, in addition to a service condition, are subject to the Company’s performance versus the total return version of the MSCI US REIT Index and a triple-net lease peer group, as defined by the Compensation Committee. Upon evaluating the results of the market conditions, the final number of shares is determined and such shares vest based on satisfaction of the service condition. The PSUs are amortized on a straight-line basis over the vesting period. During the period from April 24, 2015 to September 30, 2015, no PSUs were forfeited due to termination of service.

As of September 30, 2015, total unrecognized compensation expense related to PSUs was approximately $1.2 million, and the weighted-average vesting period was 2.6 years. The fair value of each PSU award is estimated at the date of grant using a Monte Carlo

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

simulation. The simulation requires assumptions for expected volatility, risk-free return, and dividend yield. Our assumptions include a 0% dividend yield, which is the mathematical equivalent to reinvesting the dividends over the three-year performance period as is consistent with the terms of the PSUs. The following table summarizes the assumptions used to value the PSUs granted during the period from April 24, 2015 to September 30, 2015:

 

 

 

April 24 - September 30, 2015

 

Expected term (years)

 

 

2.9

 

Expected volatility

 

 

26.6

%

Expected annual dividend

 

 

0.0

%

Risk free rate

 

 

0.9

%

 

For the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, we recognized $0.8 million and $1.1 million of compensation expense, respectively, related to restricted stock awards and performance-based awards, which is recorded in general and administrative expense on our condensed consolidated statement of income.

 

Note 9. Related Party Transactions

In connection with the Spin-Off, we issued approximately 149.8 million shares of our common stock, par value $0.0001 per share, to Windstream as partial consideration for the contribution of the Distribution Systems and the Consumer CLEC Business. Windstream Holdings distributed approximately 80.4% of the CS&L shares it received to existing stockholders of Windstream Holdings and retained a passive ownership interest of approximately 19.6% of the common stock of CS&L. As a result of this ownership Windstream is deemed to be a related party. Our Condensed Consolidated Financial Statements reflect the following transactions with Windstream.

Revenues – The Company records leasing revenue pursuant to the Master Lease. For the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, we recognized leasing revenues of $167.0 million and $291.1 million, respectively, related to the Master Lease.

General and Administrative Expenses –We are party to a Transition Services Agreement (“TSA”) pursuant to which Windstream and its affiliates provide, on an interim basis, various services, including but not limited to information technology services, payment processing and collection services, financial and tax services, regulatory compliance and other support services. For the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, we incurred $55,000 and $88,000 of expense under the TSA, respectively.

CLEC Operating Expenses –We are party to a Wholesale Master Services Agreement (“Wholesale Agreement”) and a Master Services Agreement with Windstream related to the Consumer CLEC Business. Under the Wholesale Agreement, Windstream provides us transport services (local and long distance telecommunications service), provisioning services (directory assistance, directory listing, service activation and service changes), and repair services (routine and emergency network maintenance, network audits and network security). Under the Master Services Agreement, Windstream provides billing and collections services to CS&L. During the three months ended September 30, 2015, we incurred expenses of $3.8 million and $0.4 million related to the Wholesale Agreement and Master Services Agreement, respectively. For the period from April 24, 2015 to September 30, 2015 we incurred expenses of $6.5 million and $0.7 million related to the Wholesale Agreement and Master Services Agreement, respectively.

At September 30, 2015 there was a $17.6 million dividend payable to Windstream related to the dividend declared on August 11, 2015, based on Windstream ownership of CS&L shares as of the September 30, 2015 record date. In addition, there was $1.6 million accounts receivable from Windstream related to the collection of Consumer CLEC Business revenues, net of amounts owed to Windstream under the Wholesale Agreement and Master Services Agreement recorded in accounts receivable on our Condensed Consolidated Balance Sheet.

 

 

Note 10. Earnings Per Share

Our restricted stock awards are considered participating securities as they receive non-forfeitable rights to dividends at the same rate as common stock. As participating securities, we included these instruments in the computation of earnings per share under the two-class method described in FASB ASC 260, Earnings per Share.

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

We also issue PSUs; however these units contain forfeitable rights to receive dividends and are therefore considered non-participating restrictive shares and are not dilutive under the two-class method until performance conditions are met.

The following sets forth the computation of basic and diluted earnings per share under the two-class method:

 

 

 

Three Months Ended

 

 

Period from

 

(Thousands, except per share data)

 

September 30, 2015

 

 

April 24 - September 30, 2015

 

Basic earnings per share:

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

Net income

 

$

9,403

 

 

$

17,704

 

Less: Income allocated to participating securities

 

 

(430

)

 

 

(755

)

Net income applicable to common shares

 

$

8,973

 

 

$

16,949

 

Denominator:

 

 

 

 

 

 

 

 

Basic weighted-average common shares outstanding

 

 

149,834

 

 

 

149,831

 

Basic earnings per common share

 

$

0.06

 

 

$

0.11

 

 

 

 

Three Months Ended

 

 

Period from

 

(Thousands, except per share data)

 

September 30, 2015

 

 

April 24 - September 30, 2015

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

Net income

 

$

9,403

 

 

$

17,704

 

Less: Income allocated to participating securities

 

 

(430

)

 

 

(755

)

Net income applicable to common shares

 

$

8,973

 

 

$

16,949

 

Denominator:

 

 

 

 

 

 

 

 

Basic weighted-average common shares outstanding

 

 

149,834

 

 

 

149,831

 

Effect of dilutive non-participating securities

 

 

-

 

 

 

-

 

Weighted-average shares for dilutive earnings per common share

 

 

149,834

 

 

 

149,831

 

Dilutive earnings per common share

 

$

0.06

 

 

$

0.11

 

 

Note 11. Segment Information

 

Our management, including our chief executive officer, who is our chief operating decision maker, manages our operations as two reportable business segments: Leasing and Consumer CLEC. Our Leasing segment represents our REIT operations and corporate expenses not directly attributable to the Consumer CLEC segment. The Consumer CLEC segment represents the operations of our Consumer CLEC Business and corporate expenses directly attributable to the operation of that business. We evaluate the performance of each segment based on Adjusted EBITDA, which is an operating performance measure defined as net income determined in accordance with GAAP, before interest expense, provision for income taxes, depreciation and amortization, stock-based compensation expense and the impact, which may be recurring in nature, of acquisition and transaction related expenses, the write off of unamortized deferred financing costs, costs incurred as a result of the early repayment of debt, changes in the fair value of contingent consideration and financial instruments, and other similar items. The Company believes that net income, as defined by GAAP, is the most appropriate earnings metric; however we believe that Adjusted EBITDA serves as a useful supplement to net income because it allows investors, analysts and management to evaluate the performance of our segments in a manner that is comparable period over period. Adjusted EBITDA should not be considered as an alternative to net income as determined in accordance with GAAP.

Selected financial data related to our segments is presented below for the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015:

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

 

 

Three Months Ended September 30, 2015

 

(Thousands)

 

Leasing Operations

 

 

Consumer CLEC

 

 

Subtotal of Reportable Segments

 

Revenues

 

$

166,959

 

 

$

6,675

 

 

$

173,634

 

Adjusted EBITDA

 

 

163,509

 

 

 

1,527

 

 

 

165,036

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

86,307

 

 

 

964

 

 

 

87,271

 

Interest expense

 

 

 

 

 

 

 

 

 

 

66,511

 

Acquisition and transaction related costs

 

 

 

 

 

 

 

 

 

 

804

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

779

 

Income tax expense

 

 

 

 

 

 

 

 

 

 

268

 

Net income

 

 

 

 

 

 

 

 

 

$

9,403

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

 

315

 

 

 

-

 

 

 

315

 

 

 

 

Period from April 24, 2015 to September 30, 2015

 

(Thousands)

 

Leasing Operations

 

 

Consumer CLEC

 

 

Subtotal of Reportable Segments

 

Revenues

 

$

291,131

 

 

$

11,251

 

 

$

302,382

 

Adjusted EBITDA

 

 

284,858

 

 

 

2,362

 

 

 

287,220

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

150,108

 

 

 

1,607

 

 

 

151,715

 

Interest expense

 

 

 

 

 

 

 

 

 

 

115,307

 

Acquisition and transaction related costs

 

 

 

 

 

 

 

 

 

 

877

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

1,117

 

Income tax expense

 

 

 

 

 

 

 

 

 

 

500

 

Net income

 

 

 

 

 

 

 

 

 

$

17,704

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

 

712

 

 

 

-

 

 

 

712

 

 

Total assets by business segment as of September 30, 2015 are as follows:

 

(Thousands)

 

Leasing Operations

 

 

Consumer CLEC

 

 

Subtotal of Reportable Segments

 

Total assets

 

 

2,607,946

 

 

 

14,833

 

 

 

2,622,779

 

 

 

 

Note 12. Commitments and Contingencies

In the ordinary course of our business, we are subject to claims and administrative proceedings, none of which we believe are material or would be expected to have, individually or in the aggregate, a material adverse effect on our business, financial condition, cash flows or results of operations.

Windstream has requested, and we have agreed, to fund up to $50 million of capital expenditures during the remainder of 2015. Monthly rent paid by Windstream will increase in accordance with the Master Lease effective as of the date of the funding. As of September 30, 2015, we have not funded any amounts under this commitment.

 

 

Note 13. Accumulated Other Comprehensive Income

Changes in accumulated other comprehensive income by component is as follows for the three months ended September 30, 2015:

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

 

(Thousands)

 

Changes in Fair Value of Effective Cash Flow Hedge

 

 

Total

 

Beginning balance at July 1, 2015

 

$

28,551

 

 

$

28,551

 

Other comprehensive loss before reclassifications

 

 

(36,511

)

 

 

(36,511

)

Amounts reclassified from accumulated other comprehensive income

 

 

(6,033

)

 

 

(6,033

)

Ending balance at September 30, 2015

 

$

(13,993

)

 

$

(13,993

)

 

 

Changes in accumulated other comprehensive income by component is as follows for the period from April 24, 2015 to September 30, 2015:

 

(Thousands)

 

Changes in Fair Value of Effective Cash Flow Hedge

 

 

Total

 

Beginning balance at April 24, 2015

 

$

-

 

 

$

-

 

Other comprehensive loss before reclassifications

 

 

(3,690

)

 

 

(3,690

)

Amounts reclassified from accumulated other comprehensive income

 

 

(10,303

)

 

 

(10,303

)

Ending balance at September 30, 2015

 

$

(13,993

)

 

$

(13,993

)

 

 

 

Note 14. Supplemental Guarantor Information

In connection with the issuance of our 6.00% Senior Secured Notes due 2023, 8.25% Senior Unsecured Notes due 2023 and Term Loan B Facility due 2022, the Guarantors provided guarantees of that indebtedness. These guarantees are full and unconditional as well as joint and several. All property assets and related operations of the Guarantors are pledged as collateral under these obligations and the Guarantors are subject to restrictions on certain investments and payments. Subject to the terms and provisions of the debt agreements, in certain circumstances, a Guarantor may be released from its guarantee obligation including, upon the sale or transfer of any portion of its equity interest or all or substantially all its property, and upon any Guarantor being designated an Unrestricted Subsidiary, as defined in the Credit Agreement, or otherwise no longer being required to remain a Guarantor given its size or regulatory restrictions.

The following information summarizes our Condensed Consolidating Balance Sheet as of September 30, 2015, Condensed Consolidating Statements of Comprehensive Income for the three months ended September 30, 2015 and for the period from April 24, 2015 to September 30, 2015, and the Condensed Consolidating Statement of Cash Flows for the period April 24, 2015 to September 30, 2015:

 

 

 

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Communications Sales & Leasing, Inc.

Notes to the Condensed Consolidated Financial Statements – Continued

 

 

 

Condensed Consolidating Balance Sheet

As of September 30, 2015

 

(Thousands)

 

CS&L

 

 

CSL Capital

 

 

Guarantors

 

 

Non-Guarantors

 

 

Eliminations