Products and Services Revenues

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 revenues 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 revenues, which consist of Universal Service Fund ("USF") and Connect America Fund ("CAF") support payments and other operating revenues. We receive federal support payments from both federal and state USF programs and 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


•	Affiliates services, we provide to our affiliates, 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.

Our operating revenues for our products and services consisted of the following categories:



	Three Months Ended March 31,
	2018		2017
	(Dollars in millions)
IP & Data Services	$	146	151
Transport & Infrastructure	759		769
Voice & Collaboration	460		511
IT & Managed Services	2		1
Regulatory	52		54
Affiliates services	711		676
Total operating revenues	$	2,130	2,162

We recognize revenues in our consolidated statements of operations for certain USF surcharges and transaction taxes that we bill to our customers. Our consolidated statements of operations also reflect the offsetting expense for the amounts we remit to the government agencies. The total amount of such surcharges and transaction taxes that we included in revenues aggregated $34 million and $33 million for the three months ended March 31, 2018 and 2017, respectively. These USF surcharges are assigned to the products and services categories based on the underlying revenues. We also act as a collection agent for certain other USF and transaction taxes that we are required by government agencies to bill our customers, for which we do not record any revenue or expense because we only act as a pass-through agent.

Our operations are integrated into and reported as part of the consolidated segment data of CenturyLink. CenturyLink's chief operating decision maker ("CODM") is our CODM, but reviews our financial information on an aggregate basis only in connection with our quarterly and annual reports that we file with the Securities and Exchange Commission. Consequently, we do not provide our discrete financial information to the CODM on a regular basis. As such, we have one reportable segment.

Revenue Recognition

The following table presents our reported results under ASC 606 and a reconciliation to results using the historical accounting method:



	Three Months Ended March 31, 2018
	(Dollars in millions, except per share amounts and shares in thousands)
	Reported Balances as of March 31, 2018		Impact of 606		ASC 605 Historical Adjusted Balances
Operating revenues	$	2,130	(9	)	$	2,121
Cost of services and products (exclusive of depreciation and amortization)	707		6		713
Selling, general and administrative	215		(1	)	214
Income tax expense	130		(4	)	126
Net income	$	380	(10	)	$	370

The following table presents a reconciliation of certain consolidated balance sheet captions under ASC 606 to the balance sheet results using the historical accounting method:



	As of March 31, 2018
	(Dollars in millions)
	Reported Balances as of March 31, 2018			Impact of 606		ASC 605 Historical Adjusted Balances
Other current assets	$	217		(109	)	$	108
Other long-term assets, net	100			(31	)	69
Advance billing and customer deposits	255			1		256
Deferred income taxes, net	1,003			(41	)	962
Other long-term liabilities	80			27		107
Accumulated deficit	(505		)	(138	)	(643		)

Pursuant to ASU 2014-19 discussed in Note 1 above, the following table provides disaggregation of revenue from contracts with customers as of March 31, 2018:



	Three Months Ended March 31, 2018
	(Dollars in millions)
	Total Revenue		Adjustments for Non-ASC 606 Revenue ⁽⁷⁾		Total Revenue from Contracts with Customers
IP & Data Services⁽¹⁾	$	146	—		146
Transport & Infrastructure⁽²⁾	759		(26	)	733
Voice & Collaboration ⁽³⁾	460		—		460
IT & Managed Services ⁽⁴⁾	2		—		2
Regulatory revenues ⁽⁵⁾	52		(52	)	—
Affiliate revenues⁽⁶⁾	711		—		711
Total revenues	$	2,130	(78	)	2,052

Timing of Revenue
Goods transferred at a point in time					$	11
Services performed over time					2,041
Total revenues from contracts with customers					$	2,052



(1	)	Includes primarily VPN data network, Ethernet, IP and ancillary revenues.
(2	)	Includes primarily broadband, private line (including business data services) and ancillary revenues.
(3	)	Includes local voice and other ancillary revenues.
(4	)	Includes IT services and managed services revenues.
(5	)	Includes CAF Phase I, CAF Phase 2 and federal and state USF support revenue.
(6	)	Includes telecommunications and data services we bill to our affiliates.
(7	)	Includes regulatory revenues, lease revenues and sublease rental income, which are not within the scope of ASC 606.

The following table provides balances of customer receivables, contract assets and liabilities as of March 31, 2018 and January 1, 2018:



	March 31, 2018		January 1, 2018
	(Dollars in millions)
Customer receivables ⁽¹⁾	$	561	631
Contract liabilities	79		78
Contract assets	$	113	93

(1) Gross customer receivables of $602 million and $669 million, net of allowance for doubtful accounts of $41 million and $38 million, at March 31, 2018 and January 1, 2018, respectively.

Contract liabilities constitute consideration we have received from our customers in exchange for services or products to be delivered by us in the future. We defer recognizing this consideration as revenue until we have satisfied the related performance obligation to the customer.

We recognize revenue for services when we provide the applicable service or when control is transferred. Recognition of certain payments received in advance of services being provided is deferred until the service is provided. These advance payments include certain activation and certain installation charges, which we recognize as revenue over the expected contract term, which ranges from one year to over seven years depending on the service. In most cases, termination fees or other fees on existing contracts that are negotiated in conjunction with new contracts are deferred and recognized over the new contract term.

We offer bundle discounts to our customers who receive certain groupings of services. These bundle discounts are included in our calculation of the total transaction price with the customer which is allocated to the various services in the bundled offering based on the standalone selling price of services included in each bundled combination.

Customer contracts that include both equipment and services are evaluated to determine whether the performance obligations are separable. If the performance obligations are deemed separable and separate earnings processes exist, the total transaction price with the customer is allocated to each performance obligation based on the relative standalone selling price of the separate performance obligation. The standalone selling price is the price we sell to similar customers. The total transaction price is the total consideration that we expect to be entitled to (excluding amounts subject to revenue constraints) in exchange for transferring the equipment and services to the customer under the existing contract. The revenue associated with each performance obligation is then recognized as earned. For example, if we receive an advance payment when we sell equipment and continuing service together, we immediately recognize as revenue the amount of the total transaction price allocated to the equipment at the time title or control is transferred to the customer. The portion of the advance payment allocated to the service based upon its relative selling price is recognized ratably over the contract term.

We periodically permit other telecommunications carriers to use optical capacity on our network. These transactions are structured as indefeasible rights of use, commonly referred to as IRUs, which are the exclusive right to use a specified amount of capacity or fiber for a specified term, typically 20 years. We account for the cash consideration received on transfers of optical capacity and fiber assets and on all of the other elements deliverable under an IRU, as lease revenue, non ASC 606, ratably over the term of the agreement. We do not recognize revenue on any contemporaneous exchanges of our optical capacity assets for other optical capacity assets.

In connection with offering products and services provided to the end user by third-party vendors, we review the relationship between us, the vendor and the end user to assess whether revenue should be reported on a gross or net basis. In assessing whether revenue should be reported on a gross or net basis, we consider whether we act as a principal in the transaction and control the goods and services used to fulfill the performance obligation(s) associated with the transaction. Based on our agreement with DIRECTV, we offer this service through a sales agency relationship which we report on a net basis.

We have service level commitments pursuant to contracts with certain of our customers. To the extent that such service levels are not achieved or are otherwise disputed due to performance or service issues or other service interruptions or conditions, we will estimate the amount of credits to be issued and record a reduction to revenues in the period that the service level commitment was not met.

As of March 31, 2018, 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 $311 million. We expect to recognize approximately 98% of this revenue through 2020, with the balance recognized thereafter.

The following table provides changes in our contract acquisition costs and fulfillment costs:



	Three Months Ended March 31, 2018
	(Dollars in millions)
	Acquisition Costs			Fulfillment Costs
Beginning of period balance	$	91		37
Costs incurred	14			4
Amortization	(15		)	(5	)
End of period balance	$	90		36

We expect that incremental commissions paid as a result of obtaining contracts and costs incurred to fulfill customer contracts are recoverable and therefore capitalized them as acquisition and fulfillment costs in the amount of $126 million at March 31, 2018. The amount of these capitalized costs that are anticipated to be amortized in the next twelve months are included in other current assets on the consolidated balance sheet. The amount of capitalized costs expected to be amortized beyond the next twelve months is included in other assets on our consolidated balance.

Capitalized commissions and fulfillment costs are amortized based on the transfer of services to which the assets relate to which typically range from 30 months to 49 months. The amortization of capitalized commissions are included in selling, general and administrative expenses and the amortization of capitalized fulfillment costs are included in cost of services and products (exclusive of depreciation and amortization) in our consolidated statement of operations. We recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets is less than one year.