Windstream 2015 Annual Report Download - page 197

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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F-67
5. Long-term Debt and Lease Obligations, Continued:
Long-term Lease Obligations
Leaseback of Telecommunications Network Assets - Following the spin-off transaction (see Note 3), on April 24, 2015, Windstream
Holdings entered into a long-term triple-net master lease with CS&L to lease back the telecommunications network assets. Under
terms of the master lease, Windstream Holdings has the exclusive right to use the telecommunications network assets for an initial
term of 15 years with up to four, five-year renewal options. Windstream Holdings is required to pay all property taxes, insurance,
and repair or maintenance costs associated with the leased property. The master lease provides for an annual rent of $650.0 million
paid in equal monthly installments in advance and is fixed for the first three years. Thereafter, rent will increase on an annual basis
at a base rent escalator of 0.5 percent. Future lease payments due under the agreement reset to fair market rental rates upon
Windstream Holdings’ execution of the renewal options. During December 2015, we requested and CS&L agreed to fund $43.1
million of capital expenditures. As a result, the annual lease payment increased at a rate of 8.125 percent of the funds received
from CS&L, or from $650.0 million to $653.5 million. CS&L also has the right, but not the obligation, upon Windstream’s request,
to fund additional capital expenditures of Windstream in an aggregate amount of up to $250.0 million for a maximum period of
five years. Monthly rent paid by us to CS&L will increase in accordance with the master lease effective as of the date of the
funding. If CS&L exercises this right, the lease payments under the master lease will be adjusted at a rate of 8.125 percent of the
capital expenditures funded by CS&L during the first two years and at a floating rate based on CS&L’s cost of capital thereafter.
Additionally, if CS&L agrees to fund the entire $250.0 million, the initial term of the master lease will be increased from 15 years
to 20 years and the number of renewal terms will be reduced from four renewal terms of five years each to three renewal terms
of five years each.
Due to various forms of continuing involvement, including Windstream Services or its subsidiaries, retaining bare legal title (but
not beneficial ownership) to the various easements, permits and pole attachments related to the telecommunications network assets,
we accounted for the transaction as a failed spin-leaseback for financial reporting purposes. As a result, the net book value of the
network assets transferred to CS&L continue to be reported in our consolidated balance sheet and all depreciable assets will be
fully depreciated over the initial lease term of 15 years.
At inception of the master lease, we recorded a long-term lease obligation of approximately $5.1 billion equal to the sum of the
minimum future annual lease payments over the 15-year lease term discounted to the present value based on Windstream Services’
incremental borrowing rate. Funding received from CS&L in December 2015 for capital expenditures was recorded as an increase
to the long-term lease obligation. The effective interest rate on the long-term lease obligation is approximately 10.1 percent. As
annual lease payments are made, a portion of the payment will decrease the long-term lease obligation with the balance of the
payment charged to interest expense using the effective interest method.
As the master lease was entered into by Windstream Holdings for the direct benefit of Windstream Services and its subsidiaries,
Windstream Services is also deemed to have continuing involvement due to retaining its regulatory obligations associated with
operating the telecommunications network assets. Accordingly, the effects of the failed spin-leaseback transaction have also been
reflected in the standalone consolidated financial statements of Windstream Services. Notwithstanding the foregoing accounting
treatment, neither Windstream Services or its subsidiaries is a counterparty or obligor to the master lease agreement.
Leaseback of Real Estate Contributed to Pension Plan - During the third quarter of 2014, we contributed certain of our owned real
property to the Windstream Pension Plan and then entered into agreements to leaseback the properties for continued use by our
operating subsidiaries. Independent appraisals of the properties contributed were obtained and at the dates of contribution the
properties’ aggregate fair value was $80.9 million. The lease agreements include initial lease terms of 10 years for certain properties
and 20 years for the remaining properties at an aggregate annual rent of approximately $6.3 million. The lease agreements provide
for annual rent increases ranging from 2.0 percent to 3.0 percent over the initial lease term and may be renewed for up to three
additional five-year terms. The properties are managed on behalf of the Windstream Pension Plan by an independent fiduciary
and terms of the lease agreements were negotiated with the fiduciary on an arm’s-length basis. During the fourth quarter of 2015
in conjunction with the sale of the data center business, Windstream Services repurchased at fair value one of the properties
contributed to the Windstream Pension Plan for $8.2 million in cash. As a result, we derecognized a portion of the associated long-
term lease obligation of $8.7 million and recorded a pretax gain of $0.5 million. Following the repurchase, aggregate annual rent
due under the lease agreements declined from approximately $6.3 million to $6.0 million.