CenturyLink, Inc. (now Lumen Technologies, Inc.) — Form 10-Q summary
Reporting period: Quarter and nine months ended September 30, 2017. The filing was made under the name CenturyLink; it reports the Level 3 acquisition, which closed November 1, 2017, as a subsequent event, not as part of the quarter’s operating results. Unless noted otherwise, amounts are in U.S. dollars.
Business context and reporting period
CenturyLink provided communications services to residential, business, wholesale and government customers. At quarter-end it reported 10.5 million access lines and 5.8 million broadband subscribers. In May 2017, it sold its data-center and colocation business. On November 1, it acquired Level 3, a transaction expected to materially change the company’s scale, leverage, cash requirements and operating results.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $4.034 billion | $4.382 billion | $12.333 billion | $13.181 billion |
| Operating income | $487 million | $593 million | $1.485 billion | $1.928 billion |
| Net income | $92 million | $152 million | $272 million | $584 million |
| Diluted EPS | $0.17 | $0.28 | $0.50 | $1.08 |
| Operating cash flow | Not separately provided for quarter | Not separately provided for quarter | $2.700 billion | $3.512 billion |
- Revenue fell 8% in Q3 and 6% year to date. Operating income declined 18% and 23%, respectively; net income declined 39% and 53%.
- Operating margin was approximately 12.1% in Q3 2017 versus 13.5% in Q3 2016, and 12.0% for the first nine months versus 14.6% a year earlier.
- Revenue declines reflected ongoing legacy-service losses and the divested colocation business. Q3 strategic-services revenue fell 7%, legacy services 10%, and data integration 18%. Excluding the colocation revenue reduction, strategic-services revenue was slightly higher in Q3 and flat year to date.
- Operating expenses decreased, but not enough to offset lower revenue. Q3 interest expense rose 11% to $362 million, partly reflecting acquisition financing and the failed-sale-leaseback accounting treatment.
- For the first nine months, investing cash outflow was $850 million, including $2.363 billion of capital expenditures and $1.467 billion of net cash proceeds from the data-center sale. Financing cash inflow was $4.090 billion, including debt proceeds and restricted acquisition-funding cash.
- At September 30, cash and cash equivalents were $160 million; the balance sheet also included $6.004 billion of restricted cash held in escrow for the Level 3 transaction. Current assets were $2.694 billion and current liabilities $3.266 billion.
- Debt was $24.978 billion before discounts and issuance costs, including $124 million of current maturities. This compares with $19.993 billion at December 31, 2016; the increase primarily reflects the $6 billion term loan prefunded into escrow for the acquisition. The filing reported $24.605 billion of consolidated debt principal excluding specified adjustments and capital-lease obligations.
- Quarterly dividends declared were $0.54 per share. Nine-month dividends paid were $881 million.
Material changes versus the prior comparable period
- Access lines declined 6% to 10.506 million, broadband subscribers declined 3% to 5.767 million, and employees declined 7% to 39,500 year over year. Management estimated full-year 2017 access-line losses of 6.0%–7.5%.
- Enterprise segment revenue decreased 11% in Q3 and 8% year to date; its margin declined to 40% from 42% in Q3 and to 42% from 44% year to date. Consumer revenue decreased 6% in both periods; its margin declined to 55% from 56% in Q3 and to 57% from 58% year to date.
- Operating cash flow declined $812 million year to date, attributed to lower earnings, higher cash taxes and working-capital changes, as well as the divestiture.
- The company sold its data-center and colocation business for $1.8 billion in pretax cash proceeds and a minority interest valued at $150 million. The transaction generated an $82 million net loss in the nine-month results after failed-sale-leaseback effects; the company said the sale excluding those accounting effects generated a $20 million gain.
Outlook, management commentary, risks and unusual items
- The Level 3 acquisition consideration included approximately $9.6 billion cash and 517 million CenturyLink shares; CenturyLink assumed approximately $11 billion of Level 3 debt. Management anticipated higher future interest and capital expenditures, material transaction and integration costs, and approximately $279 million of additional quarterly dividends from the newly issued shares.
- Management expected approximately $225 million of merger-related transaction costs in Q4 2017. It forecast approximately $600 million of capital investment and $573 million of dividends in the final three months of 2017. The company expected full-year 2017 cash income taxes of $325 million–$375 million, excluding the stated sale-related tax impact and Level 3 effects.
- Management expected to continue the $0.54 quarterly dividend, subject to board discretion. It cautioned that cash generation, debt, covenants and post-acquisition funding needs could affect capital allocation and dividends.
- Following the acquisition, CenturyLink’s unsecured debt ratings were downgraded by the agencies cited in the filing; Moody’s assigned a negative outlook. New acquisition facilities included floating-rate borrowings, increasing exposure to interest-rate changes. Credit agreements include leverage and interest-coverage tests and restrictions, including on dividends and additional debt.
- Major business risks include continued competition and substitution away from legacy voice and private-line services, broadband and video competition, integration and synergy execution, increased leverage, refinancing and covenant risk, pension and retiree-benefit obligations, regulatory changes, and network or cybersecurity disruptions.
- Legal and contingency matters include consumer and shareholder claims alleging improper sales and billing practices, a Minnesota Attorney General suit, Missouri tax disputes, switched-access litigation and matters assumed with Level 3. Outcomes were uncertain; some matters could materially affect results. The filing stated that a Level 3 Brazilian tax matter could produce up to $54 million of loss beyond recorded accruals and described other disputed foreign tax and employment claims.
- Hurricanes caused network and facility damage. Estimated restoration spending was $20 million–$25 million for CenturyLink and $6 million for Level 3; estimates could change as surveys were completed.
- Disclosure controls were assessed as effective at September 30, 2017, and no material third-quarter change in internal control over financial reporting was reported.
Important facts for investors to verify
- Post-acquisition consolidated debt, interest costs, liquidity, covenant headroom and updated credit ratings, including the treatment of Level 3 debt.
- Whether revenue declines—especially access lines, legacy services and broadband subscribers—stabilize, and whether strategic-service growth offsets them.
- Actual integration costs, realized synergies, customer retention, capital spending and the final purchase-price allocation for Level 3.
- Cash flow available after capital expenditures, debt service, taxes, pension and retiree-benefit payments, and dividends; confirm the board’s continuing dividend policy.
- Developments and accruals in billing-practices litigation, tax disputes, switched-access matters and Level 3 contingencies.
- Final hurricane restoration costs and the ongoing financial effects of the data-center sale and its failed-sale-leaseback accounting.