Business context and reporting period
CenturyLink, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The filing describes an integrated communications provider serving residential and business customers, with Business and Consumer reporting segments. The filing registrant is CenturyLink, Inc.; the supplied company metadata uses the later name Lumen Technologies, Inc.
Financial results and liquidity
Second quarter 2016 (compared with Q2 2015; dollars in millions except per-share data): revenue was $4,398, down 0.5%; operating income was $650, up 18%; net income was $196, up 37%; and diluted EPS was $0.36 versus $0.26. Operating margin rose to 14.8% from 12.4%, while net margin increased to 4.5% from 3.2%.
First half 2016 (compared with first half 2015): revenue was $8,799, down 0.8%; operating income was $1,344, up 12%; net income was $432, up 29%; and diluted EPS was $0.80 versus $0.60. Operating margin was 15.3% versus 13.5%; net margin was 4.9% versus 3.8%.
- Revenue mix shifted: first-half strategic services revenue rose 5% to $4,019, while legacy services declined 7% to $3,926 and data integration fell 16% to $239. Other revenue rose 19% to $615, largely reflecting higher CAF support.
- Second-quarter segment results: Business revenue fell 2% to $2,597 and segment income fell 4% to $1,110; Consumer revenue fell 1% to $1,494 and segment income fell 3% to $840. Segment margins were 43% and 56%, respectively.
- Cash from operations for the first half was $2,601, versus $2,481 a year earlier. Capital expenditures and capitalized software were $1,264; operating cash flow less that spending was approximately $1,337. Investing used $1,279 and financing used $1,257. Cash increased $65 to $191.
- At June 30, cash was $191; current liabilities were $4,842 and current assets were $2,791. Debt was $19,616 including current maturities, with $18,165 classified as long-term. The company reported $2 billion of availability on its $2 billion revolving credit facility and no facility borrowings.
- Dividends declared were $0.54 per share for Q2 and $1.08 for the first half; dividends paid in the first half totaled $586.
Material changes, outlook, risks and unusual items
- Management attributed revenue pressure chiefly to continuing customer and volume losses in legacy voice, access and private-line services. Access lines declined 6% year over year to 11.4 million; broadband subscribers fell 2% to 6.0 million. Prism TV subscribers rose 21% to 311,000. Management estimated full-year 2016 access-line losses of 5%–6%.
- Strategic-service growth reflected greater Ethernet, MPLS and facilities-based video demand and broadband price increases, partly offset by hosting and broadband customer declines. CAF Phase 2 support added $52 million to Q2 revenue and $104 million to first-half revenue year over year; management did not expect CAF Phase 2 to materially change full-year 2016 other revenue versus 2015.
- Management anticipated approximately $1.8 billion of capital investment during the remaining six months of 2016 and up to $583 million of dividends at the then-current rate. Estimated 2016 cash income taxes were $400 million–$500 million, as federal NOL carryforwards were substantially depleted. Management expected post-retirement benefit cash needs to rise beginning in 2017.
- Financing activity included issuance of $1 billion of 7.5% notes due 2024, generating approximately $988 million net, and repayment at maturity of $1.184 billion of Embarq notes and $235 million of Qwest notes. Debt ratings included below-investment-grade ratings for CenturyLink, Inc.; Moody’s downgraded CenturyLink and Qwest in March 2016. The company reported compliance with material debt covenants.
- Key contingencies include switched-access charge litigation and regulatory proceedings, Missouri municipal tax claims, and a Comcast tax-sharing dispute seeking approximately $80 million. In one Missouri case, a court ruling could produce liability well above the company’s recorded contingent liability; CenturyLink planned to appeal. The company had not accrued for the Comcast matter, stating liability was not probable.
- CenturyLink identified a potential refund exposure of approximately $40 million related to missed CAF Phase 1 deployment requirements; $23 million was recorded in current liabilities and $17 million in noncurrent liabilities. It also cited uncertainty over broadband Title II regulation and proposed FCC business-data-service rules.
- The company continued evaluating strategic alternatives for its data-center and colocation operations, including a possible partnership, joint venture or sale. First-half colocation revenue was approximately $311 million.
- Management highlighted sustained competitive and technology-driven pressure, pricing and margin compression, higher video-content costs, substantial debt and capital needs, rising cash taxes and retiree-health costs, and the possibility of material regulatory or litigation impacts. It cautioned that interim results may not indicate full-year results.
Most important facts for investors to verify
- Whether strategic-service growth can offset continuing legacy revenue declines, access-line losses and competitive pricing pressure.
- How much of operating cash flow is available after network investment, dividends, debt service, taxes and post-retirement benefit payments.
- Debt refinancing costs, rating-agency actions and continued compliance with leverage covenants.
- Outcome and potential exposure from Missouri tax litigation, switched-access disputes, CAF deployment requirements and other material contingencies.
- Any decision or transaction regarding the data-center and colocation business, and its effect on revenue, cash flow and debt.
- Progress and economics of CAF Phase 2 buildout, including whether the anticipated capital spending earns adequate returns.