CenturyLink, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; the filing also reports fourth-quarter results. The supplied filing is for CenturyLink, Inc., not a filing under the Lumen Technologies name. Amounts are in U.S. dollars.
Business context
CenturyLink provided residential and business communications services, including broadband, voice, data networking, hosting, video and IT services. At year-end it reported approximately 11.1 million access lines, 5.9 million broadband subscribers and 325,000 Prism TV subscribers. Business and consumer operations were its two reportable segments.
Financial and operating results
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $17.470 billion | $17.900 billion |
| Operating income | $2.331 billion | $2.605 billion |
| Net income | $626 million | $878 million |
| Diluted EPS | $1.16 | $1.58 |
| Operating cash flow | $4.608 billion | $5.152 billion |
| Capital expenditures and capitalized software | $2.981 billion | $2.872 billion |
| Cash and cash equivalents at year-end | $222 million | $126 million |
| Total long-term debt reported | $19.993 billion | $20.225 billion |
| Stockholders’ equity | $13.399 billion | $14.060 billion |
Revenue declined 2% year over year. Operating margin was approximately 13.3%, versus 14.6% in 2015; net margin was approximately 3.6%, versus 4.9%. Operating cash flow less reported capital expenditures was approximately $1.627 billion, down from $2.280 billion in 2015; this is a simple derived measure, not company-reported free cash flow.
Strategic-services revenue increased 4% to $8.050 billion, while legacy-services revenue fell 8% to $7.672 billion. Data-integration revenue declined 8% to $533 million. Access lines fell about 5.6% and broadband subscribers about 1.7%; Prism TV subscribers increased about 14%.
Fourth-quarter revenue was $4.289 billion, operating income $392 million and net income $42 million, compared with $4.476 billion, $751 million and $338 million, respectively, in fourth-quarter 2015.
Material changes and unusual items
- Operating cash flow decreased $544 million, primarily reflecting higher cash taxes and lower profitability. Cash income taxes paid were $397 million in 2016 versus $63 million in 2015.
- 2016 included $164 million of fourth-quarter severance and other one-time termination benefits and $52 million of Level 3 transaction expenses. The filing’s selected-results discussion also cites $189 million of workforce-reduction expenses; the difference from the $164 million fourth-quarter charge is not reconciled in the excerpt.
- A change in the method for calculating pension and post-retirement service and interest costs reduced 2016 benefit expense by approximately $149 million and increased net income by $91 million, or $0.17 per diluted share. This was a change in estimate and prior periods were not restated.
- CAF Phase 2 support added $201 million of revenue in 2016 relative to the prior interstate USF program. The company reported receiving $214 million more cash from CAF Phase 2 than the projected prior-program amount.
- Quarterly dividends remained $0.54 per share, or $2.16 annualized. The board retained discretion to change or suspend dividends.
Liquidity, debt and commitments
At December 31, 2016, CenturyLink had $222 million of cash and $1.630 billion of available borrowing capacity under its $2 billion revolving credit facility; $370 million was drawn. Contractual debt principal was $1.544 billion due in 2017, with total scheduled long-term debt principal of $20.319 billion. The company said it was in compliance with material debt covenants. Its senior unsecured ratings included BB from S&P, Ba3 from Moody’s and BB+ from Fitch, below investment grade for CenturyLink, Inc.
Accounting unfunded status was $2.409 billion for pension plans and $3.360 billion for post-retirement benefit plans. Post-retirement trust assets had been substantially depleted; the company expected net post-retirement benefit payments of $275 million in 2017, compared with $129 million paid in 2016. It anticipated a voluntary $100 million pension contribution in 2017, although no qualified-plan contribution was then required.
Outlook, transactions and principal risks
- Management projected approximately $2.6 billion of 2017 capital expenditures, excluding spending for Level 3 operations expected to be acquired. It forecast 2017 access-line losses of 4%–6%.
- CenturyLink expected 2017 cash income taxes of $500–$600 million before the effects of the contemplated Level 3 acquisition, plus $100–$200 million of sale-related tax payments for the data-center transaction.
- The proposed Level 3 acquisition was a cash-and-stock transaction: Level 3 holders were to receive $26.50 in cash and 1.4286 CenturyLink shares per share. Existing CenturyLink shareholders were expected to own approximately 51% of the combined company. Closing was anticipated by the end of the third quarter of 2017, subject to shareholder, regulatory and other approvals. CenturyLink expected to issue approximately 538 million shares and assume about $10.9 billion of Level 3 debt; financing and integration costs and increased interest and dividend outlays were expected.
- The proposed sale of 57 data centers and the colocation business was expected to generate net cash proceeds of $1.5–$1.7 billion, partly for the Level 3 acquisition. The business generated $622 million of 2016 revenue. The transaction remained subject to approvals and closing conditions.
- Key risks include persistent legacy-revenue declines and competition, broadband investment and CAF buildout obligations, regulatory change, cyberattacks and network disruptions, pension and health-benefit funding, debt and refinancing needs, and successful completion and integration of the pending transactions. CAF Phase 1 noncompliance had already resulted in a $23 million refund in 2016.
- Material contingencies included switched-access charge disputes and Missouri municipal tax litigation; the filing states outcomes were uncertain. A proposed settlement of a shareholder suit concerning the Level 3 transaction remained subject to court approval.
Investor verification priorities
- Verify the Level 3 transaction’s final approvals, financing terms, debt burden, share issuance, integration costs and realization of expected benefits.
- Check closing proceeds, taxes and retained interests from the data-center sale, and the resulting loss of operating cash flow.
- Assess whether cash generation can cover capital investment, debt maturities, benefit payments and the dividend, particularly as cash taxes rise.
- Track legacy access-line and broadband trends against strategic-services growth, margins and the 2017 line-loss outlook.
- Review CAF buildout progress and exposure to funding reductions or penalties, as well as developments in material legal and tax matters.