CenturyLink, Inc. — Q1 2017 Form 10-Q
Business context and period. The filing covers the three months ended March 31, 2017, compared with Q1 2016. CenturyLink provided communications services to residential and business customers, operating in 37 states with 10.9 million access lines and 5.9 million broadband subscribers at quarter-end. The filing’s registrant is CenturyLink, Inc.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Operating revenue | $4.209 billion | $4.401 billion | Down 4% |
| Operating income | $631 million | $688 million | Down 8% |
| Operating margin | 15.0% | 15.6% | Down 0.6 percentage points |
| Net income | $163 million | $236 million | Down 31% |
| Diluted EPS | $0.30 | $0.44 | Down 32% |
| Operating cash flow | $1.057 billion | $1.423 billion | Down $366 million |
| Capital expenditures and capitalized software | $780 million | $611 million | Up $169 million |
Operating cash flow less capital expenditures was $277 million, compared with $812 million in Q1 2016. The company paid $296 million in dividends and declared $0.54 per share.
Revenue mix showed strategic services up 1% to $2.000 billion, legacy services down 9% to $1.803 billion, data integration up 2% to $118 million, and other revenue down 6% to $288 million. Segment revenue and margins weakened: enterprise revenue was $2.356 billion, down 4%, with a 44% margin versus 46%; consumer revenue was $1.412 billion, down 5%, with a 57% margin versus 59%.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $214 million at March 31, 2017, versus $222 million at year-end. Current assets were $4.968 billion and current liabilities $5.096 billion.
- Long-term debt on the balance sheet was $18.180 billion, with $1.499 billion of current maturities. The company separately reported $19.878 billion of consolidated long-term debt principal, excluding specified discounts, issuance costs and lease/other obligations.
- CenturyLink had $1.625 billion of borrowing capacity available under its $2 billion revolving credit facility; $375 million was drawn. Management reported compliance with material debt covenants.
- Debt fair value was estimated at $20.095 billion versus a carrying amount of $19.553 billion, excluding capital lease and other obligations.
Material changes, outlook and notable items
- Level 3 acquisition pending: Shareholders of both companies approved the cash-and-stock transaction on March 16, 2017. CenturyLink expected closing by the end of Q3 2017, subject to regulatory and other conditions. Level 3 shareholders were to receive $26.50 cash and 1.4286 CenturyLink shares per share; CenturyLink expected to issue approximately 538 million shares. Level 3 had $10.9 billion of debt outstanding at December 31, 2016. CenturyLink expected substantial new borrowing, higher interest costs and material transaction and integration costs; credit ratings were under negative review or watch following the announcement.
- Data-center and colocation divestiture: The sale closed May 1, 2017, after quarter-end, for initial pre-tax cash proceeds of $1.86 billion, subject to customary adjustments, plus a minority interest in Cyxtera. The purchaser assumed $297 million of related capital lease obligations. CenturyLink estimated $75 million to $150 million of tax expense from the sale and related actions; $15 million had been accrued in Q1. The company expected operating cash flow to fall by about $30 million to $45 million per quarter following the divestiture.
- Operating trends: Access lines fell 6% year over year to 10.945 million; broadband subscribers fell 2% to 5.945 million; employee count declined 7% to 40,000. Management estimated full-year 2017 access-line losses of 4% to 6%. Legacy voice, access and private-line declines were attributed to competition, customer migration and technology substitution; strategic growth in Ethernet, MPLS and facilities-based video partly offset losses.
- Cash spending and taxes: Management estimated about $1.9 billion of capital investment for the remaining nine months of 2017, excluding Level 3, and $400 million to $500 million of 2017 cash income taxes, excluding divestiture taxes and the acquisition’s impact. It expected approximately $1.421 billion of debt maturities in the remainder of 2017. A voluntary $100 million pension contribution was expected during the remainder of the year.
- Unusual items: The Q1 effective tax rate was 46.9%, versus 37.9% a year earlier, reflecting share-based compensation, the divestiture-related tax impact and state apportionment changes. A $11 million impairment related to assets held for sale was recorded in SG&A. The company ceased depreciation and amortization on the divested business after meeting held-for-sale criteria, reducing Q1 expense by an estimated $50 million.
- Risks and contingencies: Risks include continued legacy-revenue erosion, competitive pricing, high leverage, dividend and refinancing capacity, merger approvals and integration, potential rating downgrades, CAF buildout requirements, labor agreements expiring in 2017, and pension and post-retirement obligations. Legal matters include disputes over switched-access charges, Missouri municipal tax claims and patent litigation; outcomes were described as uncertain. CenturyLink said disclosure controls were effective and reported no material Q1 change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the Level 3 acquisition closed on the anticipated timetable and its final financing, debt, share issuance, integration costs and expected benefits.
- Final net proceeds and tax cost of the data-center sale, and the actual recurring cash-flow impact of losing that business.
- Whether revenue declines, especially in legacy services, continue and whether strategic-service growth can offset them without further margin deterioration.
- Cash generation after capital investment, near-term debt maturities, credit-rating developments and the sustainability of the $0.54 quarterly dividend.
- Actual cash taxes, pension funding, CAF spending and outcomes of material legal and regulatory matters.