CenturyLink, Inc. — Q3 2011 Form 10-Q
Filing identity: The filing is for CenturyLink, Inc. for the quarter ended September 30, 2011; it is not filed under the later name Lumen Technologies. Unless noted otherwise, financial amounts are in millions of dollars.
Business context and reporting period
CenturyLink provided communications services, including voice, broadband, data, video, wholesale network, hosting and colocation services. Results include Qwest from its April 1, 2011 acquisition and Savvis from July 15, 2011. The company cautions that comparisons with 2010 are less meaningful because the acquisitions substantially changed the size and mix of the business. The nine-month results are not necessarily indicative of full-year results.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $4,596 | $1,748 | $10,698 | $5,320 |
| Operating income | $551 | $506 | $1,495 | $1,574 |
| Net income | $140 | $232 | $466 | $723 |
| Diluted EPS | $0.23 | $0.76 | $0.92 | $2.39 |
| Operating margin | 12.0% | 29.0% | 14.0% | 29.6% |
- Cash flow and investment: Nine-month operating cash flow was $3,473; capital expenditures and capitalized software were $1,511. Operating cash flow less those expenditures was approximately $1,962, before acquisitions, dividends and debt activity.
- Cash and liquidity: Cash was $1,123 at September 30, 2011, versus $173 at year-end 2010. Working capital was negative $929, compared with positive $132 at year-end. The company had a $1,700 revolving credit facility, with no borrowings and only an immaterial amount of letters of credit outstanding under it; a separate letter-of-credit facility had $129 outstanding.
- Debt: Total long-term debt, including current maturities, was $22,176, versus $7,328 at year-end 2010. Current maturities were $1,034. Debt increased principally with the Qwest acquisition and acquisition-related financing. Management reported compliance with debt covenants.
- Dividends: Dividends declared were $0.725 per share for the quarter and $2.175 year to date. Cash dividends paid during the nine months were $1,105.
Material changes versus the prior comparable period
- Reported revenue rose by $2,848 in Q3 and $5,378 year to date, largely due to acquired operations. Qwest contributed $2,731 of Q3 revenue and $5,476 year-to-date; Savvis contributed $223 in both periods. Legacy CenturyLink revenue declined 6.1% in Q3 and 6.0% year to date.
- Despite higher reported revenue, Q3 net income declined to $140 from $232 and year-to-date net income declined to $466 from $723. Management cited acquisition, severance and integration costs, higher depreciation and amortization from acquisition accounting, and increased interest expense. Share issuance for the acquisitions also reduced EPS through a larger share count.
- Legacy services revenue continued to weaken, primarily with access-line losses and customer migration. Strategic services, particularly broadband and private line, partly offset the declines. CenturyLink reported 14.8 million access lines and 5.5 million broadband subscribers at quarter-end; its legacy CenturyLink access lines declined 7.1% year over year.
- Total segment margin was 53% in Q3, versus 62% in Q3 2010. Regional and business market margins were lower, in part reflecting Qwest; wholesale margin was 70%. Savvis reported $223 revenue, $51 segment income and a 23% margin for its post-acquisition period.
Outlook, management commentary, risks and unusual items
- Outlook: Management expected to maintain the current annual dividend of $2.90 per share, subject to board discretion. It forecast 2011 capital expenditures of $2.35–$2.50 billion and approximately $3 billion for 2012. It expected to reduce consolidated debt by $800–$1,300 by the end of 2012, depending on circumstances and market conditions.
- Integration and spending: The company estimated Qwest transaction and integration operating expenses of approximately $800–$1,000 in total, plus approximately $200 in integration capital expenditures. Management warned that costs could be higher or take longer to realize than expected savings. The filing does not provide a comparable total integration-cost estimate for Savvis.
- Debt and refinancing: CenturyLink expected to refinance a substantial portion of maturing debt through future debt issuance. A rating agency had placed its outlook at negative, citing the need to reduce leverage while maintaining free cash flow. Market access, ratings and refinancing terms were identified as risks. In October 2011, Qwest Corporation issued notes and used proceeds and cash to redeem $1,500 of 8.875% notes due 2012.
- Pension and benefits: The company expected approximately $500 of required pension contributions in 2012 and anticipated voluntary contributions exceeding $100 based on September 30 valuations. Qwest acquisition accounting added unfunded pension and postretirement liabilities of $490 and $2,522, respectively.
- Acquisition accounting and goodwill: Qwest and Savvis purchase-price allocations remained preliminary, with final valuations expected by Q1 and Q2 2012, respectively. Changes could materially affect goodwill and future depreciation or amortization. No goodwill impairment was recorded, but estimated fair value for regional and wholesale reporting units exceeded carrying value by less than 5%; a 25-basis-point higher discount rate would have required further impairment testing.
- Other risks and contingencies: Risks included ongoing wireline access-line losses, competition and price pressure, regulatory changes, integration execution, energy and power needs at data centers, and collective bargaining. Material Qwest litigation included KPNQwest claims seeking approximately €4.2 billion (about $5.7 billion at the cited exchange rate); the company said outcomes were uncertain and it could not estimate the timing or impact. The filing reported no material adverse effect expected from certain other proceedings, but outcomes were not predictable.
Most important facts for investors to verify
- Separate acquisition-driven revenue growth from underlying trends in legacy CenturyLink, Qwest and Savvis operations; review organic revenue, access-line losses and strategic-services growth.
- Track whether integration costs, anticipated savings and capital spending stay within management’s estimates, and whether operating margins recover.
- Assess debt reduction, refinancing availability, credit ratings, near-term maturities and compliance with leverage covenants.
- Review pension funding needs, the ability to sustain the dividend, and the final purchase-price allocations and resulting amortization expense.
- Monitor goodwill headroom and material litigation, particularly the KPNQwest matters, as well as regulatory outcomes affecting intercarrier compensation and universal service.