Business context and reporting period
This is CenturyLink, Inc.’s Form 10-K for the fiscal year ended December 31, 2017; the filing predates the company’s later Lumen Technologies name. It covers a communications provider serving business, wholesale, government and residential customers. Level 3 was acquired on November 1, 2017, so 2017 results include only two months of Level 3 operations and are not directly comparable with 2016. The fourth-quarter figures below are unaudited.
CenturyLink acquired Level 3 for preliminary aggregate consideration of $19.617 billion, including cash and 517.3 million CenturyLink shares; the combined company was approximately 51% owned by legacy CenturyLink shareholders and 49% by former Level 3 shareholders. In May 2017, it sold its data center and colocation business for $1.8 billion in cash proceeds and a minority stake in Cyxtera.
Financial and operating results
| Metric | FY 2017 | FY 2016 | Change / context |
|---|---|---|---|
| Revenue | $17.656 billion | $17.470 billion | Up 1%; includes $1.39 billion of post-acquisition Level 3 revenue. Legacy CenturyLink revenue fell $1.204 billion. |
| Operating income | $2.009 billion | $2.333 billion | Down 14%; operating margin was approximately 11.4%, versus 13.3%. |
| Net income | $1.389 billion | $626 million | FY 2017 includes a roughly $1.1 billion tax benefit from the Tax Cuts and Jobs Act. |
| Operating cash flow | $3.878 billion | $4.608 billion | Down $730 million. |
| Capital expenditures and capitalized software | $3.106 billion | $2.981 billion | Operating cash flow less this spending was approximately $772 million in 2017; this simple measure is not company-defined free cash flow. |
| Cash and cash equivalents | $551 million | $222 million | Year-end balance. |
| Total long-term debt on balance sheet | $37.726 billion | $19.993 billion | Includes the effect of the Level 3 acquisition; reported principal debt was $37.162 billion excluding certain discounts, issuance costs, leases and other obligations. |
| Interest expense | $1.481 billion | $1.318 billion | Up 12%, primarily reflecting acquisition financing and assumed Level 3 debt. |
At year-end, $1.595 billion of borrowing capacity was available under the revolving credit facility. Total assets were $75.611 billion and stockholders’ equity was $23.491 billion. Pension and post-retirement plans were underfunded by approximately $2.062 billion and $3.352 billion, respectively.
FY 2017 reported revenue increased despite declines in the legacy business: voice and collaboration revenue fell 4%, transport and infrastructure fell 4%, and IP and data services increased 20%, principally reflecting Level 3’s inclusion. Consumer-segment revenue declined 6% to $5.704 billion, and its margin declined to 55% from 56%. Business-segment revenue rose 5% to $11.220 billion, but its margin declined to 39% from 40%.
For Q4 2017, revenue was $5.323 billion, operating income $524 million and net income $1.117 billion, compared with $4.289 billion, $405 million and $42 million, respectively, in Q4 2016. The year-over-year comparison is affected by Level 3’s inclusion and the large Q4 tax benefit.
Material changes, outlook and risks
- Transactions and unusual items: Acquisition-related expenses were $271 million in 2017. The data-center sale was accounted for as a failed sale-leaseback; related accounting reduced 2017 net income by $103 million, and a combined $82 million loss was recorded in selling, general and administrative expense. The filing expected similar non-cash adjustments in 2018.
- Outlook: Management estimated 2018 capital investment of $3.8–$3.9 billion, excluding integration capital, and approximately $2.3 billion of common dividends if the quarterly rate remained $0.54 per share. It estimated 2018 cash income taxes of approximately $100 million, excluding a pending refund request, and expected Level 3 tax-loss carryforwards to reduce federal cash taxes, subject to limitations and uncertainty.
- Integration and financing: Management cited expected scale, market diversification and network benefits from Level 3, but cautioned that integration costs could exceed savings in the near term and that anticipated synergies might not be achieved. The acquisition materially increased debt; a 100-basis-point increase in LIBOR was estimated to reduce annual pre-tax earnings by $131 million.
- Operating and regulatory risks: The filing describes persistent wireline voice and access-line losses, price pressure, competition in broadband and enterprise services, significant network investment needs, cyber and service-outage risks, and reliance on other carriers and suppliers. CAF Phase 2 support was approximately $500 million annually for six years, tied to infrastructure commitments for about 1.2 million rural locations in 33 states; failure to meet requirements could jeopardize funding and lead to penalties.
- Contingencies and customer billing: A board special committee reviewing consumer sales and billing found sales monitoring was insufficient and that ordering, billing software, systems and human errors contributed to customer confusion or inaccurate bills. Related consumer, shareholder and state proceedings were pending. The filing also identifies switched-access disputes, state tax litigation and inherited Level 3 matters; outcomes were uncertain.
- Reporting and controls: The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Level 3, representing 8% of consolidated revenue and 15% of specified assets, was excluded from the 2017 internal-control assessment while integration was underway. Level 3 purchase-price allocation remained preliminary.
Important facts for investors to verify
- How the combined company’s revenue, margins, cash flow and customer trends developed after the two-month Level 3 contribution in 2017.
- Whether integration costs, cost savings and network synergies meet management’s expectations, and whether purchase accounting adjustments materially change reported results.
- Debt repayment, refinancing capacity, leverage covenants, interest-rate exposure and the sustainability of the $0.54 quarterly dividend.
- Actual 2018 capital spending, CAF buildout progress, cash taxes and the availability and Section 382 limitations of acquired tax-loss carryforwards.
- Developments in consumer billing litigation and controls, switched-access and tax disputes, other contingencies, and the eventual costs of pension and post-retirement obligations.