Business context and reporting period
CenturyLink, Inc. (the company now known as Lumen Technologies, Inc.) filed this unaudited Form 10-Q for the quarter ended March 31, 2013. It provides communications services to residential, business, government, and wholesale customers, as well as data hosting and cloud services. The company reported 13.6 million access lines, 5.9 million broadband subscribers, and 54 data centers at quarter-end. Management cautions that first-quarter results are not necessarily indicative of full-year results.
Financial and operating performance
- Revenue: $4.513 billion, down 2% from $4.610 billion. Strategic-services revenue rose 4% to $2.142 billion, while legacy-services revenue fell 8% to $1.974 billion.
- Profitability: Operating income increased to $782 million from $654 million; operating margin was approximately 17.3%, versus 14.2%. Net income was $298 million, up from $200 million, and diluted EPS was $0.48 versus $0.32. The effective tax rate increased to 41.0% from 39.6%.
- Expenses: Operating expenses declined 6% to $3.731 billion. Cost of services, SG&A, and depreciation and amortization all decreased year over year.
- Cash flow and investment: Cash from operations was $1.387 billion, down from $1.583 billion. Capital expenditures and capitalized software were $663 million, implying approximate operating cash flow less capex of $724 million, compared with $905 million. Cash at quarter-end was $476 million.
- Debt and liquidity: Total debt was approximately $20.8 billion, including $1.193 billion of current maturities. The company had $1.925 billion available under its $2.0 billion revolving facility and reported a $708 million working-capital deficit. It issued $1.0 billion of 5.625% notes due 2020 for net proceeds of about $988 million.
- Shareholder returns: The company declared dividends of $0.54 per share, down from $0.725. It repurchased 11.1 million shares for $386 million during the quarter, under a new $2 billion authorization.
Material changes versus the prior comparable period
- Revenue declined as ongoing access-line losses and customer migration away from traditional services outweighed growth in strategic offerings. Access lines were down 5.7% year over year, while broadband subscribers increased 3.0%.
- Lower operating expenses and depreciation, together with reduced interest expense, supported higher operating income and net income despite lower revenue. Other income included a $32 million gain on the sale of wireless spectrum.
- Business segment income increased to $623 million from $598 million, and its margin improved to 41.4% from 39.7%. Consumer income was $985 million versus $997 million; wholesale income was $633 million versus $650 million. Data-hosting revenue grew 8%, but income fell to $70 million from $79 million as growth investments increased expenses.
- The company reorganized reporting into consumer, business, wholesale, and data-hosting segments; comparative segment results were restated. The change did not affect total revenue, operating expenses, or net income.
- Operating cash flow fell by $196 million, primarily reflecting changes in retirement-benefit payments and working-capital items. Financing cash flow shifted from $481 million provided in 2012 to $538 million used in 2013, including the stock repurchases.
Outlook, commentary, risks, and unusual items
- Management estimated 2013 access-line losses of 5.4%–5.9% and full-year capital expenditures of approximately $2.8–$3.0 billion. It expected second-quarter operating expenses to rise from first-quarter levels, citing seasonality, strategic investment, and higher data-integration costs.
- The company expected to continue its quarterly dividend practice, subject to board discretion, and anticipated using cash from operations and available credit to meet obligations, fund capital expenditures, and pay dividends.
- Management identified competition, technology shifts, regulation, and migration from legacy voice services as continuing pressures. Strategic-service growth, bundling, broadband and video investment, cloud offerings, and cost efficiencies are intended to offset those pressures; success and timing are uncertain.
- Credit agencies downgraded CenturyLink ratings following capital-allocation changes. Management warned of potentially higher borrowing costs and possible limits on capital-market access. About $2.2 billion of debt securities mature over the next 36 months, including approximately $750 million of Qwest notes due in June 2013.
- Pension and post-retirement obligations were materially underfunded at year-end 2012: $2.6 billion for pension plans and $3.4 billion for other post-retirement benefits. The company contributed $147 million to pension trusts in Q1 and did not expect further required contributions for the rest of 2013.
- Significant litigation includes Dutch KPNQwest proceedings in which plaintiffs seek approximately €4.2 billion (about $5.4 billion) plus interest; the company had not accrued a liability and said outcomes were uncertain. Railroad-right-of-way class actions had settlements approved in some states, with other approvals pending; the accrued amount was described as immaterial.
- Approximately 12,000 employees were covered by collective bargaining agreements that expired in October 2012 and had been extended during negotiations. The filing cites potential labor disruption, alongside cybersecurity, network capacity, regulatory, refinancing, acquisition-integration, and data-center power and lease risks.
- The company said it remained in compliance with debt covenants and that disclosure controls were effective; it reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether strategic-service growth and cost reductions can offset continuing access-line and legacy-revenue declines.
- Cash generation after capital expenditures, pension funding, dividends, and the ongoing share-repurchase program.
- Debt refinancing capacity, rating effects, covenant headroom, and the upcoming 2013 maturities.
- Progress and potential exposure in the KPNQwest and other legal proceedings, and labor-contract negotiations.
- Execution and returns on planned capital spending, broadband and video initiatives, and data-hosting/cloud investments.
- Dividend sustainability and the board’s capital-allocation priorities; the filing states that dividend policy may change at the board’s discretion.