CenturyLink, Inc. (formerly CenturyTel, Inc.) — Q2 2010 Form 10-Q
Period: Quarter and six months ended June 30, 2010. This filing is by CenturyLink, not a filing under the later Lumen Technologies name. Financial statements are unaudited.
Business context and comparability
CenturyLink provided voice, broadband, data, network access and other communications services in 33 states, with approximately 6.8 million access lines and 2.3 million broadband customers at June 30, 2010. It reported one operating segment. Embarq was acquired July 1, 2009, so 2010 results include Embarq while the comparable 2009 reported results generally do not; management cautions that year-over-year comparisons are therefore less meaningful. The filing also reclassified certain revenues, with prior periods restated.
Key financial metrics
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Operating revenue | $1.772 billion | $634.5 million | $3.572 billion | $1.271 billion |
| Operating income | $523.0 million | $149.4 million | $1.068 billion | $313.8 million |
| Net income attributable to CenturyLink | $238.8 million | $69.0 million | $491.4 million | $136.2 million |
| Diluted earnings per share | $0.79 | $0.68 | $1.63 | $1.35 |
| Operating margin | 29.5% | 23.5% | 29.9% | 24.7% |
Margins are calculated from reported revenue and operating income; acquisition-related differences limit comparability. Interest expense was $143.2 million in Q2 and $285.5 million for the first half, substantially higher than the prior-year periods, largely because of Embarq debt. The six-month effective tax rate was 38.6%.
Cash flow, liquidity and debt: First-half operating cash flow was $881.2 million, investing cash use was $360.0 million, including $362.2 million of property and equipment payments, and financing cash use was $496.7 million. Cash increased $24.6 million to $186.4 million. At June 30, total debt was approximately $7.675 billion, comprising $496.6 million of current maturities and $7.179 billion of long-term debt. Current assets were $1.084 billion and current liabilities $1.630 billion. The company paid $436.9 million in dividends during the first half. It contributed $300 million to the legacy Embarq pension plan in Q1.
As of July 31, 2010, the company reported approximately $100 million drawn on its revolving facilities, $56 million of letters of credit outstanding, and no commercial paper borrowings. These are post-quarter figures. Approximately 97% of debt was fixed-rate; estimated debt fair value was $8.1 billion.
Material changes and unusual items
- Embarq accounted for approximately $2.486 billion of first-half 2010 revenue. Management attributed most reported revenue, expense and operating-income increases to the acquisition and also cited the changed treatment of intercompany transactions following the end of regulatory accounting.
- Excluding Embarq, legacy-market access-line losses and declines in voice and network access revenue continued. Access lines declined 146,300, or 2.1%, in Q2 and 272,000, or 3.9%, in the first half. DSL customer growth supported data revenue.
- First-half 2010 identified one-time items totaled $81.6 million, including $39.5 million of Embarq integration costs, $28.1 million of severance and accelerated share-based compensation, $10.0 million of Qwest transaction costs, and a $4.0 million Medicare subsidy tax charge.
- CenturyLink agreed to acquire Qwest in an all-stock transaction: Qwest holders would receive 0.1664 CenturyLink shares per Qwest share, with expected ownership of approximately 49.5% of the combined company for Qwest holders. Closing was anticipated in the first half of 2011, subject to shareholder, regulatory and other approvals. Either party could owe a $350 million termination fee in specified circumstances.
Outlook, commentary and risks
- Management budgeted 2010 capital expenditures of $825–875 million and estimated 2010 access-line losses of 7.5%–8.5%. It stated that voice and network access revenue pressures were expected to continue.
- The company stated its intention to continue current dividend practices, which represented an annualized $2.90 per common share, but emphasized that the board could change or suspend dividends and that cash needs, capital spending, regulation, debt covenants and credit ratings could affect payments.
- The FCC’s National Broadband Plan could reduce Universal Service Fund support and network access revenue; outcomes and effects remained uncertain. State proceedings could also put downward pressure on intrastate access rates.
- After the Qwest announcement, S&P placed the company’s BBB- debt rating under review for possible downgrade; Moody’s affirmed Baa3 but changed its outlook to negative. The filing warned that completing the Qwest deal would increase leverage and involve substantial integration costs and execution risks.
- Other key risks include continued wireline substitution and competition, successful integration of Embarq and potentially Qwest, pension funding and investment performance, access to credit markets, regulatory changes, and service or network disruptions. Management reported disclosure controls were effective as of June 30, 2010.
Investor verification priorities
- Confirm the Embarq acquisition’s effect on reported growth and compare with pro forma or legacy-business trends rather than treating reported year-over-year increases as organic growth.
- Track access-line losses, broadband customer growth, and voice/network access revenue trends against management’s 2010 estimate.
- Verify actual capital spending, operating cash flow, pension contributions, debt levels and refinancing needs against the stated outlook and facility availability.
- Monitor Qwest approval and closing status, transaction financing and leverage implications, termination-fee exposure, and integration costs.
- Assess dividend sustainability alongside cash requirements, debt covenants, credit ratings and potential regulatory reductions in support or access revenue.
- Review the status and potential exposure of disclosed litigation and other contingencies, including the Qwest-related matters and claims for more than $30 million in access charges that CenturyLink had not reserved.