CenturyLink, Inc. (now Lumen Technologies) — Q1 2018 Form 10-Q
Filing identity and period: The filing is by CenturyLink, Inc. for the three months ended March 31, 2018; it predates the company’s Lumen Technologies name. Financial amounts below are in U.S. dollars, generally millions unless stated otherwise.
Business context and reporting period
CenturyLink provides communications, broadband, data-network, IT and managed services to business and consumer customers. Level 3, acquired November 1, 2017, is included in Q1 2018 results but not in Q1 2017 reported results, making year-over-year comparisons materially affected by the acquisition. Level 3 contributed $2.062 billion of Q1 2018 revenue, net of intercompany eliminations. The company reported 5.0 million consumer broadband subscribers, down 6% from a year earlier.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $5,945 | $4,209 |
| Operating income | $750 | $631 |
| Operating margin | 12.6% | 15.0% |
| Net income | $115 | $163 |
| Diluted EPS | $0.11 | $0.30 |
| Net cash from operating activities | $1,667 | $1,057 |
| Capital expenditures and capitalized software | $805 | $780 |
| Cash, cash equivalents and restricted cash at quarter-end | $537 | $216 |
Revenue rose 41%, largely due to Level 3. Operating expenses increased 45%; lower net income reflected higher interest expense and other cost changes despite higher operating income. Interest expense was $535 million, up 68%. Cash flow from operations less reported capital expenditures was approximately $862 million; this is a simple calculation, not a company-defined free-cash-flow measure.
Reportable-segment adjusted EBITDA was $2.536 billion, with a 44% total margin. Business-segment adjusted EBITDA was $1.770 billion (40% margin); consumer-segment adjusted EBITDA was $766 million (56% margin). Segment EBITDA excludes, among other items, depreciation and amortization and interest.
At March 31, total debt was $37.377 billion, including $437 million of current maturities; cash and cash equivalents were $501 million. The company had $2.168 billion of available revolving-credit capacity and no borrowings outstanding on that facility. Current assets were $4.183 billion and current liabilities $4.767 billion. Debt covenants were reported as compliant.
Material changes versus the prior comparable period
- Reported revenue growth and the increase in business-segment revenue primarily reflect the inclusion of Level 3; they should not be read as organic growth. CenturyLink stated unaudited Q1 2017 pro forma combined revenue of $6.194 billion and net income of $172 million, while cautioning that pro forma figures are illustrative and not necessarily indicative.
- Consumer revenue decreased 5% to $1.379 billion, primarily because of continued traditional voice declines. Consumer broadband subscribers fell by 305,000 year over year.
- Reported business revenue increased 69% to $4.383 billion, largely from Level 3. CenturyLink also described ongoing weakness in legacy voice and transport/infrastructure revenue, including the effect of its 2017 data-center and colocation sale.
- Total debt decreased from $37.726 billion at December 31, 2017 to $37.377 billion at March 31, 2018. Quarterly dividends declared remained $0.54 per share; dividends paid were $580 million.
Outlook, commentary, risks and unusual items
- Capital allocation: Management projected approximately $3.850 billion of 2018 cash capital investment excluding integration capital, and estimated total capital expenditures at approximately 16% of revenue, including CAF Phase 2 and integration capital. It expected quarterly common dividends of approximately $576 million at the $0.54-per-share rate, subject to Board discretion.
- Taxes: Management expected Level 3 net operating losses to significantly reduce federal cash taxes for several years, subject to limitations and the company’s ability to use them. Accounting for the Tax Cuts and Jobs Act remained provisional; changes could materially affect future tax expense. A $64 million adjustment in Q1 reduced the previously recorded $1.1 billion tax-reform benefit.
- Acquisition and integration: Q1 included $70 million of Level 3 integration expenses and $1 million of transaction expenses. The preliminary purchase-price allocation remained subject to change, including acquired asset values and goodwill. Final fair-value determinations could differ significantly.
- Competition and operating trends: Management cited pricing pressure, technology substitution, declining legacy voice/access lines and private-line demand, and strong competition in broadband, cloud and colocation. These trends may weigh on revenue and margins. The company also cited network security, outages, regulation, integration execution, debt access and cash-generation risks.
- Unusual item: CenturyLink discontinued its Stream and over-the-top offerings effective March 31, 2018. The MD&A reports a $42 million impairment related to hardware, software and capitalized development costs; the cash-flow reconciliation separately lists $27 million of asset impairment. Investors should check the related financial-statement detail for the scope and reconciliation of these amounts.
- Contingencies: Disclosed matters include consumer and securities litigation relating to alleged sales practices, switched-access disputes, tax assessments and claims assumed with Level 3. Potential exposure in certain matters is described, but outcomes are uncertain and some losses cannot be estimated clearly.
- Other: The company expected a voluntary $100 million pension contribution during the remainder of 2018. It also reported that approximately 26% of employees were represented by unions and that agreements covering fewer than 1,000 employees had expired and were being renegotiated.
Important facts for investors to verify
- Separate acquisition-driven growth from organic trends, using comparable pro forma or segment data and the filing’s revenue-category disclosures.
- Track Level 3 integration spending, realized cost synergies, purchase-accounting revisions and any resulting changes in amortization, goodwill or earnings.
- Assess debt reduction, interest burden, refinancing needs, credit ratings, floating-rate exposure and liquidity relative to capital investment and dividends.
- Monitor consumer broadband subscriber losses, traditional voice declines, pricing pressure and segment margins.
- Follow the final tax-reform accounting, the usability and limitations of acquired NOLs, and any material developments in litigation and regulatory contingencies.