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CENTURYLINK, INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) Unless the context requires otherwise, references in this report to
"CenturyLink," "we," "us" and "our" refer to CenturyLink, Inc. and its
consolidated subsidiaries, including Qwest Communications International Inc. and
its consolidated subsidiaries (referred to as "Qwest") for periods on or after
April 1, 2011 and including SAVVIS, Inc. and its consolidated subsidiaries
(referred to as "Savvis") for periods on or after July 15, 2011.
All references to "Notes" in this Item 2 refer to the Notes to Consolidated
Financial Statements included in Item 1 of this quarterly report.
Certain statements in this report constitute forward-looking statements. See
the last paragraph of this Item 2 and "Risk Factors" in Item 1A of Part II of
this report for a discussion of certain factors that could cause our actual
results to differ from our anticipated results.
Overview
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") included herein should be read in conjunction with MD&A and
the other information included in our Annual Report on Form 10-K for the year
ended December 31, 2011. The results of operations for the first nine months of
the year are not indicative of the results of operations that might be expected
for the entire year.
We are an integrated communications company engaged primarily in providing
an array of communications services to our residential, business, governmental
and wholesale customers. Our communications services include local and
long-distance, network access, private line (including special access), public
access, broadband, data, managed hosting (including cloud hosting), colocation,
wireless, and video services. In certain local and regional markets, we also
provide local access and fiber transport services to competitive local exchange
carriers and security monitoring services. We strive to maintain our customer
relationships by, among other things, bundling our service offerings to provide
our customers with a complete offering of integrated communications services.
As of September 30, 2012, we operated 13.9 million access lines in 37
states, and served 5.8 million broadband subscribers. During the second quarter
of 2012, we updated our methodology for counting broadband subscribers to
include residential, business and wholesale subscribers instead of only
residential and small business subscribers. We have restated our previously
reported amounts to reflect this change. Our access line count includes only
those access lines that we use to provide services to external customers and
excludes lines used solely by us and our affiliates. Our counting methodology
also excludes unbundled loops and includes stand-alone broadband subscribers.
Our counting methodology may not be comparable to those of other companies. We
also operate 53 data centers throughout North America, Europe and Asia.
Our consolidated financial statements include the accounts of
CenturyLink, Inc. ("CenturyLink") and its majority-owned subsidiaries. These
subsidiaries include Savvis beginning July 15, 2011, and Qwest beginning
April 1, 2011. For more information, see Note 2-Acquisitions. Due to the
significant size of these acquisitions, direct comparisons of our consolidated
results of operations for the three and nine months ended September 30, 2012 to
the three and nine months ended September 30, 2011 are less meaningful than
usual. We discuss below, under "Segment Results", certain trends that we believe
are significant to the combined company.
In the discussion that follows, we refer to the incremental business
activities that we now operate as a result of the Savvis acquisition and the
Qwest acquisition as "Legacy Savvis" and "Legacy Qwest", respectively.
References to "Legacy CenturyLink", when used in reference to a comparison of
our consolidated results for the nine months ended September 30, 2012 and 2011,
mean the business we
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operated prior to the Qwest and Savvis acquisitions, and, when used in reference
to a comparison of our consolidated results for the three months ended
September 30, 2012 and 2011, mean the business we operated immediately prior to
the Savvis acquisition on July 15, 2011.
We have incurred operating expenses related to our acquisition of Savvis in
July 2011, Qwest in April 2011 and Embarq Corporation ("Embarq") in July 2009.
These expenses are reflected in cost of services and products and selling,
general and administrative expenses in our consolidated statements of operations
as summarized below.
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
(Dollars in millions)
Cost of services and products (exclusive
of depreciation and amortization):
Integration and other expenses
associated with acquisitions $ 4 14 13 39
Severance expenses, accelerated
recognition of share-based awards and
retention compensation associated with
acquisitions - 3 - 18
$ 4 17 13 57
Selling, general and administrative:
Integration and other expenses
associated with acquisitions $ 9 89 22 211
Severance expenses, accelerated
recognition of share-based awards and
retention compensation associated with
acquisitions 4 (2) 33 137
$ 13 87 55 348
This table does not include costs incurred by Qwest or Savvis prior to being
acquired by us. Based on current plans and information, we estimate that, in
relation to our Qwest acquisition, we expect integration expenses to be between
$600 to $700 million (which includes approximately $455 million of cumulative
expenses incurred through September 30, 2012) and our capital expenditures
associated with integration activities will approximate $200 million (which
includes approximately $52 million of cumulative capital expenditures incurred
through September 30, 2012). We anticipate that the amount of our integration
costs in future quarters will vary substantially based on integration activities
conducted during those periods and could in certain cases be significantly
higher than those incurred by us during the three months ended September 30,
2012.
Effective April 1, 2012, in order to more effectively leverage the strategic
assets from our recent acquisitions of Embarq, Qwest and Savvis to better serve
our business and government customers, we internally restructured our business
into the following operating segments:
º •
º Regional markets, which consists primarily of providing products and
services to residential consumers, state and local governments, small
to medium-sized businesses and enterprise customers that in each case
are located mainly within one of our six regions;
º •
º Wholesale markets, which consists primarily of providing products and
services to other domestic and international communications providers;
º •
º Enterprise markets-network, which consists primarily of providing
network communications products and services to national and
international enterprise and government customers; and
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º •
º Enterprise markets-data hosting, which consists primarily of providing
colocation, managed hosting and cloud services to national and
international enterprise and government customers.
We report financial information separately for each of these segments;
however, as described in further detail below, our segment information does not
include capital expenditures, total assets, or certain revenues and expenses
that we manage on a centralized basis. As we continue to integrate our recent
acquisitions, we plan to make additional changes to the way we assess
performance and make decisions about allocating resources, which could further
change our segment reporting. Our segment results are not necessarily indicative
of the results of operations that our segments would have achieved had they
operated as stand-alone entities during the periods presented. For additional
information about our segments, see Note 9-Segment Information and "Results of
Operations-Segment Results" below.
Results of Operations
The following table summarizes the results of our consolidated operations
for the three and nine months ended September 30, 2012 and 2011, presented in a
manner that we believe will be useful for understanding the relevant trends
affecting our business. Our operating results include operations of Savvis for
periods after July 15, 2011 and Qwest for periods after April 1, 2011.
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
(Dollars in millions except per share amounts)
Operating revenues $ 4,571 4,596 13,793 10,698
Operating expenses 3,835 4,048 11,746 9,206
Operating income 736 548 2,047 1,492
Other income (expense) (314) (317) (1,171) (736)
Income tax expense 152 93 332 292
Net income $ 270 138 544 464
EARNINGS PER COMMON SHARE
Basic $ .43 .22 .88 .91
Diluted $ .43 .22 .87 .91
The following table summarizes certain of our operational metrics:
As of September 30, Increase /
2012 2011 (Decrease) % Change
(in thousands)
Broadband subscribers 5,807 5,579 228 4%
Access lines 13,946 14,803 (857) (6)%
Employees 46.5 49.3 (2.8) (6)%
During the second quarter of 2012, we updated our methodology for counting
broadband subscribers to include residential, business and wholesale subscribers
instead of only residential and small business subscribers. We have restated our
previously reported amounts to reflect this change.
During the last several years, we have experienced revenue declines
(excluding the impact of acquisitions) primarily due to declines in access
lines, intrastate access rates and minutes of use. Prior to its acquisition,
Qwest had experienced similar declines in its revenues. To mitigate these
declines, we remain focused on efforts to, among other things:
º •
º promote long-term relationships with our customers through bundling of
integrated services;
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º •
º provide new services, such as video, cloud hosting, managed hosting,
colocation services and other additional services that may become
available in the future due to advances in technology or improvements
in our infrastructure;
º •
º provide our broadband and premium services to a higher percentage of
our customers;
º •
º pursue acquisitions of additional assets if available at attractive
prices;
º •
º increase usage of our networks; and
º •
º market our products and services to new customers.
Operating Revenues
We currently categorize our products, services and revenues among the
following four categories:
º •
º Strategic services, which include primarily broadband, private line
(including special access which we market to wholesale and business
customers who require dedicated equipment to transmit large amounts of
data between sites), Multi-Protocol Label Switching ("MPLS") (which is
a data networking technology that can deliver the quality of service
required to support real-time voice and video), hosting (including
cloud hosting and managed hosting), colocation, Ethernet, video
(including resold satellite and our facilities-based video services),
voice over Internet Protocol ("VoIP") and Verizon Wireless services;
º •
º Legacy services, which include primarily local, long-distance,
switched access, public access, integrated services digital network
("ISDN") (which uses regular telephone lines to support voice, video
and data applications), and traditional wide area network ("WAN")
services (which allows a local communications network to link to
networks in remote locations);
º •
º Data integration, which includes the sale of telecommunications
equipment located on customers' premises and related professional
services, such as network management, installation and maintenance of
data equipment and building of proprietary fiber-optic broadband
networks for our government and business customers; and
º •
º Other, which consists primarily of universal service fund ("USF")
revenue and surcharges. Unlike the first three revenue categories,
other revenues are not included in our segment revenues.
Our total operating revenues increased for the nine months ended
September 30, 2012 due primarily to our acquisitions of Qwest and Savvis.
The following tables summarize our operating revenues:
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Strategic services $ 2,101 1,960 100 41 141
Legacy services 2,045 2,223 (178) - (178)
Data integration 168 166 2 - 2
Other 257 247 10 - 10
Total operating revenues $ 4,571 4,596 (66) 41 (25)
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Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Strategic services $ 6,237 4,229 216 1,207 585 2,008
Legacy services 6,284 5,494 (458) 1,248 - 790
Data integration 483 349 18 116 - 134
Other 789 626 31 132 - 163
Total operating revenues $ 13,793 10,698 (193) 2,703 585 3,095
As noted in the tables above, total operating revenues decreased $25 million
for the three months ended September 30, 2012 due primarily to a decline in
legacy services revenues relating principally to the continuing loss of access
lines in our markets. We believe the decline in the number of access lines was
primarily due to the displacement of traditional wireline telephone services by
other competitive products and services. We estimate that our access lines loss
will be between 5.6% and 6.0% in 2012. Our legacy services revenues were also
negatively impacted in 2012 by the continued migration of customers to bundled
service offerings at lower effective rates. The decreases in our legacy services
revenues were partially offset by higher revenues from strategic services
revenues. Ethernet, MPLS, Internet Protocol Television ("IPTV"), Competitive
Local Exchange Carriers ("CLEC") and broadband services accounted for a majority
of the growth in strategic services revenues.
Legacy CenturyLink operating revenues decreased $193 million during the nine
months ended September 30, 2012 as compared to the nine months ended
September 30, 2011, primarily due to the factors cited above for the three
months ended September 30, 2012.
Further analysis of our operating revenues by segment is provided below in
"Segment Results."
Operating Expenses
Our operating expenses increased substantially for the nine months ended
September 30, 2012, in comparison to 2011 primarily due to our acquisitions of
Qwest and Savvis.
The following tables summarize our operating expenses:
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Cost of services and products
(exclusive of depreciation and
amortization) $ 1,943 1,950 (29) 22 (7)
Selling, general and
administrative 748 870 (132) 10 (122)
Depreciation and amortization 1,144 1,228 (96) 12 (84)
Total operating expenses $ 3,835 4,048 (257) 44 (213)
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Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Cost of services and
products (exclusive of
depreciation and
amortization) $ 5,732 4,357 (12) 1,082 305 1,375
Selling, general and
administrative 2,454 2,075 (257) 483 153 379
Depreciation and
amortization 3,560 2,774 (117) 741 162 786
Total operating expenses $ 11,746 9,206 (386) 2,306 620 2,540
For the three and nine months ended September 30, 2012, Legacy CenturyLink
cost of services and products (exclusive of depreciation and amortization) were
slightly lower as compared to the comparable periods in 2011. During the
periods, we experienced decreases in severance and salaries and wages, which
were partially offset by increases in customer premise equipment and maintenance
costs, network expense, and contractor costs.
Legacy CenturyLink's selling, general and administrative expenses decreased
for the three and nine months ended September 30, 2012 primarily due to a
decrease in severance and integration expenses relating to our recent
acquisitions, as well as a decrease in salaries, wages, and employee benefits
due to a reduction in headcount. As discussed in the "overview" section, our
selling general and administrative expenses for the three and nine months ended
September 30, 2011 included substantial severance and integration costs related
to the Qwest acquisition. See Note 2-Acquisitions.
Effective January 1, 2012, we changed our rates of capitalized labor as we
transitioned certain of Qwest's legacy systems to our historical company
systems. This transition resulted in an estimated $30 million to $45 million
increase in the amount of labor capitalized as an asset compared to the amount
that would have been capitalized if Qwest had continued to use its legacy
systems and a corresponding estimated $30 million to $45 million decrease in
operating expenses for the nine months ended September 30, 2012. This change is
expected to result in an estimated operating expense reduction of approximately
$35 million to $60 million for the year ending December 31, 2012.
Excluding the effects of the acquisitions of Qwest and Savvis, depreciation
and amortization expense for Legacy CenturyLink decreased due to annual updates
of our depreciation rates for capitalized assets and an out-of-period accounting
adjustment, partially offset by net growth in capital assets.
Further analysis of our operating expenses by segment is provided below in
"Segment Results."
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Other Consolidated Results
The following tables summarize our total other income (expense) and income
tax expense:
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Interest expense $ (326) (324) (1) 3 2
Other income (expense) 12 7 5 - 5
Total other income (expense) $ (314) (317) (6) 3 (3)
Income tax expense 152 93 nm nm 59
Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Interest expense $ (1,004) (732) 87 169 16 272
Net loss on early retirement
of debt (194) (1) 201 (8) - 193
Other income (expense) 27 (3) (30) (1) 1 (30)
Total other income (expense) $ (1,171) (736) 258 160 17 435
Income tax expense 332 292 nm nm nm 40
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nm-We believe it is not meaningful to attribute changes in income tax expense to
the acquisitions of Savvis or Qwest.
Interest Expense
Interest expense for the three months ended September 30, 2012 was fairly
flat when compared to a year ago. However, this was due substantially to a
significant reduction in the amortization of Qwest debt premiums recorded at
acquisition as a result of various debt redemptions offset by a significant net
reduction in bond coupon interest due to several refinancings along with
increased capitalized interest. See "Liquidity and Capital Resources" for the
details of the debt redemptions and refinancing.
Interest expense for the nine months ended September 30, 2012 increased by
$272 million compared to the year ago period. This increase is primarily due to
the 2012 period containing nine months of Qwest interest expense compared to the
2011 period only containing six months.
The increase in interest expense attributable to Legacy CenturyLink was due
primarily to the issuance of $2 billion in notes in June 2011 to fund the cash
portion of the acquisition of Savvis.
Net Loss on Early Retirement of Debt
In the second quarter of 2012, our subsidiaries Embarq and QC completed
premium-priced cash tender offers for the purchase of certain of their
respective outstanding debt securities, resulting in an aggregate loss of
$193 million. Also in the second quarter of 2012, Embarq and our subsidiary
Qwest Communications International Inc. ("QCII") redeemed certain of their
respective outstanding debt securities which resulted in a net loss of
$9 million.
In the first quarter of 2012, QCII redeemed certain of its outstanding debt
securities, which resulted in a gain of $8 million.
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Other Income (Expense)
Other income (expense) reflects certain items not directly related to our
core operations, including our share of income from our 49% interest in a
cellular partnership, interest income, gains and losses from non-operating asset
dispositions and impairments and foreign currency gains and losses. Other income
(expense) was greater for the three months ended September 30, 2012 as compared
to the three months ended September 30, 2011 due primarily to a gain on the sale
of our auction rate securities. Other income (expense) was greater for the nine
months ended September 30, 2012 as compared to the nine months ended
September 30, 2011 due to gains on the sales of our auction rate securities and
the recognition of a one-time $16 million fee paid in June 2011 relating to the
acquisition of Savvis.
Income Tax Expense
Income tax expense for the nine months ended September 30, 2012 and 2011 was
$332 million and $292 million, respectively. The effective tax rate for the nine
months ended September 30, 2012 was 37.9% compared to 38.7% for the comparative
prior year period. The 2012 year-to-date effective tax rate reflects the
reversal of a valuation allowance related to the auction rate securities, while
the 2011 year-to-date effective tax rate reflects the effects of a valuation
allowance reversal related to a state net operating loss, which is partially
offset by the effects of non-deductible transaction costs.
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Segment Results
General
We have restated previously reported segment results due to the
above-described reorganization of our business. Segment results are summarized
below:
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
(Dollars in millions)
Total segment revenues $ 4,314 4,349 13,004 10,072
Total segment expenses 2,037 2,043 6,039 4,428
Total segment income $ 2,277 2,306 6,965 5,644
Total margin percentage 53% 53% 54% 56%
Regional markets:
Revenues $ 2,468 2,522 7,431 6,199
Expenses 1,079 1,092 3,158 2,592
Income $ 1,389 1,430 4,273 3,607
Margin percentage 56% 57% 58% 58%
Wholesale markets:
Revenues $ 908 982 2,813 2,344
Expenses 273 307 846 708
Income $ 635 675 1,967 1,636
Margin percentage 70% 69% 70% 70%
Enterprise markets-network:
Revenues $ 658 622 1,938 1,298
Expenses 466 479 1,402 961
Income $ 192 143 536 337
Margin percentage 29% 23% 28% 26%
Enterprise markets-data hosting:
Revenues $ 280 223 822 231
Expenses 219 165 633 167
Income $ 61 58 189 64
Margin percentage 22% 26% 23% 28%
In connection with the internal reorganization of our segments effective
April 1, 2012, we also revised the way we categorize our segment revenues and
segment expenses. Our major categories of segment revenues are strategic
services, legacy services and data integration, each of which is described in
more detail in "Operating Revenues" above.
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As indicated in Note 9-Segment Information, we have the following four
segments, which currently derive revenues from the following categories of
products and services:
Segment Revenues
Regional Markets Strategic, Legacy and Data Integration
Wholesale Markets Strategic and Legacy
Enterprise Markets-Network Strategic, Legacy and Data Integration
Enterprise Markets-Data Hosting Strategic
We report our segment expenses for our four segments as follows:
º •
º Direct expenses, which primarily are specific expenses incurred as a
direct result of providing services and products to segment customers,
along with selling, general and administrative expenses that are
directly associated with specific segment customers or activities; and
º •
º Allocated expenses, which include network expenses, facilities
expenses and other expenses such as fleet and real estate expenses.
During the first quarter of 2012, as we transitioned certain of Qwest's
legacy systems to our historical company systems, we updated our methodologies
for reporting our direct expenses and for allocating our expenses to our
segments. Specifically, we no longer include certain fleet expenses for our
regional markets segment in direct expenses; they are now expenses allocated to
our segments, with the exception of enterprise markets-data hosting. In
addition, we now more fully allocate network building rent and power expenses to
our regional markets, wholesale markets and enterprise markets-network segments.
We determined that it was impracticable to recast our segment results for prior
periods to reflect these changes in methodology.
During the second quarter of 2012, as we reorganized our business into our
four segments as indicated above, we further revised our methodology for how we
allocate our expenses to our segments to better align segment expenses with
related revenues. Under our revised methodology, we no longer allocate certain
product development costs to our segments, but we do now allocate certain
expenses from our enterprise markets-data hosting segment to our other three
segments. We have restated prior periods to reflect these changes in our
methodology.
We do not assign depreciation and amortization expense to our segments, as
the related assets and capital expenditures are centrally managed. Similarly,
severance expenses, restructuring expenses and, subject to an exception for our
enterprise markets-data hosting segment, certain centrally managed
administrative functions (such as finance, information technology, legal and
human resources) are not assigned to our segments. Interest expense is also
excluded from segment results because we manage our financing on a total company
basis and have not allocated assets or debt to specific segments. In addition,
other income (expense) does not relate to our segment operations and is
therefore excluded from our segment results. Our segment results do not include
any intersegment revenue or expenses.
Regional Markets
The operations of our regional markets segment have been impacted by several
significant trends, including those described below.
º •
º Strategic services. We continue to focus on increasing subscribers of
our broadband services in our regional markets segment. In order to
remain competitive, we believe continually increasing connection
speeds is important. As a result, we continue to invest in our fiber
to the node ("FTTN") deployment, which allows for the delivery of
higher speed broadband services. While traditional broadband services
are declining, they have been more than offset by growth in
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fiber-based broadband services. We also continue to expand our product
offerings including facilities-based video services, Ethernet, MPLS
and other managed services and we continue to enhance our marketing
efforts as we compete in a maturing market in which most consumers
already have broadband services. We expect these efforts will improve
our ability to compete and increase our strategic revenues.
º •
º Facilities-based video expenses. As we continue to expand our
facilities-based video service infrastructure, we are incurring
start-up expenses in advance of the revenue that this service is
expected to generate. Although, over time, we expect that our revenue
for facilities-based video services will offset the expenses incurred,
the timing of this revenue growth is uncertain.
º •
º Access lines. Our voice revenues have been, and we expect they will
continue to be, adversely affected by access line losses. Intense
competition and product substitution continue to drive our access line
losses. For example, many consumers are substituting cable and
wireless voice and electronic mail, texting and social networking
services for traditional voice telecommunications services. We expect
that these factors will continue to negatively impact our business. As
a result of the expected loss of access line revenues, we continue to
offer service bundling and other product promotions to help mitigate
this trend, as described below.
º •
º Service bundling and product promotions. We offer our customers the
ability to bundle multiple products and services. These customers can
bundle local services with other services such as broadband, video,
long-distance and wireless. While our video and wireless services are
an important piece of our customer retention strategy, they do not
significantly contribute to our strategic services revenues. However,
we believe customers value the convenience of, and price discounts
associated with, receiving multiple services through a single company.
While bundle price discounts have resulted in lower average revenues
for our individual products, we believe service bundles continue to
positively impact our customer retention and our ability to compete
with other telecommunications service providers. In addition to our
bundle discounts, we also offer from time to time limited time
promotions on our broadband service, which we believe further aids our
ability to attract and retain customers and increase usage of our
services.
º •
º Data integration. We expect both data integration revenue and the
related costs will fluctuate from quarter to quarter as this offering
tends to be more sensitive than others to changes in the economy and
in spending trends of our state and local government customers.
º •
º Operating efficiencies. We continue to evaluate our operating
structure and focus. This involves balancing our segment workforce in
response to our workload requirements, productivity improvements and
changes in industry, competitive, technological and regulatory
conditions.
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The following tables summarize the results of operations from our regional
markets segment:
Regional Markets Segment
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 912 845 67 - 67
Legacy services 1,491 1,599 (108) - (108)
Data integration 65 78 (13) - (13)
Total revenues 2,468 2,522 (54) - (54)
Segment expenses:
Direct 1,002 1,028 (26) - (26)
Allocated 77 64 13 - 13
Total expenses 1,079 1,092 (13) - (13)
Segment income $ 1,389 1,430 (41) - (41)
Segment margin percentage 56% 57%
Regional Markets Segment
Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 2,693 2,008 136 546 3 685
Legacy services 4,541 4,018 (279) 802 - 523
Data integration 197 173 (8) 32 - 24
Total revenues 7,431 6,199 (151) 1,380 3 1,232
Segment expenses:
Direct 2,945 2,455 (24) 514 - 490
Allocated 213 137 53 20 3 76
Total expenses 3,158 2,592 29 534 3 566
Segment income $ 4,273 3,607 (180) 846 - 666
Segment margin percentage 58% 58%
Segment Income
Regional markets segment income decreased for the three months ended
September 30, 2012 compared to the three months ended September 30, 2011. The
acquisition of Qwest on April 1, 2011 largely contributed to an increase in our
regional markets segment income for the nine months ended September 30, 2012 as
compared to the nine months ended September 30, 2011.
Segment Revenues
Excluding revenues attributable to the Qwest and Savvis acquisitions,
regional markets revenues decreased for the three and nine months ended
September 30, 2012 as compared to the three and nine months ended September 30,
2011 due to declines in legacy services revenues, partially offset by growth in
strategic services revenues. Legacy services revenues decreased primarily due to
declines in local and long-distance services associated principally with access
line losses resulting from the competitive pressures and product substitution
further described previously. Growth in strategic services revenues
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was due principally to increases in the number of broadband subscribers as well
as volume increases in our facilities-based video, Ethernet, and MPLS services.
Segment Expenses
Regional markets total expenses decreased for the three months ended
September 30, 2012 compared to the three months ended September 30, 2011 due
primarily to decreases in salaries and related benefits.
Regional markets total expenses, exclusive of Legacy Qwest and Legacy Savvis
expenses, increased for the nine months ended September 30, 2012 as compared to
the nine months ended September 30, 2011, due to an increase in allocated
expenses. Allocated expenses increased primarily due to our updated methodology
more fully allocating to our segments network and building rent and related
power expenses. Direct expenses decreased due to decreases in employee related
expenses, fleet expenses, and marketing costs, and were partially offset by
increases in customer premise equipment costs and network service costs.
Wholesale Markets
The operations of our wholesale markets segment have been impacted by
several significant trends, including those described below:
º •
º Private line services (including special access). Demand for our
private line services continues to increase, despite our customers'
optimization of their networks, industry consolidation and
technological migration. While we expect that these factors will
continue to negatively impact our wholesale markets segment, we
ultimately believe the bandwidth consumption growth in our fiber-based
special access services provided to wireless carriers for backhaul
will, over time, offset the decline in copper-based special access
services provided to wireless carriers as they migrate to Ethernet
services, although the timing and magnitude of this technological
migration is uncertain.
º •
º Access and local services revenues. Our access and local services
revenues have been and we expect will continue to be, adversely
affected by technological migration, industry consolidation,
regulation and rate reductions. For example, wholesale consumers are
substituting cable, wireless and VoIP services for traditional voice
telecommunications services, resulting in continued access revenue
loss. We expect these factors will continue to adversely impact our
wholesale markets segment.
º •
º Switched access revenues. We believe that changes related to the
Connect America and Intercarrier Compensation Reform order ("CAF
order") adopted by the Federal Communications Commission ("FCC") on
October 27, 2011 will substantially increase the pace of reductions in
the amount of switched access revenues we receive in our wholesale
markets segment.
º •
º Long-distance services revenues. Wholesale long-distance revenues
continue to decline as a result of customer migration to more
technologically advanced services, price compression, declining demand
for traditional voice services and industry consolidation.
º •
º Operating efficiencies. We continue to evaluate our operating
structure and focus. This involves balancing our segment workforce in
response to our workload requirements, productivity improvements and
changes in industry, competitive, technological and regulatory
conditions.
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The following tables summarize the results of operations from our wholesale
markets segment:
Wholesale Markets Segment
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 568 574 (7) 1 (6)
Legacy services 340 408 (68) - (68)
Total revenues 908 982 (75) 1 (74)
Segment expenses:
Direct 38 44 (6) - (6)
Allocated 235 263 (28) - (28)
Total expenses 273 307 (34) - (34)
Segment income $ 635 675 (41) 1 (40)
Segment margin percentage 70% 69%
Wholesale Markets Segment
Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 1,724 1,344 32 339 9 380
Legacy services 1,089 1,000 (159) 248 - 89
Total revenues 2,813 2,344 (127) 587 9 469
Segment expenses:
Direct 131 122 (4) 13 - 9
Allocated 715 586 (32) 155 6 129
Total expenses 846 708 (36) 168 6 138
Segment income $ 1,967 1,636 (91) 419 3 331
Segment margin percentage 70% 70%
Segment Income
Wholesale markets segment income decreased for the three months ended
September 30, 2012 compared to the three months ended September 30, 2011. The
acquisition of Qwest on April 1, 2011 largely contributed to an increase in our
wholesale markets segment income for the nine months ended September 30, 2012 as
compared to the nine months ended September 30, 2011.
Segment Revenues
Excluding revenues attributable to the Qwest and Savvis acquisitions,
wholesale markets revenues decreased for the three and nine months ended
September 30, 2012 compared to the three and nine months ended September 30,
2011. Strategic revenues declined slightly for the three month comparative
period due to a reduction in low-bandwidth subscribers while the nine month
period increased due to growth in certain strategic services revenues including
Ethernet. The decrease in legacy services revenues for the three and nine month
comparative periods was driven by continuing declines in access, long-distance
and local services volumes due to the CAF order, as well as the
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substitution of cable, wireless, VoIP and other services for traditional voice
telecommunications services.
Segment Expenses
Excluding expenses attributable to the Qwest and Savvis acquisitions,
wholesale markets total expenses decreased for the three and nine months ended
September 30, 2012 compared to the three and nine months ended September 30,
2011 due to a lower allocation of fleet and network real estate expenses due to
the above-described updated expense allocation methodology and to reductions in
employee related expenses.
Enterprise Markets - Network
The operations of our enterprise markets-network segment have been impacted
by several significant trends, including those described below.
º •
º Strategic services. Our mix of total segment revenues continues to
migrate from legacy services to strategic services as our enterprise
and government customers increasingly demand customized and integrated
data, Internet and voice services. We offer to our enterprise
customers diverse combinations of products and services such as
private line, MPLS and VoIP services. We believe these services afford
our customers more flexibility in managing their communications needs
and enable us to improve the effectiveness and efficiency of their
operations. Although we are experiencing price compression on our
strategic services due to competition, we expect overall revenues from
these services to grow.
º •
º Legacy services. We face intense competition with respect to our
legacy services and continue to see customers migrating away from
these services and into strategic services. In addition, our legacy
services revenues have been, and we expect they will continue to be,
adversely affected by access line losses and price compression.
º •
º Data integration. We expect both data integration revenue and the
related costs will fluctuate from quarter to quarter as this offering
tends to be more sensitive than others to changes in the economy and
in spending trends of our federal government customers.
º •
º Operating efficiencies. We continue to evaluate our operating
structure and focus. This involves balancing our segment workforce in
response to our productivity improvements while achieving operational
efficiencies and improving our processes through automation. We also
expect our enterprise markets-network segment to benefit indirectly
from enhanced efficiencies in our company-wide network operations.
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The following tables summarize the results of operations from our enterprise
markets-network segment:
Enterprise Markets-Network Segment
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 341 318 23 - 23
Legacy services 214 216 (2) - (2)
Data integration 103 88 15 - 15
Total revenues 658 622 36 - 36
Segment expenses:
Direct 189 183 6 - 6
Allocated 277 296 (19) - (19)
Total expenses 466 479 (13) - (13)
Segment income $ 192 143 49 - 49
Segment margin percentage 29% 23%
Enterprise Markets-Network Segment
Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 998 646 31 314 7 352
Legacy services 654 476 (20) 198 - 178
Data integration 286 176 26 84 - 110
Total revenues 1,938 1,298 37 596 7 640
Segment expenses:
Direct 572 369 23 180 - 203
Allocated 830 592 (30) 261 7 238
Total expenses 1,402 961 (7) 441 7 441
Segment income $ 536 337 44 155 - 199
Segment margin percentage 28% 26%
Segment Income
Enterprise markets-network segment income increased for the three months
ended September 30, 2012 compared to the three months ended September 30, 2011.
The acquisition of Qwest on April 1, 2011 substantially increased the scale of
our enterprise markets-network segment, resulting in an increase in our segment
income for the nine months ended September 30, 2012 as compared to the nine
months ended September 30, 2011.
Segment Revenues
Legacy CenturyLink enterprise markets-network segment revenues increased for
the three months and nine months ended September 30, 2012 as compared to the
three months and nine months ended September 30, 2011. These increases primarily
reflected increased strategic services revenues due to increased volumes of MPLS
services and increased data integration revenues due to maintenance
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and installation of customer premise equipment. Lower revenues from legacy
services driven by access line losses and price compression partially offset the
increases in strategic services revenues and data integration revenues.
Enterprise markets-network total revenues for the nine months ended
September 30, 2012 compared to the nine months ended September 30, 2011
increased principally due to the acquisition of Qwest, as well as to the
increases in strategic services revenues and data integration revenues noted
above.
Segment Expenses
Legacy CenturyLink enterprise markets-network segment expenses decreased for
the nine months ended September 30, 2012 as compared to the nine months ended
September 30, 2011 primarily due to decreased allocated expenses partially
offset by increased direct expenses. Allocated expenses decreased for both the
three and nine months ended September 30, 2012 due to lower allocation of fleet
and network real estate expenses due to the above-described updated expense
allocation methodology. The increase in direct expenses was primarily due to
increased maintenance and installation costs associated with customer premise
equipment, partially offset by decreases in employee related expenses.
Enterprise markets-network total expenses for the nine months ended
September 30, 2012 compared to the nine months ended September 30, 2011
increased primarily due to the acquisition of Qwest.
Enterprise Markets - Data Hosting
The operations of our enterprise markets-data hosting segment is largely
comprised of the operations of our Legacy Savvis services for periods after the
July 15, 2011 acquisition date, which have been impacted by significant trends,
including those described below.
º •
º Colocation. Colocation is designed for clients seeking data center
space and power for their server and networking equipment needs. Our
data centers provide our domestic and international clients with a
secure, high-powered, purpose-built location for their IT equipment.
We anticipate continued pricing pressure for these services as
wholesale vendors enter the enterprise colocation market; however, we
believe that our combination of global data center assets, operational
expertise and broad range of services strengthens our competitive
position.
º •
º Managed hosting. Our managed hosting services provide a fully managed
solution for a customer's IT infrastructure and network needs, and
include dedicated and cloud hosting services, utility and computing
storage, consulting and managed security services. We expect
increasing pricing pressure on the managed hosting business from
competing cloud computing offerings. However, we remain focused on
expanding our managed hosting business, specifically in our cloud
service offerings, which we believe is a key to growth. We believe
that we have continued to strengthen our position in the cloud
services market by adding differentiating features to our cloud
products.
º •
º Operating efficiencies. We continue to evaluate our operating
structure and focus. This involves balancing our segment workforce in
response to our workload requirements, productivity improvements and
changes in industry, competitive, technological and regulatory
conditions.
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The following tables summarize the results of operations from our enterprise
markets-data hosting segment:
Enterprise Markets-Data Hosting Segment
Three Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 280 223 17 40 57
Total revenues 280 223 17 40 57
Segment expenses:
Direct 236 184 19 33 52
Allocated (17) (19) 3 (1) 2
Total expenses 219 165 22 32 54
Segment income $ 61 58 (5) 8 3
Segment margin percentage 22% 26%
Enterprise Markets-Data Hosting Segment
Nine Months Ended
September 30, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment revenues:
Strategic services $ 822 231 17 8 566 591
Total revenues 822 231 17 8 566 591
Segment expenses:
Direct 687 195 23 11 458 492
Allocated (54) (28) 1 (10) (17) (26)
Total expenses 633 167 24 1 441 466
Segment income $ 189 64 (7) 7 125 125
Segment margin percentage 23% 28%
Segment Income
The acquisition of Savvis on July 15, 2011 substantially increased the scale
of our enterprise markets-data hosting segment, resulting in an increase in our
segment income for the three and nine months ended September 30, 2012 as
compared to the three and nine months ended September 30, 2011.
Segment Revenues
Savvis operations accounted for 97% of our enterprise markets-data hosting
segment revenues for the nine months ended September 30, 2012. Growth in
strategic services is driven by roughly equivalent increases in both colocation
and managed hosting.
Segment Expenses
Exclusive of the acquisitions of Savvis and Qwest, Legacy CenturyLink
enterprise markets-data hosting segment direct expenses increased for the three
and nine months ended September 30, 2012 as
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compared to the three and nine months ended September 30, 2011 due primarily to
increases in salaries and benefits caused by a higher headcount and an increase
in facility costs.
Due to the continuing use of Legacy Savvis accounting systems, the direct
expenses of our enterprise markets-data hosting segment includes certain data
communication, operational, and selling, general, and administrative costs that
are allocated to our other three segments and are offset by corporate allocated
expenses which may result in a negative allocation balance.
Liquidity and Capital Resources
Overview
As of September 30, 2012, we held cash and cash equivalents of $194 million
compared to $128 million as of December 31, 2011 and had $1.72 billion available
under our revolving credit facility, which is described further below (the
"Credit Facility"). We have generally relied on cash provided by operations and
our revolving credit facility to fund our operating and capital expenditures,
make our dividend payments and repay a portion of our maturing debt. Our
operations have historically provided a stable source of cash flow that has
helped us meet the needs of the business.
As of September 30, 2012, we had a working capital deficit of $1.1 billion,
reflecting current liabilities of $4.9 billion and current assets of
$3.8 billion, compared to a working capital deficit of $500 million as of
December 31, 2011. The change in our working capital position is primarily due
to a $718 million increase in current maturities of long-term debt, as partially
offset by decreases in our accounts payable balance and increases in current
assets due to the reclassification of certain assets held for sale as current
assets.
We anticipate that our existing cash balances and net cash provided by
operating activities will enable us to meet our other current obligations, fund
capital expenditures and pay dividends to our shareholders. We also may draw on
our revolving credit facility as a source of liquidity if and when necessary.
During the nine months ended September 30, 2012, we received net proceeds of
$3.4 billion from the issuance of senior notes and term loan borrowings effected
in anticipation of paying down portions of our long-term debt.
We currently expect to continue our current annual dividend of $2.90 per
common share, subject to our board's discretion. See "Risk Factors-Risks
Affecting Our Business" in Item 1A of Part II of this report.
Credit Facility
On April 6, 2012, we amended and restated our $1.7 billion revolving credit
facility to increase the aggregate principal amount available to $2.0 billion
and to extend the maturity date to April 2017. This amended credit facility (the
"Credit Facility") has 18 lenders, with commitments ranging from $2.5 million to
$181 million and allows us to obtain revolving loans and to issue up to
$400 million of letters of credit, which will reduce the amount available for
other extensions of credit. Interest is assessed on borrowings using either the
LIBOR or the base rate (as defined in the Credit Facility) plus an applicable
margin between 1.25% and 2.25% per annum for LIBOR loans and 0.25% and 1.25% per
annum for base rate loans depending on our then current senior unsecured
long-term debt rating. Our obligations under the Credit Facility are guaranteed
by two of our wholly-owned subsidiaries, Embarq and QCII, and one of QCII's
wholly-owned subsidiaries. As of September 30, 2012, there was $280 million of
borrowings outstanding under the Credit Facility.
Under the Credit Facility, we are subject to various covenants, including
(i) covenants that restrict our ability to engage in certain asset sales,
mergers or other fundamental changes or to incur liens and
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(ii) financial covenants that stipulate that we shall not permit our ratio of
consolidated total funded debt to consolidated EBITDA to exceed 4.0 to 1.0 and
the ratio of consolidated EBITDA to the sum of consolidated interest expense and
preferred stock dividends to be less than 1.5 to 1.0. Our obligation to repay
amounts outstanding may be accelerated upon specified events of default,
including failures to make payments when due, defaults of obligations under
certain other debt, breaches of representations, warranties or covenants,
commencement of bankruptcy proceedings and certain other failures to discharge
specified obligations or comply with specified laws. To the extent that our
EBITDA is reduced by cash settlements or judgments, including in respect of any
of the matters discussed in Note 10-Commitments and Contingencies, our debt to
EBITDA ratios under certain debt agreements will be adversely affected (with the
above terms and ratios having the meanings and being calculated in the manner
stipulated in the Credit Facility agreement). This could reduce our financing
flexibility due to potential restrictions on incurring additional debt under
certain provisions of our debt agreements or, in certain circumstances, could
result in a default under certain provisions of such agreements.
In April 2011, CenturyLink entered into a $160 million uncommitted revolving
letter of credit facility. As of September 30, 2012, our outstanding letters of
credit totaled $131 million under this facility.
Debt and Other Financing Arrangements
Subject to market conditions, we expect to continue to issue debt securities
from time to time in the future to refinance a substantial portion of our
maturing debt, including issuing QC debt securities to refinance its maturing
debt. The availability, interest rate and other terms of any new borrowings will
depend on the ratings assigned to us and QC by credit rating agencies, among
others factors. Following our announcement in April 2011 of our agreement to
purchase Savvis, one of these agencies revised its previous outlook on its
rating of our debt securities from stable to negative and indicated that it
could downgrade our debt credit ratings if we are unable to reduce our "debt
leverage ratio" while maintaining "free cash flow" (each as defined by the
ratings agency) over certain specified periods. Based on our discussions with
this rating agency, we currently expect that within the next couple of quarters
this agency will make a determination whether to maintain its negative outlook,
restore our stable outlook, or downgrade our credit ratings. Although we cannot
predict the agency's ultimate determination, any downgrade could impact our
access to debt capital and raise our borrowing costs. See "Risk Factors-Risks
Affecting our Liquidity."
On October 26, 2012, QCII redeemed all $550 million of its 8.00% Notes due
2015 using funds borrowed under our Credit Facility. This redemption resulted in
a gain of $15 million.
As of September 30, 2012, we believe we were in compliance with the
provisions and covenants of our debt agreements.
Capital Expenditures
We incur capital expenditures on an ongoing basis in order to enhance and
modernize our networks, compete effectively in our markets and expand our
service offerings. We evaluate capital expenditure projects based on a variety
of factors, including expected strategic impacts (such as forecasted revenue
growth or productivity, expense and service impacts) and our expected return on
investment. The amount of capital investment is influenced by, among other
things, demand for our services and products, cash generated by operating
activities and regulatory considerations. We estimate our total 2012 capital
expenditures will be approximately $2.8 billion to $2.9 billion.
Our capital expenditures continue to be focused on our strategic services
such as video, broadband and managed hosting services. In particular, we will
continue to focus on expanding our fiber infrastructure, including installations
of "fiber to the tower," or FTTT. FTTT is a type of telecommunications network
consisting of fiber-optic cables that run from a wireless carrier's mobile
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telephone switching office to cellular towers to enable the delivery of higher
bandwidth services supporting mobile technologies than would otherwise generally
be available through a more traditional copper-based telecommunications network.
We have agreed to accept approximately $35 million of the $90 million
available to us from Phase 1 of the FCC's Connect America Fund ("CAF")
established by Congress to help telecommunications carriers defray the cost of
providing broadband access to remote customers. We intend to use the funds to
deploy broadband service for up to 45,000 homes in unserved rural areas
principally in Colorado, Minnesota, New Mexico, Virginia and Washington. We
determined that restrictions on the use of these funds have made acceptance of
additional CAF funds uneconomical. We have, however, filed with the FCC a waiver
application, which, if granted, would allow us to deploy broadband services with
CAF funds to approximately 60,000 more homes in high-cost unserved areas in our
markets.
Pension and Post-retirement Benefit Obligations
We are subject to material obligations under our existing defined benefit
pension plans and other post-retirement benefit plans. The accounting funding
status of our plans is measured annually at December 31. As of December 31,
2011, the accounting unfunded status of our pension and other post-retirement
benefit obligations was $1.782 billion and $3.237 billion, respectively. See
Note 8-Employee Benefits of our Form 10-K for the year ended December 31, 2011
for additional information about our pension and other post-retirement benefit
arrangements.
Benefits paid by our qualified pension plans are paid through a trust that
holds all plan assets. We made cash contributions of approximately $32 million
in third quarter 2012. Based on current circumstances, we do not expect to make
any further contributions for the remainder of 2012. We currently expect that
our required contributions for 2013 will be approximately $35 million, based on
current laws and circumstances, including the impacts of the Moving Ahead for
Progress in the 21st Century Act ("MAP-21"), which was signed into law on
July 6, 2012. This legislation contains pension-related provisions which, among
other things, provide near-term relief from the impact of recent low interest
rates on pension funding requirements and an increase in the premiums paid to
the Pension Benefit Guaranty Corporation ("PBGC"). Under MAP-21, companies will
be permitted to calculate their pension obligations based on 25-year historic
average rates, which exceed the two-year average rates being used prior to the
legislation. Consequently, this legislation will lower the amount of required
pension plan contributions. This relief is available commencing in 2012, but
gradually decreases each year through 2016, at which time the reduced level of
relief is frozen with respect to future years. Based on several assumptions, we
have projected that this relief will reduce our pension plan funding
requirements over the next five years by approximately $1 billion, which will
correspondingly enhance our cash flows over this period. The legislation will
not, however, affect pension liabilities recorded on our financial statements
under generally accepted accounting principles. Partially offsetting this
relief, MAP-21 provides for an annual increase beginning in 2013 to both the
fixed premiums, based on plan participants, and the variable premiums, based on
unfunded vested benefits, paid to PBGC. Based on various assumptions, we
estimate that our premiums payable to PBGC through 2016 will increase by
approximately $60 million as a result of the new legislation. The actual amount
of required contributions to our plans, and premiums paid to PBGC, will depend
on earnings on plan investments, prevailing interest and discount rates,
demographic experience, changes in plan benefits and any further changes in
funding laws and regulations.
Certain of our post-retirement health care and life insurance benefits plans
are unfunded. Several trusts hold assets that are used to help cover the health
care costs of certain retirees. As of December 31, 2011, the fair value of the
trust assets was $693 million; however, a portion of these assets is comprised
of investments with restricted liquidity. We estimate that the more liquid
assets in the trust will be adequate to provide continuing reimbursements for
covered post-retirement health
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care costs for approximately four years, based on current circumstances.
Thereafter, covered benefits will be paid either directly by us or from the
trusts as the remaining assets become liquid. This projected four year period
could be substantially shorter or longer depending on changes in projected
health care costs, returns on plan assets, the timing of maturities of illiquid
plan assets and future changes in benefits.
Our estimated annual long-term rate of return on the pension and
post-retirement plans trust assets is 7.5% based on the assets currently held;
however, actual returns could vary widely in any given year.
Historical Information
The following table summarizes our cash flow activities (which include cash
flows from Savvis and Qwest after their respective acquisition dates):
Nine Months Ended
September 30, Increase /
2012 2011 (Decrease)
(Dollars in millions)
Net cash provided by operating activities $ 4,686 3,473 1,213
Net cash used in investing activities (1,863) (2,749) (886)
Net cash (used in) provided by financing
activities (2,759) 241 (3,000)
The increase in net cash provided by operating activities is primarily
attributable to the acquisitions of Qwest and Savvis, which contributed net cash
provided by operating activities of approximately $2.52 billion during the nine
months ended September 30, 2012, compared to the $1.58 billion contributed by
Qwest and Savvis during the nine months ended September 30, 2011. Our
consolidated financial statements in Item 1 of Part I in this report provide
information about the components of net income and differences between net
income and net cash provided by operating activities. For additional information
about our operating results, see "Results of Operations" above.
Net cash used in investing activities included payments for property, plant
and equipment and capitalized software of $2.02 billion in 2012, including
$1.37 billion for Qwest and Savvis' capital expenditures, compared to the
$795 million invested by Qwest and Savvis in 2011. The 2012 capital expenditures
exceeded the amount expended for property, plant and equipment and capitalized
software in the comparable 2011 period by $513 million. This increase in capital
expenditures was more than offset by the payment of $1.68 billion, net of
$94 million cash received, for the acquisition of Savvis on July 15, 2011.
Net cash used in financing activities decreased for the nine months ended
September 30, 2012, compared to the nine months ended September 30, 2011,
primarily due to a $3.09 billion increase in payments to reduce long-term debt,
a $311 million related increase in early retirement of debt costs, and a
$252 million increase in dividends paid attributable to an increase in the
average number of shares outstanding. These increases in cash used in financing
activities were partially offset by a $204 million increase in the net proceeds
from the issuance of debt securities and a $368 million increase in net
borrowings under our Credit Facility.
On August 29, 2012, CenturyLink paid $29 million and $30 million,
respectively, to retire its outstanding Rural Utilities Service and Rural
Telephone Bank debt.
On August 15, 2012, CenturyLink paid at maturity the $318 million principal
amount of it 7.875% Notes.
On July 20, 2012, QC redeemed all $484 million of its 7.50% Notes due 2023,
which resulted in an immaterial loss.
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On June 25, 2012, QC issued $400 million aggregate principal amount of 7.00%
Notes due 2052 in exchange for net proceeds, after deducting underwriting
discounts and expenses, of $387 million. The Notes are unsecured obligations and
may be redeemed, in whole or in part, on or after July 1, 2017 at a redemption
price equal to 100% of the principal amount redeemed plus accrued interest.
On May 17, 2012, QCII redeemed $500 million of its 7.50% Notes due 2014,
which resulted in an immaterial gain.
On April 23, 2012, Embarq redeemed the remaining $200 million of its 6.738%
Notes due 2013, which resulted in an immaterial loss.
On April 18, 2012, CenturyLink entered into a term loan in the amount of
$440 million with CoBank and several other Farm Credit System banks. This term
loan is payable in 29 consecutive quarterly installments of $5.5 million in
principal plus interest through April 18, 2019, when the balance will be due. We
have the option of paying monthly interest based upon either the London
Interbank Offered Rate ("LIBOR") or the base rate (as defined in the credit
agreement) plus an applicable margin between 1.50% to 2.50% per annum for LIBOR
loans and 0.50% to 1.50% per annum for base rate loans depending on our then
current senior unsecured long-term debt rating. Our term loan is guaranteed by
two of our wholly-owned subsidiaries, Embarq and QCII, and one of QCII's
wholly-owned subsidiaries. The remaining terms and conditions of our term loan
are substantially similar to those set forth in our Credit Facility, as further
described below.
On April 18, 2012, QC completed a cash tender offer to purchase a portion of
its $811 million of 8.375% Notes due 2016 and its $400 million of 7.625% Notes
due 2015. With respect to its 8.375% Notes due 2016, QC received and accepted
tenders of approximately $575 million aggregate principal amount of these notes,
or 71%, for $722 million including a premium, fees and accrued interest. With
respect to its 7.625% Notes due 2015, QC received and accepted tenders of
approximately $308 million aggregate principal amount of these notes, or 77%,
for $369 million including a premium, fees and accrued interest. The completion
of this tender offer resulted in a loss of $46 million.
On April 2, 2012, QC issued $525 million aggregate principal amount of 7.00%
Notes due 2052 in exchange for net proceeds, after deducting underwriting
discounts and expenses, of $508 million. The Notes are unsecured obligations and
may be redeemed, in whole or in part, on or after April 1, 2017 at a redemption
price equal to 100% of the principal amount redeemed plus accrued interest.
On April 2, 2012, Embarq completed a cash tender offer to purchase a portion
of its $528 million of 6.738% Notes due 2013 and its $2.0 billion of 7.082%
Notes due 2016. With respect to its 6.738% Notes due 2013, Embarq received and
accepted tenders of approximately $328 million aggregate principal amount of
these notes, or 62%, for $360 million including a premium, fees and accrued
interest. With respect to its 7.082% Notes due 2016, Embarq received and
accepted tenders of approximately $816 million aggregate principal amount of
these notes, or 41%, for $944 million including a premium, fees and accrued
interest. The completion of these tender offers resulted in a loss of
$144 million.
On March 12, 2012, CenturyLink issued (i) $650 million aggregate principal
amount of 7.65% Senior Notes due 2042 in exchange for net proceeds, after
deducting underwriting discounts, of approximately $644 million and
(ii) $1.4 billion aggregate principal amount of 5.80% Senior Notes due 2022 in
exchange for net proceeds, after deducting underwriting discounts, of
approximately $1.389 billion. The Notes are unsecured obligations and may be
redeemed at any time on the terms and conditions specified therein.
On March 1, 2012, QCII redeemed $800 million of its 7.50% Notes due 2014,
which resulted in an immaterial gain.
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Certain Matters Related to Acquisitions
Qwest's pre-existing debt obligations consisted primarily of debt securities
issued by QCII and two of its subsidiaries while Savvis' remaining debt
obligations consist primarily of capital leases, all of which are now included
in our consolidated debt balances. The indentures governing Qwest's debt
securities contain customary covenants that restrict the ability of Qwest or its
subsidiaries from making certain payments and investments, granting liens and
selling or transferring assets. Based on current circumstances, we do not
anticipate that these covenants will significantly restrict our ability to
manage cash balances or transfer cash between entities within our consolidated
group of companies as needed.
In accounting for the Qwest acquisition, we recognized Qwest's debt
securities at their estimated fair values, which totaled $12.292 billion as of
April 1, 2011. Our acquisition date fair value estimates were based primarily on
quoted market prices in active markets and other observable inputs where quoted
market prices were not available. The fair value of Qwest's debt securities
exceeded their stated principal balances on the acquisition date by
$693 million, which we recorded as premium.
The table below summarizes the premiums recognized as a reduction to
interest expense or extinguished during the periods indicated:
Nine Months Ended Year Ended Total Since
September 30, 2012 December 31, 2011 Acquisition
(Dollars in millions)
Amortized $ 68 154 222
Extinguished(1) 140 58 198
Total premiums recognized $ 208 212 420
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º (1)
º See "Debt and Other Financing Arrangements" for more information
The remaining premium of $273 million as of September 30, 2012 will reduce
interest expense in future periods, unless otherwise extinguished.
Net Operating Loss Carryforwards
We are currently using federal net operating loss carryforwards ("NOLs") to
offset a portion of our taxable income. We expect to deplete a significant
portion of these NOLs and certain other deferred tax attributes by 2014, and
substantially all of these tax benefits by 2015. Once our NOLs are fully
utilized, we expect that the amount of our cash flows dedicated to the payment
of federal taxes will increase substantially. The amounts of those payments will
depend upon many factors, including future earnings, tax law changes, and future
tax circumstances. For additional information, see "Risk Factors-Risks Relating
to our Recent Acquisitions" appearing in Item 1A of Part II of this report.
Other Matters
CenturyLink has cash management arrangements with certain of our principal
subsidiaries, in which substantial portions of the subsidiaries' cash is
regularly advanced to us. In accordance with generally accepted accounting
principles, these advances are eliminated as intercompany transactions. Although
CenturyLink periodically repays these advances to fund the subsidiaries' cash
requirements throughout the year, at any given point in time we may owe a
substantial sum to our subsidiaries under these advances, which are not
recognized on our consolidated balance sheets.
Approximately 28% of our employees are subject to collective bargaining
agreements that expired on October 6, 2012. We are currently negotiating the
terms of new agreements. In the meantime, the predecessor agreements have been
extended, and the applicable unions have agreed to provide us with
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at least twenty-four hour advance notice before terminating those predecessor
agreements. Any strikes or other changes in our labor relations could have a
significant impact on our business. See "Risk Factors-Other Risks" in Item 1A of
Part II of this report. If we fail to extend or renegotiate our collective
bargaining agreements with our labor unions as they expire from time to time, or
if our unionized employees were to engage in a strike or other work stoppage,
our business and operating results could be materially harmed. To help mitigate
this potential risk, we have established contingency plans in which we would
assign trained, non-represented employees to cover jobs for represented
employees in the event of a work stoppage to provide continuity for our
customers.
We also are involved in various legal proceedings that could have a material
adverse effect on our financial position. See Note 10-Commitment and
Contingencies for the current status of such legal proceedings, including
matters involving Qwest.
Off-Balance Sheet Arrangements
We have no special purpose or limited purpose entities that provide
off-balance sheet financing, liquidity, or market or credit risk support and we
do not engage in hedging or other similar activities that expose us to any
significant liabilities that are not (i) reflected on the face of the
consolidated financial statements or (ii) discussed under the heading "Market
Risk" below. There were no substantial changes to our contractual obligations in
the nine months ended September 30, 2012, when compared to the disclosures
provided in our Annual Report on Form 10-K for the year ended December 31, 2011.
Market Risk
We are exposed to market risk from changes in interest rates on our variable
rate long-term debt obligations and fluctuations in certain foreign currencies.
We seek to maintain a favorable mix of fixed and variable rate debt in an effort
to limit interest costs and cash flow volatility resulting from changes in
rates.
From time to time, we have used derivative instruments to (i) lock-in or
swap our exposure to changing or variable interest rates for fixed interest
rates or (ii) to swap obligations to pay fixed interest rates for variable
interest rates. As of September 30, 2012, we had no such instruments
outstanding.
There were no material changes to market risks arising from changes in
interest rates for the nine months ended September 30, 2012, when compared to
the disclosures provided in our Annual Report on Form 10-K for the year ended
December 31, 2011.
Other Information
Our website is www.centurylink.com. We routinely post important investor
information in the "Investor Relations" section of our website at
ir.centurylink.com. The information contained on, or that may be accessed
through, our website is not part of this quarterly report. You may obtain free
electronic copies of our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and all amendments to those reports in
the "Investor Relations" section of our website (ir.centurylink.com) under the
heading "SEC Filings." These reports are available on our website as soon as
reasonably practicable after we electronically file them with the SEC.
In addition to historical information, this MD&A includes certain
forward-looking statements that are based on current expectations only, and are
subject to a number of risks, uncertainties and assumptions, many of which are
beyond our control. Actual events and results may differ materially from those
anticipated, estimated or projected if one or more of these risks or
uncertainties materialize, or if underlying assumptions prove incorrect. Factors
that could affect actual results include but are not limited to: the
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timing, success and overall effects of competition from a wide variety of
competitive providers; the risks inherent in rapid technological change; the
effects of ongoing changes in the regulation of the communications industry
(including those arising out of the Federal Communications Commission's
October 27, 2011 order regarding intercarrier compensation and the USF, among
other things); our ability to successfully negotiate collective bargaining
agreements on reasonable terms without work stoppages; our ability to
effectively adjust to changes in the communications industry and changes in the
composition of our markets and product mix caused by our recent acquisitions;
our ability to successfully integrate recently-acquired operations into our
incumbent operations, including the possibility that the anticipated benefits
from our recent acquisitions cannot be fully realized in a timely manner or at
all, or that integrating the acquired operations will be more difficult,
disruptive or costly than anticipated; our ability to use net operating loss
carryovers of Qwest in projected amounts; our ability to effectively manage our
expansion opportunities, including retaining and hiring key personnel; possible
changes in the demand for, or pricing of, our products and services; our ability
to successfully introduce new product or service offerings on a timely and
cost-effective basis; our continued access to credit markets on favorable terms;
our ability to collect our receivables from financially troubled communications
companies; any adverse developments in legal proceedings involving us; our
ability to pay a $2.90 per common share dividend annually, which may be affected
by changes in our cash requirements, capital spending plans, cash flows or
financial position; unanticipated increases or other changes in our future cash
requirements, whether caused by unanticipated increases in capital expenditures,
increases in pension funding requirements or otherwise; the effects of adverse
weather; other risks referenced from time to time in this report (including in
"Risk Factors" in Item 1A of Part II of this report) or other of our filings
with the SEC; and the effects of more general factors such as changes in
interest rates, in tax rates, in accounting policies or practices, in operating,
medical, pension or administrative costs, in general market, labor or economic
conditions, or in legislation, regulation or public policy. These and other
uncertainties related to our business and our recent acquisitions are described
in greater detail in Item 1A of our Form 10-K for the year ended December 31,
2011, as updated and supplemented by our subsequent SEC reports, including this
report. You should be aware that new factors may emerge from time to time and it
is not possible for us to identify all such factors nor can we predict the
impact of each such factor on the business or the extent to which any one or
more factors may cause actual results to differ from those reflected in any
forward-looking statements. You are further cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date of
this report. We undertake no obligation to update any of our forward-looking
statements for any reason.
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