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CTL > SEC Filings for CTL > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for CENTURYLINK, INC

Form 10-Q for CENTURYLINK, INC


9-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless the context requires otherwise, references in this report to "CenturyLink," "we," "us" and "our" refer to CenturyLink, Inc. and its consolidated subsidiaries.
All references to "Notes" in this Item 2 refer to the Notes to Consolidated Financial Statements included in Item 1 of Part I of this 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 or otherwise impact our business, financial condition, results of operations, liquidity or prospects. 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, 2013, and with the consolidated financial statements and related notes in Item 1 of Part I of this report. The results of operations for the first three months of the year are not necessarily 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, broadband, private line (including special access), Multi-Protocol Label Switching ("MPLS"), data integration, managed hosting (including cloud hosting), colocation, Ethernet, network access, public access, wireless, video and other ancillary 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. At March 31, 2014, we operated 12.9 million access lines in 37 states, served approximately 6.1 million broadband subscribers, and operated 56 data centers throughout North America, Europe and Asia. Our methodology for counting access lines, subscriber lines and data centers may not be comparable to those of other companies.
We report the following four segments in our consolidated financial statements:
Consumer. Consists generally of providing strategic and legacy products and services to residential consumers. Our strategic products and services offered to these customers include our broadband, wireless and video services, including our Prism TV services. Our legacy services offered to these customers include local and long-distance service.

Business. Consists generally of providing strategic and legacy products and services to commercial, enterprise, global and governmental customers. Our strategic products and services offered to these customers include our private line, broadband, Ethernet, MPLS, Voice over Internet Protocol ("VoIP"), and network management services. Our legacy services offered to these customers include local and long-distance service.

Wholesale. Consists generally of providing strategic and legacy products and services to other communications providers. Our strategic products and services offered to these customers are mainly private line (including special access), dedicated internet access, digital subscriber line ("DSL") and MPLS. Our legacy services offered to these customers include the resale of our services, the sale of unbundled network elements ("UNEs") which allow our wholesale customers to use our network or a combination of our network and their own networks to provide voice and data services to their customers, long-distance and switched access services and other services, including billing and collection, pole rental, floor space and database services.

Hosting. Consists primarily of providing colocation, managed hosting and cloud hosting services to commercial, enterprise, global, governmental and wholesale customers.

Our segment information does not include capital expenditures, total assets, or certain revenues and expenses that we manage on a centralized basis and are reviewed by our chief operating decision maker ("CODM") only on a consolidated basis. 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 7-Segment Information to our consolidated financial statements in Item 1 of Part I of this report and "Results of Operations-Segment Results" below.


Results of Operations
The following table summarizes the results of our consolidated operations for
the three months ended March 31, 2014 and 2013:
                                                               Three Months Ended March 31,
                                                              2014                       2013
                                                      (Dollars in millions except per share amounts)
Operating revenues                                    $          4,538                       4,513
Operating expenses                                               3,885                       3,731
Operating income                                                   653                         782
Other income (expense), net                                       (322 )                      (277 )
Income tax expense                                                 128                         207
Net income                                            $            203                         298
Basic earnings per common share                       $           0.35                        0.48
Diluted earnings per common share                     $           0.35                        0.48

The following table summarizes our broadband subscribers, access lines, data centers and number of employees:

                                            As of March 31,                  Increase /
                                         2014                2013 (2)        (Decrease)        % Change
                                 (in thousands except for data centers, which are actual
                                                        amounts)
Operational metrics:
Total broadband subscribers (1)            6,057                 5,917             140              2.4  %
Total access lines (1)                    12,882                13,561            (679 )           (5.0 )%
Total data centers (3)                        56                    54               2              3.7  %
Total employees                             46.5                  46.6            (0.1 )           (0.2 )%



(1) Broadband subscribers are customers that purchase high-speed Internet connection service through their existing telephone lines and fiber-optic cables, and access lines are lines reaching from the customers' premises to a connection with the public network.

(2) The prior year numbers have been adjusted to include the operational metrics of our wholly owned subsidiary, El Paso County Telephone Company, which had been previously excluded. The increase (in thousands) related to including El Paso County Telephone Company's broadband subscribers and access lines, in the table above, is approximately 2 and 3, respectively.

(3) Data centers are located throughout North America, Europe and Asia.

During the last several years, we have experienced revenue decline (excluding the impact of acquisitions) primarily due to declines in access lines, intrastate access rates and minutes of use. To mitigate these declines, we remain focused on efforts to, among other things:
promote long-term relationships with our customers through bundling of integrated services;

provide new services, such as video, cloud hosting, managed hosting, colocation and other additional services that may become available in the future due to, among other things, advances in technology or improvements in our infrastructure;

provide our broadband and premium services to a higher percentage of our customers;

pursue acquisitions of additional assets if available at attractive prices;

increase usage of our networks; and

market our products and services to new customers.


Operating Revenues
We categorize our products, services and revenues among the following four categories:
Strategic services, which include primarily broadband, private line (including special access, which we market to wholesale and business customers), MPLS (which is a data networking technology that can deliver the quality of service required to support real-time voice and video service), hosting (including cloud hosting and managed hosting), colocation, Ethernet, video (including our facilities-based video services, which we now offer in twelve markets, and our resold satellite service), VoIP and Verizon Wireless services;

Legacy services, which include primarily local, long-distance, switched 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);

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 governmental and business customers; and

Other revenues, which consists primarily of USF revenue and surcharges. Unlike the first three revenue categories, other revenues are not included in our segment revenues.

The following table summarizes our operating revenues under our revenue categorization:

                                  Three Months Ended March 31,        Increase /
                                      2014              2013          (Decrease)        % Change
                                              (Dollars in millions)
Strategic services             $          2,281           2,164             117               5  %
Legacy services                           1,829           1,952            (123 )            (6 )%
Data integration                            174             140              34              24  %
Other                                       254             257              (3 )            (1 )%
Total operating revenues       $          4,538           4,513              25               1  %

Our operating revenues increased by $25 million, or approximately 1%, during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase in operating revenues is primarily due to growth in our strategic services revenues and data integration revenues, which were partially offset by declines in legacy services revenues compared to the prior year. During 2013, operating revenues attributable to certain bundled and CLEC services were revised, which resulted in a net increase to strategic service revenues of $22 million and a corresponding net reduction to legacy services revenues of $22 million. For additional information on the revisions to certain bundled and CLEC services, see Note 7-Segment Information to our consolidated financial statements in Item 1 of Part I of this report. The growth in our strategic services revenues is primarily due to increases in broadband, Ethernet, MPLS, facilities-based video, managed hosting and colocation services, which were slightly offset by declines in private line (including special access) services. The increase in data integration revenues, which are typically more volatile than several of our other sources of revenue, is primarily due to higher sales of customer premise equipment to governmental and business customers during the period. The decrease in legacy services revenues is attributable to declining local and long-distance and access services which reflect the continuing loss of access lines and loss of access revenues associated with internet and wireless substitution in our markets. At March 31, 2014, we had approximately 12.9 million access lines, or approximately 5.0% less than the number of access lines we operated at March 31, 2013. 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 at a rate between 4.8% and 5.7% over the full year of 2014.
Further analysis of our operating revenues by segment is provided below in "Segment Results."


Operating Expenses
Total operating expenses increased by $154 million, or 4%, for the three months
ended March 31, 2014 as compared to the three months ended March 31, 2013.
The following table summarizes our operating expenses:
                                  Three Months Ended March 31,        Increase /
                                      2014              2013          (Decrease)         % Change
                                                        (Dollars in millions)
Cost of services and products
(exclusive of depreciation and
amortization)                  $          1,935           1,796             139                8  %
Selling, general and
administrative                              843             818              25                3  %
Depreciation and amortization             1,107           1,117             (10 )             (1 )%
Total operating expenses       $          3,885           3,731             154                4  %

Cost of services and products (exclusive of depreciation and amortization) increased by $139 million, or 8%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 primarily due to increases in professional fees, customer premise equipment installation expense, facility costs, network expense, real estate and power costs and employee related costs. Selling, general and administrative expenses increased by $25 million, or 3%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 primarily due to increases in employee related costs, marketing and advertising, property and other taxes and external commissions, which were slightly offset by a decrease in professional fees.
Depreciation and amortization expenses decreased by $10 million, or 1%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. Depreciation expense decreased by $1 million from $718 million in the three months ended March 31, 2013 to $717 million in the three months ended March 31, 2014 due primarily to depreciation rate changes, which was partially offset by changes in our estimates of the remaining economic lives of certain switch and circuit network equipment and the growth in new plant. The rate changes were the result of our plant aging and becoming fully depreciated or retired at a faster rate than the addition of new plant. We expect that the impact of the depreciation rate changes will be increasingly offset over the remaining nine months of 2014 as we upgrade or build additional plant. Amortization expense decreased by $9 million from $399 million in the three months ended March 31, 2013 to $390 million in the three months ended March 31, 2014 due primarily to the use of accelerated amortization methods for a portion of the customer relationship assets that were acquired with the acquisitions of Embarq in 2009 and Qwest in 2011 and due to our software investments becoming fully amortized faster than new software is acquired, which were partially offset by a change in the estimate of the remaining economic lives of the Savvis trade name and certain cloud software. For more information about the changes in our estimates of the remaining economic lives, see Note 1-Basis of Presentation to our consolidated financial statements in Item 1 of Part I of this report. Further analysis of our operating expenses by segment is provided below in "Segment Results."
Other Consolidated Results
The following table summarizes our total other income (expense) and income tax expense:

                                      Three Months Ended March 31,         Increase /
                                         2014                2013          (Decrease)         % Change
                                                           (Dollars in millions)
Interest expense                  $         (331 )              (316 )            15                5  %
Other income (expense)                         9                  39             (30 )            (77 )%
Total other income (expense), net $         (322 )              (277 )            45               16  %
Income tax expense                $          128                 207             (79 )            (38 )%

Interest Expense
Interest expense increased $15 million, or 5%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 primarily due to a higher average outstanding debt balance and a reduction in the amortization of debt premiums.


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 foreign currency gains and losses. Other income was lower by $30 million for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 primarily due to a $32 million gain on the sale of wireless spectrum in January 2013, which was partially offset by gains on foreign currency transactions in 2014.
Income Tax Expense
Income tax expense decreased by $79 million for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. For the three months ended March 31, 2014, and 2013, our effective income tax rate was 38.7%, and 41.0%, respectively. The 2013 effective tax rate reflects the impact of an accounting adjustment for nondeductible life insurance costs. Segment Results
General
Segment results are summarized below:

                          Three Months Ended March 31,
                              2014              2013
                              (Dollars in millions)
Total segment revenues  $       4,284            4,256
Total segment expenses          2,099            1,928
Total segment income    $       2,185            2,328
Total margin percentage            51 %             55 %
Consumer:
Revenues                $       1,509            1,511
Expenses                          583              549
Income                  $         926              962
Margin percentage                  61 %             64 %
Business:
Revenues                $       1,559            1,505
Expenses                          966              857
Income                  $         593              648
Margin percentage                  38 %             43 %
Wholesale:
Revenues                $         862              906
Expenses                          276              274
Income                  $         586              632
Margin percentage                  68 %             70 %
Hosting:
Revenues                $         354              334
Expenses                          274              248
Income                  $          80               86
Margin percentage                  23 %             26 %


During the first quarter of 2014, we adopted several changes with respect to the assignment of certain expenses to our segments. We have restated the previously reported segment results for the three months ended March 31, 2013 to conform to the current presentation. The nature of the most significant changes and the related effect on segment expenses for the three months ended March 31, 2013 are as follows:
The method for allocating certain shared costs of consumer sales and care, including bad debt expense and credit card fees, was revised, which resulted in an increase in consumer segment expenses of $20 million and a corresponding decrease in business segment expenses for the three months ended March 31, 2013; and

Hosting segment expenses have been conformed to the reporting of our other segments' expenses. Specifically, our integration efforts and centralization of certain administrative functions reached the point where it has become more practical to discontinue including certain finance, information technology, legal and human resources expenses in the hosting segment, which resulted in a decrease of $18 million in hosting segment expenses for the three months ended March 31, 2013.

Our segment revenues include all revenues from our strategic and legacy services and data integration as described in more detail above. Segment revenues are based upon each customer's classification to an individual segment. We report our segment revenues based upon all services provided to that segment's customers, with the exception of hosting revenue generated from business and wholesale customers, which is reported in hosting segment revenues. We report our segment expenses for our four segments as follows:
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

Allocated expenses, which include network expenses, facilities expenses and other expenses such as fleet and real estate expenses.

We do not assign depreciation and amortization expense or impairments to our segments, as the related assets and capital expenditures are centrally managed and are not monitored by or reported to the chief operating decision maker ("CODM") by segment. Similarly, severance expenses, restructuring expenses and, 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. Other income (expense) is not monitored as a part of our segment operations and is therefore excluded from our segment results. Consumer
The operations of our consumer segment have been impacted by several significant trends, including those described below:
Strategic services. In order to remain competitive and attract additional residential broadband subscribers, we believe it is important to continually increase our broadband network's scope and connection speeds. As a result, we continue to invest in our broadband network, which allows for the delivery of higher speed broadband services to a greater number of customers. We compete in a maturing broadband market in which most consumers already have broadband services and growth rates in new subscribers have slowed. Moreover, as described further in Item 1A of Part II of this report, demand for our broadband services could be adversely affected by competitors providing services at higher broadband speed than ours or using advanced wireless data technologies. We also continue to expand our strategic product offerings, including facilities-based video services. The expansion of our facilities-based video service infrastructure requires us to incur 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. We believe these efforts will improve our ability to compete and increase our strategic revenues;

Legacy services. 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 services and electronic mail, texting and social networking non-voice 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 revenues associated with access lines, we continue to offer our customers service bundling and other product promotions to help mitigate this trend, as described below;


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 we believe our bundled service offerings can help retain customers, they also tend to lower our profit margins in the consumer segment; and

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.

The following table summarizes the results of operations from our consumer segment:

                                                 Consumer Segment
                             Three Months Ended March 31,       Increase /
                               2014                2013         (Decrease)     % Change
                                              (Dollars in millions)
Segment revenues:
Strategic services        $       702                  645           57           9  %
Legacy services                   806                  864          (58 )        (7 )%
Data integration                    1                    2           (1 )       (50 )%
Total revenues                  1,509                1,511           (2 )         -  %
Segment expenses:
Direct                            466                  436           30           7  %
Allocated                         117                  113            4           4  %
Total expenses                    583                  549           34           6  %
Segment income            $       926                  962          (36 )        (4 )%
Segment margin percentage          61 %                 64 %

Segment Revenues
Consumer revenues decreased $2 million, or less than 1%, for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. Growth in strategic services revenues were more than offset by the decline in legacy services revenues. The increase in strategic services revenues is due primarily to volume increases in our facilities-based video services and increases in the number of broadband subscribers, as well as from price . . .

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