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CENTURYLINK, INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) All references to "Notes" in this Item 7 refer to the Notes to Consolidated
Financial Statements included in Item 8 of this report. Certain statements in
this report constitute forward-looking statements. See "Special Note Regarding
Forward-Looking Statements" in Item 1 of this report for factors relating to
these statements and "Risk Factors" in Item 1A of this report for a discussion
of certain risk factors applicable to our business, financial condition and
results of operations.
Overview
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. 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 December 31, 2012, we operated approximately 13.7 million access lines in
37 states, served approximately 5.8 million broadband subscribers, and operated
54 data centers throughout North America, Europe and Asia. During 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. For purposes of counting our access lines, we include only
those access lines that we use to provide services to external customers and
exclude lines used solely by us and our affiliates. Our counting methodology
also excludes unbundled loops and includes stand-alone broadband subscribers.
Our methodology for counting access lines may not be comparable to those of
other companies.
Our consolidated financial statements include the accounts of
CenturyLink, Inc. ("CenturyLink") and its majority-owned subsidiaries. These
subsidiaries include SAVVIS, Inc. ("Savvis") as of July 15, 2011 and Qwest
Communications International Inc. ("Qwest") as of April 1, 2011. See
Note 2-Acquisitions to the consolidated financial statements in Item 8 of this
report. Due to the significant size of these acquisitions, direct comparisons of
our results of operations for the years ended December 31, 2012, 2011 and 2010
to prior periods are less meaningful than usual. We discuss below, under
"Results of Operations-Segment Results", certain trends that we believe are
significant, even if they are not necessarily material 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 years ended December 31, 2012 and 2011, mean
the business we operated prior to the Qwest and Savvis acquisitions. Due to the
magnitude of our recent acquisitions in relation to Legacy CenturyLink
operations, in the combined company variance discussions below we have
separately reflected the impacts of both the Legacy Qwest and Legacy Savvis
operations for enhanced visibility, although we actively manage the combined
company through our four segments, as discussed further below.
We have incurred operating expenses related to our acquisitions of Savvis in
July 2011, Qwest in April 2011 and Embarq in July 2009. These expenses are
reflected in cost of services and products and
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selling, general and administrative expenses in our consolidated statements of
operations as summarized below.
Years Ended December 31,
2012 2011 2010
(Dollars in millions)
Cost of services and products:
Integration and other expenses associated with
acquisitions $ 22 43 37
Severance expenses, accelerated recognition of
share-based awards and retention compensation
associated with acquisitions - 24 12
Total $ 22 67 49
Selling, general and administrative:
Expenses incurred to effect acquisitions $ - 79 13
Integration and other expenses associated with
acquisitions 25 172 64
Severance expenses, accelerated recognition of
share-based awards and retention compensation
associated with acquisitions 36 149 19
Total $ 61 400 96
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, in relation
to our Qwest acquisition, total integration, severance and retention expenses to
be between $600 million to $700 million (which includes approximately
$464 million of cumulative expenses incurred through December 31, 2012) and our
capital expenditures associated with integration activities will approximate
$200 million (which includes approximately $63 million of cumulative capital
expenditures incurred through December 31, 2012). We anticipate that the amount
of our integration costs in future years 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 year ended
December 31, 2012.
For several years prior to 2011, we reported our operations as a single
segment. However, in 2011, in connection with our acquisitions of Qwest on
April 1, 2011 and Savvis on July 15, 2011, we reorganized our business into the
following operating segments:
º •
º Regional markets. Consisted primarily of providing products and
services to residential consumers, small to medium-sized businesses
and regional enterprise customers;
º •
º Business markets. Consisted primarily of providing products and
services to enterprise and government customers;
º •
º Wholesale markets. Consisted primarily of providing products and
services to other communications providers; and
º •
º Savvis operations. Consisted primarily of providing hosting and
network services primarily to business customers provided by Legacy
Savvis.
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In the second quarter of 2012, in order to more effectively deploy the
strategic assets acquired from Qwest and Savvis and to better serve our business
and government customers, we restructured our business into the following
operating segments:
º •
º Regional markets. Consists primarily of providing strategic and legacy
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.
Our strategic products and services offered to these customers include
our private line, broadband, MPLS, hosting, video services, and
wireless services. Our legacy services offered to these customers
consist primarily of local and long-distance service;
º •
º Wholesale markets. Consists primarily of providing strategic and
legacy products and services to other domestic and international
communications providers. Our strategic products and services offered
to these customers are mainly private line (including special access)
and MPLS. Our legacy services offered to these customers include UNEs
which allow our wholesale customers the use of 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;
º •
º Enterprise markets-network. Consists primarily of providing strategic
and legacy network communications products and services to national
and international enterprise and government customers. Our strategic
products and services offered to these customers include our private
line, broadband, MPLS and hosting services. Our legacy services
offered to these customers consist primarily of local and
long-distance services; and
º •
º Enterprise markets-data hosting. Consists primarily of providing
colocation, managed hosting and cloud hosting services to national and
international enterprise and government customers.
Due to system limitations, we have determined that it is impracticable to
report 2010 segment information using our segment structure described above. As
such, only 2011 financial data has been revised under our segment structure
described above.
We now report financial information separately for each of these segments;
however, our segment information does not include capital expenditures, total
assets, or certain revenues and expenses that we manage on a centralized basis
and are only reviewed by our chief operating decision maker ("CODM") 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 13-Segment Information to the consolidated
financial statements in Item 8 of this report and "Results of Operations-Segment
Results" below.
On January 3, 2013, we announced a reorganization of our operating segments.
Consequently, beginning with the first quarter of 2013, we will report the
following four segments in our consolidated financial statements: consumer,
business, wholesale and data hosting. The primary purpose of the reorganization
is to strengthen our focus on the enterprise business market while continuing
our commitment to our hosting and consumer customers. The reorganization
combines business sales and operations functions that resided in the enterprise
markets-network segment and the regional markets segment into the new business
segment. The remaining customers serviced by the regional markets segment will
become the new consumer segment. Our wholesale markets and enterprises
markets-data hosting segments will not be impacted by the organizational
realignment.
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Results of Operations
The following table summarizes the results of our consolidated operations
for the years ended December 31, 2012, 2011 and 2010. Our operating results
include operations of Savvis for periods after July 15, 2011 and Qwest for
periods after April 1, 2011.
Years Ended December 31,
2012 2011 2010
(Dollars in millions except
per share amounts)
Operating revenues $ 18,376 15,351 7,042
Operating expenses 15,663 13,326 4,982
Operating income 2,713 2,025 2,060
Other income (expense) (1,463 ) (1,077 ) (529 )
Income tax expense 473 375 583
Net income $ 777 573 948
Basic earnings per common share $ 1.25 1.07 3.13
Diluted earnings per common share $ 1.25 1.07 3.13
Due to our acquisitions of Qwest on April 1, 2011 and Savvis on July 15,
2011, our 2012 operating results reflect a full year of Qwest's and Savvis'
results, as compared to our 2011 operating results, which reflect only nine
months of Qwest's operating results and five and a half months of Savvis'
operating results.
The increase in net income in 2012 was primarily due to the 2012 period
containing a full year of Qwest's operating results compared to the 2011 period
only containing nine months and a significant decrease from 2011 in the amount
of acquisition, severance and integration expenses resulting from our recent
acquisitions, as presented in the table under the "Overview" section above. The
lower levels of net income in 2011 as compared to 2010 were primarily due to
increased acquisition, severance and integration expenses attributable to the
April 1, 2011 acquisition of Qwest. The post-acquisition operations of Legacy
Savvis and Legacy Qwest, which included substantial severance and integration
expenses and significant acquisition accounting adjustments to depreciation and
amortization expense based on valuation estimates, did not contribute
significantly to our consolidated net income in 2011. See Note 2-Acquisitions
and Note 3-Goodwill, Customer Relationships and Other Intangible Assets to the
consolidated financial statements in Item 8 of this report. Within our Legacy
CenturyLink business, growth in strategic services revenues (which we describe
further below) did not fully offset lower revenues from other services and
products, further contributing to decreases in consolidated net income.
Diluted earnings per common share in 2012 was higher than 2011 as a result
of increased net income for 2012. Diluted earnings per common share in 2011 was
substantially lower than the amounts for the corresponding period of 2010 due to
decreases in net income, as well as increases in the weighted average number of
outstanding common shares. The increase in the weighted average number of
outstanding common shares during 2012 and 2011 was primarily attributable to the
issuance of approximately 294 million shares in connection with the Qwest
acquisition on April 1, 2011 and the issuance of approximately 14.3 million
shares in connection with the Savvis acquisition on July 15, 2011.
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The following table summarizes our broadband subscribers, access lines and
number of employees:
As of December 31,
2012 2011 2010
(in thousands)
Operational metrics:
Broadband subscribers 5,848 5,652 2,349
Access lines 13,748 14,584 6,489
Employees 47.0 49.2 20.3
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
primarily due to declines in access lines, intrastate access rates and minutes
of use. Prior to our 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;
º •
º 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;
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), 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), VoIP and Verizon Wireless services;
º •
º Legacy services, which include primarily local, long-distance,
switched access, public access, ISDN (which uses regular telephone
lines to support voice, video and data applications), and 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 to customers for use on their premises and related
professional services, such as network management, installation and
maintenance of data equipment and building of proprietary fiber-optic
networks for our government and business customers; and
º •
º 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.
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The following table summarizes our operating revenues under our current
revenue categorization which is presented in a manner that we believe will be
useful for understanding the relevant trends affecting our business:
Years Ended
December 31, Increase (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Strategic services $ 8,361 6,262 307 1,207 585 2,099
Legacy services 8,287 7,672 (633 ) 1,248 - 615
Data integration 672 537 19 116 - 135
Other 1,056 880 44 132 - 176
Total operating revenues $ 18,376 15,351 (263 ) 2,703 585 3,025
During 2012, operating revenues attributable to certain products and
services were reclassified from legacy services to strategic services. Due to
system limitations, we have determined that is impracticable to restate 2010's
operating revenues to conform to our current revenue categorization. For
comparability purposes, we have included our operating revenues for the years
ended December 31, 2011 and 2010 under our prior revenue categorization:
Years Ended
December 31, Increase (Decrease)
2011 2010 CenturyLink Qwest Savvis Total
(Dollars in millions)
Strategic services $ 6,254 2,049 150 3,572 483 4,205
Legacy services 7,680 4,288 (483 ) 3,875 - 3,392
Data integration 537 158 (23 ) 402 - 379
Other 880 547 (24 ) 357 - 333
Total operating revenues $ 15,351 7,042 (380 ) 8,206 483 8,309
Our operating revenues increased substantially in both 2012 and 2011 as
compared to 2011 and 2010, respectively, due to our acquisitions of Qwest on
April 1, 2011 and Savvis on July 15, 2011. Total operating revenues increased
$3.025 billion in 2012 as compared to 2011 and increased $8.309 billion in 2011
as compared to 2010. As reflected in the chart above, our acquisitions of Qwest
and Savvis contributed incremental operating revenues (net of intercompany
eliminations) of $2.7 billion and $585 million, respectively, to our 2012
revenues. Legacy CenturyLink operating revenues decreased $263 million, or 1.7%,
in 2012 and $380 million, or 5.4%, in 2011 as compared to the prior year period.
These decreases were primarily attributable to declines in legacy services
revenues, which reflected the continuing loss of access lines in our markets. At
December 31, 2012, we had 13.748 million access lines, of which 8.055 million
were in Legacy Qwest's markets. Access lines in our Legacy CenturyLink markets
declined to 5.693 million at December 31, 2012 from 6.051 million at
December 31, 2011, a decrease of 5.93% during 2012, and were 6.489 million at
December 31, 2010, a decrease of 6.75% during 2011. 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 5.4% and 5.9% in 2013. Our
legacy services revenues were also negatively impacted in 2012 by the continued
reduction in access revenues and 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,
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MPLS, Internet Protocol Television ("IPTV"), VoIP and broadband services
accounted for a majority of the growth in strategic services revenues.
We are aggressively marketing our strategic services (including our data
hosting services) and data integration to offset the continuing declines in our
legacy services revenues. We believe our recent acquisitions of Savvis and Qwest
will strengthen our ability to achieve this goal.
Further analysis of our operating revenues by segment is provided below in
"Segment Results."
Operating Expenses
Our current definitions of operating expenses are as follows:
º •
º Cost of services and products (exclusive of depreciation and
amortization) are expenses incurred in providing products and services
to our customers. These expenses include: employee-related expenses
directly attributable to operating and maintaining our network (such
as salaries, wages, benefits and professional fees); facilities
expenses (which include third-party telecommunications expenses we
incur for using other carriers' networks to provide services to our
customers); rents and utilities expenses; equipment sales expenses
(such as data integration and modem expenses); costs for universal
service funds ("USF") (which are federal and state funds that are
established to promote the availability of telecommunications services
to all consumers at reasonable and affordable rates, among other
things, and to which we are often required to contribute); and other
expenses directly related to our network and hosting operations.
º •
º Selling, general and administrative expenses are corporate overhead
and other operating expenses. These expenses include: employee-related
expenses (such as salaries, wages, internal commissions, benefits and
professional fees) directly attributable to selling products or
services and employee-related expenses for administrative functions;
marketing and advertising; taxes (such as property and other taxes)
and fees; external commissions; bad debt expense; and other selling,
general and administrative expenses.
These expense classifications may not be comparable to those of other
companies.
During 2012 and 2011, our operating expenses increased substantially in
comparison to 2011 and 2010 primarily due to our acquisitions of Qwest and
Savvis.
The following tables summarize our operating expenses:
Years Ended
December 31, Increase (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Cost of services and
products (exclusive of
depreciation and
amortization) $ 7,639 6,325 (73 ) 1,082 305 1,314
Selling, general and
administrative 3,244 2,975 (367 ) 483 153 269
Depreciation and
amortization 4,780 4,026 (149 ) 741 162 754
Total operating expenses $ 15,663 13,326 (589 ) 2,306 620 2,337
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Years Ended
December 31, Increase (Decrease)
2011 2010 CenturyLink Qwest Savvis Total
(Dollars in millions)
Cost of services and
products (exclusive of
depreciation and
amortization) $ 6,325 2,544 (4 ) 3,523 262 3,781
Selling, general and
administrative 2,975 1,004 60 1,791 120 1,971
Depreciation and
amortization 4,026 1,434 72 2,394 126 2,592
Total operating expenses $ 13,326 4,982 128 7,708 508 8,344
The acquisitions of Qwest and Savvis largely contributed to the increase in
total operating expenses of $2.337 billion in 2012. Excluding the effects of
Legacy Qwest and Legacy Savvis expenses, total operating expenses in 2012
decreased $589 million, or 4.4%, due primarily to decreases in employee-related
expenses, severance and integration expenses relating to our recent acquisitions
and depreciation and amortization expense. The increase in total operating
expenses of $8.344 billion in 2011 was largely attributable to the inclusion of
$7.7 billion in post-acquisition Legacy Qwest operating expenses (net of
intercompany eliminations) in our consolidated operating expenses. In addition,
the acquisition of Savvis on July 15, 2011 increased our consolidated operating
expenses for 2011 by $508 million. As discussed in the "Overview" section, our
operating expenses for 2012, 2011, and 2010 included substantial severance and
integration costs related to the Qwest, Savvis and Embarq acquisitions as well
as significant acquisition accounting adjustments to depreciation and
amortization expense. See Note 2-Acquisitions and Note 3-Goodwill, Customer
Relationships and Other Intangible Assets to the consolidated financial
statements in Item 8 of this report. Excluding the effects of Legacy Qwest and
Legacy Savvis expenses, total operating expenses in 2011 increased $128 million,
or 2.6%, due primarily to integration costs associated with the Qwest
acquisition and increased costs of providing our facilities-based video services
to more customers.
For the year ended December 31, 2012, Legacy CenturyLink cost of services
and products (exclusive of depreciation and amortization) were slightly lower as
compared to 2011. During the year, we experienced decreases in severance,
salaries and wages and related benefits, which were partially offset by
increases in customer premise equipment and maintenance costs, network expense,
and contractor costs. Cost of services and products for Legacy CenturyLink
operations was relatively unchanged in 2011. For 2011, $55 million of higher
costs of services and products associated with providing our facilities-based
video service were substantially offset by a $28 million decrease in salaries
and benefits and a $20 million decrease in facilities costs associated with the
migration of legacy Embarq long-distance traffic to our internal networks.
Legacy CenturyLink selling, general and administrative expenses decreased
$367 million, or 2.8%, for 2012 as compared to 2011, while selling, general and
administrative expenses increased $60 million, or 6.0%, for 2011 as compared to
2010. The decrease in 2012 primarily was 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. For
all periods presented, our expenses include significant transaction, severance
and integration expenses related to the Qwest, Savvis and Embarq acquisitions
(see table in "Overview" above). Changes in the timing and amount of Qwest and
Savvis integration expenses resulted in a net increase in Legacy CenturyLink's
2011 selling, general and administrative expenses compared to 2010. This
increase was partially offset by a decrease of $33 million in 2011 in operating
taxes, which were primarily due to favorable property tax and transaction tax
settlements. In addition, in 2011 we had a decrease of $20 million in
compensation expenses, which were primarily due to workforce reductions and
lower pension expense.
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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 $40 million to $55 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 $40 million to $55 million decrease in
operating expenses for the year ended December 31, 2012. The reduction in
expenses described above, net of tax, increased net income approximately
$25 million to $34 million, or $0.04 to $0.05 per basic and diluted common
share, for the year ended December 31, 2012.
Excluding the effects of the acquisitions of Qwest and Savvis, depreciation
and amortization expense for Legacy CenturyLink decreased $149 million, or 3.7%,
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. Depreciation and amortization for Legacy CenturyLink increased
$72 million, or 5.0%, in 2011 primarily due to higher levels of property, plant
and equipment and an out-of-period accounting adjustment corrected in 2012.
Further analysis of our operating expenses by segment is provided below in
"Segment Results."
Other Consolidated Results
The following tables summarize our total other income (expense) and income
tax expense:
Years Ended
December 31, Increase (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Interest expense $ (1,319 ) (1,072 ) 62 169 16 247
Net loss on early retirement
of debt (179 ) (8 ) 179 (8 ) - 171
Other income (expense) 35 3 32 (1 ) 1 32
Total other income (expense) $ (1,463 ) (1,077 ) 273 160 17 386
Income tax expense $ 473 375 nm nm nm 98
Years Ended
December 31, Increase (Decrease)
2011 2010 CenturyLink Qwest Savvis Total
(Dollars in millions)
Interest expense $ (1,072 ) (544 ) 34 486 8 528
Net loss on early retirement
of debt (8 ) - - 8 - 8
Other income (expense) 3 15 17 (2 ) (3 ) 12
Total other income (expense) $ (1,077 ) (529 ) 51 492 5 548
Income tax expense $ 375 583 nm nm nm (208 )
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nm-Attributing changes in income tax expense to the acquisitions of Savvis and
Qwest is considered not meaningful.
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Interest Expense
Interest expense for the year ended December 31, 2012 increased by
$247 million compared to 2011. This increase is primarily due to the 2012 period
containing a full year of Qwest interest expense compared to the 2011 period
containing only nine months. Interest expense increased $528 million in 2011
primarily due to higher debt balances associated principally with debt assumed
in the Qwest acquisition and incurred to finance the Savvis acquisition. See
Note 4-Long-term Debt and Credit Facilities to the consolidated financial
statements in Item 8 of this report and "Liquidity and Capital Resources" below
for additional information about those transactions.
Interest expense for Legacy CenturyLink increased $62 million, or 5.8%, in
2012 compared to 2011 and increased $34 million, or 6.3%, in 2011 compared to
2010. The increase in both years is substantially due to interest on our
$2 billion aggregate principal amount of senior notes issued in June 2011 to
finance the Savvis acquisition. The 2012 increase is due to those notes being
outstanding for a full year versus a partial year in 2011. The 2011 increase was
due to those notes being outstanding for a partial year versus not at all in
2010.
Net Loss on Early Retirement of Debt
In the fourth quarter of 2012, QCII redeemed certain of its outstanding debt
securities, which resulted in a gain of $15 million.
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
$190 million. Also in the second quarter of 2012, our subsidiaries Embarq and
QCII redeemed certain of their respective outstanding debt securities which
resulted in a net loss of $9 million.
During 2012, QCII and QC redeemed certain of their outstanding debt
securities, which resulted in a gain of $5 million.
In the fourth quarter and second quarter of 2011, QC redeemed certain of its
outstanding debt securities which resulted in a total net loss of $8 million.
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
for Legacy CenturyLink was greater for the year ended December 31, 2012 as
compared to 2011 due to gains on the sales of our auction rate securities and
the recognition in 2011 of $16 million in transaction expenses incurred in
connection with terminating an unused bridge loan financing commitment related
to the Savvis acquisition. See Note 2-Acquisitions to the consolidated financial
statements in Item 8 of this report. Other income for Legacy CenturyLink
decreased $17 million in 2011, as compared to 2010 primarily due to the
$16 million in transaction expenses discussed above.
Income Tax Expense
Our income tax expense for the years ended December 31, 2012 and
2011increased $98 million and decreased $208 million, respectively, from the
amounts for the comparable prior year. Our increase in 2012 was primarily due to
a $302 million, or 32%, increase in income before income tax expense as compared
to 2011. Our decrease in 2011 was primarily due to a decrease in income before
income tax expense, which was attributable to a decline in operating income and
increased interest expense directly related to the acquisition of Qwest. For the
years ended December 31, 2012, 2011 and 2010, our effective income tax rate was
37.8%, 39.6% and 38.1%, respectively. The 2012 effective tax rate reflects the
$16 million reversal of a valuation allowance related to the auction rate
securities we sold in 2012,
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a $12 million benefit related to state NOLs net of valuation allowance, and a
$6 million expense associated with reversing a receivable related to periods
that have been effectively settled with the IRS. The 2011 rate increase was due
in part to $24 million of non-deductible transaction costs and an $8 million
valuation allowance recorded on deferred tax assets that require future income
of a special character to realize the benefits. Such increase was partially
offset by a $16 million reduction in our valuation allowance related to state
NOLs due primarily to the effects of a tax law change in one of the states in
which we operate. Certain merger-related costs incurred during 2010 are also
non-deductible for income tax purposes and similarly increased our effective
income tax rate. See Note 12-Income Taxes to the consolidated financial
statements in Item 8 of this report and "Income Taxes" below for additional
information.
Segment Results
As described further above under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Overview," we revised
our segment structure in 2012 and restated previously reported segment results
for the year ended December 31, 2011 to conform to our 2012 segment
presentation. The following table summarizes our segment results for 2012 and
2011 under our segment categorization at December 31, 2012.
Years Ended December 31,
2012 2011
(Dollars in millions)
Total segment revenues $ 17,320 14,471
Total segment expenses 8,094 6,513
Total segment income $ 9,226 7,958
Total margin percentage 53% 55%
Regional markets:
Revenues $ 9,876 8,743
Expenses 4,218 3,673
Income $ 5,658 5,070
Margin percentage 57% 58%
Wholesale markets:
Revenues $ 3,721 3,305
Expenses 1,117 1,021
Income $ 2,604 2,284
Margin percentage 70% 69%
Enterprise markets-network:
Revenues $ 2,609 1,933
Expenses 1,891 1,450
Income $ 718 483
Margin percentage 28% 25%
Enterprise markets-data hosting:
Revenues $ 1,114 490
Expenses 868 369
Income $ 246 121
Margin percentage 22% 25%
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Due to system limitations, we have determined that it is impracticable to
restate 2010's reported segments to conform to our current segment
categorization at December 31, 2012. For comparability purposes, we have
included our segment information for the years ended December 31, 2011 and 2010
based on the segment categorization we were operating under at the end of 2011.
Years Ended December 31,
2011 2010
(Dollars in millions)
Total segment revenues $ 14,471 6,495
Total segment expenses 6,535 2,403
Total segment income $ 7,936 4,092
Total margin percentage 55% 63%
Regional markets:
Revenues $ 7,832 4,640
Expenses 3,398 1,783
Income $ 4,434 2,857
Margin percentage 57% 62%
Business markets:
Revenues $ 2,861 266
Expenses 1,736 120
Income $ 1,125 146
Margin percentage 39% 55%
Wholesale markets:
Revenues $ 3,295 1,589
Expenses 1,021 500
Income $ 2,274 1,089
Margin percentage 69% 69%
Savvis operations:
Revenues $ 483 -
Expenses 380 -
Income $ 103 -
Margin percentage 21% -
The lower levels of margin percentage for regional markets and business
markets in 2011 were primarily attributable to the inclusion of Qwest's results
beginning April 1, 2011.
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The following table reconciles our total segment revenues and total segment
income presented above to operating revenues and operating income reported in
our consolidated statements of operations.
Years Ended December 31,
2012 2011 2010
(Dollars in millions)
Total segment revenues $ 17,320 14,471 6,495
Other operating revenues 1,056 880 547
Operating revenues reported in our consolidated
statements of operations $ 18,376 15,351 7,042
Total segment income $ 9,226 7,958 4,092
Other operating revenues 1,056 880 547
Depreciation and amortization (4,780 ) (4,026 ) (1,434 )
Other unassigned operating expenses (2,789 ) (2,787 ) (1,145 )
Operating income reported in our consolidated
statement of operations $ 2,713 2,025 2,060
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. 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 restated our segment results for 2011 to reflect these changes in
our methodology. We determined that it was impracticable to recast our segment
results for 2010 under our revised 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
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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.
As discussed under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Overview", beginning in the first
quarter of 2013, we plan to report our operations under the following four
segments: consumer, business, wholesale and data hosting.
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
(broadband) network, 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 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 refine 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 revenues associated with access
lines, 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;
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, many
of whom have recently experienced budget cuts; and
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 table summarizes the results of operations from our regional
markets segment:
Regional Markets Segment
Years Ended December 31, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment
revenues:
Strategic
services $ 3,607 2,890 168 546 3 717
Legacy services 5,996 5,593 (399 ) 802 - 403
Data integration 273 260 (19 ) 32 - 13
Total revenues 9,876 8,743 (250 ) 1,380 3 1,133
Segment
expenses:
Direct 3,939 3,469 (44 ) 514 - 470
Allocated 279 204 52 20 3 75
Total expenses 4,218 3,673 8 534 3 545
Segment income $ 5,658 5,070 (258 ) 846 - 588
Segment margin
percentage 57% 58%
Segment Income
The acquisition of Qwest on April 1, 2011 largely contributed to an increase
in our regional markets segment income of $588 million for the year ended
December 31, 2012 as compared to 2011. Our consolidated segment margin
percentage remained relatively unchanged from 2011 to 2012. Segment income for
our Legacy CenturyLink operations decreased $258 million as compared to 2011
reflecting declines in revenues while expenses remained relatively flat.
Segment Revenues
Excluding revenues attributable to the Legacy Qwest and Legacy Savvis
acquisitions, regional markets revenues decreased $250 million, or 2.9%, for the
year ended December 31, 2012 as compared to 2011 due to declines in legacy
services revenues and the implementation of the CAF order, 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 described previously. Growth in strategic services revenues
was principally due 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, exclusive of Legacy Qwest and Legacy Savvis
expenses, increased $8 million for the year ended December 31, 2012 as compared
to 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, which were partially offset by increases in customer premise equipment
costs and network service costs.
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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 could
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; and
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. We also expect our wholesale markets segment to benefit
indirectly from enhanced efficiencies in our company-wide network
operations.
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The following table summarizes the results of operations from our wholesale
markets segment:
Wholesale Markets Segment
Years Ended December 31, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment
revenues:
Strategic
services $ 2,296 1,915 33 339 9 381
Legacy services 1,424 1,389 (213 ) 248 - 35
Data integration 1 1 - - - -
Total revenues 3,721 3,305 (180 ) 587 9 416
Segment
expenses:
Direct 169 174 (18 ) 13 - (5 )
Allocated 948 847 (60 ) 155 6 101
Total expenses 1,117 1,021 (78 ) 168 6 96
Segment income $ 2,604 2,284 (102 ) 419 3 320
Segment margin
percentage 70% 69%
Segment Income
The acquisition of Qwest on April 1, 2011 largely contributed to an increase
in our wholesale markets segment income of $320 million for the year ended
December 31, 2012 as compared to 2011. Segment income for our Legacy CenturyLink
operations decreased $102 million for the year ended December 31, 2012 as
compared to 2011, primarily reflecting declines in revenues, as discussed
further below.
Segment Revenues
Excluding revenues attributable to the Legacy Qwest and Legacy Savvis
acquisitions, wholesale markets revenues decreased $180 million, or 5.5%, for
the year ended December 31, 2012 as compared to 2011. This decrease reflects
substantially lower revenues from legacy services, partially offset by growth in
revenues from strategic services. Strategic services revenues increased
primarily due to growth in Ethernet and broadband services. The decrease in
legacy services revenues was driven by continuing declines in access,
long-distance and local services volumes, and the implementation of the CAF
order, as well as the substitution of cable, wireless, VoIP and other services
for traditional voice telecommunications services.
Segment Expenses
Wholesale markets expenses, exclusive of Legacy Qwest and Legacy Savvis
expenses, decreased $78 million, or 7.6%, for the year ended December 31, 2012
as compared to 2011. The decrease in Legacy CenturyLink wholesale markets
expenses was primarily 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.
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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 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. In addition,
changes to our compensation programs, which focus on higher margin
strategic services, could negatively impact data integration revenues;
and
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.
The following table summarizes the results of operations from our enterprise
markets-network segment:
Enterprise Markets-Network Segment
Years Ended December 31, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment revenues:
Strategic
services $ 1,344 967 56 314 7 377
Legacy services 867 690 (21 ) 198 - 177
Data integration 398 276 38 84 - 122
Total revenues 2,609 1,933 73 596 7 676
Segment expenses:
Direct 781 568 33 180 - 213
Allocated 1,110 882 (40 ) 261 7 228
Total expenses 1,891 1,450 (7 ) 441 7 441
Segment income $ 718 483 80 155 - 235
Segment margin
percentage 28% 25%
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Segment Income
The acquisition of Qwest on April 1, 2011 substantially increased the scale
of our enterprise markets-network segment, resulting in an increase of
$235 million in segment income for the year ended December 31, 2012 as compared
to 2011. Segment income for our Legacy CenturyLink operations increased
$80 million for the year ended December 31, 2012 as compared to 2011, primarily
reflecting an increase in revenues.
Segment Revenues
Excluding revenues attributable to the Legacy Qwest and Legacy Savvis
acquisitions, enterprise markets-network segment revenues increased by
$73 million for the year ended December 31, 2012 as compared to the year ended
December 31, 2011. The increase was primarily due to growth in strategic
services revenues from increased volumes of MPLS services and increased data
integration revenues from maintenance and installation of customer premise
equipment. Lower revenues from legacy services were driven by access line losses
and price compression partially offset the increases in strategic services
revenues and data integration revenues.
Segment Expenses
Enterprise markets-network segment expenses, exclusive of Legacy Qwest and
Legacy Savvis expenses, decreased by $7 million for the year ended December 31,
2012 as compared to the year ended December 31, 2011 primarily due to decreased
allocated expenses partially offset by increased direct expenses. Allocated
expenses decreased for the year ended December 31, 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-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 hosting offerings. However, we remain focused on
expanding our managed hosting business, specifically in our cloud
hosting offerings, which we believe is a key to growth. We believe
that we have continued to strengthen our position in the cloud hosting
market by adding differentiating features to our cloud hosting
products; and
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 table summarizes the results of operations from our enterprise
markets-data hosting segment:
Enterprise Markets-Data Hosting Segment
Years Ended December 31, Increase / (Decrease)
2012 2011 CenturyLink Qwest Savvis Total
(Dollars in millions)
Segment
revenues:
Strategic
services $ 1,114 490 50 8 566 624
Total revenues 1,114 490 50 8 566 624
Segment
expenses:
Direct 940 415 56 11 458 525
Allocated (72 ) (46 ) 1 (10 ) (17 ) (26 )
Total expenses 868 369 57 1 441 499
Segment income $ 246 121 (7 ) 7 125 125
Segment margin
percentage 22% 25%
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 of
$125 million in our segment income for the year ended December 31, 2012 as
compared to the year ended December 31, 2011.
Segment Revenues
Savvis operations accounted for 97% of our enterprise markets-data hosting
segment revenues for the year ended December 31, 2012. Growth in strategic
services is driven by roughly equivalent increases in both colocation and
managed hosting.
Segment Expenses
Excluding the expenses attributable to the Legacy Qwest and Legacy Savvis
acquisitions, enterprise markets-data hosting segment direct expenses increased
for the year ended December 31, 2012 as compared to the year ended December 31,
2011 primarily due 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 resulted in a negative net allocation impact.
Other Operational Matters
Approximately 26% 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 at least
24 hour advance notice before terminating those predecessor agreements. If we
fail to extend or renegotiate our collective bargaining agreements with our
labor unions, or if our unionized employees were to engage in a strike or other
work stoppage, our business and operating results could
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be materially harmed. See "Risk Factors-Other Risks Affecting Our Business" in
Item 1A of this report. 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.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with
accounting principles that are generally accepted in the United States. The
preparation of these consolidated financial statements requires management to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. We have identified certain policies and
estimates as critical to our business operations and the understanding of our
past or present results of operations related to (i) business combinations;
(ii) goodwill, customer relationships and other intangible assets;
(iii) property, plant and equipment; (iv) pension and post-retirement benefits;
(v) loss contingencies and litigation reserves; and (vi) income taxes. These
policies and estimates are considered critical because they had a material
impact, or they have the potential to have a material impact, on our
consolidated financial statements and because they require significant
judgments, assumptions or estimates. We believe that the estimates, judgments
and assumptions made when accounting for the items described below are
reasonable, based on information available at the time they are made. However,
there can be no assurance that actual results will not differ from those
estimates.
Business Combinations
We have accounted for our acquisitions of Qwest on April 1, 2011 and Savvis
on July 15, 2011 under the acquisition method of accounting, whereby the
tangible and separately identifiable intangible assets acquired and liabilities
assumed are recognized at their estimated fair values at the acquisition date.
The portion of the purchase price in excess of the estimated fair value of the
net tangible and separately identifiable intangible assets acquired represents
goodwill. The estimates of fair value and resulting allocation of the purchase
price related to our acquisitions of Qwest and Savvis involved significant
estimates and judgments by our management. In arriving at the fair values of
assets acquired and liabilities assumed, we considered the following generally
accepted valuation approaches: the cost approach, income approach and market
approach. Our estimates also included assumptions about projected growth rates,
cost of capital, effective tax rates, tax amortization periods, technology life
cycles, the regulatory and legal environment and industry and economic trends.
Small changes in the underlying assumptions could impact the estimates of fair
value by material amounts, which could in turn materially impact our results of
operations.
Goodwill, Customer Relationships and Other Intangible Assets
We amortize customer relationships over primarily over an estimated life of
10 years to 12.5 years, using either the sum-of-the-years-digits or
straight-line methods, depending on the type of customer. We amortize
capitalized software, which consists primarily of assets obtained from the Qwest
acquisition, using the straight-line method over estimated lives ranging up to
seven years. Approximately $237 million of our capitalized software represents
costs to develop an integrated billing and customer care system and is being
amortized over a 20 year period that began in 2004. We amortize trade names and
patent assets predominantly using the sum-of-the-years digits over an estimated
life of four years. Other intangible assets not arising from business
combinations are initially recorded at cost. Where there are no legal,
regulatory, contractual or other factors that would reasonably limit the useful
life of an intangible asset, we classify the intangible asset as
indefinite-lived and such intangible assets are not amortized. We periodically
review the estimated lives and methods used to amortize our other intangible
assets. The amount of future amortization expense may differ materially from
current amounts, depending on the results of our periodic reviews.
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Our long-lived intangible assets with indefinite lives are tested for
impairment annually, or, under certain circumstances, more frequently, such as
when events or circumstances indicate there may be an impairment. These assets
are carried at historical cost if their estimated fair value is greater than
their carrying amounts. However, if their estimated fair value is less than the
carrying amount, other indefinite-lived intangible assets are reduced to their
estimated fair value through an impairment charge to our consolidated statements
of operations. We early adopted the provisions of Accounting Standards Update
("ASU") 2012-2, Intangibles-Goodwill and Other (Topic 350): Testing
Indefinite-Lived Intangible Assets for Impairment, during the fourth quarter of
2012, which allows us the option to first review qualitative factors to
determine the likelihood of whether the indefinite-lived intangible asset is
impaired before performing a qualitative impairment test. Under this approach,
if we determine that it is more likely than not that the indefinite-lived
intangible asset is impaired, we will be required to compute and compare the
fair value of the indefinite-lived intangible asset to its carrying amount to
determine and measure the impairment loss, if any. We completed our qualitative
assessment as of December 31, 2012 and concluded it is not more likely than not
that our indefinite-lived intangible assets are impaired; thus, no impairment
charge was recorded in 2012.
Our goodwill was derived from numerous acquisitions where the purchase price
exceeded the fair value of the net assets acquired. For more information on our
recent acquisitions and resulting fair values, see Note 2-Acquisitions to the
consolidated financial statements in Item 8 of this report.
We are required to reassign goodwill to reporting units each time we
reorganize our internal reporting structure which causes a change in our
operating segments. Goodwill is reassigned to the reporting units using a
relative fair value allocation approach. We utilize the earnings before
interest, tax and depreciation as our allocation methodology as it represents a
reasonable proxy for the fair value of the operations being reorganized.
We have attributed our goodwill balance to our segments at December 31, 2012
as follows:
(Dollars in millions)
Regional markets $ 15,170
Wholesale markets 3,283
Enterprise markets-network 1,788
Enterprise markets-data hosting 1,491
Total goodwill $ 21,732
For additional information on the April 1, 2012 reorganization of our
segments, see Note 13-Segment Information to the consolidated financial
statements in Item 8 of this report.
We are required to test goodwill for impairment at least annually, or more
frequently if events or a change in circumstances indicate that an impairment
may have occurred. We are required to write-down the value of goodwill in
periods in which the recorded amount of goodwill exceeds the fair value. Our
reporting units, which we refer to as our segments, are not discrete legal
entities with discrete financial statements. Our assets and liabilities are
employed in and relate to the operations of multiple reporting units. Therefore,
each time we perform goodwill impairment analysis on a reporting unit, we
estimate the equity carrying value and future cash flows of each of our segments
using allocation methodologies. Certain estimates, judgments and assumptions are
required to perform these allocations. We believe these estimates, judgments and
assumptions to be reasonable, but slight changes in many of these can
significantly affect each reporting unit's equity carrying value and future cash
flows utilized for our goodwill impairment test. Our annual measurement date for
testing goodwill impairment is September 30. As of September 30, 2012, we tested
for goodwill impairment on our reporting units, which were our four operating
segments (regional markets, wholesale markets,
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enterprise markets-network and enterprise markets-data hosting) that we
recognized following our internal reorganization earlier in 2012.
In the third quarter of 2011, we adopted the provisions of ASU 2011-08,
Testing Goodwill for Impairment, which permits us to make a qualitative
assessment of whether it is more likely than not that a reporting unit's
estimated fair value is less than its carrying amount before applying the
two-step goodwill impairment test, which requires us (i) in step one, to
identify potential impairments by comparing the estimated fair value of a
reporting unit against its carrying value and (ii) in step two, to quantify any
impairment identified in step one. At September 30, 2012, as a result of the
April 1, 2012 internal reorganization of our four segments we did not have a
baseline valuation to perform a qualitative assessment. We estimated the fair
value of our four segments using an equal weighting based on a market approach
and a discounted cash flow method. The market approach includes the use of
comparable multiples of publicly traded companies whose services are comparable
to ours. The discounted cash flow method is based on the present value of
projected cash flows and a terminal value, which represents the expected
normalized cash flows of the segments beyond the cash flows from the discrete
nine-year projection period. We discounted the estimated cash flows for our
regional markets, wholesale markets, and enterprise markets-network segments
using a rate that represents a market participant's weighted average cost of
capital, which we determined to be approximately 6.0% as of the measurement date
(which was comprised of an after-tax cost of debt of 3.2% and a cost of equity
of 8.4%). We discounted the estimated cash flows of our enterprise markets-data
hosting segment using a rate that represents a market participant's estimated
weighted average cost of capital, which we determined to be approximately 11.0%
as of the measurement date (which was comprised of an after-tax cost of debt of
3.2% and a cost of equity of 12.0%). We also reconciled the estimated fair
values of the segments to our market capitalization as of September 30, 2012 and
concluded that the indicated implied control premium of approximately 14% was
reasonable based on recent transactions in the market place. Based on our
analysis performed with respect to our reporting units described above, we
concluded that our goodwill was not impaired as of September 30, 2012.
As of September 30, 2012, based on our analysis performed with respect to
our four reporting units, the estimated fair value of our equity exceeded our
carrying value of equity for our regional markets, wholesale markets, enterprise
markets-network and enterprise markets-data hosting segments by 19%, 130%, 78%
and 10%, respectively.
We may be required to assess our goodwill for impairment before our next
required testing date of September 30, 2013 under certain circumstances,
including any failure of our future operating results to meet forecasted
expectations or any significant increases in our weighted average cost of
capital. In addition, we cannot assure that adverse conditions will not trigger
future goodwill impairment testing or an impairment charge. A number of factors,
many of which we have no ability to control, could affect our financial
condition, operating results and business prospects and could cause our actual
results to differ from the estimates and assumptions we employed in our goodwill
impairment testing. These factors include, but are not limited to, (i) further
weakening in the overall economy; (ii) a significant decline in our stock price
and resulting market capitalization; (iii) changes in the discount rate;
(iv) successful efforts by our competitors to gain market share in our markets;
(v) adverse changes as a result of regulatory actions; (vi) a significant
adverse change in legal factors or in the overall business climate; and
(vii) recognition of a goodwill impairment loss in the financial statements of a
subsidiary that is a component of our reporting units. For additional
information, see "Risk Factors" in Item 1A of this report. We will continue to
monitor certain events that impact our operations to determine if an interim
assessment of goodwill impairment should be performed prior to the next required
testing date of September 30, 2013.
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Property, Plant and Equipment
Property, plant and equipment acquired in connection with our acquisitions
was recorded based on its estimated fair value as of its acquisition date.
Property, plant and equipment purchased subsequent to our acquisitions is
recorded at cost plus the estimated value of any associated legally or
contractually required asset retirement obligation. Renewals and betterments of
plant and equipment are capitalized while repairs, as well as renewals of minor
items, are charged to operating expense. Depreciation of property, plant and
equipment is provided on the straight-line method using class or overall group
rates. The group method provides for the recognition of the remaining net
investment, less anticipated net salvage value, over the remaining useful life
of the assets. This method requires the periodic revision of depreciation rates.
Normal retirements of property, plant and equipment are charged against
accumulated depreciation, with no gain or loss recognized. Other types of
property, plant and equipment are stated at cost and, when sold or retired, a
gain or loss is recognized. We depreciate such property on the straight-line
method over estimated service lives ranging from 3 to 45 years.
We perform annual internal reviews to evaluate the reasonableness of the
depreciable lives for our property, plant and equipment. Our reviews utilize
models that take into account actual usage, physical wear and tear, replacement
history, assumptions about technology evolution and, in certain instances,
actuarially determined probabilities to estimate the remaining life of our asset
base.
Due to rapid changes in technology and the competitive environment,
selecting the estimated economic life of telecommunications plant, equipment and
software requires a significant amount of judgment. We regularly review data on
utilization of equipment, asset retirements and salvage values to determine
adjustments to our depreciation rates. The effect of a hypothetical one year
increase or decrease in the estimated remaining useful lives of our property,
plant and equipment would have decreased depreciation by approximately
$460 million or increased depreciation by approximately $650 million,
respectively.
We review long-lived assets, other than goodwill and other intangible assets
with indefinite lives, for impairment whenever facts and circumstances indicate
that the carrying amounts of the assets may not be recoverable. For measurement
purposes, long-lived assets are grouped with other assets and liabilities at the
lowest level for which identifiable cash flows are largely independent of the
cash flows of other assets and liabilities, absent a material change in
operations. An impairment loss is recognized only if the carrying amount of the
asset group is not recoverable and exceeds its fair value. Recoverability of the
asset group to be held and used is measured by comparing the carrying amount of
the asset group to the estimated undiscounted future net cash flows expected to
be generated by the asset group. If the asset group's carrying value is not
recoverable, an impairment charge is recognized for the amount by which the
carrying amount of the asset group exceeds its fair value. We determine fair
values by using a combination of comparable market values and discounted cash
flows, as appropriate. During 2012, we did not incur changes in events or
circumstances that would indicate that the carrying amounts of our long-lived
assets, other than goodwill and other intangible assets with indefinite lives,
may not be recoverable. As a result, no impairment charge was recorded in 2012.
Pension and Post-Retirement Benefits
We sponsor several noncontributory defined benefit pension plans (referred
to as our pension plans) for a substantial portion of our employees. In addition
to these tax "qualified" pension plans, we also maintain several non-qualified
pension plans for certain eligible highly compensated employees. We also
maintain post-retirement benefit plans that provide health care and life
insurance benefits for certain eligible retirees.
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Pension and post-retirement health care and life insurance benefits
attributed to eligible employees' service during the year, as well as interest
on benefit obligations, are accrued currently. Pension and post-retirement
benefit expenses are recognized over the period in which the employee renders
service and becomes eligible to receive benefits as determined using the
projected unit credit method. Pension prior service costs and certain actuarial
gains and losses are recognized as components of net periodic expense over the
average remaining service period of participating employees expected to receive
benefits. Post-retirement healthcare prior service costs are recognized as
components of net periodic expense over the average expected years to full
benefit eligibility for active employees. Certain post-retirement actuarial
gains or losses are amortized on a straight-line basis over the average expected
future working lifetime of active employees.
In computing the pension and post-retirement health care and life insurance
benefits expenses and obligations, the most significant assumptions we make
include discount rate, expected rate of return on plan assets, health care trend
rates and our evaluation of the legal basis for plan amendments. The plan
benefits covered by collective bargaining agreements as negotiated with our
employees' unions can also significantly impact the amount of expense, benefit
obligations and pension assets that we record.
The discount rate is the rate at which we believe we could effectively
settle the benefit obligations as of the end of the year. We selected the
discount rate based on a cash flow matching analysis using hypothetical yield
curves developed by an actuarial firm from U.S. corporate bonds rated high
quality and projections of the future benefit payments that constitute the
projected benefit obligation for the plans. This process establishes the uniform
discount rate that produces the same present value of the estimated future
benefit payments as is generated by discounting each year's benefit payments by
a spot rate applicable to that year. The spot rates used in this process are
derived from a yield curve created from yields on the 60th to 90th percentile of
U.S. high quality bonds.
The expected rate of return on plan assets is the long-term rate of return
we expect to earn on the plans' assets in the future. The rate of return is
determined by the strategic allocation of plan assets and the long-term risk and
return forecast for each asset class. The forecasts for each asset class are
generated primarily from an analysis of the long-term expectations of various
third party investment management organizations. The expected rate of return on
plan assets is reviewed annually and revised, as necessary, to reflect changes
in the financial markets and our investment strategy.
To compute the expected return on pension and post-retirement benefit plan
assets, we apply an expected rate of return to the fair value of the pension
plan assets and to the fair value of the post-retirement benefit plan assets
adjusted for contribution timing and for projected benefit payments to be made
from the plan assets. Annual market volatility for these assets is reflected in
subsequent years' net periodic combined benefits expense.
Changes in any of the above factors could significantly impact operating
expenses in the consolidated statements of operations and other comprehensive
(loss) income in the consolidated statements of comprehensive (loss) income as
well as the value of the liability and accumulated other comprehensive income
(loss) of stockholders' equity on our consolidated balance sheets. The expected
return on plan assets is reflected as a reduction to our pension and
post-retirement benefit expense. If our assumed expected rates of return for
2012 were 100 basis points lower, our qualified pension and post-retirement
benefit expenses would have increased by $118 million. If our assumed discount
rates for 2012 were 100 basis points lower, our qualified pension and
post-retirement benefit expenses would have increased by $78 million and our
projected benefit obligation would have increased by approximately $2.2 billion.
An increase of 100 basis points in the initial healthcare cost trend rate would
have increased our post-retirement benefit expense by $11 million and increased
our projected post-retirement benefit obligation by $77 million.
The trusts for the pension and post-retirement benefits plans hold
investments in equities, fixed income, real estate and other assets such as
private equity assets. The assets held by these trusts are
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reflected at estimated fair value as of December 31, 2012. For additional
information on our trust investments, see Note 8-Employee Benefits to the
consolidated financial statements in Item 8 of this report.
Loss Contingencies and Litigation Reserves
We are involved in several material legal proceedings, as described in more
detail in "Legal Proceedings" in Item 3 of this report. We assess potential
losses in relation to these and other pending or threatened tax and legal
matters. For matters not related to income taxes, if a loss is considered
probable and the amount can be reasonably estimated, we recognize an expense for
the estimated loss. To the extent these estimates are more or less than the
actual liability resulting from the resolution of these matters, our earnings
will be increased or decreased accordingly. If the differences are material, our
consolidated financial statements could be materially impacted. If a loss is
considered reasonably possible, we disclose the estimate of the potential loss
if material but we do not recognize any expense for the potential loss.
For matters related to income taxes, we determine that if the impact of an
uncertain tax position is more likely than not to be sustained upon audit by the
relevant taxing authority, then we recognize a benefit for the largest amount
that is more likely than not to be sustained. No portion of an uncertain tax
position will be recognized if the position has less than a 50% likelihood of
being sustained. Though the validity of any tax position is a matter of tax law,
the body of statutory, regulatory and interpretive guidance on the application
of the law is complex and often ambiguous. Because of this, whether a tax
position will ultimately be sustained may be uncertain. The overall tax
liability recorded for uncertain tax positions as of the successor dates of
December 31, 2012 and December 31, 2011, considers the anticipated utilization
of any applicable tax credits and net operating losses ("NOLs").
Income Taxes
Our provision for income taxes includes amounts for tax consequences
deferred to future periods. We record deferred income tax assets and liabilities
reflecting future tax consequences attributable to tax net operating losses, or
NOLs, tax credit carryforwards and differences between the financial statement
carrying value of assets and liabilities and the tax bases of those assets and
liabilities. Deferred taxes are computed using enacted tax rates expected to
apply in the year in which the differences are expected to affect taxable
income. The effect on deferred income tax assets and liabilities of a change in
tax rate is recognized in earnings in the period that includes the enactment
date.
The measurement of deferred taxes often involves the exercise of
considerable judgment related to the realization of tax basis. Our deferred tax
assets and liabilities reflect our assessment that tax positions taken in filed
tax returns and the resulting tax basis, are more likely than not to be
sustained if they are audited by taxing authorities. Also, assessing tax rates
that we expect to apply and determining the years when the temporary differences
are expected to affect taxable income requires judgment about the future
apportionment of our income among the states in which we operate. Any changes in
our practices or judgments involved in the measurement of deferred tax assets
and liabilities could materially impact our financial condition or results of
operations.
We record deferred income tax assets and liabilities as described above.
Valuation allowances are established when necessary to reduce deferred income
tax assets to amounts that we believe are more likely than not to be recovered.
We evaluate our deferred tax assets quarterly to determine whether adjustments
to our valuation allowance are appropriate in light of changes in facts or
circumstances, such as changes in tax law, interactions with taxing authorities
and developments in case law. In making this evaluation, we rely on our recent
history of pre-tax earnings, estimated timing of future deductions and benefits
represented by the deferred tax assets and our forecasts of future earnings, the
latter two
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of which involve the exercise of significant judgment. At December 31, 2012, we
established a valuation allowance of $281 million, primarily related to state
NOLs, as it is more likely than not that this amount will not be utilized prior
to expiration. If forecasts of future earnings and the nature and estimated
timing of future deductions and benefits change in the future, we may determine
that a valuation allowance for certain deferred tax assets is appropriate, which
could materially impact our financial condition or results of operations. See
Note 12-Income Taxes to the consolidated financial statements in Item 8 of this
report for additional information.
Liquidity and Capital Resources
Overview
At December 31, 2012, we held cash and cash equivalents of $211 million and
we had $1.180 billion available under our $2 billion revolving credit facility
(referred to as our "Credit Facility", which is described further below). At
December 31, 2012, cash and cash equivalents of $58 million were held in foreign
bank accounts for the purpose of funding our foreign operations. Repatriation of
some foreign balances is restricted by local law and subject to United States
federal income taxes, less applicable foreign tax credits. Excluding cash used
for acquisitions, we have generally relied on cash generated by operations and
our Credit Facility to fund our operating and capital expenditures and other
cash requirements.
At December 31, 2012, we had a working capital deficit of $982 million,
reflecting current liabilities of $4.595 billion and current assets of
$3.613 billion, compared to negative working capital of $500 million at
December 31, 2011. The unfavorable change in our working capital position is
primarily due to an increase in current maturities of long-term debt of
$725 million, partially offset by a decrease in accounts payable of
$193 million. 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 Credit Facility as a source of liquidity if and when
necessary.
We currently expect to continue our current practice of paying quarterly
cash dividends in respect of our common stock, subject to our board's discretion
to modify or terminate this practice at any time.
Credit Facilities
On April 6, 2012, we amended and restated our $1.7 billion revolving credit
facility to increase the aggregate principal amount available to $2 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 upon issuance reduce the amount
available for other extensions of credit. Interest is assessed on borrowings
using either the LIBOR or the base rate (each 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. In the event of a ratings
decline below "investment grade" as defined, Savvis and its operating
subsidiaries will become guarantors of the Credit Facility. At December 31,
2012, we had $820 million in borrowings and no amounts of letters of credit
outstanding under the Credit Facility.
Under the Credit Facility, we, and our indirect subsidiary, Qwest
Corporation, must maintain a debt to EBITDA (earnings before interest, taxes,
depreciation and amortization, as defined in our Credit Facility) ratio of not
more than 4.0:1.0 and 2.85:1.0, respectively, as of the last day of each fiscal
quarter for the four quarters then ended. The Credit Facility also contains a
negative pledge covenant, which generally requires us to secure equally and
ratably any advances under the Credit Facility if we
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pledge assets or permit liens on our property for the benefit of other
debtholders. The Credit Facility also has a cross payment default provision, and
the Credit Facility and certain of our debt securities also have cross
acceleration provisions. When present, these provisions could have a wider
impact on liquidity than might otherwise arise from a default or acceleration of
a single debt instrument. To the extent that our EBITDA (as defined in our
Credit Facility) is reduced by cash settlements or judgments, including in
respect of any of the matters discussed in Note 15-Commitments and Contingencies
to the consolidated financial statements in Item 8 of this report, our debt to
EBITDA ratios under certain debt agreements will be adversely affected. 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, we entered into a $160 million uncommitted revolving letter
of credit facility. At December 31, 2012, our outstanding letters of credit
totaled $120 million under this facility.
Stock Repurchase Program
On February 13, 2013, we announced our board's approval of a two-year
program to repurchase up to an aggregate of $2.0 billion of our outstanding
common stock. We expect to execute this share repurchase program primarily in
open market transactions, subject to market conditions and other factors.
Debt and Other Financing Arrangements
Approximately $176 million of our CenturyLink, Inc. Series O 5.500% notes
will mature on April 1, 2013, and $750 million of Qwest Corporation floating
rate senior notes will mature on June 15, 2013. In addition, approximately
$59 million of Embarq 6.875% notes and $50 million of Embarq 6.750% notes will
mature on July 15, 2013 and August 15, 2013, respectively. 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 on February 13, 2013 of changes in our capital
allocation plans, one credit agency downgraded CenturyLink's debt credit ratings
and another indicated that it has placed CenturyLink's debt credit ratings under
review for a downgrade. As of the date of this report, the credit ratings for
the senior unsecured debt of CenturyLink, Inc. and Qwest Corporation were as
follows:
Agency CenturyLink, Inc. Qwest Corporation
Standard & Poor's BB BBB-
Moody's Investors Baa3
Service, Inc. Baa3 (under review for
(under review for downgrade) downgrade)
Fitch Ratings BB+ BBB-
Additional downgrades of CenturyLink's senior unsecured debt ratings could
under certain circumstances incrementally increase the cost of our borrowing
under the Credit Facility or require us to add a couple of additional subsidiary
guarantors thereunder. In addition, the recent actions of the credit agencies,
and any additional downgrades in the future, could impact our access to debt
capital or further raise our borrowing costs. See "Risk Factors-Risks Affecting
our Liquidity and Capital Resources" in Item 1A of this report.
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Future Contractual Obligations
The following table summarizes our estimated future contractual obligations
as of December 31, 2012:
2018 and
2013 2014 2015 2016 2017 thereafter Total
(Dollars in millions)
Long-term debt,
including current
maturities and capital
lease obligations $ 1,205 781 545 1,488 2,313 14,255 20,587
Interest on long-term
debt and
capital leases(1) 1,317 1,279 1,220 1,148 1,034 14,397 20,395
Operating leases 297 252 219 183 156 964 2,071
Purchase commitments(2) 213 76 53 45 41 96 524
Post-retirement benefit
obligation 74 73 72 70 68 1,100 1,457
Non-qualified pension
obligations 6 5 5 5 5 22 48
Unrecognized tax
benefits(3) - - - - - 87 87
Other 14 4 5 8 11 135 177
Total future
contractual
obligations(4) $ 3,126 2,470 2,119 2,947 3,628 31,056 45,346
--------------------------------------------------------------------------------
º (1)
º Actual interest paid in all years may differ due to future refinancing of
debt. Interest on our floating rate debt was calculated for all years using
the rates effective at December 31, 2012.
º (2)
º We have various long-term, non-cancelable purchase commitments for
advertising and promotion services, including advertising and marketing at
sports arenas and other venues and events. We also have service related
commitments with various vendors for data processing, technical and
software support services. Future payments under certain service contracts
will vary depending on our actual usage. In the table above we estimated
payments for these service contracts based on the level of services we
expect to receive.
º (3)
º Represents the amount of tax and interest we would pay for our unrecognized
tax benefits. Of our total balance of unrecognized tax benefits of
$78 million and related estimated interest and penalties of $33 million,
only $87 million would result in future cash payments if our tax positions
were not upheld. The remaining $24 million is an unrecognized tax benefit
in the form of a refund claim that, if not granted, would not result in a
cash payment and therefore is not included in the table above. See
Note 12-Income Taxes to the consolidated financial statements in Item 8 of
this report for additional information. The timing of any payments for our
unrecognized tax benefits cannot be predicted with certainty; therefore,
such amount is reflected in the "2018 and thereafter" column in the above
table.
º (4)
º The table is limited to contractual obligations only and does not include:
º •
º contingent liabilities;
º •
º our open purchase orders as of December 31, 2012. These purchase
orders are generally issued at fair value, and are generally
cancelable without penalty;
º •
º other long-term liabilities, such as accruals for legal matters and
other taxes that are not contractual obligations by nature. We cannot
determine with any degree of reliability the years in which these
liabilities might ultimately settle;
º •
º cash funding requirements for qualified pension benefits payable to
certain eligible current and future retirees. Benefits paid by our
qualified pension plans are paid through trusts. Cash funding
requirements for these trusts are not included in this table as we are
not able to reliably estimate required contributions to the trusts.
Our funding projections are discussed further below;
º •
º certain post-retirement benefits payable to certain eligible current
and future retirees. Not all of our post-retirement benefit obligation
amount is a contractual obligation and only the portion that we
believe is a contractual obligation is reported in the table. See
additional information on our benefits plans in Note 8-Employee
Benefits to the consolidated financial statements in Item 8 of this
report;
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º •
º contract termination fees. These fees are non-recurring payments, the
timing and payment of which, if any, is uncertain. In the ordinary
course of business and to optimize our cost structure, we enter into
contracts with terms greater than one year to use the network
facilities of other carriers and to purchase other goods and services.
Our contracts to use other carriers' network facilities generally have
no minimum volume requirements and are based on an interrelationship
of volumes and discounted rates. Assuming we terminate these contracts
in 2013, the contract termination fees would be approximately
$495 million. Under the same assumption, termination fees for these
contracts to purchase goods and services would be $31 million. In the
normal course of business, we do not believe payment of these fees is
likely; and
º •
º potential indemnification obligations to counterparties in certain
agreements entered into in the normal course of business. The nature
and terms of these arrangements vary. Historically, we have not
incurred significant costs related to performance under these types of
arrangements.
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, operating, productivity, expense or 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 flow generated by
operating activities, cash required for other purposes and regulatory
considerations. We estimate our total 2013 capital expenditures to be
approximately $2.85 billion to $3.05 billion.
Our capital expenditures continue to be focused on our strategic services
such as video, broadband and managed hosting services. In particular, we expect
to continue to focus on expanding our fiber infrastructure, including
installations of "fiber to the tower," which is a type of telecommunications
network consisting of fiber-optic cables that run from a wireless carrier's
mobile 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. For more information on capital spending, see
Items 1 and 1A of this report.
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. We received approximately $32 million in CAF funds during 2012 and
received approximately $3 million in January 2013.
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 unfunded
status as of December 31, 2012 of our defined pension plans and other
post-retirement benefit obligations were $2.6 billion and $3.4 billion,
respectively. See Note 8-Employee Benefits to the consolidated financial
statements in Item 8 of this report 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 $32 million during the year
ended December 31, 2012 to our qualified pension plans. In the first quarter of
2013, we made cash contributions totaling $147 million. Based on current laws
and circumstances, we do not expect any further required contributions to the
plans for
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the remainder of 2013. For information on a 2012 law that reduced the amount of
our required pension plan cash contributions, please see our Quarterly Report on
Form 10-Q for the quarter ended September 30, 2012.
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, 2012, the fair value of these
trust assets was $626 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 care costs for approximately four years.
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 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 plans trust
assets is 7.50% and for the post-retirement plans trust assets ranges from 6.00%
to 7.50% based on the assets currently held; however, actual returns could vary
widely in any given year.
Historical Information
The following table summarizes our consolidated cash flow activities (which
include cash flows from Savvis and Qwest after their respective acquisition
dates):
Years Ended December 31, Increase
2012 2011 (Decrease)
(Dollars in millions)
Net cash provided by operating
activities $ 6,065 4,201 1,864
Net cash used in investing activities (2,690 ) (3,647 ) (957 )
Net cash used in financing activities (3,295 ) (577 ) 2,718
Years Ended December 31, Increase
2011 2010 (Decrease)
(Dollars in millions)
Net cash provided by operating
activities $ 4,201 2,045 2,156
Net cash used in investing activities (3,647 ) (859 ) 2,788
Net cash used in financing activities (577 ) (1,175 ) (598 )
The increase in net cash provided by operating activities for 2012 and
2011is primarily attributable to the acquisitions of Qwest and Savvis, which
contributed net cash provided by operating activities of approximately
$3.4 billion in 2012 and $2.2 billion in 2011. Our consolidated financial
statements in Item 8 of 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 $2.9 billion in 2012, including
$1.9 billion for Qwest and Savvis' capital expenditures. Net cash used in
investing activities included payments for property, plant and equipment and
capitalized software of $2.4 billion in 2011, including $1.3 billion for Qwest
and Savvis' post-acquisition capital expenditures, compared to $864 million in
2010. In addition, we paid $1.7 billion, net of $61 million cash received, for
the acquisition of Savvis on July 15, 2011. Cash used in investing activities in
2011 was partially offset by cash acquired through the April 1, 2011 acquisition
of Qwest of $419 million, net of $5 million cash paid.
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Net cash used in financing activities increased in 2012 compared to 2011,
primarily due to a net long-term debt pay down of $1.8 billion in 2012 versus a
net long-term debt issuance of $1.1 billion in 2011, a $2.9 billion difference.
This difference was primarily due to the $2 billion senior notes issued in June
2011to finance the Savvis acquisition. Also contributing was a $255 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 $631 million increase in net borrowings under our Credit
Facility. Net cash used in financing activities decreased in 2011 primarily due
to us receiving net debt proceeds in excess of payments of approximately
$1.1 billion in 2011 versus debt payments of $500 million in 2010. In addition,
our cash dividends paid increased $677 million in 2011 as compared to 2010
primarily as a result of the issuance of 308 million common shares in connection
with our acquisitions of Qwest and Savvis in 2011.
On October 26, 2012, QCII redeemed all $550 million of its 8.00% Notes due
2015, which resulted in a gain of $15 million.
On August 29, 2012, certain subsidiaries of 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 its 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.
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 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 Qwest Communications International Inc
("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 described further in Note 4-Long-Term Debt and Credit
Facilities to the consolidated financial statements in Item 8 of this report).
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 these tender offers resulted in a loss of $46 million.
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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.
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 long-term
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 recorded 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 a premium.
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The table below summarizes the portions of this premium recognized as a
reduction to interest expense or extinguished during the periods indicated:
Years Ended
December 31, Total Since
2012 2011 Acquisition
(Dollars in millions)
Amortized $ 86 154 240
Extinguished(1) 177 58 235
Total premiums recognized $ 263 212 475
--------------------------------------------------------------------------------
º (1)
º See "Debt and Other Financing Arrangements" for more information
The remaining premium of $218 million as of December 31, 2012 will reduce
interest expense in future periods, unless otherwise extinguished.
Net Operating Loss Carryforwards
We are currently using federal NOLs to offset a portion of our federal
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
amounts 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 Related to
our Recent Acquisitions" appearing in Item 1A of Part II of this report.
Other Matters
CenturyLink has cash management arrangements with certain of its principal
subsidiaries, in which substantial portions of the subsidiaries' cash is
regularly advanced to CenturyLink. 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.
In connection with reclassifying certain wireless spectrum assets as assets
held for sale, during the second quarter of 2012 we reclassified $154 million
from "other intangible assets, net" to "current assets-other." For more
information on the sale of these assets, see "Business-Operations-Products and
Services-Additional Information" in Item 1 of this report.
We also are involved in various legal proceedings that could have a material
adverse effect on our financial position. See Note 15-Commitment and
Contingencies to the consolidated financial statements in Item 8 of this report
for the current status of such legal proceedings, including matters involving
Qwest.
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.
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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 December 31, 2012, we had no such instruments outstanding.
We have established policies and procedures for risk assessment and the
approval, reporting and monitoring of derivative instrument activities. We do
not hold or issue derivative financial instruments for trading or speculative
purposes. Management periodically reviews our exposure to interest rate
fluctuations and implements strategies to manage the exposure.
There were no material changes to market risks arising from changes in
interest rates for the year ended December 31, 2012, when compared to the
disclosures provided in our Annual Report on Form 10-K for the year ended
December 31, 2011.
At December 31, 2012, we have approximately $19.9 billion (excluding capital
lease and other obligations with a carrying amount of $734 million) of long-term
debt outstanding, 89.9% of which bears interest at fixed rates and is therefore
not exposed to interest rate risk. We had $2 billion floating rate debt exposed
to changes in the London InterBank Offered Rate (LIBOR). A hypothetical increase
of 100 basis points in LIBOR relative to this debt would decrease our annual
pre-tax earnings by $20 million.
With our acquisition of Savvis in July 2011, we have become exposed to the
risk of fluctuations in the foreign currencies in which its international
operations are denominated, primarily the Euro, the British Pound, the Canadian
Dollar, the Japanese Yen and the Singapore Dollar. As a consolidated entity, the
percentage of revenues generated and costs incurred that are denominated in
these currencies are immaterial. We use a sensitivity analysis to estimate our
exposure to this foreign currency risk, measuring the change in financial
position arising from hypothetical 10% change in the exchange rates of these
currencies, relative to the U.S. Dollar with all other variables held constant.
The aggregate potential change in the fair value of assets resulting from a
hypothetical 10% change in these exchange rates was $18 million at December 31,
2012.
Certain shortcomings are inherent in the method of analysis presented in the
computation of exposures to market risks. Actual values may differ materially
from those presented above if market conditions vary from the assumptions used
in the analyses performed. These analyses only incorporate the risk exposures
that existed at December 31, 2012.
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 leasing, 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, (ii) disclosed in Note 15-Commitments and
Contingencies to the consolidated financial statements in Item 8 of this report,
or in the Future Contractual Obligations table included in this Item 7 above or
(iii) discussed under the heading "Market Risk" above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information in "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Market Risk" in Item 7 of this report is
incorporated herein by reference.
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