Reaffirms Full Year 2004 Business Outlook
Reports Communications Revenue of $389 Million For The First Quarter
Announced Launch of Consumer VoIP Services;
Acquired ICG’s Dial Access Business
Expects Debt Reduction of Approximately $245 Million In Second Quarter
BROOMFIELD, Colo., April 29, 2004 – Level 3 Communications, Inc. (Nasdaq:LVLT) today announced its first quarter results. Consolidated revenue was $899 million for the first quarter compared to $988 million for the fourth quarter 2003. Communications revenue was $389 million versus $399 million for the previous quarter, and information services revenue was $494 million compared to the seasonally strong fourth quarter revenue of $565 million.
Consolidated Adjusted OIBDA(1) was $128 million in the first quarter 2004, which exceeded the projection of $110 million - $120 million and compares to $129 million for the previous quarter. The net loss for the first quarter 2004 increased to $147 million or $0.22 per share compared to a net loss for the previous quarter of $121 million or $0.18 per share. Included in the net loss for the first quarter 2004 was a $23 million gain on the sale of the company’s remaining investment in Commonwealth Telephone Enterprises, Inc., or $0.03 per share. Included in the net loss for the previous quarter was a $37 million gain on extinguishment of debt and a $38 million tax benefit.
Overview
“Despite a challenging market environment, we are pleased with our market share gains and customer wins, including the government sector, as well as our improved operating margins in the first quarter,” said James Q. Crowe, CEO of Level 3. “Consistent with the past few quarters, Level 3 continues to focus on launching new services and is gaining momentum in our addressable markets. We are encouraged by the initial response from our distribution partners and their customers, and expect to benefit from the continued migration of voice from traditional circuit-switched services to softswitch-based VoIP services.”
First Quarter Financial Results Compared to Projections (1)
| Metric ($ in millions) |
First Quarter Actuals | First Quarter Projections (1) |
|
Communications Services Revenue (2) |
$359 |
|
|
Reciprocal Compensation |
$23 |
|
|
Termination and Settlement Revenue |
$7 |
|
|
Communications Revenue |
$389 |
$380-$400 |
|
Information Services Revenue |
$494 |
|
|
Other Revenue |
$16 |
|
|
Consolidated Revenue |
$899 |
|
|
Consolidated Adjusted OIBDA (3)(4) |
$128 |
$110-$120 |
|
Capital Expenditures (5) |
$48 |
$65 |
|
Unlevered Cash Flow (4) |
$44 |
|
|
Communications Gross Margin (4) |
79% |
(1) Projections issued February 5, 2004
(2) Communications Services Revenue is GAAP communications revenue minus reciprocal compensation revenue
(3) Consolidated Adjusted OIBDA includes $2 million in restructuring charges and excludes $9 million in stock-based compensation expense
(4) See schedule of non-GAAP metrics for definition and reconciliation to GAAP measures
(5) Gross capital expenditures were $52 million for the quarter and accrual reversals were $4 million
Consolidated Cash Flow and Liquidity
During the first quarter 2004, unlevered cash flow(1) was $44 million, versus $57 million during the fourth quarter. Consolidated free cash flow for the first quarter was negative $40 million, versus negative $15 million for the previous quarter.
As of March 31, 2004, the company had cash and cash equivalents of approximately $1.1 billion, which was unchanged from December 31, 2003.
“Our consolidated free cash flow for the first quarter is in line with our expected increase in capital expenditures to support previously won customer contracts and working capital needs during the quarter,” said Sunit Patel, CFO of Level 3.
Communications Business
Revenue
Communications revenue for the first quarter 2004 was $389 million, versus $399 million for the previous quarter. Total communications revenue for the first quarter consisted of $366 million of communications services revenue and $23 million of reciprocal compensation revenue, compared to $376 million and $23 million in the fourth quarter.
Included in communications services revenue was $7 million and $3 million of settlement and termination revenue for the first and fourth quarters, respectively. Communications services revenue, excluding settlement and termination revenue, decreased by $14 million quarter over quarter. This decline is primarily a result of expected, previously disclosed price decreases in managed modem related revenue during the first quarter 2004.
The communications deferred revenue balance increased by $17 million from December 31, 2003, primarily as a result of sales to the government sector and systems integrators.
Cost of Revenue
Communications cost of revenue for the first quarter was $81 million versus cost of revenue of $87 million for the previous quarter. Communications gross margin(1) was 79 percent for the first quarter compared to 78 percent in the fourth quarter. Communications cost of revenue decreased in the first quarter primarily due to reduced network expenses associated with the Genuity integration.
Selling, General and Administrative Expenses (SG&A)
Communications SG&A expenses decreased to $201 million for the first quarter, versus $214 million for the previous quarter. For the same periods, communications SG&A expenses include $9 million and $19 million of non-cash stock compensation expenses respectively.
The total number of employees in the communications business increased by approximately 100 during the first quarter to approximately 3,380 primarily as a result of the hiring of additional sales personnel during the quarter.
Adjusted Operating Income Before Depreciation and Amortization (OIBDA)
Adjusted OIBDA(1) for the communications business increased to $116 million for the first quarter from $110 million for the previous quarter. Communications Adjusted OIBDA margin(1) was 30 percent for the first quarter versus 28 percent in the previous quarter.
Communications Adjusted OIBDA for the first quarter excludes $9 million in non-cash stock compensation expense. Communications Adjusted OIBDA for the fourth quarter included $7 million in restructuring charges and excluded $19 million in non-cash stock compensation expense.
Information Services Business
Results for the information services business include the Software Spectrum and (i)Structure subsidiaries.
Revenue and Adjusted Operating Income before Depreciation and Amortization (OIBDA)
Information services revenue was $494 million for the first quarter, versus $565 million for the previous quarter and included $4 million of termination revenue at (i)Structure. The decrease in revenue for the first quarter is due to seasonality in the company’s Software Spectrum business.
Adjusted OIBDA(1) for the information services business was $11 million for the first quarter, including $2 million in restructuring charges, compared to $15 million for the previous quarter, which included $4 million in restructuring charges and excluded $4 million in non-cash stock compensation expense.
“As expected, revenue for our information services business declined due to typical seasonality between the fourth and first quarter and continued adoption of agency type agreements,” said Charles C. Miller, vice chairman of Level 3. “We continue to focus on improving operational efficiency and gaining the benefits of integrating previous acquisitions.”
The total number of employees in the information services business decreased to approximately 1,310 at the end of the first quarter from approximately 1,375 at the end of the previous quarter.
Other Businesses
The company’s other businesses consist primarily of coal mining operations.
Revenue and Adjusted OIBDA
Revenue and Adjusted OIBDA(1) from other businesses were $16 million and $1 million in the first quarter compared to $24 million and $4 million for the previous quarter.
Corporate Transactions
Acquisitions
As recently announced, Level 3 acquired the managed modem business of ICG Communications, Inc. in April 2004 for approximately $35 million in cash. The business provides dial-up Internet access to America Online, EarthLink, MSN, United Online and other ISPs. The company expects the acquisition to add incremental revenue of approximately $35 million in 2004.
Termination of Vendor Agreement
Subsequent to the end of the first quarter, the company closed its previously announced settlement to terminate its vendor agreement with Allegiance Telecom. The company paid $54 million in cash to terminate its obligation to use certain managed modem assets through December 2006, including the use of operating equipment. The termination of this contract eliminates $213 million in capital lease obligations.
Debt Reduction
As a result of the company’s termination of its vendor agreement with Allegiance and expected principal payments on capital leases during the second quarter, capital lease obligations are expected to decrease by approximately $245 million during the second quarter from a balance of $268 million at March 31, 2004.
“In addition to meeting the company’s cash return criteria, both transactions further expand the company’s local interconnection footprint, which is key to providing cost effective VoIP services,” said Kevin O’Hara, president and COO of Level 3.
New Service Offerings
“A primary focus for the company this year is deploying new services that leverage Level 3’s existing network infrastructure and address large, established markets for communications services, particularly in the voice market,” said O’Hara. “With the addition of our consumer-oriented VoIP services announced during the quarter, Level 3’s overall addressable market has nearly tripled over the last year to approximately $100 billion.
“Given the continued adoption of broadband, as well as the continued improvements in VoIP technology, the voice market is moving from traditional circuit-switched voice services to softswitch-based voice services, or VoIP. We believe this is a great opportunity for Level 3 as we offer high-quality, cost-effective VoIP services with enhanced functionality over our extensive softswitch platform and local interconnections that reach over 93 percent of the U.S. population.”
Softswitch Services
The company currently offers wholesale VoIP services aimed at service providers and businesses, and recently announced two new wholesale services aimed at residential users. These new services are expected to serve more than 300 of the largest U.S. markets by the end of 2004.
(3)VoIP EnhancedSM Local Service is targeted towards cable operators, enhanced service providers, IXCs and others who currently operate their own switching infrastructure, but want to deploy residential voice services cost effectively with minimal involvement in local interconnection issues.
The service enables VoIP providers the flexibility to select from a number of functionalities, including: local and long distance calling, access to the traditional telephone network (PSTN), local phone numbers, operator assistance, directory listings, E911 emergency and local number portability.
HomeToneSM is a turnkey VoIP residential service offering local and long distance capabilities. Along with the features of (3)VoIP Enhanced Local Service, HomeTone also includes additional features such as voicemail, call waiting, caller ID, three-way conferencing, unified messaging, personal locator service, and end-user Web-based account management. HomeTone will be sold through distribution partners including ISPs, cable operators, and enhanced service providers.
“We believe that VoIP represents a significant opportunity for Level 3,” said O’Hara. “Our extensive softswitch platform, which handles over 25 billion minutes of traffic per month, is a significant competitive advantage.”
Transport and Infrastructure Services
During the first quarter, the company launched two new metropolitan transport services, (3)Link® Metro Wavelength and (3)Link Metro Ethernet, in its 36 metropolitan cities. These new services are complementary to the company’s existing metropolitan offerings including private line and dark fiber.
Business Outlook
“In our fourth quarter earnings release, we announced that our largest managed modem customer, AOL, had preliminarily notified the company of its intent to significantly reduce overall purchases of dial-up capacity ports and to proportionately reduce purchases from the company,” said Crowe. “We have now finalized the terms of the reduction in ports and pricing modifications and agreed to related amendments to our agreements with AOL. Based on these agreements we expect, beginning in the third quarter, to reduce ports provided to AOL by approximately one-third."
“The expected decline in 2004 managed modem revenue is a function of reduced pricing and a greater than proportionate decline in our dial-up capacity relative to the subscriber declines in the U.S. narrowband market. Over time, the company continues to expect its managed modem business to decline in line with the ongoing consumer shift from narrowband to broadband as well as continued pricing compression."
“Including the expected effects of all port reductions and price compression in our managed modem business, but excluding the positive effect of revenue from the acquisition of ICG’s managed modem business, the company is reaffirming its business outlook for 2004.”
“This quarter, we are pleased to report industry leading Communications Adjusted OIBDA margins of 30 percent,” Crowe said. “We expect second quarter Communications Adjusted OIBDA margins to decline to approximately 20 percent primarily as a result of network and integration expenses associated with the acquisition of ICG’s managed modem business."
“Additionally, in accordance with GAAP, the addition of Allegiance’s managed modem assets result in a reduction of debt and an increase in our network expenses, and therefore does not result in an improvement in our operating results until the integration is complete."
“Taking into account expected overall operational performance, including the effects of both transactions, we expect Communications Adjusted OIBDA margins to improve to the mid-20 percent range for the third quarter and to the high-20 percent range by year-end."
“These expected improvements in margins, together with our previously announced projection that we will experience a return to growth in communications revenue in the latter part of this year, are a result of the company’s new service initiatives and the tripling of our addressable market to approximately $100 billion.”
Second Quarter 2004
| Metric ($ in millions) |
>Second Quarter Projections |
|
Communications Revenue |
$375-$395 |
|
Consolidated Adjusted OIBDA |
$80-$90 |
|
Capital Expenditures |
$70 |
“Our projection for second quarter communications revenue reflects the benefit of additional revenue from the ICG acquisition offset by expected reductions in revenue from our existing managed modem business from pricing and other factors,” said Patel.
Consolidated Adjusted OIBDA is expected to decline to $80 million - $90 million in the second quarter primarily as a result of additional network expense related to the termination of the Allegiance vendor agreement, which shifts approximately $9 million of capital lease principal payments and interest expense to network expenses, as well as expenses associated with the integration of ICG managed modem traffic, and an expected increase in sales, marketing and promotion expenses. The company expects to achieve network expense synergies from both the Allegiance and ICG transactions in the second half of 2004, with corresponding improvements in Communications Adjusted OIBDA margins back to recently reported levels. Revenue from the ICG acquisition in the second quarter is expected to be offset by an equal amount of network expense and therefore does not contribute to Communications Adjusted OIBDA until the latter half of 2004.
Capital expenditures are expected to increase to approximately $70 million in the second quarter as the company continues investing in previously announced service initiatives and network build-out related to previously awarded contracts.
Summary
“I am pleased with our successes in the marketplace during the first quarter, including our government channel, and the increased pace of new services introduction,” said Crowe. “We remain encouraged by the discussions and market trials we are having with our customers for VoIP services."
“While the communications marketplace certainly remains challenging, we continue to believe the combination of our new services and increased addressable market, together with our strong liquidity and solid balance sheet, put us in a strong competitive position.”
Conference Call Information
Level 3 will hold a conference call to discuss the company’s first quarter results at 11 a.m. Eastern Time today. To join the call, please dial 612-326-1011. A live broadcast of the call can also be heard on Level 3’s Web site at http://www.level3.com/. An audio replay of the call will be accessible on the company’s Web site or by dialing 320-365-3844; access code 724885.
Statement of Operations
Balance Sheets
Consolidated Cash Flow
View Schedule to Reconcile to non-GAAP Financial Metrics
About Level 3 Communications
Level 3 Communications, Inc. (NASDAQ: LVLT), an international communications company, operates one of the largest Internet backbones in the world, connecting 180 markets in 18 countries. The company serves a broad range of wholesale, enterprise and content customers with a comprehensive suite of services including: Internet Protocol (IP) services, broadband transport and infrastructure services, colocation services, voice and voice over IP services, content delivery and media distribution services. These services provide the building blocks to enable Level 3’s customers to meet their growing demands for advanced communications solutions. The company’s Web address is www.Level3.com.
"Level 3 Communications,” "Level 3," the red 3D brackets and the Level 3 Communications logo are registered service marks of Level 3 Communications, LLC in the United States and/or other countries. Level 3 services are provided by wholly owned subsidiaries of Level 3 Communications, Inc. Any other service, product or company names recited herein may be trademarks or service marks of their respective owners.
Forward-Looking Statement
Some of the statements that we make in this press release are forward looking in nature. These statements are based on management’s current expectations or beliefs. These forward looking statements are not a guarantee of performance and are subject to a number of uncertainties and other factors, many of which are outside our control, which could cause actual events to differ materially from those expressed or implied by the statements. The most important factors that could prevent us from achieving our stated goals include, but are not limited to our ability to: successfully integrate acquisitions; increase the volume of traffic on our network; defend our intellectual property and proprietary rights; develop new products and services that meet customer demands and generate acceptable margins; successfully complete commercial testing of new technology and information systems to support new products and services; attract and retain qualified management and other personnel; and meet all of the terms and conditions of our debt obligations. Additional information concerning these and other important factors can be found within Level 3’s filings with the Securities and Exchange Commission. Statements in this press release should be evaluated in light of these important factors. Level 3 is under no obligation to, and expressly disclaims any such obligation to, update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.
