Reports Communications Revenue of $423 Million
Continued Success With Customer Contracts During Quarter;
Increasing Investment in Network
BROOMFIELD, Colo., October 27, 2004 – Level 3 Communications, Inc. (Nasdaq:LVLT) today announced its third quarter results. Consolidated revenue was $840 million for the third quarter compared to $918 million for the second quarter 2004. Communications revenue was $423 million versus $391 million for the previous quarter, and information services revenue was $392 million compared to $503 million for the previous quarter.
The net loss for the third quarter 2004 increased to $171 million, or $0.25 per share, compared to a net loss for the previous quarter of $63 million, or $0.09 per share. Included in the net loss for the previous quarter was a $147 million gain associated with the elimination of a capital lease obligation due to the termination of a vendor contract. Consolidated Adjusted OIBDA(1) was $129 million in the third quarter 2004, which exceeded the projection of $100 million to $120 million and compares to $94 million for the previous quarter. Approximately $67 million in reciprocal compensation and $4 million of communications service revenue was recognized in the third quarter as a result of an agreement signed with a local carrier.
Overview
“During the third quarter, we experienced rising demand and new contract awards for our communications services offerings, particularly for VoIP services,” said James Q. Crowe, CEO of Level 3.
Third Quarter Financial Results Compared to Projections (1)
| Metric ($ in millions) |
Third Quarter Actuals | Third Quarter Projections (1) |
| Communications Services Revenue (2) (excluding termination and settlement revenue) |
$344 | |
| Reciprocal Compensation | $78 | |
| Termination and Settlement Revenue | $1 | |
| Communications Revenue | $423 | $400-$420 |
| Information Services Revenue | $392 | |
| Other Revenue | $25 | |
| Consolidated Revenue | $840 | |
| Consolidated Adjusted OIBDA (3)(4) | $129 | $100-$120 |
| Capital Expenditures (5) | $82 | $85 |
| Unlevered Cash Flow (4) | ($14) | |
| Free Cash Flow (4) | ($98) | |
| Communications Gross Margin (4) | 72% |
(1) Projections issued July 28, 2004
(2) Communications Services Revenue is GAAP communications revenue minus reciprocal compensation
revenue
(3) Consolidated Adjusted OIBDA excludes $10 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 $84 million for the quarter and accrual reversals were $2 million
Consolidated Cash Flow and Liquidity
During the third quarter 2004, unlevered cash flow(1) was negative $14 million, versus positive $15 million during the second quarter. Consolidated free cash flow for the third quarter was negative $98 million, versus negative $109 million for the previous quarter.
As of September 30, 2004, the company had cash and marketable securities of $856 million compared to $957 million at June 30, 2004.
“Our unlevered cash flow declined quarter over quarter primarily due to working capital fluctuations in the information services business, lower managed modem revenue and increased capital expenditures in our communications business,” said Sunit Patel, CFO of Level 3. “Our consolidated free cash flow improved primarily due to a decrease in cash interest payments. Additionally, we saw the benefit of decreased network expense associated with the integration of the ICG, Allegiance and KMC dial-up networks. We expect to see further benefits from decreases in network expense in future periods.”
Communications Business
Revenue
Communications revenue for the third quarter 2004 was $423 million, versus $391 million for the previous quarter. Total communications revenue for the third quarter consisted of $345 million of communications services revenue and $78 million of reciprocal compensation revenue, compared to $365 million and $26 million in the second quarter. Approximately $67 million of reciprocal compensation and $4 million of communications services revenue was recognized in the third quarter as a result of an agreement signed with a local phone company, of which $48 million in cash had been received in prior periods.
Included in communications services revenue was $1 million and $2 million of termination revenue for the third and second quarters, respectively. Communications services revenue decreased by $20 million quarter over quarter primarily due to an expected reduction in revenue from one large dial-up access customer partially offset by increases in voice and IP & Data services revenue.
| Communications Revenue ($ in millions) | Quarter ended September 30, 2004 |
Quarter ended June 30, 2004 |
Percent Change |
| Transport and Infrastructure | $115 | $118 | (2.5%) |
| Softswitch | $124 | $146 | (15.1%) |
| IP & Data Services | $106 | $101 | 5.0% |
| Communications Services Revenue | $345 | $365 | (5.5%) |
| Reciprocal Compensation | $78 | $26 | 200.0% |
| Communications Revenue | $423 | $391 |
8.2% |
Cost of Revenue
Communications cost of revenue for the third quarter was $116 million versus $119 million for the previous quarter. Communications gross margin(1) was 72 percent for the third quarter compared to 70 percent in the second quarter. The improvement in communications gross margin is primarily attributable to the increase in reciprocal compensation revenue in the third quarter. Communications cost of revenue decreased in the third quarter primarily due to expected decreases in network expenses associated with the ICG acquisition and the termination and renegotiation of vendor agreements with Allegiance and KMC Telecom.
Selling, General and Administrative Expenses (SG&A)
Communications SG&A expenses were $204 million for the third quarter, versus $202 million for the previous quarter. Communications SG&A expenses include $10 million of non-cash stock compensation expense in the third quarter and $9 million in the second quarter. For both periods, SG&A expenses include a $4 million reduction associated with property taxes.
The total number of employees in the communications business increased to approximately 3,540 during the third quarter from approximately 3,500 in the second quarter.
Adjusted Operating Income Before Depreciation and Amortization (OIBDA)
Adjusted OIBDA(1) for the communications business increased to $113 million for the third quarter from $79 million for the previous quarter. Communications Adjusted OIBDA margin(1) was 27 percent for the third quarter versus 20 percent in the previous quarter. This increase in Communications Adjusted OIBDA was primarily the result of the expected increase in revenue from reciprocal compensation as previously described.
Communications Adjusted OIBDA excludes non-cash stock compensation expense of $10 million in the third quarter and $9 million in the second quarter.
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 $392 million for the third quarter. This compares to revenue of $503 million for the previous quarter and $437 million for the same period last year. An increase in agency-type sales in the third quarter of 2004 resulted in the decline from the same period in 2003. The value of software sold in the third quarter of 2004 was consistent with that sold in the same period last year, but in accordance with GAAP treatment of agency sales agreements, the company recognizes a service fee as revenue instead of the full value of the software sold.
Adjusted OIBDA(1) for the information services business was $9 million for the third quarter, compared to $11 million for the previous quarter which excluded $1 million in non-cash stock compensation expense. For the same period last year, Adjusted OIBDA was negative $8 million, which included $11 million in restructuring charges and excluded $1 million in non-cash stock compensation expense.
“We are pleased with the performance of our information services business and the continued strength in the global software market,” said Charles C. Miller, vice chairman of Level 3. “The reduction in third quarter revenue compared to the previous quarter is a result of normal seasonality.”
The total number of employees in the information services business increased to approximately 1,325 at the end of the third quarter from approximately 1,300 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 $25 million and $7 million in the third quarter compared to $24 million and $4 million for the previous quarter. Adjusted OIBDA for the third quarter includes approximately $5 million in insurance proceeds from environmental claim payments.
New Customer Contracts
“We signed and announced a number of new customer contracts during the quarter, and are particularly encouraged by the strong interest we’re seeing for our new wholesale and consumer VoIP services, and for our IP VPN services,” said Kevin O’Hara, president and COO. “In addition, Level 3 has recently been awarded several large unannounced transport and infrastructure and VoIP service contracts by cable operators, wireless companies and local and long-haul carriers.”
Among the more significant announcements made during the quarter were a major IP VPN agreement with CSC, VoIP agreements with Charter and Skype, transport agreements with Chunghwa Telecom and Adelphia, and a colocation agreement with EarthLink. More recently, Level 3 announced a major IP VPN contract with Northrop Grumman and a significant IP transit agreement with NTL.
“We are pleased that we’ve seen strong interest in our services from customers and that our capabilities are being included in their service offerings,” said O’Hara. “As we have mentioned previously, there is a fair amount of interconnection work and systems integration between Level 3 and our partners that must be accomplished before we begin to generate revenue under these contracts. Revenue growth from new customer contracts will also be a function of our customers’ success in the marketplace and their overall rollout schedules.”
Corporate Transactions
As previously announced, the company acquired Sprint’s wholesale dial-up business on October 1, 2004, for $34 million in cash. Most customer contracts were not assigned at closing, and the company expects assumption or assignment of these contracts for a majority of customers before the end of the year. Until such time as a customer contract is assumed or assigned, amounts received for services provided by Sprint are accounted for as a reduction in purchase price.
While dependent upon the timing of the assumption or assignment of customer contracts, the company expects to recognize approximately $5 million in revenue from this transaction in the fourth quarter 2004 and approximately $35 million in revenue in 2005. The company expects to migrate customers to the Level 3 network by mid-2005.
Regulatory Events/Reciprocal Compensation
The company recognizes reciprocal compensation revenue for compensable minutes of ISP-bound traffic that is terminated on Level 3’s network for its dial-up Internet access customers. Reciprocal compensation is collected either under a negotiated interconnection agreement signed with a carrier, or under the FCC’s mandated regime.
FCC Regime
In October 2004, the FCC approved certain aspects of a forbearance petition filed by Core Communications in July 2003. Specifically, the FCC lifted ISP-bound traffic growth caps and new market exclusion. The FCC rate cap of $.0007 did not change in this order. Certain of the company’s interconnection agreements contain language that supersedes this order.
Certain ISP-bound traffic that is terminated on the Level 3 network is expected to be subject to the FCC’s ISP Remand Order, which has been pending at the FCC for two years. The FCC has indicated that it will rule on the ISP Remand Order soon. The ruling is expected to address, among other things, the FCC’s basis for asserting jurisdiction over ISP-bound traffic.
Once the FCC has ruled on the ISP Remand Order, the company will determine the impact of that decision on its current interconnection agreements. If an agreement contains a change-of-law provision, a party can invoke the change-of-law clauses to modify the terms of that agreement. If there is no change-of-law provision in the agreement, the previously negotiated terms will stay in place until expiration of the agreement. When an agreement expires, the parties would default to the FCC rules on ISP-bound traffic.
Verizon Interconnection Agreement
During the quarter, the company signed an amendment to its existing Interconnection Agreement with Verizon Communications. Under the amendment, which was retroactive to April 1, 2004, the intercarrier compensation rate for local, ISP-bound traffic was set at $.0005 for year 2004, $0.00045 for year 2005, and $.0004 for year 2006. The amendment expires in December 2006 and is not subject to change in law.
In general, Level 3 prefers negotiated interconnection agreements to arbitrated agreements given the uncertainty in the regulatory environment. The company believes that negotiated agreements can provide the company with more predictable intercarrier relationships including interconnection and compensation arrangements.
“Importantly, interconnection agreements with local carriers, including the recently signed Verizon agreement, allow us to further leverage our existing Softswitch infrastructure for our VoIP services,” said Sureel Choksi, executive vice president and president, Softswitch Services.
As previously announced, the company has also negotiated interconnection agreements with BellSouth and SBC which expire December 2006 and December 2004 respectively.
“While subject to future regulatory changes, we believe the company will recognize approximately $100 million to $125 million in reciprocal compensation revenue in 2005,” said Patel.
Business Outlook
Revenue
“Given our performance and new customer contracts signed year to date, we are updating our previously issued projection for communications revenue, including reciprocal compensation revenue but excluding termination revenue, from a high-single digit percent reduction to a low single-digit percent decline in 2004 versus 2003,” said Patel. “This includes approximately $40 million in revenue from managed modem acquisitions in 2004.”
Adjusted OIBDA
““We are reaffirming our previously issued projection for Consolidated Adjusted OIBDA for 2004. This projection was that 2004 Consolidated Adjusted OIBDA, excluding termination and settlement revenue, will be consistent with 2003,” Patel said.
Free Cash Flow
“We are increasing our expected use of cash in 2004 as a result of business activity during the third quarter,” said Patel. “First, we are increasing our capital expenditures in the fourth quarter to support our traffic growth and new customer contracts won in the third and fourth quarters. Second, we have seen an increase in integration expenses associated with our acquisition activity. Finally, while revenue from new services continues to grow, we are receiving lower-than-expected cash payments from IRU sales. As a result, we expect full-year Consolidated Free Cash Flow to be negative $280 million to $310 million versus our previous expectation of negative $200 million to $250 million.”
Fourth Quarter 2004
| Metric ($ in millions) |
Fourth Quarter Projections |
| Communications Revenue | $455-$475 |
| Consolidated Adjusted OIBDA | $155-$170 |
| Capital Expenditures | $90 |
“We expect communications revenue to increase in the fourth quarter primarily as a result of approximately $100 million in termination revenue as the result of the expected termination of a customer dark fiber contract,” said Patel. “Additionally, we expect to see an increase in communications services revenue. This increase is expected to come from a continued ramp in our voice business and other services, as well as approximately $5 million in revenue from the Sprint managed modem acquisition.”
Consolidated Adjusted OIBDA is expected to increase to between $155 million and $170 million in the fourth quarter primarily as a result of higher communications revenue as described above. In addition, network expenses associated with the ICG acquisition and the integration of Allegiance and KMC are expected to continue to decline in the fourth quarter.
Capital expenditures are expected to increase to approximately $90 million in the fourth quarter as the company continues investing in new service initiatives and its network as a result of previously awarded contracts.
Summary
“We continued to make progress during the quarter on a number of fronts,” Crowe said. “We saw an increase in sales, particularly for VoIP services, as well as increases in IP traffic across our network. Additionally, we have made significant progress during the quarter in expanding our indirect sales channels to help us take advantage of our growing opportunities. I believe this positive momentum positions us well for continued growth and success in the marketplace.”
Conference Call Information
Level 3 will hold a conference call to discuss the company’s third quarter results at 10:00 a.m. Eastern Time today. To join the call, please dial 612-326-1003. A live broadcast of the call can also be heard on Level 3’s Web site at 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 749593.
View Q3-04 Financial Statements
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.
