Financial and Business Highlights
BROOMFIELD, Colo., October 23, 2007- Level 3 Communications, Inc. (NASDAQ: LVLT) reported consolidated revenue of $1.061 billion for the third quarter 2007, compared to consolidated revenue of $1.052 billion for the second quarter 2007.
The net loss for the third quarter 2007 was $174 million, or $0.11 per share, compared to a net loss of $202 million, or $0.13 per share, for the second quarter 2007.
Consolidated Adjusted EBITDA(1) increased to $215 million in the third quarter 2007, compared to $193 million for the second quarter 2007.
“While we continued to grow Core Communications Services revenues and we did meet our guidance measures in the third quarter, the company had difficulties with provisioning orders for its services,” said James Q. Crowe, CEO of Level 3. “The breadth of the problem was greater than we had earlier diagnosed, and we did not increase provisioning capacity as we had expected. This increase in provisioning capacity was necessary to meet the revenue increases we had previously projected. As a result, we are lowering our Consolidated Adjusted EBITDA guidance for the full year 2007 and the full year 2008. We are disappointed by our performance, particularly given the strength of the current market. We believe we have identified the underlying causes of our provisioning constraints, and we have begun to implement additional changes. We are focused on correcting this issue as quickly as possible.”
Third Quarter 2007 Financial Results
| Metric ($ in millions) Revenue |
Consolidated |
Third Quarter Projections(1) |
|
Core Communications Services |
$909 |
$905-$925 |
|
Other Communications Services |
$63 |
$60-$65 |
|
SBC Contract Services |
$71 |
$40-$60 |
|
Total Communications Revenue |
$1,043 |
$1,005-$1,050 |
|
Other Revenue |
$18 |
|
|
Total Consolidated Revenue |
$1,061 |
|
|
Consolidated Adjusted EBITDA (2)(3) |
$215 |
$210-$230 |
|
Capital Expenditures |
$155 |
|
|
Unlevered Cash Flow (3) |
$76 |
|
|
Free Cash Flow (3) |
$(54) |
|
|
Communications Gross Margin (3) |
58% |
|
|
Communications Adjusted EBITDA Margin (3) |
21% |
|
(1) Projections issued July 26, 2007.
(2) Consolidated Adjusted EBITDA excludes $24 million in non-cash compensation expense and includes $1 million of cash restructuring charges for the third quarter 2007.
(3) See schedule of non-GAAP metrics for definition and reconciliation to GAAP measures.
Communications Business
Revenue
Total Communications Revenue increased to $1.043 billion during the third quarter, versus $1.035 billion for the previous quarter. Contributing to this increase was a $21 million increase in Core Communications Services revenue, offset by a slightly less than expected $13 million decline in Other Communications Services and SBC Contract Services revenue. During the third quarter 2007, the company recognized $4 million in termination revenue in its Core Communications Services revenue, compared to $2 million during the second quarter 2007.
| Communications Revenue ($ in millions) |
Quarter ended September 30, 2007 |
Quarter ended June 30, 2007 |
Percent Change |
|
Transport and Infrastructure(2) |
$438 |
$420 |
4% |
|
IP and Data(1) (2) |
$144 |
$143 |
1% |
|
Voice |
$291 |
$292 |
<(1)% |
|
Vyvx |
$36 |
$33 |
9% |
|
Total Core Communications Services |
$909 |
$888 |
2% |
|
|
|
|
|
|
Other Communications Services |
$63 |
$71 |
(11)% |
|
|
|
|
|
|
SBC Contract Services |
$71 |
$76 |
(7)% |
|
|
|
|
|
|
Total Communications Revenue |
$1,043 |
$1,035 |
1% |
(1)Communications revenue for the third quarter includes approximately $1 million from Servecast.
(2) A billing methodology change that took effect July 1, 2007 resulted in a $3 million revenue impact, with higher revenue recognized for certain customers in Transport and Infrastructure and lower revenue recognized in IP and Data compared to the second quarter.
In the third quarter, Level 3’s top 10 customers, in alphabetical order, were Alltel, AT&T Inc., British Telecom, Comcast Corporation, Commonwealth of Pennsylvania, EarthLink, Inc., Qwest Communications International Inc., Time Warner, Inc., Verizon Communications and Vonage Holdings Corporation. Including the SBC contract, these top 10 customers represent 32 percent of Total Communications revenue, and excluding the SBC contract, 27 percent of Total Communications revenue.
Core Communications Services
Core Communications Services revenue increased quarter over quarter by 2 percent. The increase was due primarily to the growth in transport services and Vyvx broadcast services, although growth was moderated across all services due to service activation issues.
Transport and Infrastructure revenues grew during the quarter resulting primarily from growth in colocation, wavelengths services and metro transport. IP and Data services revenue grew slightly during the quarter, primarily due to growth in High Speed IP revenue and the addition of Servecast revenue during the quarter, offset by declines in Dedicated Internet Access revenue resulting from seasonality and delayed installations.
Voice revenues declined slightly during the quarter, with continued growth in the cable and wireless segments offset by a decline in voice revenues in the voice service provider segment. Vyvx revenues increased sharply during the quarter, driven primarily by an increase in advertising distribution revenue and continued growth in high definition programming.
In the third quarter 2007, the breakdown of Core Communications Services revenue by each market group was as follows:
Other Communications Services
Other Communications Services revenue declined by 11 percent to $63 million during the quarter, as a result of expected declines in managed modem services.
SBC Contract Services
SBC Contract Services revenue was $71 million in the third quarter, including monthly performance bonuses of approximately $3 million, a decline of 7 percent compared to the second quarter. The company expects to earn the final bonus payments of $15.5 million in the fourth quarter 2007, but otherwise expects revenues associated with this contract to continue to decline, as previously disclosed.
Deferred Revenue
The communications deferred revenue balance decreased to $930 million at the end of the third quarter 2007, compared to $943 million at the end of the second quarter 2007, primarily due to the amortization of existing deferred revenue for indefeasible right of use (IRU) contracts exceeding deferred revenue resulting from new IRU contracts during the quarter.
Cost of Revenue
Communications cost of revenue for the third quarter 2007 increased to $438 million, versus $437 million in the previous quarter. Communications Gross Margin(1) was 58 percent for the third quarter 2007 and for the second quarter 2007. Communications revenue increased $8 million in the quarter and Communications Gross Margin increased by $7 million. During the third quarter, the company incurred network expenses associated with the pre-provisioning of network facilities in anticipation of more significant revenue growth. In addition, revenue mix in the quarter shifted due to lower growth in high margin services and a higher than expected proportion of lower margin SBC Contract revenues as a percent of Total Communications revenue. As a result, while the company continued to make progress on optimization efforts, the Communications Gross Margin percentage did not improve as much as anticipated during the third quarter.
Selling, General and Administrative (SG&A) Expenses
Communications SG&A expenses declined to $413 million for the third quarter 2007, versus $427 million for the previous quarter. Both the third quarter 2007 and second quarter 2007 Communications SG&A expenses include $24 million of non-cash compensation expense. SG&A expenses decreased in the third quarter 2007 primarily due to a decrease in incentive-based compensation expenses, as well as a decrease in headcount during the quarter.
Communications Adjusted EBITDA
Communications Adjusted EBITDA(1) increased to $215 million for the third quarter 2007, compared to $194 million for the previous quarter. Communications Adjusted EBITDA increased in the period primarily due to an increase in Core Communications Services revenue and reductions in SG&A.
Third quarter 2007 Communications Adjusted EBITDA excludes $24 million of non-cash compensation expense and includes a $1 million restructuring charge associated with reductions in workforce as part of the company’s integration efforts. Second quarter 2007 Communications Adjusted EBITDA excludes $24 million of non-cash compensation expense and $1 million of non-cash impairment charges and includes a $1 million restructuring charge related to integration.
Consolidated Cash Flow and Liquidity
During the third quarter 2007, Unlevered Cash Flow(1) was positive $76 million, versus negative $64 million for the previous quarter. Consolidated Free Cash Flow(1) for the third quarter 2007 was negative $54 million, versus negative $141 million for the previous quarter. Working capital was a source of cash in the third quarter, and net cash interest expense for the third quarter 2007 was $130 million.
As of September 30, 2007, the company had cash and marketable securities of approximately $697 million.
Integration Update
“Level 3 and each of the six network companies we acquired employed different provisioning processes and systems,” said Kevin O’Hara, president and COO of Level 3. “Our integration plan assumed that our new, integrated processes and systems, Project Unity, would be developed and deployed in stages starting in 2007 and running throughout 2008. During the development and deployment of Unity, we expected to increase the throughput of the existing, legacy provisioning systems by developing temporary processes and systems and by assigning more people and resources than would normally be required.
“While the fundamental approach was sound, we made some implementation decisions that in retrospect made achieving our provisioning throughput targets more difficult. In particular, we took certain processes which had been centralized and split them up among our customer facing groups, which made identifying and fixing throughput issues more difficult. As a result, we fell short this quarter in increasing our provisioning capabilities to the level we expected. While we had previously made changes to the organization managing the service activation and service management processes, and we did see some benefits from the changes, we did not implement sufficient measures to improve our provisioning throughput to the level we anticipated at the time of our second quarter earnings release. We have recently conducted a comprehensive analysis of both the organization and the processes and systems that we are using until Unity is deployed.”
In response to this analysis, the company has taken the following actions:
“We believe that these organizational changes along with business process improvements will address the issues that were preventing increased provisioning throughput,” said O’Hara.
“In addition, we are continuing the development of Unity. That development remains largely on track. We have begun user training on the initial elements of Unity and we have begun the initial deployment. We expect that Unity development and deployment will continue through the balance of 2007 and 2008, and that this effort will improve our provisioning process throughput.”
Level 3 remains on track to achieve the $200 million of integration synergies it anticipated for the full year 2007. At the end of the second quarter, the company reported that it had achieved run rate synergies of $140 million. As of the end of the third quarter, annualized run rate synergies were $185 million, with approximately $80 million in network expense savings and $105 million in operating expense savings. The company has met its network expense synergies as of the end of the third quarter and is on track to achieve the projected operating expense synergies of $120 million before the end of 2007.
During the third quarter, the company incurred approximately $20 million of integration expenses for a total of $80 million year to date, and still expects to incur approximately $100 million in integration expenses for the full year. While headcount was added in the third quarter to improve the provisioning process, and additional headcount is expected to be hired in the fourth quarter to assist with that effort, the company remains within overall headcount reduction targets for the full year 2007.
Corporate Transactions
Acquisitions
On July 11, 2007, Level 3 acquired Servecast, a Dublin, Ireland provider of live and on-demand video management and streaming services for broadband and mobile platforms, expanding the company’s content delivery network capabilities. The company paid approximately $45 million in cash consideration. This is a strategic capabilities acquisition that does not require the type of physical integration associated with the larger, previously announced metro and backbone transactions.
As previously announced, on October 16, 2007, Level 3 announced the acquisition of certain AT&T assets that were divested as a result of the merger between AT&T and BellSouth.
Business Outlook
“Primarily due to the provisioning issues we have been experiencing, we have lowered our Consolidated Adjusted EBITDA guidance for both the full year 2007 and 2008,” said Sunit Patel, CFO of Level 3. “Specifically, we have lowered Consolidated Adjusted EBITDA guidance for the full year 2007 from a range of $860 million to $920 million to a range of $813 million to $833 million and for the full year 2008 from $1.15 billion to $1.3 billion to $950 million to $1.1 billion.
“Our previously implied fourth quarter Core Communications Services revenue and Consolidated Adjusted EBITDA guidance required improvement in our provisioning capabilities. However, our recurring services revenue did not grow as much as we expected in the third quarter and that gap compounds in the fourth quarter. Further, we did not see the growth in usage services, primarily voice services that we had anticipated. Also, in anticipation of revenue growth, we incurred network expenses that reduced our gross margin performance.”
The reduction in Consolidated Adjusted EBITDA guidance in 2008 is primarily driven by: the annualized reduction in the fourth quarter 2007 Consolidated Adjusted EBITDA and the decrease in the rate of revenue growth in 2008. The high incremental margin impact of the revenue reductions is evident in the guidance change.
“At the low end of the 2008 range, the revised guidance assumes the recent rate of sales and net installations will continue with some minimal improvement in our provisioning throughput until we begin to realize significant benefit from Project Unity in the second half of 2008,” said Patel.
“The upper end of revised guidance is predicated on achieving more significant improvements in the rate of sales and net installations beginning later this year. For 2007, assuming the guidance range for the fourth quarter, the implied Core Communications Services annualized revenue growth rate, is now 9 to 12 percent versus the 17 percent we had originally projected.”
Metric ($ in millions) |
Fourth Quarter 2007 Projections |
2007 Full Year Projections |
|
Core Communications Services Revenue |
$930-$950 |
$3,597-$3,617 |
|
Other Communications Services Revenue |
$55-$60 |
$273-$278 |
|
SBC Contract Services Revenue |
$65-$85 |
$295-$315 |
|
Total Communications Revenue |
$1,050-$1,095 |
$4,165-$4,210 |
|
Consolidated Adjusted EBITDA |
$235-$255 |
$813-$833 |
|
Consolidated Capital Expenditures |
|
$600-$650 |
|
Net Cash Interest Expense (1) |
|
$500 |
(1) 2007 full year includes approximately $55 million in interest income.
Summary
“I am disappointed by our inability to increase our provisioning productivity at the rate we had expected,” said Crowe. “We can and should do better. However, our overall market opportunity is strong and growing. Our problems are not caused by demand, pricing or our ability to market and sell our services. Our ability to grow faster is in our own hands, and we realize the urgency with which our provisioning problems must be addressed.”
Conference Call and Web Site Information
Level 3 will hold a conference call to discuss the company’s third quarter results at 9 a.m. EDT today. To join the call, please dial 612-332-1213. A live broadcast of the call can also be heard on Level 3’s Web site at http://www.level3.com/q0307report.html. An audio replay of the call will be accessible until 11:59 p.m. EDT on Tuesday, November 6, 2007 by dialing 320-365-3844; access code 888765. An archived webcast of the third quarter conference call together with the press release, financial statements and non-GAAP reconciliations may also be accessed at http://www.level3.com/investor_relations/index.html.
View Q3-2007 Financial Statements
View Schedule to Reconcile to non-GAAP Financial Metric
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, and 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 made 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 Level 3’s control, which could cause actual events to differ materially from those expressed or implied by the statements. The most important factors that could prevent Level 3 from achieving its stated goals include, but are not limited to the company’s ability to: successfully integrate acquisitions; increase the volume of traffic on the network; defend 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 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.
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