Level 3 Q3 2006

Level 3 has announced the Level 3 Q3 2006 results:

Third Quarter Financial and Business Highlights

  • Consolidated Revenue of $875 million
  • Net Loss of $138 million, or $0.12 per share
  • Consolidated Adjusted OIBDA of $176 million
  • Consolidated Free Cash Flow of negative $64 million
  • Software Spectrum results reflected as discontinued operations

Level 3 Communications, Inc. (Nasdaq: LVLT) reported consolidated revenue of $875 million for the third quarter 2006, compared to consolidated revenue of $835 million for the second quarter 2006.  As the company completed the sale of its Software Spectrum, Inc. subsidiary in the third quarter of 2006, the results of operations of Software Spectrum are reflected as discontinued operations for all periods provided in this release and are not consolidated with the results of operations of Level 3’s communications and other businesses.The net loss for the third quarter 2006 was $138 million, or $0.12 per share, compared to a net loss of $201 million, or $0.23 per share, for the previous quarter. Included in the net loss for the third quarter is a gain of $33 million associated with the sale of Software Spectrum, or $0.03 per share. Included in the net loss for the second quarter 2006 was a loss of $55 million, or $0.06 per share, attributable to the amendment and restatement of the Level 3 Financing, Inc.’s $730 million credit agreement.

“Excluding the benefit of acquisitions during the third quarter, we had an approximately 6 percent growth in core communications services revenue,” said James Q. Crowe, CEO of Level 3. “This positive outcome is the result of particularly strong contributions from transport and infrastructure and voice services, the ongoing stabilization in the pricing environment; and the positive impact of industry consolidation. The trend in organic growth bodes well for future performance, and the communications business saw positive contributions from the WilTel integration and other, more recent acquisitions.”

Consolidated Adjusted OIBDA(1) defined as Adjusted Operating Income Before Depreciation and Amortization was $176 million in the third quarter 2006, compared to third quarter 2006 projections of $170 million to $190 million and $170 million for the second quarter 2006.

“Our favorable performance in core services revenue was offset by declines in SBC Contract Services revenues and higher operating expenses, which were primarily due to the acceleration of certain integration related expenses and increased costs attributable to the acquired companies,” said Sunit S. Patel, CFO of Level 3.

Third Quarter 2006 Financial Results

Metric
($ in millions)
Revenue
Consolidated
Third Quarter
Results
Third Quarter Projections(1)
Core Communications $544 $525 – $535
Other Communications $107 $100 -$105
SBC Contract Services $207 $205- $245
Total Communications Revenue $858 $830 – $885
Other Revenue $17
Total Consolidated Revenue $875
Consolidated Adjusted OIBDA (2)(3) $176 $170 – $190
Capital Expenditures $120
Unlevered Cash Flow (3) $121
Free Cash Flow (3) $(64)
Communications Gross Margin (3) 57%
Communications Adjusted OIBDA Margin (3) 20% ~20%
  1. Projections issued July 25, 2006.
  2. Consolidated Adjusted OIBDA excludes $18 million in non-cash compensation expense and $1 million of non-cash impairment charges.
  3. See schedule of non-GAAP metrics for definition and reconciliation to GAAP measures.

Communications Business

Revenue
Communications revenue for the third quarter 2006 was $858 million, versus $819 million for the previous quarter. The company recognized less than $1 million in termination revenue during the third quarter 2006 and $3 million in termination revenue during the second quarter 2006, primarily related to the SBC Contract Services.

Communications Revenue
($ in millions)

Quarter ended
Sept. 30, 2006 (1)

Quarter ended
June 30, 2006 (2)

Percent
Change

Transport and Infrastructure

$284

$217

31%

IP and Data

$78

$67

16%

Voice

$153

$107

43%

Vyvx

$29

$30

(3%)

Total Core Communications Services

$544

$421

29%

Other Communications Services

$107

$120

(11%)

 

 

 

SBC Contract Services

$207

$278

(26%)

 

 

 

Total Communications Revenue

$858

$819

5%

  1. Communications revenue for the third quarter includes approximately $37 million of revenue from Progress Telecom and ICG Communications, and approximately $83 million of revenue from TelCove and Looking Glass.
  2. Communications revenue for the second quarter includes approximately $21 million of revenue from Progress Telecom and ICG Communications.

Core Communications Services
Core Communications Services revenue, which includes transport and infrastructure, wholesale IP and Data, Voice and Vyvx, increased quarter over quarter by 29 percent due to a 6 percent organic growth in core communications services, primarily from transport and infrastructure and voice services, the benefit of a full quarter’s revenue from ICG Communications, as well as revenue for part of the quarter from the acquisitions of TelCove and Looking Glass Networks.

Other Communications Services
Other Communications Services revenue declined 11 percent to $107 million during the quarter, as a result of expected declines in managed modem and managed services.

SBC Contract Services
SBC Contract Services declined by 26 percent from the previous quarter. As previously disclosed, SBC has announced its intention to migrate the services provided under the agreement to its own network facilities in accordance with terms previously negotiated by WilTel. Under the terms of this agreement, SBC agreed to pay WilTel a minimum amount of gross margin regardless of the actual revenue generated under the contract. Accordingly, while the company expects future SBC Contract Services quarterly revenue will be difficult to predict and the rate of decline to vary from quarter to quarter, the gross margin contribution over time is fixed.

The communications deferred revenue balance was $896 million at the end of the third quarter 2006, compared to $912 million at the end of the second quarter. The decline in communications deferred revenue quarter over quarter is a result of the amortization of previously recognized deferred revenue balances and a $20 million decrease associated with an integration related change in the billing cycle for certain legacy WilTel customers, partially offset by cash receipts associated with wavelength and dark fiber sales.  Excluding the effect of the change in the billing cycle, the communications deferred revenue balance would have increased from the second quarter by $4 million.

Cost of Revenue
Communications cost of revenue for the third quarter 2006 was $368 million, versus $385 million in the previous quarter. Cost of revenue decreased during the quarter primarily due to the benefit of synergies from the WilTel integration and lower expenses associated with SBC Contract Services revenue partially offset by increases from a full quarter of costs associated with ICG Communications, and a partial quarter of costs associated with TelCove and Looking Glass.

Communications gross margin(1) was 57 percent for the third quarter, versus 53 percent for the second quarter. The increase in communications gross margin is primarily attributable to the higher margin revenue from TelCove, Looking Glass and ICG Communications; organic growth in our core communications services; a reduction in lower margin services associated with SBC Contract Services revenue; and integration benefits from the WilTel acquisition.

“We are pleased with the improvement in our gross margin,” said Crowe. “Given positive market conditions and the benefits of integration activity and acquisitions, we expect improvements in gross margin to continue in the fourth quarter.”

Selling, General and Administrative Expenses (SG&A)
Communications SG&A expenses were $333 million for the third quarter 2006, versus $281 million for the previous quarter. The third and second quarter 2006 Communications SG&A expenses include $18 million and $20 million, respectively, of non-cash compensation expense. SG&A increased in the third quarter primarily due to costs associated with TelCove and Looking Glass, and a full quarter of costs from ICG Communications.

“Our integration expenses increased in the quarter as we started integrating various operating and business support systems and processes,” said Patel. “For the balance of the year, we are accelerating some of the metro integration efforts that were previously planned for 2007.”  

Adjusted OIBDA
Adjusted OIBDA(1) for the communications business increased to $174 million for the third quarter 2006, compared to $170 million for the previous quarter.

Communications Adjusted OIBDA margin(1) was 20 percent for the third quarter 2006, versus 21 percent in the previous quarter.

Communications Adjusted OIBDA in the third quarter includes $1 million in cash restructuring charges associated with reductions in workforce resulting from the integration of acquired businesses and excludes a $1 million non-cash asset impairment charge, and $18 million of non-cash compensation expense. Second quarter 2006 Communications Adjusted OIBDA includes $3 million in cash restructuring charges associated with reductions in workforce resulting from the integration of acquired businesses and excludes a $4 million non-cash asset impairment charge, and $20 million of non-cash compensation expense.

Other Businesses
The company’s other businesses consist primarily of coal mining operations.

Revenue and Adjusted OIBDA
Revenue from other businesses was $17 million in the third quarter, compared to $16 million in the second quarter of 2006. Consolidated Adjusted OIBDA(1) from Other Businesses in the third quarter was $2 million and Other Businesses did not contribute to Consolidated Adjusted OIBDA in the second quarter 2006.

Consolidated Cash Flow and Liquidity
During the third quarter 2006, Unlevered Cash Flow(1) was positive $121 million, versus positive $93 million for the previous quarter. Consolidated Free Cash Flow for the third quarter was negative $64 million, versus negative $13 million for the previous quarter.

As of September 30, 2006, the company had cash and marketable securities of approximately $1.2 billion. “The combination of the company’s acquisitions, financing activities during the year and continued organic core communications growth has strengthened our financial condition,” said Patel.
 
Corporate Transactions

Acquisitions
On October 17, 2006, Level 3 announced that it had signed a definitive agreement to acquire Broadwing Corporation. Under the terms of the agreement, Level 3 will pay $8.18 of cash plus 1.3411 shares of Level 3 common stock for each share of Broadwing common stock outstanding at closing. In total, Level 3 expects to pay approximately $744 million of cash and issue approximately 122 million shares of common stock.

During the third quarter, Level 3 closed the acquisitions of Telcove and Looking Glass. Also during the third quarter, Level 3 completed the sale of Software Spectrum to Insight Enterprises, Inc. for total proceeds of $353 million in cash, consisting of $287 million in purchase price and approximately $66 million in a working capital adjustment. The cash received at closing remains subject to certain post-closing adjustments.

Organizational Update

  • The Wholesale Markets Group services the communications needs of the largest global service providers, including carriers, cable companies, wireless companies, and voice service providers. These customers typically integrate Level 3 services into their own products and services to offer to their end user customers.
  • The Content Markets Group focuses on serving media and content companies with large and growing bandwidth needs. Customers in this market include video distribution companies, providers of gaming, mega-portals, software service providers, social networking providers, as well as more traditional media distribution companies such as broadcasters, television networks and sports leagues.
  • The Business Markets Group targets enterprise customers and regional carriers who value a local, professional sales force.  Specific customer markets include small, medium, and large businesses, local and regional carriers, state and local government entities, and higher education institutions.
  • The European Markets Group serves the largest European consumers of bandwidth, including the largest European and international carriers, large system integrators, voice service providers, cable operators, Internet service providers, content providers, and government and education sectors.

“The alignment around customer markets we believe will continue to drive rapid growth while enabling the company to better focus on the needs of our customers, and deliver the high quality services they expect from Level 3,” said Kevin O’Hara, president and COO of Level 3. “Each group is supported by the dedicated sales, marketing, product management, customer facing operations, and necessary support resources required to execute and grow revenues in these key segments.”

Integration Update
We have completed the majority of the physical integration of WilTel’s network, and we are seeing the benefit of the network and operating expense savings we expected from this acquisition in our results this quarter,” said O’Hara. “Our primary focus going forward will be to continue the integration efforts of our metro acquisitions and begin the integration work on Broadwing subject to the requirements and restrictions of applicable law.

“The integrations of the metro acquisitions are underway, and we are beginning to see the benefits of our increased local footprints across the communications business. We are on track to complete the majority of the integration of these companies by the end of 2007.”

Capital Markets Activity
During the third quarter, the company redeemed all of its outstanding 9 1/8% Senior Notes due 2008 and 10 1/2% Senior Discount Notes due 2008. Aggregate principal, call premium and accrued interest totaled $470 million. As a result, long-term debt due in 2008 was reduced by approximately $460 million.

2006 Business Outlook

Communications Revenue
“The continued strength in our core communications business and our strengthening gross margin are indicators of strong momentum,” said Crowe. “We are confident in our ability to continue to deliver industry leading growth in our core communications revenues.”

Metric
($ in millions)
FourthQuarter Projections (1) 2006
Full Year Projections (1)
Core Communications Services revenue $595 – $605 $1,950- $1,960
Other Communications Services revenue $90 – $95 $440 – $445
SBC Contract Services $100 – $130 $875 – $905
Total Communications Revenue $785 – $830 $3,265 – $3,310
Consolidated Adjusted OIBDA $180 – $200 $670 – $690
Communications Adjusted OIBDA Margin ~23% ~21%
Consolidated Capital Expenditures N/A $390 – $410
Net Cash Interest Expense N/A $495

“We are increasing the midpoint for our 2006 core communications services and total communications revenue as a result of stronger than anticipated organic growth,” said Patel. “Excluding benefits from the pending acquisition of Broadwing, we reiterate our expectation that Consolidated Adjusted OIBDA in 2007 will be $830 million to $890 million.”

Summary
“We are pleased with the continued demand we are seeing from our customers, we believe our performance this quarter continues to demonstrate that our business and industry dynamics are strong,” said Crowe. “We believe we are well positioned for the future. In addition, we believe our pending acquisition of Broadwing creates significant value for our stockholders and expands our opportunities for growth.”

Conference Call and Web site Information

Level 3 will hold a conference call to discuss the company’s third quarter results at 10 a.m. EDT today. To join the call, please dial 612-332-0342. 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 843661. 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/.

View Q3-2006 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. Through its customers, Level 3 is the primary provider of Internet connectivity for millions of broadband subscribers. The company provides a comprehensive suite of services over its broadband fiber optic network including Internet Protocol (IP) services, broadband transport and infrastructure services, colocation services, voice services and voice over IP services. These services provide building blocks that enable Level 3’s customers to meet their growing demands for advanced communications solutions. The company’s Web address is http://www.level3.com/.

“Level 3 Communications,” “Level 3” and the Level 3 Communications logo are registered service marks of Level 3 Communications, Inc. in the United States and/or other countries. Any other product and company names herein may be trademarks of their respective owners. Level 3 services are provided by wholly owned subsidiaries of Level 3 Communications, Inc.

Forward-Looking Statement
Some of the statements made by Level 3 in this press release are forward-looking in nature. Actual results may differ materially from those projected in forward-looking statements. Level 3 believes that its primary risk factors include, but are not limited to: increasing the volume of traffic on Level 3’s network; developing new products and services that meet customer demands and generate acceptable margins; successfully completing commercial testing of new technology and information systems to support new products and services, including voice transmission services; stabilizing or reducing the rate of price compression on certain of our communications services; integrating strategic acquisitions; attracting and retaining qualified management and other personnel; and the ability to 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 release should be evaluated in light of these important factors

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