Company Completes Acquisition of TelCove
Increases 2006 and 2007 Communications Adjusted OIBDA Projections
Second Quarter Financial and Business Highlights
BROOMFIELD, Colo., July 25, 2006 — Level 3 Communications, Inc. (Nasdaq:LVLT) reported consolidated revenue of $1.53 billion for the second quarter 2006, compared to $1.27 billion for the first quarter 2006. Communications revenue was $819 million in the second quarter, versus $804 million for the previous quarter. Information services revenue was $695 million in the second quarter, compared to $445 million for the previous quarter and $504 million for the same quarter last year.
The net loss for the second quarter 2006 was $201 million, or $0.23 per share, compared to a net loss of $168 million, or $0.20 per share, for the previous quarter. During the quarter, the company reviewed its estimated useful lives, used to calculate depreciation for optical fiber. Based on this review, the company determined the useful life of its optical fiber should be extended. Accordingly, depreciation expense decreased by $18 million, or $0.02 per share, in the second quarter. The company also recorded a loss of $55 million in the second quarter, or $0.06 per share, attributable to the amendment and restatement of the Level 3 Financing, Inc.’s $730 million credit agreement. Included in the net loss for the first quarter 2006 was a gain of $27 million, or $0.03 per share, that was recorded as a result of the company’s $692 million private debt exchange offer, which was completed in January 2006.
Consolidated Adjusted OIBDA(1) defined as Adjusted Operating Income Before Depreciation and Amortization was $196 million in the second quarter 2006, compared to previous projections of $170 million to $190 million and $150 million for the previous quarter.
“During the second quarter, our margins in the communications business increased and the company generated positive free cash flow,” said James Q. Crowe, CEO of Level 3. “Additionally, the communications business saw positive contributions from the benefit of the WilTel integration, recent acquisitions and continuing demand for our Core Communications Services.”
Second Quarter 2006 Financial Results
| Metric ($ in millions) |
Conslidated Second Quarter Results(1) | Second Quarter Projections (2) |
| Core Communications | $421 | $415 - $425 |
| Other Compensation | $120 | $115 - $120 |
| SBC Contract Services | $278 | $285 - $295 |
| Total Communications Revenue | $819 | $815 - $840 |
| Information Services Revenue | $695 | |
| Other Revenue | $16 | |
| Total Consolidated Revenue | $1,530 | |
| Consolidated Adjusted OIBDA (3)(4) | $196 | $170-$190 |
| Capital Expenditures | $75 | |
| Unlevered Cash Flow (4) | $167 | |
| Free Cash Flow (4) | $61 | |
| Communications Gross Margin (4) | 53% | |
| Communications Adjusted OIBDA Margin (4)(5) | 21% |
~20% |
(1) Consolidated results for the second quarter include approximately $15 million of revenue from Progress Telecom and $6 million of revenue from ICG Communications for June 1, 2006, through June 30, 2006.
(2) Projections issued April 25, 2006.
(3) Consolidated Adjusted OIBDA excludes $21 million in non-cash compensation expense and $4 million of non-cash impairment charges.
(4) See schedule of non-GAAP metrics for definition and reconciliation to GAAP measures.
(5) Communications Adjusted OIBDA Margin excludes $20 million in non-cash compensation and $4 million of non-cash impairment charges.
Communications Business
Revenue
Communications revenue for the second quarter 2006 was $819 million, versus $804 million for the previous quarter. The company recognized approximately $3 million in termination revenue during the second quarter primarily related to SBC Contract Services.
| Communications Revenue ($ in millions) |
Quarter Ended June 30, 2006(1) |
Quarter Ended March 31, 2006(2) |
Percent Change |
| Transport and Infrastructure | $217 | $198 | 10% |
| Wholesale IP & Data Services | $67 | $64 | 5% |
| Voice | $107 | $98 | 9% |
| Vyvx | $30 | $29 | 3% |
| Total Core Communications Services | $421 | $389 |
8% |
| Other Communications Services | $120 | $123 | (2%) |
| SBC Contract Services | $278 | $292 | (5%) |
| Total Communications Revenue | $819 | $804 | 2% |
(1) Second quarter 2006 includes $3 million of termination revenue, $15 million in revenue from Progress Telecom and $6 million of revenue from ICG Communications from June 1, 2006 through June 30, 2006.
(2) First quarter 2006 includes $2 million in revenue from Progress Telecom.
Core Communications Services
Core Communications Services revenue, which includes transport and infrastructure, wholesale IP and Data, Voice and Vyvx, increased primarily due to a full quarter’s revenue from Progress Telecom; the benefit of the acquisition of ICG Communications during the quarter; and organic growth in voice, transport and infrastructure, and wholesale IP and data.
Other Communications Services
Other Communications Services revenue declined during the quarter as expected due to declines in managed modem and managed services.
SBC Contract Services
SBC Contract Services declined by five 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 fixed 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, the gross margin contribution over time is fixed.
The communications deferred revenue balance was $912 million at the end of the second quarter 2006, compared to $922 million at the end of the first quarter. The decline in communications deferred revenue quarter over quarter is a result of the amortization of previously recognized deferred revenue balances and the acceleration of $3 million of deferred revenue during the quarter due to terminations, partially offset by cash receipts associated with wavelength and dark fiber sales.
Cost of Revenue
Communications cost of revenue for the second quarter 2006 was $385 million, versus $396 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.
Communications gross margin(1) was 53 percent for the second quarter, versus 51 percent for the first quarter. The increase in communications gross margin is primarily attributable to the benefit of the Progress and ICG acquisitions and lower cost of revenue.
Selling, General and Administrative Expenses (SG&A)
Communications SG&A expenses were $281 million for the second quarter 2006, versus $274 million for the previous quarter. The first quarter included a $7 million property tax benefit. The second and first quarter 2006 Communications SG&A expenses include $20 million and $14 million respectively of non-cash compensation expense. Excluding the effect of the property tax benefit and non-cash compensation expenses, SG&A decreased in the second quarter by approximately $6 million, while the company absorbed a full quarter’s worth of SG&A expense from Progress Telecom, compared to 10 days in the first quarter, plus the inclusion of one month of ICG’s SG&A expenses.
Adjusted OIBDA
Adjusted OIBDA(1) for the communications business increased to $170 million for the second quarter 2006, compared to $147 million for the previous quarter.
Communications Adjusted OIBDA margin(1) was 21 percent for the second quarter 2006, versus 18 percent in the previous quarter.
Communications Adjusted OIBDA in the second quarter includes $3 million in cash restructuring charges associated with reductions in workforce resulting from the WilTel integration and excludes a $4 million non-cash asset impairment charge, and $20 million of non-cash compensation expense. First quarter 2006 Communications Adjusted OIBDA includes $1 million in cash restructuring charges associated with reductions in workforce resulting from the WilTel integration and excludes a $3 million non-cash asset impairment charge, and $14 million of non-cash compensation expense.
Information Services Business
The company’s information services business consists of the results from the Software Spectrum subsidiary.
Revenue and Adjusted OIBDA
Information services revenue was $695 million for the second quarter 2006. This compares to revenue of $445 million for the previous quarter and $504 million for the same period last year. Information services Adjusted OIBDA(1) was $26 million for the second quarter, and excludes $1 million in non-cash compensation expense. This compares to information services Adjusted OIBDA of $3 million in the previous quarter, which included $1 million of cash restructuring charges related to business solution partnering agreements and excluded $1 million in non-cash stock compensation expense. For the same period last year, information services Adjusted OIBDA was $12 million and included less than $1 million of non-cash stock compensation expense.
“We are pleased with the performance of our Software Spectrum business during the second quarter,” said Charles C. Miller, vice chairman of Level 3. “Our revenue and Adjusted OIBDA results reflect revenue growth from certain large customers, revenue increases from our mid-market sales efforts and the benefit of seasonality associated with Microsoft’s fiscal year-end.”
On July 20, 2006, Level 3 signed a definitive agreement to sell Software Spectrum to Insight Enterprises, Inc., a leading provider of information technology products and services. Under the terms of the agreement, Level 3 will receive total consideration of $287 million in cash. The purchase price is subject to customary working capital and certain other post-closing adjustments. The transaction is expected to close in the third quarter 2006. As a result of the pending sale of Software Spectrum, its results will be reflected as discontinued operations beginning in the third quarter of 2006.
Other Businesses
The company’s other businesses consist primarily of coal mining operations.
Revenue and Adjusted OIBDA
Revenue from other businesses was $16 million in the second quarter, compared to $18 million in the first quarter of 2006. Other businesses did not contribute Consolidated Adjusted OIBDA(1) in the first or second quarter 2006.
Consolidated Cash Flow and Liquidity
During the second quarter 2006, Unlevered Cash Flow(1) was positive $167 million, versus negative $12 million for the previous quarter. Consolidated Free Cash Flow for the second quarter was positive $61 million, versus negative $122 million for the previous quarter.
“The improvement in our second quarter consolidated free cash flow is a result of increased Consolidated Adjusted OIBDA, and improved working capital sources, primarily from our Software Spectrum business,” said Sunit Patel, CFO of Level 3. “We expect to report negative free cash flow during the second half of 2006 primarily due to higher capital expenditures and an increase in cash interest expense compared to the first six months of 2006. We are pleased with the progress we are making toward generating positive free cash flow on a sustainable basis.”
As of June 30, 2006, the company had cash and marketable securities of approximately $2.2 billion compared to approximately $992 million at March 31, 2006. Pro forma for the July 13, 2006 redemption of its outstanding 9 1/8% Senior Notes due 2008 and 10½% Senior Discount Notes due 2008 and the closing of the acquisition of TelCove, Inc. on July 24, 2006, the company had cash and marketable securities of approximately $1.1 billion at June 30, 2006.
“The combination of the company’s acquisitions, recent financing activities, continued organic core communications growth and the pending sale of Software Spectrum, provides the company with significant additional flexibility and liquidity” said Patel. “Growth in our Adjusted OIBDA and improvement in business fundamentals and in our capital structure have reduced our debt leverage significantly compared to one year ago.”
Corporate Transactions
Acquisitions
On July 24, 2006, Level 3 closed its previously announced acquisition of TelCove, Inc., a privately held Pennsylvania-based telecommunications company. Level 3 paid consideration to the TelCove security holders of 149,944,647 million shares of Level 3 common stock and approximately $445.8 million in cash. Also in connection with the closing, Level 3 is using approximately $132 million in cash to pay off outstanding TelCove debt. The transaction also included approximately $13 million in capital leases, which are expected to remain outstanding.
On June 5, 2006, Level 3 announced a definitive agreement to acquire Looking Glass Networks. Under the terms of the agreement, Level 3 will pay total consideration to Looking Glass’ securityholders of $96 million, consisting of $87 million in unregistered shares of Level 3 common stock and $9 million in cash. At closing, Level 3 will also pay Looking Glass debt of approximately $69 million. Closing is expected to occur by mid-third quarter 2006.
On May 31, 2006, the company closed its previously announced acquisition of ICG Communications, for consideration of approximately 26 million shares of Level 3 common stock and $45 million in cash, subject to adjustment based on the subsequent calculation of actual closing date working capital.
Integration Update
“A substantial portion of the integration of WilTel is complete, and we’ve begun to see the benefit of the synergies we expected from this acquisition,” said Kevin O’Hara, president and COO of Level 3. “Our primary focus going forward will be to complete the WilTel integration and continue the integration efforts of our metro acquisitions. The integration of our metro acquisitions, Progress, ICG, TelCove and the pending acquisition of Looking Glass, are different from traditional consolidation transactions, where the majority of value is derived by eliminating duplicative costs. These companies are high-margin, growing businesses, and the primary benefits of integration are the extension of the Level 3 network into regional and local markets and the elimination of certain third-party network expenses for the existing Level 3 communications business.”
Capital Markets Activity
During the second quarter, Level 3 raised approximately $904 million of gross proceeds through the offering of an aggregate of 125 million shares of its common stock and $335 million aggregate principal amount of its 3.5% Convertible Senior Notes due 2012 in separate underwritten public offerings. During the quarter, the company also issued an additional $300 million of its 12.25% Senior Notes due 2013, which were initially issued in the first quarter and amended its $730 million credit facility to, among other things, reduce the interest rate payable on that facility.
Subsequent to quarter end, the company redeemed all of its outstanding 9 1/8% Senior Notes due 2008 and 10½% 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 $460 million.
2006 Business Outlook
Communications Revenue
“The strength of our business in the first two quarters this year bodes well for the balance of 2006 and beyond,” said Crowe.
| Metric ($ in millions) |
Third Quarter Projections(1) | 2006 Full Year Projections(1) |
| Core Communications Services revenue | $525 - $535 |
$1,875- $2,000 |
| Other Communications Services revenue | $100 - $105 | $425 - $450 |
| SBC Contract Services | $205 - $245 | $850 - $950 |
| Total Communications Revenue | $830 - $885 | $3,150 - $3,400 |
| Consolidated Adjusted OIBDA | $170 - $190 | $650 - $710 |
| Communications Adjusted OIBDA Margin | ~20% | ~21% |
| Consolidated Capital Expenditures | N/A | $360 - $410 |
| Net Cash Interest Expense | N/A | $495 |
(1) Assumes acquisition of Looking Glass Networks closes by mid-third quarter 2006. Excludes Software Spectrum.
“Our full-year 2006 and 2007 Consolidated Adjusted OIBDA projections now exclude the benefit of approximately $40 million in Adjusted OIBDA from Software Spectrum,” said Patel. “Relative to our projections issued on April 25, we are increasing Communications Adjusted OIBDA by $55 million due to the acquisition of TelCove and the expected acquisition of Looking Glass, as well as better performance in Core Communications Services. We expect Communications Adjusted OIBDA margin to be approximately 21 percent for the full year 2006.
“We expect Consolidated Adjusted OIBDA in 2007 to be $830 million to $890 million or about a $150 million increase from our previous projection as a result of the $40 million reduction from Software Spectrum, and a $190 million increase to Communications Adjusted OIBDA related to the benefit of the TelCove acquisition, the pending Looking Glass acquisition, plus a higher contribution from Core Communications Services.”
Summary
“We believe another strong quarter helps demonstrate that our business and industry dynamics are continuing to improve, and we believe that we are well positioned for growth in the future,” said Crowe.
Conference Call and Web site Information
Level 3 will hold a conference call to discuss the company’s second quarter results at 11 a.m. EDT today. To join the call, please dial 612-332-0335. 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 834228. An archived webcast of the first quarter conference call together with the press release, financial statements and non-GAAP reconciliations may also be accessed at www.Level3.com.
View Q2-06 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.
