Level 3 Communications, Inc. ( LVLT)

Q3 2010 Earnings Call Transcript

October 28, 2010 10:00 am ET

Executives

Valerie Finberg – IR

Jim Crowe – CEO

Sunit Patel – EVP and CFO

Jeff Storey – President and COO

Buddy Miller –Vice Chairman

Robin Grey – Corporate Treasurer

Analysts

Frank Louthan – Raymond James

Colby Synesael – Cowen & Co.

Scott Coleman – Goldman Sachs

Donna Jaegers – D.A. Davidson

Ana Goshko – Bank of America-Merrill Lynch

Michael Funk – Bank of America-Merrill Lynch

Chris Larsen – Piper Jaffray

David Sharret – Barclays Capital

Kevin Quinn – Goldman Sachs

Presentation

Operator

Good day and welcome to the Level 3 Communications Incorporated third quarter 2010 earnings conference call. Today’s call is being recorded. At this time, I’d like to turn the conference over Valerie Finberg, Vice President of Investor Relations. Please go ahead.

Valerie Finberg

Thank you, Jessica. Good morning everyone and thank you for joining us for the Level 3 Communications Third Quarter 2010 Earnings Call. With us on the call today are Jim Crowe, Chief Executive Officer; Jeff Storey, President and Chief Operating Officer; Sunit Patel, Executive Vice President and Chief Financial Officer; and Buddy Miller, Vice Chairman.

Before we get started, as a reminder our press release, supplementary information and the presentation slides that accompany this call are all available on the Level 3 Web site at www.level3.com under the Quarterly Financial section in the Investor Relation section of the Web site.

I also need to cover our Safe Harbor statement, which can be found on page two of our 3Q ‘10 earnings presentation and that says that information on this call and in the presentation contains financial estimates and other forward-looking statements that are subject to risk and uncertainties. Actual results may vary significantly from those statements. Our discussion of factors that may affect future results is contained in Level 3 filings with the Securities and Exchange Commission.

Finally, please note that on today’s call we will be referring to certain non-GAAP financial measures. Reconciliations between the non-GAAP financial measures and the most comparable GAAP financial measures are available in the press release, which is posted on our Web site at www.level3.com.

I will now turn the call over to Jim. Jim?

Jim Crowe

Yes, good morning. I’ve got a respiratory ailment, which may result in intermittent laryngitis. If it hits me during the call, Sunit and Jeff will pick up, but don’t be surprised if that occurs. In accordance with our normal practice, Sunit will discuss financial results for the quarter and an outlook. Jeff will discuss operational matters, including segment results. I will provide some context and a summary, and we’ll then open it up for questions. Sunit?

Sunit Patel

Thank you, Jim and good morning, everyone. I’ll start with a few quick comments on the quarter. These third quarter highlights are on slide three of our presentation.

Core Network Services revenue grew 1% sequentially and 2% year-over-year on a constant currency basis. Total Communications revenue also grew sequentially. That growth along with our richer revenue margin mix declines in cost of revenue and expense reductions drove gross margins and adjusted EBITDA margin improvement.

Consolidated adjusted EBITDA increased, compared to both the prior and year earlier quarter. I am pleased with the year-to-date adjusted EBITDA increases we have been able to realize.

The benefit of increases in CNS revenue together with our high operating leverage is evidenced by the approximately $18 million improvement in annualized Communications adjusted EBITDA from the first quarter of 2010 to the third quarter of 2010, excluding the $7 million asset sale in the first quarter of this year.

Third quarter Core Network Services sales held up consistent with second quarter sales when taking into consideration difficult summer seasonality. However, we did see a continued increase in mid-market sales. We also saw another improvement in churn sequentially and we saw an increase in customer installation.

Capital expenditures increased during the quarter, as we continued to invest for On-Net CNS revenue growth. The increase was primarily in support for more On-Net customer contracts, wavelength, CDN and broadcast network upgrades, together with increases in our network equipment inventory levels to improve installation intervals.

Turning to the detailed results for the third quarter on slide four, Core Network Services revenue was $707 million up 1% sequentially. We saw revenue growth in all of our four customer facing groups. Core Network Services revenue from wholesale was up slightly relative to the prior quarter, large enterprise and federal grew 1% and mid-market revenue increased 1%.

European Core Network Services revenue grew 3% sequentially on a constant currency basis and 6% on an as reported basis. From a product perspective compared to the prior quarter, we saw revenue growth in three or four product categories, transform infrastructure and data services.

Voice services revenue declined sequentially, primarily as a result of declines in Enterprise Voice services. This shift to a higher margin revenue mix contributed to gross margin increases on a dollar and percentage basis.

Notably our CDNs revenue were up 11% sequentially in the quarter. Also Voice services revenues was $161 million this quarter, compared to $163 million in the second quarter of 2010, and $159 million in the third quarter of last year. As we have said previously, we expect from continued volatility in Wholesale Voice services revenue as we manage for margin contributions versus revenue growth.

Turning to slide five, we saw a decline in cost of revenue and our gross margin improved to 60.6% this quarter compared to 59.9% in the second quarter of 2010 and 59% in the third quarter of 2009. The improvement in gross margin is a result of high margin On-Net CNS revenue growth, a decrease in lower margin Voice and private line services and continued network optimization.

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