Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
LVLT > SEC Filings for LVLT > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for LEVEL 3 COMMUNICATIONS INC

Form 10-Q for LEVEL 3 COMMUNICATIONS INC


8-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Level 3 Communications, Inc. and its subsidiaries ("Level 3" or the "Company") consolidated financial statements (including the notes thereto), included elsewhere herein and the Company's Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission.

This document contains forward looking statements and information that are based on the beliefs of management as well as assumptions made by and information currently available to the Company. When used in this document, the words "anticipate", "believe", "plan", "estimate" and "expect" and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this document. For a more detailed description of these risks and factors, please see the Company's Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission and Item 1A in Part II of this Form 10-Q.

Executive Summary

Overview

The Company is a facilities-based provider of a broad range of communications services. Revenue for communications services is generally recognized on a monthly basis as these services are provided. For contracts involving private line, wavelength and dark fiber services, Level 3 may receive upfront payments for services to be delivered for a period of generally up to 25 years. In these situations, Level 3 defers the revenue and amortizes it on a straight-line basis to earnings over the term of the contract.

Business Strategy and Objectives

The Company pursues the strategies discussed in Item 1. Business, "Business Overview and Strategy" as discussed in its Form 10-K for the year ended December 31, 2013. In particular, with respect to strategic financial objectives, the Company focuses its attention on the following:

growing revenue by increasing sales generated by our Core Network Services;

focusing on our enterprise customers, as this customer group has the largest potential for significant growth;


Table of Contents

continually improving the customer experience to increase customer retention and reduce customer churn;

launching new products and services to meet customer needs, in particular for enterprise customers;

reducing network costs and operating expenses;

achieving sustainable generation of positive cash flows from operations;

continuing to show improvement in Adjusted EBITDA (as defined in this Item below) as a percentage of revenue;

localizing certain decision making and interactions with our mid-market enterprise customers, including leveraging our existing network assets;

concentrating its capital expenditures on those technologies and assets that enable the Company to develop its Core Network Services; and

managing Wholesale Voice Services for margin contribution.

The Company's management continues to review all existing lines of business and service offerings to determine how those lines of business and service offerings enhance the Company's focus on the delivery of communications services and meeting its financial objectives. To the extent that certain lines of business or service offerings are not considered to be compatible with the delivery of the Company's services or with meeting its financial objectives, Level 3 may exit those lines of business or stop offering those services in part or in whole.

The Company has also been focused on improving its liquidity and financial condition, and extending the maturity dates of certain debt.

The Company will continue to look for opportunities to improve its financial position and focus its resources on growing profitable revenue and managing costs for the business.

Revenue by Channel:
                                        Three Months Ended June 30,        Six Months Ended June 30,
(dollars in millions)                       2014              2013            2014             2013
Core Network Services:
North America - Wholesale Channel     $           367     $      367     $         735     $      739
North America - Enterprise Channel                684            603             1,359          1,198
EMEA - Wholesale Channel                           86             88               173            177
EMEA - Enterprise Channel                         143            132               281            266
Latin America - Wholesale Channel                  42             40                82             80
Latin America - Enterprise Channel                157            149               306            291
Total Core Network Services                     1,479          1,379             2,936          2,751
Wholesale Voice Services and Other                146            186               298            391
Total Revenue                         $         1,625     $    1,565     $       3,234     $    3,142

Total revenue consists of:


Table of Contents

Core Network Services revenue from colocation and data center services; transport and fiber; IP and data services; and local and enterprise voice services.

Wholesale Voice Services and Other revenue from sales of long distance voice services.

Core Network Services revenue represents higher margin services and Wholesale Voice Services and Other revenue represents lower margin services. Core Network Services revenue requires different levels of investment and focus and provides different contributions to the Company's operating results than Wholesale Voice Services and Other revenue. Management believes that growth in revenue from its Core Network Services is critical to the long-term success of its business. The Company also believes it must continue to effectively manage gross margin contribution from the Wholesale Voice Services component. The Company believes that trends in its communications business are best gauged by analyzing revenue changes in Core Network Services.

Core Network Services

Colocation and data center services allow customers to place their network equipment and servers in suitable environments maintained by the Company with high-speed links providing on-net access to more than 60 countries. These services are secure, redundant and flexible to fit the varying needs of the Company's customers. Services, which vary by location, include hosting network equipment used to transport high speed data and voice over Level 3's global network; connectivity associated with Cloud services; providing managed IT services, installation, maintenance, storage and monitoring of enterprise services; and providing comprehensive IT outsource solutions.

Growth in transport (such as private line and wavelengths) and fiber revenue is largely dependent on increased demand for bandwidth services and available capital of companies requiring communications capacity for their own use or in providing capacity as a service provider to their customers. These expenditures may be in the form of monthly payments or, in the case of private line, wavelength or dark fiber services, either monthly payments or upfront payments. The Company is focused on providing end-to-end transport and fiber services to its customers to directly connect customer locations with a private network. Pricing for end-to-end metropolitan transport services have been relatively stable. For intercity transport and fiber services, the Company continues to experience pricing pressure in locations where a large number of carriers co-locate their facilities. An increase in demand may be offset by declines in unit pricing.

Internet Protocol ("IP") and data services primarily include the Company's Internet services, Virtual Private Network ("VPN"), Content Delivery Network ("CDN"), media delivery, Vyvx broadcast, Converged Business Network ("CBN"), and Managed Services. Level 3's IP and high speed IP service is high quality and is offered in a variety of capacities. The Company's VPN service permits businesses of any size to replace multiple networks with a single, cost-effective solution that greatly simplifies the converged transmission of voice, video and data. This convergence to a single platform can be obtained without sacrificing the quality of service or security levels of traditional ATM and frame relay offerings. VPN service also permits customers to prioritize network application traffic so that high priority applications, such as voice and video, are not compromised in performance by the flow of low priority applications such as email.

Voice services comprise a broad range of local and enterprise voice services using Voice over Internet Protocol ("VoIP") and traditional circuit-switch based technologies, including VoIP enhanced local service, SIP Trunking, local inbound service, Primary Rate Interface service, long distance service and toll-free service. The Company's voice services also include its comprehensive suite of audio, Web and video collaboration services.


Table of Contents

The Company believes that a source of future incremental demand for the Company's Core Network Services will be from customers that are seeking to distribute their feature rich content or video over the Internet. Revenue growth in this area is dependent on the continued increase in demand from customers and the pricing environment. An increase in the reliability and security of information transmitted over the Internet and declines in the cost to transmit data have resulted in increased utilization of e-commerce or Web-based services by businesses. Although the pricing for data services is currently relatively stable, the IP market is generally characterized by price compression and high unit growth rates depending upon the type of service.

The following provides a discussion of the Company's Core Network Services revenue in terms of the enterprise and wholesale channels.

The enterprise channel includes large, multi-national enterprises requiring large amounts of bandwidth to support their business operations, such as financial services companies, healthcare companies, content providers, retail companies and portal and search engine companies. It also includes medium sized enterprises, as well as government markets, including the U.S. federal government, the systems integrators supporting the U.S. federal government, U.S. state and local governments, academic consortia, and certain academic institutions.

The wholesale channel includes revenue from incumbent and alternative carriers in each of the regions, global carriers, wireless carriers, cable companies, satellite companies, regional service providers and voice service providers.

The Company believes that the alignment of Core Network Services around channels should allow it to drive growth while enabling it to better focus on the needs of its customers. Each of these channels is supported by dedicated employees in sales. Each of these channels is also supported by non-dedicated, centralized service delivery and management, product management and development, corporate marketing, global network services, engineering, information technology, and corporate functions, including legal, finance, strategy and human resources.

Wholesale Voice Services and Other

The Company offers wholesale voice services that target large and existing markets. The revenue potential for wholesale voice services is large; however, pricing is expected to continue to decline over time as a result of the new low-cost IP and optical-based technologies. In addition, the overall market for wholesale voice services is declining and is also being targeted by many competitors, several of which are larger and have more financial resources than the Company.

The Company also has other revenue derived from mature services that are not critical areas of emphasis for the Company. The Company expects ongoing declines in Wholesale Voice Services and Other similar to what has been experienced over the past several years.

The Company receives compensation from other carriers when it terminates traffic originating on those carriers' networks. This intercarrier compensation is based on interconnection agreements with the respective carriers or rates mandated by the Federal Communications Commission ("FCC"). The Company has interconnection agreements in place for the majority of traffic subject to intercarrier compensation. Along with addressing other matters, on November 18, 2011, the FCC established a prospective intercarrier compensation framework for terminating switched access and VoIP traffic, with elements of it becoming effective beginning on December 29, 2011. Under the framework, most terminating switched access charges and all intercarrier compensation charges are capped at current levels, and will be reduced to zero over, as relevant to Level 3, a six year transition period which began July 1, 2012. Several states, industry groups, and other telecommunications carriers filed petitions in federal court for reconsideration of the framework with the FCC, although the outcome of those petitions is unpredictable. A majority of the Company's existing intercarrier compensation revenue is associated


Table of Contents

with agreements that have expired terms, but remain effective in evergreen status. As these and other interconnection agreements expire, the Company will continue to evaluate simply allowing them to continue in evergreen status (so long as the counterparty allows the same) or negotiating new agreements. The Company earned intercarrier compensation revenue from providing managed modem services, which it has discontinued. The Company also receives intercarrier compensation from its voice services. In this case, intercarrier compensation is reported within Core Network Services revenue.

For a detailed description of the Company's broad range of communications services, please see Item 1. "Business - Our Service Offerings" of the Company's Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission.

Seasonality and Fluctuations

The Company continues to expect business fluctuations to affect sequential quarterly trends in revenue, margins and cash flow. This includes the timing, as well as any seasonality of sales and service installations, usage, rate changes and repricing for contract renewals. Historically, the Company's revenue and expense in the first quarter has been affected by the slowing of our customers' purchasing activities during the holidays and the resetting of payroll taxes in the new year. The Company's historical experience with quarterly fluctuations may not necessarily be indicative of future results.

Because revenue subject to billing disputes where collection is uncertain is not recognized until the dispute is resolved, the timing of dispute resolutions and settlements may positively or negatively affect the Company's revenue in a particular quarter. The timing of disconnections may also affect our results in a particular quarter, with disconnections early in the quarter generally having a greater effect. The timing of capital and other expenditures may affect our margins or cash flow. The convergence of any of these or other factors such as fluctuations in usage, increases or decreases in certain taxes and fees or pricing declines upon contract renewals in a particular quarter may result in the Company's revenue growing more or less than previous trends, may affect the Company's margins and other financial results and may not be indicative of future financial performance.

Critical Accounting Policies

Refer to Item 7 of the Company's Form 10-K for the year ended December 31, 2013, for a description of the Company's critical accounting policies.

Property, Plant and Equipment

The Company performs internal reviews to evaluate the depreciable lives of its property, plant and equipment annually or more frequently if new facts and circumstances arise that may affect management's original estimates. Due to the rapid changes in technology and the competitive environment, selecting the estimated economic life of telecommunications property, plant and equipment requires a significant amount of judgment. The Company's internal reviews take into account input from the Company's global engineering and network services personnel, actual usage, the physical condition of the Company's property, plant and equipment, industry data and other relevant factors.

In connection with its periodic review of the estimated useful lives of property, plant and equipment, the Company completed its evaluation in the first quarter of 2014 and determined that the period it expects to use certain assets is longer than the remaining originally estimated useful lives. The Company revised its estimated useful lives for: IP equipment from its historical estimate of four years to a revised estimate of seven years; racks and cabinets from its historical estimate of seven years to a revised estimate of 15 years; and facility equipment from its historical estimate of 10 years to its revised estimate of 15 years. In determining the change in estimated useful lives, the Company, with input from its engineering team, considered its historical usage patterns and retirements, estimates of technological obsolescence, and expected usage and maintenance. The change in the estimated useful lives of certain


Table of Contents

of the Company's property, plant and equipment was accounted for as a change in accounting estimate on a prospective basis effective January 1, 2014 under the accounting standard related to changes in accounting estimates.

The carrying values of assets subject to these revisions were (in millions):

                    January 1, 2014
IP Equipment       $             222
Racks and Cabinets               114
Facility Equipment               151
                   $             487

The change in estimated useful lives of certain of the Company's property, plant and equipment resulted in less depreciation expense than would have otherwise been recorded and in the following increase in net income for the six months ended June 30, 2014 (in millions, except per share amounts):

Net Income                   $   51
Basic Net Income per Share   $ 0.22
Diluted Net Income per Share $ 0.21


Table of Contents

Results of Operations for the Three and Six Months Ended June 30, 2014 vs. 2013

                                             Three Months Ended June 30,                 Six Months Ended June 30,
(dollars in millions)                     2014            2013       Change %         2014          2013       Change %
Revenue                               $    1,625       $  1,565          4  %     $   3,234       $ 3,142          3  %
Cost of Revenue                              613            616          -  %         1,227         1,245         (1 )%
Depreciation and Amortization                187            199         (6 )%           371           393         (6 )%
Selling, General and Administrative          569            610         (7 )%         1,116         1,209         (8 )%
Total Costs and Expenses                   1,369          1,425         (4 )%         2,714         2,847         (5 )%
Operating Income                             256            140         83  %           520           295         76  %
Other Income (Expense):
Interest expense                            (149 )         (167 )      (11 )%          (300 )        (336 )      (11 )%
Other, net                                   (44 )           14         NM              (38 )         (36 )        6  %
Total Other Expense                         (193 )         (153 )       26  %          (338 )        (372 )       (9 )%
Income (Loss) Before Income Taxes             63            (13 )       NM              182           (77 )       NM
Income Tax Expense                           (12 )          (11 )        9  %           (19 )         (25 )      (24 )%
Net Income (Loss)                     $       51       $    (24 )       NM        $     163       $  (102 )       NM


___________________
NM - Not meaningful

Discussion of all significant variances:

Revenue by Service and Product Offering:
                                            Three Months Ended June 30,                 Six Months Ended June 30,
(dollars in millions)                      2014          2013       Change %          2014            2013       Change %
Core Network Services Revenue:
Colocation and Datacenter Services     $       146     $   145         1  %     $      291          $   287         1  %
Transport and Fiber                            508         480         6  %          1,010              956         6  %
IP and Data Services                           588         522        13  %          1,161            1,040        12  %
Voice Services (Local and
Enterprise)                                    237         232         2  %            474              468         1  %
Total Core Network Service Revenue           1,479       1,379         7  %          2,936            2,751         7  %
Wholesale Voice Services and Other
Revenue                                        146         186       (22 )%            298              391       (24 )%
Total Revenue                          $     1,625     $ 1,565         4  %     $    3,234          $ 3,142         3  %

Revenue increased 4% to $1.625 billion in the three months ended June 30, 2014 compared to $1.565 billion in the same period of 2013 and increased 3% to $3.234 billion in the six months ended June 30, 2014, from $3.142 billion in the same period of 2013. The increase was driven by growth in Core Network Services revenue from enterprise customers partially offset by declines in Wholesale Voice Services and Other revenue.

The Company experienced continued growth in its IP and data services and transport and fiber services during the three and six months ended June 30, 2014 compared to the same period of 2013 driven primarily by end user customer demand for content delivery over the Internet, VPN and bandwidth in the enterprise channel as well as increases in professional services fees. The Company also experienced modest growth in colocation and datacenter services and voice services during the three and six months ended June 30, 2014.


Table of Contents

Core Network Services revenue increased in the North America, EMEA and Latin America regions during the three and six months ended June 30, 2014 compared to the same period of 2013, as a result of growth in services provided to the existing enterprise customer base and the acquisition of new customers in the enterprise channel. These increases were partially offset by decreases in wholesale channel revenue in North America and EMEA.

Wholesale Voice Services and Other revenue decreased in the three and six months ended June 30, 2014 compared to the same period of 2013 primarily as a result of declines in usage as customers transition to IP voice services. The Company continues to manage its combined wholesale voice services platform for margin contribution.

Wholesale Voice Services revenue decreased in North America and EMEA in the three and six months ended June 30, 2014 compared to the same period of 2013, due to competitive pressures and the Company's focus on maintaining or growing its margin percentage. Wholesale Voice Services and Other revenue increased in Latin America in the three months ended June 30, 2014 and remained flat in the six months ended June 30, 2014 compared to the same periods of 2013. The increase in the three months ended June 30, 2014 was due to expansion of services provided to existing customers.

Cost of Revenue includes leased capacity, right-of-way costs, access charges and other third-party costs directly attributable to the network, but excludes depreciation and amortization and related impairment expenses.

Cost of revenue as a percentage of total revenue was 38% in the three months ended June 30, 2014 compared to 39% in the same period of 2013 and was 38% in the six months ended June 30, 2014 compared to 40% in the same period of 2013. The decrease is primarily due to an improving gross margin mix of higher margin on-net Core Network Services and a decrease in lower margin Wholesale Voice Services and Other Revenue. Additionally, the Company continues to implement initiatives to reduce both fixed and variable network expenses.

Depreciation and Amortization decreased 6% to $187 million in the three months ended June 30, 2014 from $199 million in the same period of 2013 and decreased 6% to $371 million in six months ended June 30, 2014 from $393 million in the same period of 2013. The decrease is primarily attributable to a change in the estimated useful lives of certain of the Company's property, plant and equipment that resulted in a reduction of depreciation expense of $46 million in the first half year of 2014 compared to the same period of 2013. The change in accounting estimate was applied on a prospective basis effective January 1, 2014, as required under the accounting standard related to changes in accounting estimates.

Selling, General and Administrative ("SG&A") includes salaries, wages and related benefits (including non-cash, stock-based compensation expenses), property taxes, travel, insurance, rent, contract maintenance, advertising, accretion expense on asset retirement obligations and other administrative expenses. SG&A expenses also include certain network related expenses such as network facility rent, utilities and maintenance costs.

SG&A decreased 7% to $569 million in the three months ended June 30, 2014 compared to $610 million in the same period of 2013 and decreased 8% to $1.116 billion in the six months ended June 30, 2014 compared to $1.209 billion in the same period of 2013. The decrease is primarily due to lower employee cash compensation and other employee related costs, professional fees and vendor services and other discretionary costs. Professional fees and vendor services and other discretionary costs decreased primarily due to the rationalization and renegotiation of vendor services and lower travel and entertainment costs. SG&A in the three months ended June 30, 2014 includes $4 million of transaction fees related to the pending acquisition of tw telecom.


Table of Contents

Also included in SG&A in the three and six months ended June 30, 2014, are $16 . . .

  Add LVLT to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for LVLT - All Recent SEC Filings
Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.