Earnings Preview: All Work and No Play For Level 3 in Q1

April 30th, 2012 by · 37 Comments

Level 3 Communications (NYSE:LVLT, news, filings) is at a critical phase in its integration of the Global Crossing business, but one for which it won’t get much credit yet when it comes to reporting earnings this week.  It’s sort of like being 1/4 of the way done cleaning out the garage – the mess can actually appear worse to an observer even if things are going exceptionally well.  With unfavorable seasonal factors in both cash usage and revenue growth, higher integration spending prior to the synergies to be derived from it, and impatience from a market whose short term horizon is as short as ever, this is a “can’t please anyone” quarter if there ever was one.  Here are my guesses and some more specific thoughts: 

Q4/11
Q1/12

(estimate)

Comments
 - North America – Wholesale 388 390 Steady but seasonally slow growth
 - North America - Enterprise 588 591
 - EMEA – Wholesale 94 95 Pressure in UK gov revenues offsetting other gains.
 - EMEA – Enterprise 80 81
 - EMEA – UK Government 50 48
 - Latin America – Wholesale 35 36  Steady growth
 - Latin America – Enterprise 133 135
Total Core Network Services 1,368 1,376  Anything above 1368 maintains the momentum.
 - Wholesale Voice & Other 211 209
Total Comm. Services 1,579 1,585 Rounding up to Yahoo Finance’s composite number
Comm. COGS 660 657 Not including integration costs
Comm. Cash SG&A 587 580
Integration Costs 23 30 Integration spending up from $23M
Transaction Costs 39 0
Comm. Adjusted EBITDA 270 318 Includes integration & transaction costs
Adjusted earnings per share -0.62  -0.52 Excluding one-time costs
Adj. Gross margin % 58.2% 58.5%
Adj. EBITDA margin % 17.1% 20.1%
Capital Expenditures 148 175 Accelerating integration capex spending
Free Cash Flow 103 (100)-(200) Seasonality, payables cleanup, integration => red

Revenue growth: This works out to sequential CNS growth of 0.6%, but anything above zero and less than 1% will be within my expectations and indicate they’re probably still on track.  The company has been fighting hard to maintain its organic growth momentum, but given continued European pressures, the seasonality of Vyvx, and perhaps some of the minimal but non-zero single-homed churn this quarter will be their stiffest competition of the year.  I’ve taken a swing at predicting segment results under the new segment reporting structure.

SG&A & COGS:  The way my model works out for the lower edge of guidance, mid-single digit organic growth and steady integration progress will basically cancel each other out for several quarters, leaving total SG&A and COGS relatively flat for several quarters from this point.  Since Q1′s sequential organic growth should be muted, SG&A and COGS will decline in Q1.

Integration progress: They will probably have spent $30M in integration costs, realizing about $40M in synergies during the quarter.  Both numbers could be higher, but probably not much lower.  There seems little risk of hitting a speed bump this early in the process, but many synergies they have acted on won’t have fully shown up yet.  Perhaps they will have connected the transport backbones and will begin to apply their metro reach to GLBC’s revenue in the US during Q2.

EBITDA & EPS:  My EBITDA number here is probably fairly conservative, but I’d rather not let my optimism get out of hand too early – I hope they beat it soundly.  Whatever the number is, to make guidance they’ll have to step their way to more than $400M in Q4. Earnings per share excluding one-time events should improve steadily every quarter from this point onward, passing the break-even mark early in 2013.

Free Cash flow:  This will be the painful number, perhaps even more than is usual for Q1.  Capex will be up, integration spending will be up, and working capital usage will be seasonally high.  It’s all necessary and expected, but will probably be what the headlines focus in on after they quote the revenue number.

Further thoughts: A successful integration will see Level 3′s numbers dramatically transformed over the next four quarters, but it will be hard for those not already intimately familiar with Level 3 to see that potential in whatever they report this week.  The stock has given back much of its March surge to $27, so I don’t think the market is expecting fireworks either.

More on this topic (What's this?) Read more on Level 3 Communications at Wikinvest
Categories: Fiber Networks · Financials · Internet Backbones

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37 Comments So Far


  • Pappardelle says:

    Isn’t break even or small growth numbers for the first 3 qtrs. after a purchase actually a good sign for a company in this sector? Considering the competitiveness and the high costs of integration, would such postings bode very well for the 1 year and plus prospects?

    • Avatar of Rob Powell Rob Powell says:

      Yes, I’d agree with that, and it’s essentially what they have said would happen. I just don’t think it’s going to get them a lot of love until the second half.

  • Anonymous says:

    Based on the recent stock activity, dropping daily, it appears the word is out and Level 3 earnings will be a disaster report on the surface. It will take a very optimistic and intelligent view of the future to hold this stock up in short term. Another 200 + million loss for the quarter and minimal revemue growth it will be an easy target and expect the usual drop on earnings day. So nothing changes at Level 3 the miracle 14 year old company that is still alive despite losses of $150-200 a million a quarter for those 14 years and yet can raise money as required, refinance debt at will and sell a bright future story.

    The future power of the worlds most significant and largest fiber optic network thankfully is not lost on investment community.

  • CarlK says:

    If there is one area that I am in agreement with Anonymous, God forbid, it’s the fact that “The Market,” Mr. Manipulator is ALWAYS EFFICIENT in pricing the Level 3 security.

    EMT is perfectly alive here………Remember Charlie Munger when he talks about his fellow board member and long time friend, Mr. Walter Scott’s company:

    “Too hard to figure.” That’s a HA for Todd…..

    One day though–pick your year–Anonymous is going to finally find some REAL RELIGION, and drop those harlots like a cheap hooker, those who represent “The Status Quo” holding back the communications industry!

    Rob, have you formulated a Cogent preview list?

  • B says:

    What? Another kick the can down the road quarter? I’m shocked, just shocked I tell you. This never happens with this company…LOL

    • Fancy Pants says:

      I find your lack of faith (in a magical turnaround based on need for BW thats just around the corner) disturbing.

  • Anonymous says:

    Give your best guess:

    Will the stock be up or down on earnings day?

  • Anonymous says:

    Up

  • Anon says:

    Did you say free cash flow ?

  • skcusljj says:

    Rob, that revenue forecast is pitiful and, as much as I lack faith in Level 3, they should, nay better, blow through those numbers.

    Why exactly is Q1 a seasonally slow period? This is telecom, not Best Buy. Telecom contracts are executed throughout the year and expire on 1,2, 3, x year anniversaries not in the first quarter of a year.

    Furthermore, I’m not aware of any data that shows companies/people send less data for bursty ethernet applications or madk fewer phone calls for voice applications during the first quarter of a year.

    If Q1 sales are weak, that’s a function of stuffing revenue in Q4 to make the previous year’s full year guidance and meet bonus targets.

    If you’re attributing revenue weakness to writedowns, revenue writedowns, to the extent they are required to retain business, occur throughout the year, not just in the first quarter.

  • skcusljj says:

    I’ll also add to my revenue comment that you have no synergy savings in your forecast as far as I can tell.

    As B suggests above, this forecast is pure kick-the-can-down the road. The Global Crossing deal was announced last April!! Synergy-savings planning commenced immediately. The deal closed Oct 1, 2011. Synergy saving activity commenced immediately. While you can forgive no synergy savings in 2011Q4, it would be entirely unacceptable if there were no material synergy savings in 2012Q1.

    I think the earnings will be a disaster but not as disastrous as your forecast above. AND IF YOU’RE RIGHT, THIS PUPPY’S GOING TO DROP TO 17.

  • schmuckinsurance says:

    Strange comment on this board given Rob’s numbers aren’t that different than consensus and if you don’t understand telco seasonality you may be better off asking your boy Jim Cramer to explain it than wasting anyone’s time with it.

  • skcusljj says:

    schmuckinsurance, appreciate the condescension but please explain to me why there’s seasonality in telecom.

    At a high level, let’s go through the LVLT product set, in no particular order:

    Wholesale Voice
    Hosted Voice
    Enterprise Voice
    Conferencing
    Private line
    Ethernet services
    IP VPN
    IP Transit
    Data Center Hosting
    International Private Line (IPL)
    Wave Services
    CDN
    Federal Markets (NA and UK)

    I’m sure I’ve left out many services, but I believe I’ve probably captured at least 75% of the LVLT revenue stream with the above services. Can you explain to a telecom novice why and, more importantly, how seasonality plays a role?

    Is this a revenue write down hypothesis?

    Is this a usage hypothesis?

    Is this a customers don’t like to sign new contracts in Q1 hypothesis (which is odd b/c capital spending is usually strongest in first 2 quarters)?

    Why Q1 vs. Q2, Q3, Q4 for seasonality?

    I’m not asking you to explain the difference between fission and fusion, just telecom seasonality.

  • schmuckinsurance says:

    Honestly, I don’t want Rob to waste the time and that doesn’t mean I am signing up for it either. If you are serious, do an industry regression on sales by quarter. or just do it for a few companies. Otherwise, just call the sellside and ask.

    It is timely but Morgan Stanley just published their TWTC quarterly wrap a few minutes ago which was titled, “Quick Comment: Slight Seasonal Pressures Though Margins and Capex Improve.” I mention another company and another analyst just in case you don’t run the numbers for yourself.

  • skcusljj says:

    schmuck…I recommend you go back and study your econometrics carefully, especially, heteroscedasticity

    The SEC filings by TWTC and LVLT certainly don’t confirm your “obvious” theory of seasonality….From the TWTC 2011Q1 10Q…it neither confirms nor rejects your view and LVLT doesn’t even make a mention in their 2011Q1 of the word season or seasonality.

    …from the TWTC 2011Q1 10q :

    Quarterly and Other Financial Trends

    “Although our business is not inherently seasonal in nature, historically our revenue and expense in the first quarter of the year has been impacted by some seasonal factors that may cause fluctuations from the prior quarter. First quarter installations and the associated revenue have sometimes been impacted by the slowing of our customers’ purchasing activities at the end of the fourth quarter. In the first quarter of 2011, we did not experience the seasonal slowing of revenue that we have historically experienced. As we move to a higher rate of revenue growth, our historical experience with quarterly fluctuations may not necessarily be indicative of future results. Our expenses also are impacted in the first quarter by the resetting of payroll taxes and other employee-related cost increases.”

    http://sec.gov/Archives/edgar/data/1057758/000119312511134173/d10q.htm

    NOW IF YOU READ BETWEEN THE LINES…MY HYPOTHESIS THAT MEETING PREVIOUS YEAR’S EXTERNAL GUIDANCE AND BONUS TARGETS EXPLAINS AS WELL, IF NOT BETTER BASED ON THEIR 10Q COMMENTS, WHY THERE’S SO MUCH ACTIVITY IN Q4 WHICH IMPACTS Q1.

    Contrary to your desired belief Telecom is not RATIONALLY seasonal.

    In the Level 3 2011Q1 10Q the word seasonal or seasonality does not make an appearance.

    http://sec.gov/Archives/edgar/data/794323/000110465911026849/a11-9326_110q.htm

    needless to say you would have flunked the econometrics class. In mine the final was simple, Man with Peanut Butter and an Umbrella walking down street…bubble over his head saying “Whenever I eat peanut butter it rains”. Does our umbrella’d friend eating peanut butter cause it to rain?

    My question to you was simple…why is telecom seasonal? Instead of an answer you decided to attack the question. You send me down a statistical black hole. I seriously suggest that you go back and restudy the statistical concept of heteroscedasticity before you attack others who very well may be more versed in the subject than yourself.

  • skcusljj says:

    My question was innocent enough. I laid out the services LVLT provided and asked what was seasonal about them. I mentioned the rolling expiry of contracts throughout the year and said that couldn’t explain it. I commented that revenue write downs occur throughout the year so Q1 should not be more unique than any other quarter when it comes to write downs. So, why, where and how is there seasonality in Q1 for telecom companies? Could any seasonality in Q1 be tied to 4th quarter revenue stuffing which harms Q1 performance? In other words, could pushing normal Q1 funnel activity into Q4 impact Q1 performance?

    In the same space Schmuck wasted telling me he’s not going to school me, he could have explained where and why he thinks there’s seasonality. Obviously, he doesn’t know because it appears the telecom companies don’t even believe it exists either.

    I am genuinely curious why people believe there is seasonality in this industry. It’s clearly not as obvious as some here would like to make it out to be. If it were, the accountants would make sure to reflect it in their financial reports.

    When TWTC expressly states “our business is not inherently seasonal in nature” and LVLT make no mention whatsoever about seasonality in theirs, it’s obvious that clean simple explanations for seasonal outcomes deserve more scrutiny.

    • thewanderer says:

      1) LVLT is not just pure telecom but content as well, and the CDN and broadcast revenues do have a seasonal component. It’s not a huge effect, but it is enough to notice sequentially for LVLT.
      2) The larger seasonal component alluded to here tends to be in working capital and hence cash flow, and it is very easy to document both for LVLT and for GLBC historically.

  • skcusljj says:

    thewanderer, I completely agree with you on working capital. Global Crossing notoriously withheld vendor payments and incentivized customers to pay early so the company could meet cash flow targets.

    But my question was on revenue, not cash flow. Looking at cash flow on a quarterly basis is silly. Can you explain why and how CDN business is seasonal? I just don’t see it, but I could be missing something. Also, can you quantify that impact? (For example, how much CDN revenue does LVLT generate in a quarter and what percent would be impacted in Q1?) Also, why do you suppose LVLT didn’t make mention of this seasonality issue in their 2011Q1 10Q?

  • CarlK says:

    skcusljj, I can’t say whether your man carrying the umbrella while eating peanut butter in order to prove his point, causes it to rain or not, because it’s very possible that he brings out his peanut butter every time it rains.

    With this in mind, I have often thought about the lunacy behind this “seasonality” question you bring up knowing that we are dealing with “non discretionary,” mandatory telecom services monthly into perpetuity.

    You know that, “we don’t sell cotton candy,” right? So, kudos to you there.

    At the same time, I am keenly aware that if there are powerful men in cat bird seats “behind the pricing curtain” who want it to rain hard because they have been eating peanut butter aggressively, while drying the roofs of their mouths like the Sahara Desert in anticipation of the drought ending, then by hook or crook or the stomping of their feet, they will cause “price” to pummel.

    I here bastards calling for seventeen. We shall see if these PEANUT BUTTER EATING FOOLS with DRY ROTTEN MOUTHS, will have their way this time or not!

  • CarlK says:

    skcusljj, one other thing while you razzle dazzle the board with your superior intelligence on statistics.

    Since you’re not asking certain members to explain the difference between fission and fusion, can you do a better job translating what this Guru is explaining to his class surrounding heteroscedasticity?

    Is it a sexually transmitted disease or something worse? I wouldn’t know listening to this speaker, who might be a genius in his own right, except for the fact that I pity the English speaking students who must suffer through attempting to understand what the hell his accent is camouflaging while he teaches!

    http://www.youtube.com/watch?v=5jTOFItdVJg

    Lastly, why don’t you go and answer THE RIDDLE I proposed to another SKEPTIC like yourself, Mr. WRIGHT, over on the IV board!

  • skcusljj says:

    Undoubtedly, I’m going to regret providing this very crude explanation.

    There are a number of conditions where heteroscedasticity arises. One of those instances is when an explanatory variable is correlated with a disturbance term. When this occurs ordinary least squares is an ineffective estimation technique and, statistically speaking, t-test and F-tests will not be valid. Utilization of a Chow test can detect the presence of heteroscedasticity.

    Although I would bet almost anything there are no regression studies on Q1 underperformance vis a vis Q4 in the Telecom industry, I would bet, if one actually existed, all meaningful variables have not been included. I would also bet that if such a study existed you’d find that the disturbance term would be correlated with one of the independent variables. The solution would be to find another variable related to the heteroscedasity.

    In the case of our peanut butter loving man, obviously eating peanut butter doesn’t cause it to rain. But he may find himself, for example, eating peanut butter when it’s gloomy outside. If we were to regress a new independent variable, e.g., cloudiness, against rain or include it as a separate independent variable in our regression equation we will find a better explanation for the rain than our friend eating peanut butter.

    Schmuck explained nothing because he can’t explain it. If there was some meaningful statistical evidence for Q1 seasonality among telecommunications companies, it would be included in their financial reporting. Given TWTC’s very explicit qualifier that “Although our business is not inherently seasonal in nature…”, I think it’s safe to say there is no study supporting Schmuck’s comment.

  • CarlK says:

    You seem to be a TWTC fan for comparative purposes. How will you explain the fact that Level 3′s eight percent compounding annual top line growth rate, with just twice the sales force and a fraction of the “building connections” is trumping Twtc’s top line by 4.5 times inclusive of superior margins for any metric you choose to use?

    Should we call that Indian Guru in my VIDEO for an answer?

  • CarlK says:

    The other thing you’ll need to splain for Lucy and Ricky is why Mr. Manipulator gives twtc a 2.31 P/S over Level 3 which is less than ONE?

    Does Mr. Market favor slow burn, slow growth females connecting to MONOPOLIES and driving their revenue streams over alpha males who will not adhere to “The Status Quo”?

  • CarlK says:

    skcusljj, tell me which MONOPOLIST is your DADDY, then I will know why it rains when you eat PEANUT BUTTER!

  • CarlK says:

    Goldman Sucks and their friend, Enron, are still hopeful that Level 3′s fiber sold to Comcast in 2004 with expiry on it, will STOP losing SUBS! Stock price hardly misses a beat, of course.

    http://www.businessweek.com/news/2012-05-02/comcast-falls-after-reporting-video-subscriber-decline

    Investors were “hopeful for positive net video additions,” said Jason Armstrong, an analyst at Goldman Sachs Group Inc. who recommends buying the shares. “That’s what people are focused on even though Comcast has a very good story with broadband.”

  • CarlK says:

    I wish I had a t.v. program of my own, I would educate every American to cut their cable, telecom and other dumb em down BUNDLE in the JUNGLE cords forthwith, and begin empowering themselves according to their own “interests” via a NAKED INTERNET CONNECTION relative to the “limited time” they all have on their earthly journeys for being the best they can be!

    The main show and network I would create a BAN on inside the business stratosphere, of course, would be Goldman’s FRONT MAN and dubious PITCH artist, that FRICKEN CLOWN and CARNIVAL BARKER, who is a criminal, CRAMER, along with cnBS, a newly added COMCAST useless property intended to harm citizens at large in their WALLETS! imo

  • CarlK says:

    So, Will Uncle Warren lead America to a NEW BULL MARKET revived as result of his interests in TECHLAND leading the way this weekend????

    You better hope for it, America, or those SCOUNDRELS like Soros and the rest of his ilk from The Bank of Rothschild above his head will leave you in a heap of shit so high that we will never be able to dig ourselves out of it again!

    TECH will LEAD this BULL RALLY, again! Inflation will raise all life boats during the process! That other Buffett wannabee in Canada, is too damn bearish, but how did he get his grubby paws on so much of MY (3)! LOL, IMO

  • Fionn says:

    Consider how long a company can pay a blended 8% for debt capital and generate a return on invested capital of less than 1%. There is no scarcity to the LVLT offering; they are a construction company masquerading as a high tech business. You might wonder about their CDN business? Well they picked up a piece of NFLX and HBOgo, repriced the entire industry, and that revenue disappeared into revenue like it was nothing. And Management, what can you say there … you can say that they have enriched themselves and destroyed billions of dollars.

  • Anon says:

    Wow, Fionn brings it. Notes that no one here makes money but Mgmt (magical CFO deserves it, tho…). But beware, you’ve entered the L3 fan club… Did you say something about ROIC? Wouldnt it be easier to count eyeballs and buildings, not dollars or returns..

  • Fionn says:

    How can there be a LVLT fan club? Given all of the money lost here over the past 12 years. LVLT and GLBC make up about 3.5% of the long haul market (just speaking long haul here, not CDN, not datacenter). VZ and T make up the overwhelming majority and have for years; would you not say that if there was a line to draw in the sand on pricing, it would have been drawn. Where is LVLT to make money such that they be deemed a worthwhile spot for your savings. You can sell today in the 20′s, do your kids a favor.

  • Anonymous says:

    rumor is with no surprise Level 3 wil be reducing work force in advance of end of 2nd quarter. No surprise as they slowly performed Global Integration and rather then usual aggressive approach day one on synergies and headcount waited. Now with some vision and organization structure refinement are in better position to address the OPEX reductions they targetted.

  • Anon5KG says:

    Maybe because they keep hiring the dead weight tgat other carriers got rid of. Not to mention, their sales teams are almost non-existent and their support sucks. Heard it’s a nightmare over there.

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