Level 3’s Q1 Clears the Decks for Storey

Level 3 Communications (NYSE:LVLT, news, filings) closed the books on the Crowe era with their first quarter 2013 numbers.  I wasn’t expecting much, and I got what I expected – although with differences in the details of course.  Revenues were rather weak, but costs and those apparent synergies were back on track keeping EBITDA in the expected range.  Here’s a tabular look with some context:

$ in millions	Q3/12	Q4/12	Q1/13	Comments
– North America – Wholesale	386	392	372	N.A. wholesale much weaker than expected, but enterprise was strong
– North America – Enterprise	577	587	585
– EMEA – Wholesale	87	87	89	UK government pulling back as expected
– EMEA – Enterprise	94	99	97
– EMEA – UK Government	42	42	37
– Latin America – Wholesale	40	41	40	Venezuela devaluation offsetting steady growth
– Latin America – Enterprise	139	143	142
Total Core Network Services	1,365	1,391	1,372	Down 1.4% sequentially.
– Wholesale Voice & Other	225	223	205	Sharp decline in the low margin stuff.
Total Comm. Services	1,590	1,614	1,577	Below expectations.
Comm. COGS	642	655	629	Costs were a much happier story this quarter, both for COGS and SG&A.
Comm. Cash SG&A	576	599	562
Other Costs	–	-47	–
Comm. Adjusted EBITDA	372	407	386	Generally flat with the baseline from Q4 after adjusting for one time events as best I could manage.
Adjusted earnings per share	(0.26)	(0.16)	(0.36)	Including 0.10 Venezuela, 0.11 other currency effects, 0.02 legal fees
Adj. Gross margin %	59.6%	59.4%	60.1%	Breaking the 60% barrier
Adj. EBITDA margin %	23.4%	25.2%	24.5%
Capital Expenditures	227	198	169	Less than expected, but this number moves around
Free Cash Flow	(157)	202	(162)	A bit worse than I thought, but I knew it would be more than 100M.  They maintained guidance for full year postive FCF.

Revenue: A very weak North American wholesale transport number was only partially offset by a strong enterprise growth performance, while Europe and Latin America took hits from currency fluctuations.  The company says that first quarter churn of 1.6% should return to usual levels for the balance of the year, and that growth should be better in the next three quarters than in the same period last year.  That’s good, but one might have hoped to start that ramp from a higher base!

Costs & EBITDA: Costs were the bright spot this quarter, as gross and EBITDA margins regained some ground.  That means EBITDA didn’t get hammered despite the revenue miss, not that $386M is anything to write home about of course.

Earnings and Free Cash Flow: Earnings per share were strongly affected by currency issues, and came in below analyst expectations – although this has yet to emerge as a dominant metric for Level 3.  Free cash flow was slightly more red than I had expected even with capex not particularly high, but the company maintained its guidance of positive FCF for the full year.

Thoughts: A regular commenter on my earnings preview suggested this would be something of a ‘clear the decks’ release for the company, putting in place a foundation for newly minted CEO Jeff Storey to build upon.  That certainly seems to have been the case, although they didn’t yet settle the currency hedge.  The stock has lagged in advance of this report, anticipating just this sort of thing – not that traders won’t take them down a peg anyway at least initially.

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