Level 3 loss widens; sees debt reduction in wake of Allegiance termination

By Paul Deckelman

New York, April 29 - Level 3 Communications Inc. reported a wider first-quarter loss this year than a year ago, reaffirmed previously offered guidance, and said that while the outlook for the telecommunications industry remains "uncertain," it is better positioned than its corporate rivals to ride out any hard times and capitalize on changes in the industry.

The Broomfield, Colo.-based fiber optic network operator also touted what it termed a "healthy" liquidity position and said that it expected a net debt reduction in the coming quarter of $245 million, largely in connection with the recent termination of its vendor agreement with Allegiance Telecom Inc., which will eliminate some $213 million of capital lease obligations.

But Level 3 - which aggressively cut its debt burden in 2002 and 2003 via a series of debt-for-equity exchange transactions on top of having taken out $1.7 billion face amount of debt for a fraction of that amount via a massive dutch auction tender offer in 2001 - did not indicate that it has any plans at this time for further such transactions. As of Dec. 31, total long-term debt was about $5.2 billion, with another roughly $1 billion in capital lease obligations and other kinds of lease obligations.

Level 3 reported that for the first quarter ended March 31 it had a consolidated net loss of $147 million (22 cents per share) versus a $121 million loss (18 cents per share) in the preceding quarter, which ended on Dec. 31, 2003. It reported consolidated OIBDA (operating income before depreciation and amortization) of $128 million in the latest quarter, little changed from $129 million in the preceding quarter, but better than the $110 to $120 million that the company had been expected for the quarter.

Level 3 Chief Executive Officer James Q. Crowe, on a mid-morning conference call with investors and analysts following the release of the quarterly results, warned that "the industry outlook certainly remains uncertain," but said that Level 3 "continues to believe that there is substantial opportunity, and we believe we are well positioned to capitalize on that opportunity."

Touts capital efficiency

Crowe said that his company has, among other advantages, "the most efficient network systems and organization versus our competitors," and "industry-leading" capital efficiency, including a margin on revenue in its core communications business of 79% and communications-adjusted OIBDA margins of 30%, which Crowe called the best in the telecom industry.

While he cautioned that the margins would likely dip in the second quarter, due to the costs associated with Level 3's acquisition earlier this month of the modem business of ICG Communications, Inc. for about $35 million in cash and the expenses of its termination of the Allegiance vendor contract, including a $54 million settlement payment, the executive said that both of these were "good financial transactions in and of themselves" that would benefit Level 3 in the long run, and predicted that margins would return to their present levels by the latter part of the year.

$1.1 billion of cash

Crowe noted that Level 3 has $1.1 billion of available cash on hand, has paid off its senior secured debt and has no significant debt maturities before 2008, when the company's 9 1/8% and 11 % notes come due.

While the company expects a one-time turndown in consolidated free cash flow this year, in line with a decline in its managed modem services business, "we do expect that the positive long-term trend line of free cash flow will be re-established and will continue."

However, he acknowledged that "clearly, top-line growth has not been adequate," given changes taking place in the sector of the telecom industry in which Level 3 operates, and warned that "we are not assuming any significant communications market improvement" any time soon - but added that Level 3's strategy was not predicated on such an improvement and unlike its competitors, "we don't need to see significant market improvements to see significant growth in our current high margins."

Even if management is optimistic, investors are more wary, and over the past three months its bonds have headed south, with its 9 1/8% notes due 2008 having slid from levels around 95.5 in late January to the low 70s currently. Its Nasdaq-traded shares have lost half their value, going from $6 a share in late January to Thursday's close at $2.95, down another 36 cents on the session, or 10.88%.

Concerned about stock decline

Crowe acknowledged this, saying the equity investors "are rightly concerned about the decline in our current stock price, and we are too," but he termed the decline "an over reaction" to big customer AOL's recent reduction of the number of Level 3 ports it will use for its system, a development Crowe called "a surprise and disappointment."

However, he asserted that while the communications industry is "in turmoil" because of its shift from "a slow moving utility-based business to a fast-moving technology-based business," for Level 3, the change is "an opportunity."

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