Level 3, which announced it is being acquired by CenturyLink, saw revenue softness in the third quarter as smaller customer churn continued to offset gains made by its larger enterprise base.
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Jeff Storey, CEO of Level 3, told investors during the earnings call that while it is seeing continued growth from large multinational customers, the company is seeing higher levels of disconnects.
“If you look at the revenue growth from our large multi-national customers and the higher end customers of our target market you can see that our value proposition clearly resonates with these customers,” Storey said during the joint earnings and CenturyLink acquisition call. “As further evidenced in general sales are good, however our churn is too high.”
A few issues are behind the churn issue. First, the service provider implemented changes that challenged revenues on the lower end of its customer base. By moving 8,000 of its customers to inside sales, Storey said Level 3 said did not engage as well as it should with its lower-end customer base.
“We really lost focus on them as we asked our direct sales force to move up market,” Storey said. “This created a communication void with these customers and as a result we saw elevated churn from both of these groups of customers.”
Secondly, Level 3 transitioned a number of its customers to IP-based and other next-gen services a bit faster than some customers would have preferred.
“While we recognize the transition to new technologies is good for our business, it's accelerating our own customers’ transitions faster than their natural rate,” Storey said.
As a result of these changes, Level 3’s customer sales trends varied amongst its largest and smaller customers. On the high end of its base, 17 percent of Level 3’s North America enterprise core network services (CNS) revenue grew 1.9 percent sequentially. Specifically, customers that spend more than $20,000 per month grew 1.2 percent sequentially.
However, customers who spend between $2,000 and $20,000 per month declined 0.6 percent sequentially. Level 3 saw the largest declines with the smallest customers, who represented 5 percent of the company’s North America enterprise base and spend less than $2,000 per month. That group declined 18 percent sequentially.
Similar to the second quarter, Level 3 reported that within the CNS segment, revenue from its large multi-national enterprise customers rose 10 percent. Total wholesale CNS revenue declined 4.2 percent to $412 million, a factor Level 3 said was due to continued consolidation of the service provider market.
From a regional perspective, North America CNS revenue grew 1.4 percent year-over-year. Enterprise CNS revenue grew 3.1 percent to $1.16 billion driven by solid performance from Level 3’s largest customers offset by continued pressure from the low end of the company’s customer base.
EMEA continued to see struggles in the third quarter as the company saw a sharp drop in U.K. government business, where sales fell 35 percent to $17 million. Total EMEA revenues were $182 million, down year-over-year from $211 million in the same period a year ago. Level 3 also reported double-digit revenue declines in the wholesale business in the Latin America and EMEA regions.
“We knew they would be weaker but the decline sequentially for the second quarter in a row in North American revenue is surprising and makes us question if this is more of enterprise/macro issue (which is consistent with T and VZ's enterprise results) vs. a concern about TW Telecom integration (which had been the concern surrounding Q2'16 results),” said Jennifer Fritzsche, senior analyst for Wells Fargo in a research note. “That said, LVLT still generated strong EBITDA margins and FCF, with margins expanding 40 bps sequentially.”
From an overall financial perspective, Level 3 said soft sales during the quarter resulted in revenues dropping year-over-year to $2.03 billion from $2.06 billion.
A reduction in SG&A and network costs helped improve Level 3’s adjusted EBITDA to $716 million from $657 million, and the margin rose to 35.2 percent from 31.9 a year earlier. While capex rose slightly to $364 million, operating cash flow was still up to $645 million from $575 million in the same period of 2015. Net profit reached $143 million compared to just $1 million a year ago.
Level 3 maintained its full-year outlook of 10-12 percent growth in adjusted EBITDA growth and $1.0-1.1 billion in free cash flow, while increasing the capex forecast slightly to 16 percent of revenue from 15 percent. The company said the higher capex was due to increased customer demand for dark fiber and wavelength services, and the increased spending will also lead to higher depreciation and amortization expense for the year.