Level 3 Communications, Inc. (LVLT)

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Level 3 Communications, Inc. (LVLT)

Morgan Stanley Technology, Media & Telecom Conference Call

February 26, 2013 7:25 pm ET


James Crowe – Chief Executive Officer


Unidentified Analyst

Okay. Good afternoon everybody. It is my great pleasure to welcome Jim Crowe, CEO of Level 3. I’m going to ask Jim to make some opening remarks. Before that please note that all important disclosures, including personal holding disclosures and Morgan Stanley disclosures, appear at the Morgan Stanley public website, www.morganstanley.com/researchdisclosures or at the registration desk.

Jim, over to you.

James Crowe

Well, good afternoon. I’m going to take just a minute or two and provide some context, and I will start with an assertion. Our business has become a whole lot easier to understand over the last couple or three years ago – versus a couple or three years ago. Back then, those of you who followed us remembered we had revenues that were going down, revenues that were coming up. We have completed a number of acquisitions, so there was a lot of dust and smoke in the air.

Today what matters is top line growth. Below that level our margins, gross margins, EBITDA margins have been seasoned for several years. They are constant at 80% incremental gross, 60% incremental EBITDA. We have actually outperformed that because of synergies, but that is a good trendline relationship and we are at about 12% of capital.

So you would decide on the top line growth that makes sense, our cash flow production is a mathematical output of that – of that growth rate. So what determines top line growth? A number of core varying headcount. We have about 1000 and they each produce 8000 to 8500, something in that kind of range. So the logical question is why don’t we just double our sales force, double our sales.

There are two answers. First, we really like 80% gross margins. We like them financially and strategically. Financial is obvious. Strategically, the more you buy access from companies whose customers you want to take away, the local incumbents, the more difficulty you are going to have. They obviously don’t want to co-operate in helping you take their customers and if you are buying a vital feedstock, access, sooner or later you won’t be happy with the outcome.

So the conclusion is we have to have enough on-net market to support whatever is our sales force and produce 80% gross margins. That is an effort we started a couple of years ago adding buildings, which is really the way you manage that gross margin. We need to maintain a ratio roughly, where 60% of our revenue is on that with 100% gross margins, 40% off-net, with 50% gross margins, and we wouldn’t mind if more and more were on that.

It is a big effort digging up the streets of San Francisco or New York or Sao Paulo or London. It takes a lot of careful planning and management, but we have got the process going and we expect to add more and more buildings. The other limiting matter, which we have a lot of experience in and we’re getting better and better is the factory. We roughly add 10,000 orders each month, or turn them out. Each order has roughly 40 process steps. That is 400,000 process steps each month.

It is a big workflow management process. It is where we have spent a great deal of our time, our energy, our chief operating officer, Jeff Storey, his passion is process. We have shown remarkable improvement over the last two, three years. Of course we merge with Global, whenever you merge two fairly equal size companies there is going to be some surprises, good and bad, fluctuations quarter-to-quarter, but our ability to predictably meet our customers promises – the promises we make to customers is central to how many sales people we have.

We sell it and can’t turn it up, predictably that does no one any good. So maintaining 80% gross margins, predictably turning up service at huge volume that is what we are focused on. We have plenty of addressable market, plenty of customers, who want to buy from us, 64% of our revenues in the last quarter were enterprise. That grew 8% in constant currency. We want to see that continue, and we feel very good about watching the progression towards our goal, which is to grow 2% sequentially.

We say that to keep everybody co-ordinated, adding addressable market and in the factory when we hit 2% we will set some other goal. So that is where we are at.

Unidentified Analyst

Great. Okay, well, let us start with then Global Crossing, you are well into the integration now. You achieved a lot of synergies during 2012. What is left to do there and how do you think in particular, I guess going beyond the cost and Capex synergies, but cross selling the various networks and products.

James Crowe

We have got a common product catalogue that is a set of services. We are operating as one company globally. Processes and systems are largely integrated. We still have some work to do. For instance in Latin America, we’re not on the same ERP system we are in the rest of the world. That is all planned out. So I would say organizationally in process and system and in product we’re initially integrated.

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