Level 3 Communications Inc. (LVLT) Earnings Report: Q Conference Call Transcript

Transcription

1 Level 3. (LVLT) Earnings Report: Q Conference Transcript The following Level 3. conference call took place on April 28, 2016, 10:00 AM ET. This is a transcript of that earnings call: Company Participants Valerie Finberg; Level 3; Vice President, Corporate Communications and IR Jeff Storey; Level 3; President and CEO Sunit Patel; Level 3; CFO Other Participants Simon Flannery; Morgan Stanley; Analyst Brett Feldman; Goldman Sachs; Analyst Colby Synesael; Cowen and Company; Analyst Nick Del Deo; MoffettNathanson LLC; Analyst Scott Goldman; Jefferies LLC; Analyst John Hodulik; UBS; Analyst Phil Cusick; JPMorgan; Analyst James Moorman; D.A. Davidson & Co.; Analyst Michael Rollins; Citigroup; Analyst MANAGEMENT DISCUSSIO N SECTIO N Welcome to the Level 3 first quarter 2016 earnings call. (O perator Instructions) As a reminder, this conference is being recorded Thursday, April 28, I would now like to turn the conference over to Valerie Finberg, Vice President, Corporate Communications and Investor Relations. Please go ahead, ma'am. Thank you, O perator. Good morning, everyone. Thank you for joining us for the Level 3 Communications first quarter 2016 earnings call. With us on the call today are Jeff Storey, President and Chief Executive O fficer; and Sunit Patel, Executive Vice President and Chief Financial O fficer. Prior period results discussed today are presented on a pro forma basis, adjusted to exclude the Company's Venezuelan subsidiary's operations, which were deconsolidated at the end of the third quarter 2015 and adjusted to reflect changes made to customer assignments between the wholesale and enterprise channels at the beginning of 2016, due to mergers between certain customers and other changes. Unless otherwise noted, revenue and sales comparisons to prior periods are provided on a year-over-year and constant currency basis TheStr eet, Inc. Al l R i ghts R eser ved Page 1 of 15

2 I'd like to call your attention to the Safe Harbor statement that begins on page 2 of our 1Q 2016 earnings presentation. The presentation and remarks contain forward-looking statements that are subject to risks and uncertainties. Results may vary significantly from those statements, and additional information is available in the Investor Relations section of the Level 3 website and in our filings with the Securities and Exchange Commission. We will be referring to certain non-gaap financial measures. Reconciliations to the most comparable GAAP measures are available in the earnings presentation. The earnings presentation and all of our other earnings materials are available in the Investor Relations section of the Level 3 website, at investors.level3.com. With that, I'll turn the call over to Jeff. Thanks, Valerie. Good morning, everyone, and thank you for joining us. Before we get into our results this morning, I'd like to start out on a personal note. As most of you know, I am recently back from medical leave following heart surgery. The surgery and my recovery have gone extremely well and I'm very excited to be back at work. But I wanted to express my thanks for the kind wishes I received from so many people on this call. Your cards, notes, and words of support were very meaningful to me and I greatly appreciate it. I'd also like to mention the outpouring of support I received from Level 3 employees. I've mentioned a number of times before the outstanding employees we have. But as I was thinking about this call, I wanted to take the opportunity to really illustrate the point. O ne of the things that touched me most during my absence were the literally thousands of notes and s I received from employees. O f course, they wished me well, hoping for a speedy recovery and a complete recovery; but there were also many notes that expressed another thought. Many employees said things like, Jeff, while you're out, don't worry about Level 3, we've got this. O r they said, Jeff, you focus on recovery, we'll focus on driving the business. I think those notes really demonstrate something that I've known for a long time. The strength of Level 3 is our employees. We care about each other, we support each other, we take ownership of our own responsibilities but happily take on more to support a coworker in need. Ultimately, each of our employees are individually and personally committed to the success of the Company. I'd really like to thank them for their support and all they do to drive Level 3 forward. I'd also like to thank Sunit for serving as the interim CEO while I was out, as well as the entire leadership team for keeping the business on track and executing against our strategy. It's gratifying to see the strength and depth of the leadership team we have built at the Company. In fact, the focus by the entire team on profitable growth is evident in our first quarter results, with expanding margins, strong growth in adjusted EBITDA, and continued generation of free cash flow. O n today's call, we'll have a slight departure from our usual approach. I'll provide a few initial thoughts on our view of the market and the Level 3 strategy. Sunit will provide a first quarter operational update and our detailed financial results. After that, we will open it up for your questions. With that, I'll now turn to what we are seeing in the market and our strategy, which is designed to both maximize our opportunity for the long term and enable us to take advantage of the current environment. The increasingly digital and increasingly connected world is creating the need for businesses to be fully networked across their operations. At the same time, the compelling economics of the cloud are driving enterprises to include migration to the cloud as a key element of their IT strategy. Combined with the proliferation of connected devices and an ever more threatening security landscape, a hybrid cloud 2014 TheStr eet, Inc. Al l R i ghts R eser ved Page 2 of 15

3 strategy is leading to hybrid networking for many enterprises. These market factors benefit Level 3. O ur robust product portfolio and capabilities that range from dark fiber and advanced transport services like 100 gig waves, all the way up to CDN and our innovative threat intelligence services position Level 3 well to meet enterprises' complex hybrid networking needs. As we look to 2016 and beyond, our strategy is unchanged. We remain focused on operational excellence throughout the business, providing a superior experience to our customers and developing the products and capabilities to meet their evolving needs. There are four key elements to our strategy. First, focusing on enterprises as the Company's growth engine. We've been successful in capturing share of the global enterprise communications market, but our share remains low and we see a continuing opportunity to grow across all three regions. In particular, companies who view the network as fundamental to their business strategy and an enabler of growth in their own businesses are targets for our continued growth. Second, continue investing in a comprehensive and evolving product portfolio. As I mentioned, the transformation in the communications industry is underway and we continue to develop the capabilities we need to solve our customers' needs for growth, efficiency and security. Third, expanding our network and building directly to our customers' locations. We believe that having our customers on our network, or O n-net, enables us to provide better network performance and reliability, as well as an improved end-to-end experience for our customers. And fourth, but certainly not least, providing an excellent customer experience. We are investing in operational excellence to continually improve our customers' interactions with Level 3 across every aspect of the business. Central to our strategy is our vision of one that I've discussed before. O ne set of products that we take to an expanding market. O ne network to deliver those products globally. O ne set of operational support systems to enable a differentiated customer experience. And one team with the singular goal of making Level 3 the premier provider of enterprise networking services. Level 3 is a growth business. As I said on our fourth quarter earnings call, our goal is to achieve 8% yearover-year CNS enterprise revenue growth. While we aren't there yet, as a team we are working toward accelerating growth. O ur strategy and the operating plans that support our strategy are designed to deliver a differentiated customer experience and drive growth. Investing in the key areas of products, network, systems, and customer service excellence are priorities for the business. With that, I'll turn the call over to Sunit to discuss the first quarter results. Sunit? Thank you, Jeff. Good morning, everyone. Jeff, before I start, on behalf of everyone here at Level 3, we are happy you're back. Turning to slide 3, I will start by covering key areas of focus and operational progress for the first quarter before I get to the financial results. As a company, we continue to strive towards operational excellence and we are executing on many initiatives to drive growth. We are adding to our sales organization and improving sales productivity. We continue to expand the Level 3 network and enhance our products. We're operating well from a bottom line and cash flow perspective and remain focused on driving better top line growth. In the first quarter, from a sales perspective, production held steady year-over-year and grew nicely sequentially. Sales productivity continued to increase. We continue to improve our sales model, implementing a unified strategy to ensure consistency across our markets. O ur local sales presence and 2014 TheStr eet, Inc. Al l R i ghts R eser ved Page 3 of 15

4 willingness to bring fiber to customer locations have been a differentiator in our success. From a headcount perspective, the first quarter is typically when we see a higher level of churn from our quota bearing headcount. During the first quarter of this year, we held quota bearing headcount relatively steady, declining by roughly 10 people in the quarter. At the same time, we added more than 20 specialized non-quota bearing security and CDN sales representatives to help identify and close opportunities for these growth products. The size of our overall sales organization has increased and we expect that quota bearing headcount will grow for the full year. During the quarter, we further consolidated our legacy billing systems and are now on a single platform across North America and EMEA. With the consolidation of Latin America into our end-state environment later this year, we expect to be on a single global billing platform by the end of the third quarter. Additionally, we now have a single customer self-service portal interface across North America and EMEA, with plans to incorporate Latin America in the future. From a product perspective, we continued investing to meet the needs of our customers. For example, we continued to strengthen our cloud offering with the introduction of Microsoft O ffice 365 to our cloud connect solutions ecosystem. In general, we are seeing more secure enterprise connections to the cloud, driving revenue growth. Additionally, we were recently named an advance partner in the AWS Partner Network, providing network connections to improve enterprise and public sector access to the AWS cloud computing platform and services. I'd like to note that Level 3 is connected to more AWS direct connect locations globally than any other network service provider. (Indiscernible) revenue continues to grow and we have seen increased adoption of 100-gig wave services. Driven by strong interest from customers, we continue to invest in our security solutions. In February, Level 3 open its first distributor denial of service, or DDoS, scrubbing center in LatAm. This addition complements the eight other scrubbing locations we have across North America, where we have five, and EMEA, where we have three. During the quarter, in addition to the investments we made to the sales force and our product portfolio, we also continued to expand our O n-net building footprint across all three of our regions. Turning to our results from a financial perspective, I'd like to start with some highlights for the quarter, which can be found on slide 4 of our presentation. We grew core network services, or CNS, revenue by 4%. We grew CNS enterprise revenue 6%, grew North America CNS enterprise revenue 6% year-overyear and approximately 2% sequentially. We increased EBITDA by 15%, to $710 million, and generated strong free cash flow of $213 million. Turning to revenue results on slide 5, as we've seen over the last year, the difference in constant currency and as reported growth rates can be attributed to the strength of the dollar against many of the currencies. As you can see on this slide, we have provided revenue growth rates by region on both a constant currency and an as reported basis. O verall total revenue grew 2.3% and CNS revenue grew 3.6%. Within CNS, enterprise grew 5.7%, while wholesale declined 1.4%. O n a regional basis, we had a solid quarter in North America, highlighted by sequential CNS enterprise revenue growth of about 2%. In the first quarter, EMEA CNS revenue declined 4.9% and CNS enterprise revenue, excluding UK government, declined 0.5%. First quarter enterprise sales, excluding UK government, were up 20% year-over-year and 16% sequentially. During the quarter, certain large disconnects in the timing of professional services and one-time items pressured revenue growth. We have invested in sales and marketing resources in the region, including new sales leaders in France and Germany. Additionally, we've been investing in product capabilities in 2014 TheStr eet, Inc. Al l R i ghts R eser ved Page 4 of 15

5 the region, including CDN, security and voice complete, which should help drive revenue growth for the remainder of the year. In Latin America, CNS enterprise revenue remained strong, growing 10%. Also, CNS revenue growth was flat, due to a few know disconnects. Also, voice services revenue, WVS, declined 18% to $104 million in first quarter of For the full year, we continue to expect WVS revenue to decline by approximately 10%. As we said last quarter, excluding UK government revenue, we generally expect total CNS and CNS enterprise revenue growth to be stronger in 2016 compared to Looking at first quarter results, although EMEA started a bit weaker than expected, we are maintaining our full-year 2016 outlook. O ur revenue mix can be found on slide 6, with North America representing 82% of our CNS revenue, followed by EMEA at 10% and Latin America at 8%. Our enterprise customers represent 72% of CNS revenue, while wholesale customers make up the remaining 28%. Turning to slide 7 and revenue results by product group. IP and data services grew 7.2%, transport and fiber declined 0.3%, voice services grew 2.4%, and the call location and data services revenue declined 0.5%. A few highlights from an individual product perspective include CDN growth of 4%, dark fiber growth of 11%, and managed security growth of 46%. From a pricing standpoint, we haven't seen much change over the last several quarters. Moving to slide 8, network access margin expanded to 66.2%, compared to 64.5% in the first quarter The improvement in network access margin was driven by continued high margin CNS revenue growth, combined with low margin WVS revenue declines and continued expense savings from natural consolidation. Turning to slide 9, adjusted EBITDA was $710 million for the first quarter This compares to $620 million in the first quarter of The improving in adjusted EBITDA was primarily driven by the operating leverage from CNS revenue growth, the full benefit of synergies realized in 2015, and continued initiatives to manage costs. We also continued to expand adjusted EBITDA margin, which improved to 34.6% in the first quarter of 2016 compared to 30.5% in the first quarter The Company generated free cash flow of $213 million in the quarter, compared to $42 million from the year-ago quarter. After the close of the quarter, the Company redeemed $775 million of our 7% senior notes, funded by the net proceeds from our new $775 million 5.25% senior notes which closed during the first quarter. As a result of this transaction, in the second quarter 2016, we expect to recognize a loss before taxes of $40 million, or $0.11 in basics earnings per share on the extinguishment and modification of debt. We exited the quarter with a net debt to adjusted EBITDA ratio of 3.7 times and are focused on getting to the low end of our target leverage range of 3 to 4 times. In the first quarter 2016, the Company generated net income of $124 million in basic and diluted earnings per share, or $0.35 and $0.34, respectively. While the effective income tax rate in the first quarter was 43%, we continue to expect our GAAP income tax rate to average about 30% for the full year The effective income tax rate can fluctuate significantly in any quarter for discrete or unusual events. We expect the rate in the second quarter to be in the 15% to 20% range. Turning to the business outlook on slide 10, we remain confident in our performance for the remainder of the year. With our continued focus on profitable revenue growth and strong adjusted EBITDA results in the first quarter of 2016, we are increasing our outlook for full-year 2016 adjusted EBITDA growth. We now expect full-year 2016 adjusted EBITDA growth of 10% to 12%, compared to our previous outlook of 9% to 2014 TheStr eet, Inc. Al l R i ghts R eser ved Page 5 of 15

6 12%. In addition, we continue to expect to generate free cash flow of $1 billion to $1.1 billion. Additionally, we've lowered our full-year interest expense estimates, based on our recent capital markets transactions. We also updated our non-cash compensation estimate for 2016 to $170 million from $130 million, as we had underestimated the expenses for employees who will become retirement eligible in 2016 and certain performance-based stock grants. In summary, we are focused on sales momentum by growing both the sales force and sales productivity. We are driving profitable growth by executing on the investments we have made though our network expansion and product portfolio enhancement initiatives. Finally, across the business we are maintaining financial discipline and driving improved efforts to improve operational excellence and customer experience. With that, I'll turn the call over to Valerie to start Q&A. Thank you, Sunit. O perator, will you explain the process for asking questions today? Q UESTIO NS & ANSWERS (O perator Instructions) Simon Flannery, Morgan Stanley. Simo n Flanne ry (Analyst - Morgan Stanley): Thank you very much. Good morning. I wonder if you could just touch a little bit more on the EMEA situation. You gave some bookings numbers. I wasn't clear if that was for EMEA or if that was for overall. But is this something where we'll start to see the trends improve in Q2 or is it more a second half phenomenon? Thank you. Thank you, Simon. Yes, the sales bookings were for EMEA. And as I pointed out, the enterprise sales bookings were up 20% from a year ago. And also, as we say it in [our confirm], yes, we think you will start seeing EMEA's results improve for the remainder of the year, which would include from the second quarter going forward. Simo n Flanne ry (Analyst - Morgan Stanley): It's not a macro issue? No, it's not a macro issue. I think we had some one-time items, as I mentioned, in the quarter, but generally given the momentum they have, the best leading indicator is for sales production in the first quarter on the enterprise side, I think in general, all the things we said about EMEA's revenue outlook still holds as for the overall revenue outlook we provided last year. And then Jeff has a few other comments TheStr eet, Inc. Al l R i ghts R eser ved Page 6 of 15

7 Simon, we've talked before about the four core markets in EMEA, the UK, Germany, France and Benelux, and our strategy to expand in each of those markets. We've talked about the team that we've brought in and the team that we've been putting together to grow there. But we've really been investing in four key areas, which is metro fiber, continuing to build out to our customers in EMEA, built better metro access to reach those customers; expanding our product portfolio, we've launched DDos in EMEA, we have an excellent ethernet footprint, we have 100-gig wave platform; we've talked about our voice complete launch that we're underway with; and our security gateways that we've launched in the region. And we're also spending a lot of time and energy on market awareness and demand generation, and then the expansion of the sales channel. So I've talked about some of the people that we've hired in the past. But we've also been now hiring down a layer below that. So in the UK, we've hired Mike Kennedy, who is a long-term Level 3 employee, but to focus on really driving those investments in EMEA and driving our sales performance, and in particular, our enterprise sales performance. [Bart Van Aanhold] in Benelux, another long-term Level 3 employee, but now focused on making sure we're making the right investments in Benelux in driving the growth. In France and Germany, we've hired new people from outside, Thierry [Burngarden] in France and Ralph Strasburger in Germany. So we think we're continuing to augment the team. We're very excited about it. We're glad about the momentum that Sunit talked about on the sales, and in particular, enterprise sales. So we think we're doing the right things and think that team is doing well. Simo n Flanne ry (Analyst - Morgan Stanley): O kay. Great to have you back, Jeff, and good to hear you're recovered. Would you have any perspective on the bookings in North America, given that was an EMEA number? Yes. I think in general across all regions, we expect to see stronger sales production in the second quarter compared to the first. Simo n Flanne ry (Analyst - Morgan Stanley): Great. Okay. Thank you. Thank you, Simon. Brett Feldman, Goldman Sachs. Brett Feldman (Analyst - Goldman Sachs): Thanks for taking the question and definitely welcome back to Jeff. Jeff, while you were out, Sunit did a great job with the cost structure. I was hoping we can get a little bit of color on some of the key things you were able to do there. Is it all recurring in the run rate at this point, or is there anything that could cause costs to creep higher as we move through the balance of the year? So I would say there are three categories of costs. There's network expense or network access costs. Within the SG&A side, there's headcount-related expense and non-headcount-related expense. Within the headcount-related expense, we generally expect to grow that expense a little, because as I say, if we are adding to our sales organization, we'll be adding to our service delivery, service assurance 2014 TheStr eet, Inc. Al l R i ghts R eser ved Page 7 of 15

8 organizations a little, whatever support we need to increase our revenue momentum. We are investing more for network expansion, so we might need some people there. O n the non-headcount side, I think we will continue to hold those expenses down pretty tight, maybe even achieve further reductions. And then within the network access costs, in general, we're looking to make investments to drive more off net circuit costs O n-net, but at the same time, we will have revenue growth which will drive the network expense up. So I think that the key is looking at the margins, which should expand a little bit over the course of the year. Brett Feldman (Analyst - Goldman Sachs): Great. Thanks for that color. Next question, please. Colby Synesael, Cowen and Company. Colby Synesael (Analyst - Cowen and Company): Two questions, if I may. First, on the guidance rate to EBITDA, just curious why we ended up seeing a similar raise to free cash flow on the lower end, particularly with you reducing your interest expense guidance. And then my second question, curious if you still see enough sizable M&A opportunities that are out there, or do you think that a buyback is becoming incrementally more likely when we take into consideration your target leverage and where we think you'll be likely exiting the year? Thank you. O n the first question, yes, you're right, between the EBITDA raise, the midpoint raise of that was about $13 million, the interest expense, cash interest expense savings was about $10 million. We didn't really change the cash flow guidance. Altogether, that's a $23 million increase on the cash side. I think we'll look at that over the remainder the year. But at the same time, we also think it's important to have the flexibility to invest in capital expenditures if we see opportunities there, or new contract wins, or further expansions. So we'll look and see how the year progresses and come back and comment on that. And Colby, with the second question, and you've heard this answer before, but we firmly believe that putting excess cash to work is accretive to stockholder value and our priorities are investing in the business for organic growth and disciplined M&A. We have a long-term strategy that we want to continue to execute on and believe the best use of our cash is to do that. However, absent those opportunities, returning cash to stockholders makes perfect sense to us. So we will continue to look at that, with the bias toward investing our money and growing the business. Colby Synesael (Analyst - Cowen and Company): Jeff, any color on when we could expect some type of decision as it relates to that process? As I'm sure you can appreciate, you are getting towards that lower end of the range, likely by the end of this year, maybe early Is that likely the period when you would have to make that decision? Or could we see something, as it relates to a buyback program, being instituted perhaps a little bit earlier? Thanks TheStr eet, Inc. Al l R i ghts R eser ved Page 8 of 15

9 Yes. And I'm hesitant to give firm timelines on any of this stuff. But I will tell you that it's a serious consideration for us as a company and our Board of Directors is focused on this issue, as well. So again, our primary goal is to find opportunities to invest in our growth. If we can't find that, then the Board will sit down and say, okay, what should we be doing with our cash. And I apologize for being hesitant to give specific timelines, but we will look at it over the coming months with the Board. Colby Synesael (Analyst - Cowen and Company): Great. Thank you. Next question, please. Nick Del Deo, MoffettNathanson LLC. Nick Del Deo (Analyst - MoffettNathanson LLC): Hello. Thanks for taking my question. It looks like there are going to be some changes coming in the special access market -- or I guess it's now business data services, in large part because of your efforts. I realize it's hard to have any firm opinions because you don't know what the final rules are. But if they're implemented in something approximating the outline that's been laid out by Chairman Wheeler, can you at least help us dimension what you think or how material you might think the impact might be? Yes, your comments are exactly right, Nick. First of all, it's hard to comment without really knowing the rules. The vote's supposed to be today. It may be taking place right now as we speak. So we'll know more in the coming days as the rules actually come out. But we strongly support a competitive marketplace and believe the elimination of the demand lock-up agreement will create a more competitive industry and fuel investment and innovation and opportunity for Level 3. We think it's good for our customers. We think it's good for our company. We think it's good for the US economy. So while we will wait and see what the vote actually turns out to be and what the orders turn out to be, we think that Chairman Wheeler, his proposal that we've heard about, are all very positive steps for us. And we appreciate the fact that the FCC is looking at these important issues. Nick Del Deo (Analyst - MoffettNathanson LLC): Okay. And then maybe I can ask one more then. Over the last quarter or two, there's been a real surge in investor interest in small cells. Can you give us some thoughts on the topic and whether or not you think it could be a source of revenue for you guys? I think we're just at the front edges of seeing that from our wireless customers. And I think compared to the -- I'll compare and contrast to the tower opportunity, which started off as really low bandwidth and took a while before the average demand needed to a tower went up by a fair bit. The small cell opportunities in highly population dense areas, highly urban areas, network goes through some of those areas, so on the increment, I think it could create opportunities for us to take advantage of that and increase or expand our network in some of these geographies. But I think we're still at the early stages. And in our situation, we would have to look at the return opportunities we have, like buildings on that TheStr eet, Inc. Al l R i ghts R eser ved Page 9 of 15

10 But it's still a little early to evaluate. But we do think it's an opportunity, because we think in the small cells, the average demand that wireless companies will look for will be higher right out of the gate, compared to what happened in the power situation. Next question, please. Scott Goldman, Jefferies. Scott Goldman (Analyst - Jefferies LLC): Good morning and welcome back, Jeff. Glad to have you. Two questions. O ne, just want to return to the cost side and the EBITDA performance for the quarter. I realize you're not going to give us synergy numbers going forward, but I'm trying to get a sense for, I think as we exited last year, the network expense synergies were trailing behind where expectations had been, so wondering if part of what we saw on the EBITDA side of the equation this quarter was driven by maybe an acceleration in those synergies as opposed to just other cost-cutting activity? And then secondly, North America enterprise, if you look at the supplemental, it looks like 2.2% constant currency sequential growth, a good number out of the gate. I think 1Q is historically a slower quarter and then we usually see it ramp throughout the year. Sunit, you mentioned bookings were strong and expectations going forward there, so just wondering how we should think about North America enterprise and the ability to grow it above 2% sequential growth there? Thank you. So I'll take the second part first and come to the expenses. So with respect to North America, again, as Jeff outlined in his remarks, our goal, and we're not there, is to grow 8% year-over-year. So I think back to the sequential performance, the sequential performance is lumpy in any given quarter. There are onetime items and various other things involved. So 2% would mean anywhere from 1.5% to 2.49%. So I think that it's tough to really take anything from one quarter. But generally, our goal is to, if we can achieve approximately 2%, which is 2% plus or minus 0.5%, because it is lumpy when you look at sequential, then we should see the year-over-year growth trend improve. And that's really our goal on that front. As far as the cost goes, I think when you look at either the year-over-year or sequential changes on the cost side, certainly on the network expense side, we have been reducing what I'll call the fixed part of network access costs from optimization, so we did manage to do that sequentially in the first quarter compared to the fourth quarter. So that helped. Similarly, we had further optimization on circuit costs. So we did see the benefit on network access costs. So they went down from the fourth quarter to the first quarter. So we are seeing that benefit. And also, we achieved some reductions on the non-headcount side of the house. So I think both those things is what helped drive the cost down. Scott Goldman (Analyst - Jefferies LLC): Great. Thank you. Next question, please TheStreet, Inc. All Rights Reserved Page 10 of 15

11 Phil Cusick, JPMorgan. Phil Cusick (Analyst - JPMorgan): Jeff, it's good to have you back. So the co-location data center services, transport and fiber all had declined in the quarter, both sequentially and year-over-year. Can you it give some color on what's driving the decline in each one of those segments? Yes. So I think the co-location service business has been flattish. I think we're making some investments in that area that hopefully should drive better performance over time. I think the transport services had more to do with a couple of things. O ne, the year-over-year comparison, remember last year we had -- and there are some professional services and other fees in there -- we had some one-time items for Starbucks and the Fed, our federal business, is what's impacting the year-over-year comparisons. So those should generally improve over the course of the year. Phil Cusick (Analyst - JPMorgan): And that's for the co-location or that's for data center? Yes, on co-location data. Well, no, the second part of the question I think you asked was on the transport side, and that's what I was answering with respect to Starbucks and Fed. The co-location was what I answered first, which is the business has sort of been flattish, but I think that with some of the investments we've been making, especially in LatAm and some of our strategy work on our cloud connectivity platforms, we should start seeing a little better performance over the next year. Unidentif ied Participant: Got it. And if I could, one more. You talked about CDN growth of 4% in the quarter. And if I recall correctly, that's about roughly 2% of your CNS revenues. Correct. Phil Cusick (Analyst - JPMorgan): With Google moving into the CDN space, what kind of impact are you seeing or anticipating? At this point, we're not seeing as much of an impact. I think the bigger impact is, if you look at the remarks from [Akami] and others, has more to do with some of the larger guys doing more self-service. This is a large market. We think our strategy is executing well for us. So we continue to think that we should be able to play well in this market. And we focus a lot also on the media side, the media vertical, and that's also doing well for us. So we haven't seen any current impact. O bviously, over time, it could impact us, but it's still too early. Phil Cusick (Analyst - JPMorgan): Got it. Thank you for taking the questions TheStreet, Inc. All Rights Reserved Page 11 of 15

12 Next question, please. John Hodulik, UBS. John Hodulik (Analyst - UBS): First off, welcome back, Jeff. Revisiting the M&A question, can you remind us of what your criteria are as you evaluate M&A opportunities? And would you say that you're, in general, hesitant to take on a declining revenue business? And I think you've mentioned previously your sub scale in EMEA. So would this region be the primary focus, at this point? Thanks. So the criteria are businesses we think create value for our shareholders. So we have actually been pretty aggressive about taking on declining businesses in the past. If you think about WilTel, we acquired WilTel a the time where its largest customer was SBC, SBC had just acquired AT&T and was migrating traffic. And so we've actually been pretty successful at buying some aspects of declining businesses, taking the strength of the growing businesses and offsetting the weaknesses from the declining business. So I wouldn't say that's our preferred, but it's also not something that scares us away. We look at companies for a variety of different reasons, capabilities that we don't have, products and services that we don't have. If you look at our relatively small security acquisition of Black Lotus, it was because they had capabilities that we were wanting to put into our product road map and felt that was the best way to get them into the product road map is just to acquire the capabilities and deploy them over our entire footprint. So we'll keep looking at those things. We look for synergies, we look for customers, we look for network capabilities. Those are all the different types of parameters that go into making those decisions. Yes. And I would say you need to look at what we've done in the past. We'd like to continue to expand our network footprint, so a lot of facilities based acquisitions that serve enterprise customers. And also from a financial perspective, things that are accretive to free cash flow per share after a short integration period. So that's the financial criteria. Yes. John Hodulik (Analyst - UBS): And would you look to keep leverage neutral with synergies? Yes. I think that's fair. Yes. John Hodulik (Analyst - UBS): Great. Thank you TheStreet, Inc. All Rights Reserved Page 12 of 15

13 Next question, please. James Moorman, D.A. Davidson. Jame s Mo o rman (Analyst - D.A. Davidson & Co.): Thank you. A little follow-up on the M&A. It sounds like you've talked a lot about in Europe and the Benelux area in terms of doing M&A or organic or possible M&A. Any thoughts on Latin America? Sounds like that area has started to improve a little. Just a little bit more detail on what you're seeing in Latin America and then possibilities of any other organic or inorganic growth in LatAm. Thanks. First of all, we don't ever comment on particular opportunities, but you're exactly right. We do think there are opportunities in EMEA and we think there are opportunities in Latin America, and so we're very active and engaged. We believe it's our entire job to make sure we're up on every opportunity that's out there and that we're looking at all the various opportunities. We have a great business in Latin America. We have an excellent team. We have great customers and we want to continue to augment that, as we can. Same is true in EMEA. And I don't know if you want to add anything to that. No, agreed. We're looking at opportunities across all regions. Jame s Mo o rman (Analyst - D.A. Davidson & Co.): Perfect. Thanks a lot. Sure. O perator, I think we have one more question. Thank you. Michael Rollins, Citi. Michae l Ro llins (Analyst - Citigroup): Hello. Thanks for taking the question. Just two, if I could. O ne, on the non-cash stock compensation, can you talk about the reasons for the increase and if there's any implications on sales or what's happening in the business? And then secondly, just on the North American wholesale side, I you think you're looking for in your prior aspirations a modest improvement year-over-year in With the business down, I think about 90 basis points in the first quarter, do you still have the same outlook for the year or are you revisiting that outlook? Thanks. So I think on the outlook, we have the same outlook for the year. And as we indicated, the forwardlooking indicators look good, whether it's sales funnels or sales bookings. And then on the non-cash comp, as I said, some of it is underestimation. O ne was the retirement eligible. And the second thing, to 2014 TheStreet, Inc. All Rights Reserved Page 13 of 15

14 your point, was on performance-based stock grants, which are driven by growth objectives. So it was underestimation there. So I think those are really the two key reasons. We are generally pretty good about estimating these. And I have to say that we underestimated. But I think the new guidance that we have should incorporate everything we know. Michae l Ro llins (Analyst - Citigroup): So are you suggesting that bookings are running ahead of your expectations? No, I'm not saying that. I'm just saying that we've got enough evidence to reiterate and be comfortable about the outlook we have on the revenue side. Michae l Ro llins (Analyst - Citigroup): Thank you very much. That was our last question, so I'd like to close the call with a few thoughts. First of all, I'm happy to be back. I feel very fortunate to be part of a great company and a great team of employees. So I'm happy to be here. Also, our focus on profitable growth was evident in our first quarter results, as we expanded margins and generated strong free cash flow. With the transformation to hybrid networking underway in enterprise communications, we are focused on meeting the needs of our customers. We do it with innovated and differentiated products, delivering better top line growth as the market continues to move toward the core capabilities that Level 3 offers. We believe that our vision of one, one set of products, one network, one set of systems, and one team, is key to providing a superior customer experience and accelerating growth. And our guiding principle for several years, increasing our free cash flow per share, continues to be fundamental to our business model. Thank you for joining today's call and for your continued support of Level 3. O perator, that concludes the call. Thank you. All rights reserved (c) 2014 TheStreet, Inc. Please feel free to quote up to 200 words per transcript. Any quote should be accompanied by "Provided by TheStreet" and a link to the complete transcript and Any other use or method of distribution is strictly prohibited. THE INFORMATION CONTAINED IN EACH WRITTEN OR AUDIO TRANSCRIPT (the "TRANSCRIPT") IS A REPRO DUCTIO N O F A PARTICULAR CO MPANY'S CO NFERENCE CALL, CO NFERENCE PRESENTATIO N O R O THER AUDIO PRESENTATIO N. THE TRANSCRIPTS ARE PRO VIDED "AS IS" AND "AS AVAILABLE" AND THESTREET IS NOT RESPONSIBLE IN ANY WAY NOR DOES IT MAKE ANY REPRESENTATION OR WARRANTY REGARDING THE ACCURACY O R CO MPLETENESS O F THE TRANSCRIPTS AS PRO DUCED, NO R THE SUBSTANCE O F A PARTICULAR CO MPANY'S INFO RMATIO N TheStreet, Inc. All Rights Reserved Page 14 of 15

15 THE TRANSCRIPTS ARE PROVIDED FOR INFORMATIONAL PURPOSES ONLY. THESTREET IS NOT PROVIDING ANY INVESTMENT ADVICE O R ENDO RSING ANY PARTICULAR CO MPANY TheStreet, Inc. All Rights Reserved Page 15 of 15