Level 3 Communications, Inc. Q3 2008 Earnings Call Transcript

Oct.23.08 | About: Level 3 (LVLT)

Level 3 Communications, Inc (NYSE:LVLT)

Q3 2008 Earnings Call

October 23, 2008 10:00 am

Executives

Valerie Finberg – Vice President of Investor Relations

James Q. Crowe – President and Chief Executive Officer

Sunit Patel – Executive Vice President and Chief Financial Officer

Neil Hobbs – Executive Vice President

Buddy Miller – Vice-Chairman

Analysts

John Hodulik – UBS

Simon Flannery – Morgan Stanley

Jason Armstrong – Goldman Sachs

Frank Louthan – Raymond James

Michael McCormack – JP Morgan

Ana Goshko – Banc of America Securities

Michael Rollins – Citi Investment Research

David Dixon FBR Capital Markets

Donna Jaegers D.A. Davidson

Tim Horan Oppenheimer & Co.

Michael Funk Merrill Lynch

Jonathan Schildkraut Jefferies & Co.

Operator

Good day and welcome to the Level 3 Communications, Incorporated Third Quarter 2008 Earnings Conference Call. Today’s conference is being recorded. At this time I would like to turn the conference over to Valerie Finberg, Vice President of Investor Relations. Please go ahead.

Valerie Finberg

Thank you, Alan. Good morning everyone, and thank you for joining us for the Level 3 Communications Third Quarter 2008 Earnings Call. With us on the call are Jim Crowe, President and Chief Executive Officer, and Sunit Patel, Executive Vice President and Chief Financial Officer, who will provide remarks on the results of the quarter. Also with us today are Neil Hobbs, Executive Vice President, and Buddy Miller, Vice-Chairman, who will be available during our question and answer sessions.

On today’s call we will be referring to certain non-GAAP financial measures, reconciliations between the non-GAAP financial measures, and the comparable GAAP financial measure are available in the press release and on our web site.

I would also like to remind all participants that information we will discuss today contain financial estimates and other forward-looking statements that are subject to risks and uncertainties. Actual results may vary significantly from those statements. A discussion of factors that may affect future and actual results is contained in Level 3’s filings with the Securities and Exchange Commission.

With that, I’ll turn the call over to Jim.

James Q. Crowe

Thank, Valerie. In our prepared remarks, Sunit will discuss the financial results for the quarter, expectations for the year, and our liquidity and debt maturity profile. I will cover market demand, pricing trends, operational highlights for each of our market groups. During both our remarks we will also cover in some detail our views concerning the impact of the current financial market and economic uncertainty on our operations and financial position. Then Sunit, Neil Hobbs, Buddy Miller and I will take questions.

Sunit?

Sunit Patel

Thank you, Jim, and good morning everyone. Let me start with a few key highlights for the quarter. We continue to drive Core Communications revenue growth. Our sequential and year-over-year adjusted EBITDA growth and adjusted EBITDA margins clearly demonstrate the operating leverage in the business. Core Network Services revenue continues to deliver 80% incremental growth margins, and we were able to manage Wholesale Voice margin contributions to about 30%. By adding Core Services revenues with declining SG&A expenses, we expect these trends to continue in the fourth quarter. With one more quarter behind us we remain on track to showing good positive free cash flow performance in the second half of the year.

Despite economic uncertainty, as noted in the press release, we continue to feel confident about our free cash flow guidance for 2009. We completed several liability management transactions during the quarter in the first half of October, reducing our outstanding debt by $179 million, and lowering our net cash interest expense by approximately $10 million on an annualized basis.

For purposes of comparing third quarter 2008 results to prior periods, my remarks that follow exclude the $12 million deferred revenue adjustment from the second quarter of 2008 and exclude Vyvx ads results from all relevant periods.

I’ll start first with Core Communications revenue. Core Communications Services revenue was $964 million in the third quarter and grew 7% over last year. Core Network Services revenue was $791 million in the third quarter and grew 6% over third quarter, 2007. In terms of sequential performance, our Core Communications Services revenue grew 1.3% on a constant currency basis, adjusting our European results with the strengthening dollar in the quarter. This compares to sequential growth as reported of 0.5% in the second quarter and 0.5% in the first quarter.

Similarly, our Core Network Services revenue grew 1.8% on a constant currency basis. This compares to sequential growth as reported of 1.8% in the second quarter and -0.9% in the first quarter. Our Wholesale Voice Services revenue, a business which we manage for gross margin contribution, was $173 million in the third quarter of 2008, up 13% over last year and down 1% sequentially. As we have indicated previously, we expect revenues to continue to be volatile but above the previously discussed range of $600 million to $700 million in 2008.

Overall, we continue to see Core Communications Services revenue growth coming from three of our four market groups. The strongest performance came from our European Markets Group, which grew 26% year-over-year in constant currency terms. With a continued adoption of video over the internet, our Content Markets Group also continued to deliver strong results, growing 14% year-over-year. The Wholesale Markets Group grew at 7% year-over-year, with growth from wireless providers, regional U.S. carriers and international carriers and the government segment, partially offset by continued self-service initiatives by our largest customers.

Our Business Markets Group continued to be flat as revenue growth from our target customers continues to be massed by churn in the small end of the customer base. Given our experience in the telecom downturn in 2001 to 2003, we manage and monitor quite actively our credit exposure and our collections and have not seen any deterioration in our metrics.

Other than SBC Communication revenues, a reminder of the second quarter call we announced that the minimum gross margin commitment on the SBC agreement has been satisfied, and that beginning with this quarter we would report these revenues under other Communications Services revenue and eliminate the SBC contract service category from our reporting. From this now-combined revenue category in the third quarter 2008, other Communications Services revenue was $90 million, down 33% from the third quarter of 2007. Of this $90 million, $53 million was attributable to the SBC contract.

Deferred revenue. Our Communications deferred revenue balance decreased to $910 million at the end of the third quarter of 2008, from $939 million at the end of the third quarter of 2007, and from $932 million at the end of the second quarter on 2008. The decrease was primarily a result of foreign currency exchange impact during the quarter and amortization in excess of new deferred revenue transactions completed during the quarter.

Moving to cost of revenues and gross margin, Communications cost to revenue was $425 million in the third quarter as compared to $436 million in the year earlier quarter, and compared to $440 million in the second quarter. Gross margin improved 1.9 percentage points to 59.7% in the third quarter of 2008, compared to 57.8% in the third quarter of 2007, and 58.3% in the second quarter of 2008. Our gross margin was $629 million in the third quarter of 2008, compared to $597 million in the third quarter of 2007. Our gross margin was $614 million in the second quarter of 2008. This $15 million improvement, sequential improvement in comparable gross margin was primarily the result of network optimization efforts and favorable revenue mix changes during the quarter. We expect the improvements from network optimization to continue in the fourth quarter.

SG&A and adjusted EBITDA. We continued our disciplined execution of past management initiatives during the quarter, leading to a further reduction of SG&A despite an expected seasonal increase in utility costs during the quarter. Our Communications SG&A expense, excluding non-cash top-base compensation charges and restructuring and impairment charges was $370 million for the third quarter of 2008. This represents a 4% decline in SG&A from $386 million in the third quarter of 2007, and compares to $371 million in the prior quarter. We expect to see a greater dollar decrease in SG&A during the fourth quarter driven by reduction in our utility bills and further expense reduction across the business.

As we have previously indicated, in absolute dollar terms, operating expenses for all of SG&A for 2008 should show roughly a 5% decline compared to 2007. To put this in perspective, on growing our revenues, our Communications SG&A expense as a percent of revenue was over 40% in the first quarter of 2007, and we expect to exit 2008 at less than 35% in the fourth quarter of 2008. Included in third quarter 2008 restructuring costs were $2 million of severance charges.

Adjusted EBITDA. Consolidated at adjusted EBITDA, $255 million for the third quarter of 2008 grew 21% year-over-year. Our communications adjusted EBITDA was $257 million and grew 22% year-over-year on total communications revenue growth of 2% for the same period. Communications adjusted EBITDA margins improved to 24.4% in the third quarter of 2008, up from 20.3% in the third quarter of 2007 and from 22.7 % in the previous quarter. We expect normalized Communications adjusted EBITDA to show roughly a similar ramp in the fourth quarter as we saw in the third quarter. For the year we expect consolidated adjusted EBITDA to be $980 million to $1 billion.

Capital expenditures was $123 million during the third quarter of 2008, down from $155 million in the third quarter of 2007, and up from $106 million in the second quarter of 2008. We continue to expect capital expenditures to be 11% to 12 % of revenue in 2008.

Consolidated free cash flow was -$4 million during the third quarter of 2008. During the quarter our call in other businesses had a cash flow loss of $3 million. Despite the economic conditions in the market, we are confident we will be nicely free cash flow positive in the fourth quarter of 2008, and for the second half of 2008 in the aggregate. We continue to expect to be free cash flow positive for the full year 2009.

During the quarter and the first few weeks of October, we completed several liability management transactions. Using cash, we repurchased $71 million of debt during the quarter for $68 million. With this debt repurchases and given our slight ease of cash during the quarter, we had $587 million in cash and marketable securities as of September 30 of 2008. With the debt repurchase transactions and

debt-for-equity exchanges we completed during the quarter, we reduced our total debt outstanding by $179 million to $6.66 billion. This reduction in debt will reduce our net cash interest expense on an annualized basis by more than $10 million.

Our 2009 and 2010 debt maturities are now as follow: 6% since September 15, 2009, $305 million. 6% since March 15, 2010, $482 million. Two and seven-eighths percent to July 15, 2010, $355 million, and March 1, 2010, 11.5% senior notes, $14 million.

Over the last few quarters we have indicated that we have more than sufficient cash to handle our 2009 debt maturities and that we would look to refinance our 2010 maturities. Given the deterioration in the capital markets and the resulting decline in our securities prices, we will continue to look at various mechanisms to handle our 2009 and 2010 debt maturities and continue to deliver. We will balance liquidity dilution and the benefit of reducing our funding need for 2010 debt maturities. Our debt to adjusted EBITDA using third quarter adjusted EBITDA annualized is at 6.5 times now, and will trend down again in the fourth quarter. Our adjusted EBITDA to net cash interest expense on an annualized basis, that ratio is now over two times’ on an annualized basis. With respect to the current economic environment, we will continue to asses our business over the next quarter and take appropriate steps as necessary.

In summary, we had a solid quarter. We expect our adjusted EBITDA and annualized cash flow performance to continue improving. Since the last quarter we took steps to reduce our outstanding debt by $179 million and still have a comfortable liquidity position.

With that I will turn the call over to Jim.

James Q. Crowe

Thanks, Sunit. In our release we provided quarterly information by market group for Core Network Services revenue. As Sunit mentioned, this revenue segment has high incremental margins, approximately 80%. My comments concerning each market group will focus on the key revenue component and are adjusted for the sale of Vyvx ads distribution business, and for the one-time deferred revenue recognition as explained in our press release.

As noted in the release, we have experienced a lengthening of sales cycles, particularly in our Wholesale and Business Markets Group. While uncertainty exists, we believe that this increase in the time from identification of opportunity to the execution of a firm order does not indicate a decrease in underlying demand from those services. I believe this view is shared by most, if not all of our larger competitors who report a substantial and growing demand for wholesale and data services as recently as this week. Our Wholesale Markets Group segment comprises 48% of our Core Network Services revenue and grew approximately 1% quarter over quarter.

While as I noted, sales cycles have lengthened, particularly over the last several weeks of the quarter, current economic conditions have spurred wireless service providers, cable companies, foreign PTTs domestic service providers and other major customers to seek lower costs, particularly for local access. This is a plus for us since our general lack of strategic conflict with these customers and our extensive and cost-effective metro and regional facilities position us well to benefit from this trend.

Our Business Markets Group contributes 30% of Core Network Services and continues to display essentially flat top-line growth. As Sunit mentioned, this results from disconnects by smaller accounts offset by solid growth in the larger account segment. We expect these disconnects to slow over the next several months, which should improve our overall revenue growth rate performance. I would note that we have examined our exposure to distressed financial services institution and believe at this time that this segment does not present a material risk for us.

Content Markets Group revenues approximately 12% of Core Network Services and grew a robust 4%, quarter over quarter. As we noted in the press release, market demand from newer, less well-capitalized content owners has decreased but has been offset by increased sales activity among larger media, entertainment, and sports enterprises seek to make more and more content available online.

Our European Markets Group comprises about 10% of Core Network Services and grew 4% quarter over quarter, in spite of a negative currency adjustment caused by a significant strengthening of the U.S. dollar. Today this unit has not experienced any negative effects created by the economic situation, although we do closely monitor key metrics, including sales cycle durations. We are the largest IP provider in Europe and our cross-border capabilities continues to be a real differentiator.

Overall, in an aggregate, our Core Network Services revenue grew approximately 6% year-over-year and 2% quarter over quarter. That growth occurred in spite of a slightly negative contribution from the Business Markets Group. In fact, Wholesale Markets, Content Markets in Europe grew a combined 2.2% quarter over quarter for about 9% on an annualized basis, demonstrating the potential upside from improving our Business Markets Group growth rate.

In addition to the disconnects by smaller accounts I noted, Business Markets Group was probably the group most affected by both our provisioning problems in the past and by our deliberate repositioning of our sales force. We therefore expect to see positive growth from this group as we continue to make improvements in the overall customer experience and as newly-hired salespeople become more productive. I’ll discuss both these factors in a bit.

Wholesale Voice Services – that is, terminating long-distance minutes over our extensive long distance and local networks, contributed $173 million of revenue in the third quarter, down slightly from the second quarter. As Sunit mentioned and I will reiterate, this business is generally managed for cash contribution rather than for revenue. We therefore expect revenue volatility above and below a reasonably stable base of business. However, compared with the Core Network Services, this segment is much smaller in terms of contribution to gross margin and thus has a much smaller effect on consolidated results.

I will now discuss pricing and demand trends. Across most of our products the pricing environment remains healthy, as evidenced both by the comments made by our larger competitors that I referred to earlier, and by the ongoing stability in our incremental gross margins. Continuing the trend we have seen for a number of quarters, transport and infrastructure services, including long haul and metro dark fiber, wavelengths, private line and Ethernet base services are generally stable, and in some cases, such as

co-location and dark fiber, are up in absolute terms. This dynamic is increasingly apparent as one moves closer to the fiber and closer to metro and individual points of traffic aggregation.

IP and data services, particularly high-speed IP, continue to display a different dynamic. For high-speed IP we continue to expect price declines on an annualized basis of about 25% to 30% with unit demand growing more than enough to offset unit price declines. IPVPN service pricing has been stable, reflective of a newer product with strong demand.

As we previously pointed out, bandwidth demand including demand for high-speed IP is increasingly fungible across infrastructure, transport IP and content distribution service. We therefore believe that certain industry and competitor reports of slowing or increasing rates of demand growth for specific services, like high-speed IP, is often explained by larger customers shifting between various services, or perhaps even the dark fiber-based solutions, rather than fluctuations in overall aggregate demand for bandwidth. This emphasizes the importance of having a broad set of IP and optical services provided over an owned physical network, a definite strength of Level 3.

Content distribution services demand continues to be very strong, with very high growth rates although off a relatively small base. Pricing is still what I would refer to as early stage, given the relative immaturity overall supply chain. Finally, Voice Service pricing remains stable but slightly down across the board.

I’ve said in a number of forums that our operational goal for this year was to increase sales and installation rates to match previously demonstrated demand for our services. Earlier this year I reported that we believe we had created additional provisioning capacity and that we were increasing our sales force to take advantage of this fact. We ended 2007 with about 400 quota-bearing sales reps. We ended the quarter with about 450 quota-bearing salespeople and have open requisitions for about 50 more. It does take some time for new sales reps to achieve full productivity, but we do expect that over time sales will increase proportionately to headcount increases.

The operational improvements I’ve described have generally occurred within the current legacy processes and systems. By that I mean, until recently we were utilizing less than efficient processes and systems that were employed by the companies we acquired over the last 18 to 24 months. So for several quarters we have been testing and deploying a unified set of processes and systems we refer to as Unity. We are on track to migrate to our Unity processes and systems over the course of this year and over the early part of next year.

As indicated last quarter, we expect that by year-end we will achieve an important milestone. Importantly, provisioning more than about two-thirds of new high margin Core Network Services revenues on the Unity platform. I should note that this milestone is a summation of many underlying Unity releases, and just like these releases, the final deployment schedule is subject to revision based on user acceptance and operational readiness testing. This is normal and expected and individual release dates will advance or be delayed by a few weeks based on the results of this testing. Unity is an important project, since we believe that as we deploy these processes and systems, we can further increase sales, increase margins, and improve our overall customer experience.

Operator, we are now ready for Q & A. Would you please describe the process?

Question-and-Answer Session

Operator

(Operator instructions.) And we will go to John Hodulik with UBS.

John Hodulik – UBS

Thanks, good morning. A couple quick questions on BMG and the negative revenue trend there. First, Jim, you made a comment that you thought small company disconnects would slow. You know, it seems as if, you know, the economy seemed to slow down fairly dramatically in late September and October. Can you give us some of the reasons why you think that will happen, and within the base, are you seeing existing customers come back to you for discounts? Really, this could be true of the other segments as well, but does any change in your existing customers’ requests or, you know, what you are seeing from aside from disconnects, just anything else going on that would be a result of the slowing economy? Thanks.

James Q. Crowe

Yeah, the BMG top-line, which is about flat or has been about flat, is composed of two trends. Think, oh, roughly accounts 2,000-3,000 and below and those above that, 5,000 and above, give or take. Last year we determined that our systems processes and margin goals were better suited, and we were geared better to those larger accounts. And the process of disconnects is not something that was not anticipated. The upper end is actually growing, and growing reasonably in upper single-digit rates. The reason I mentioned that that trend will end is that we will over the next several months hit the end of that end of the market, the lower end. We will simply run out of that lower end. So structurally we will see some growth, we believe.

With respect to pricing, your question about overall pricing, as I said in my remarks, and I believe some of our larger customers who do have an integrated set of services, and I want to underline, it is important to have a complete set of services given the fact that bandwidth demand moves around, I think we and they have been reporting that demand in pricing, the environment there, has been positive, we have not seen any change. Obviously we are monitoring the situation. Certainly our visibility, like most corporations, is less clear than it was even a couple of months ago, but so far, pricing trends have not changed from what we have seen earlier in the year.

John Hodulik – UBS

Great, thanks.

James Q. Crowe

Next question?

Operator

We will go next to Simon Flannery with Morgan Stanley.

Simon Flannery - Morgan Stanley

Thanks a lot, good morning. I was wondering, Jim, if you could just touch on the FCC’s proposals around inter-carrier comp and universal service, and then for Sunit, any changes to thoughts about 2009 capital spending? Thanks.

James Q. Crowe

With respect to FCC comments, I would say broadly, broadly, we are able to support a series of different proposals. We have been a supporter in the past of industry consortia-proposed solutions. I think we are generally indifferent, I would say, economically to the final outcome. We would like to see some visibility. We would like to see some definition, but it is not something that affects us I think dramatically, as it might some of those who have large amounts of inter-carrier comp or who are paid large amounts of money, either for originating or terminating services.

If you are interested, Simon, we can talk about this at some length. It gets into a lot of detail and we would be more than happy to discuss it offline if you would like.

Sunit?

Simon Flannery - Morgan Stanley

Thank you.

Sunit Patel

Yeah, on capital, I do not think we make any specific comments for 2009. I mean, in the past we say generally speaking in the longer term we expect our CapEx to be 12% to 14% of revenue, and we will have more to say about that when we report next quarter.

Simon Flannery - Morgan Stanley

Okay, but you are not reassessing anything right now in light of the weaker trends you have seen recently?

Sunit Patel

No, we are. As I have said in my remarks, you know, looking at how things are going, we will continue to reassess everything over the next quarter.

Simon Flannery - Morgan Stanley

Okay, so it might be more of the low end of that number?

Sunit Patel

Could be, yes.

Simon Flannery - Morgan Stanley

Okay, thank you.

Operator

We will go next to Jason Armstrong with Goldman Sachs.

Jason Armstrong – Goldman Sachs

Thanks, good morning. A couple questions, and then maybe just a data point. On Europe, obviously a strong performance there, sort of growing through the currency headwinds. If you think about the reasons for the better performance there versus what we see in some of the non-Europe results, Jim, I am just wondering if you can sort of make comments there? Is it structural competitive differences, is it just macro headwind has not been as bad as in other places, maybe just sort of flush that point out a little bit?

And then on the convertible, obviously, some conversions this quarter, can you just talk us through what the pipeline of opportunity is there, especially going after the 2009-2010 maturities, just maybe interest levels there for us to gauge what the exchange opportunity may be from here.

And then finally the data point, just utility bills obviously have been a swing factor in the cost structure, Sunit you mentioned that. Can you quantify what the up tick was in utility costs, specifically for 3Q?

Thank you.

James Q. Crowe

Thank you, Jason. Europe benefits, I think, from some of the same trends that we see here in the U.S. we are the largest provider of IP-based services in Europe, and we are a major provider of cross-border facilities. Europe, like the U.S., is experiencing a surge in content distribution over the internet. We are a direct beneficiary of that. I was in London a couple of week ago with Sunit and we attended a conference we held where we had over a hundred content providers who discussed their plans over the next several years for distributing content across Europe – content meaning entertainment, sports content, et cetera. And since we offer an integrated set of services from the transport up to the CDN layer, we are seeing a substantial benefit from that trend. We also see strong growth particularly in eastern Europe, in northern Europe, and we see opportunities in southern Europe.

I would say those trends, by the way, extend to our Content Markets Group here in the U.S. Quarter over quarter growth in content was similar to what we saw in Europe, although if you adjust for FX, Europe was a bit stronger. We are seeing that benefit from those same trends in our Wholesale Markets Group, although given that it is a much larger group in percentage terms, it is smaller. So in all three groups – Wholesale, Business Markets and Europe, we are seeing the same kind of underlying demand trends and good pricing environment that I think, again, our larger competitors have reported. It is in our Business Markets Group that we still have work to do.

Sunit?

Sunit Patel

So, on two questions. The utility bills went up by sort of high single-digit millions of dollars. We will have a big reduction on that in the fourth quarter. Not all of it will go in the fourth quarter, but a big chunk of it will.

And then with respect to conversion opportunities, really tough to make any specific comments per se as we try to balance a fair number of things that I said in my remarks, but what I will note is that if you look at our yields, the yields are pretty attractive on our bonds from ’09, 2010, anywhere from 20% to 40%, so fairly historic in terms of the opportunity there. But really tough to make any specific comments given all the things we are trying to balance.

Jason Armstrong – Goldman Sachs

Okay, thanks.

Operator

Our next question comes from Frank Louthan with Raymond James.

Frank Louthan – Raymond James

Great, thanks. Just wanted to, you know, look forward on a couple of other things. On the Unity projects that you have seen a little bit of traction, can you give us an idea of when we should see some more traction from that? And then in looking forward from refinancing, in the past you have been pretty clear about doing things that are equity-friendly; do you still see it that way, and can you give us an update on what you have seen on the special access trends out of the (inaudible 00:39:39). You have been commenting before that they have been removing some of the price volumes and discounts. Is that still the case?

James Q. Crowe

I will take the first and third question while you think about respond to the second, Sunit.

With respect to Unity deployment, I will provide an overall context. I think I said last quarter and indicated even the quarter before that we felt we had returned our install intervals so that we were meeting the promises that we made to our customers. Now, late last year when we reported difficulties, we had issues with customer experience, and if you wanted a metric that many customers were pointing to, specifically it was the increase in install intervals which grew in some cases to double what they should have been.

On average they were up 50-60% above what they should have been. Unacceptable performance. We said earlier this year that install intervals had returned to the levels so that we were meeting our promises to customers, although at a lower install level than we could have and should have achieved, as demonstrated by the kind of sales we had last year, but were unable to install.

What Unity enables us to do is to – at install intervals we hope will continue to decrease, and even become more of a competitive differentiator, increase the amount of sales, increase the throughput. If you would – there are many, many, many underlying releases and process changes that make up Unity, but we have said if there is a single metric that we would point to, it would be provisioning about two-thirds of our high margin Core Network Services, the incremental installs, which we expect – and we expect to achieve that milestone, we have said, about year-end.

We are still on track to do that, although I always caveat that statement by saying we are talking about process and software releases. It is normal and expected that any individual release based on operational readiness and user acceptance testing might move a few weeks one way or another. That can happen, that is expected, but we are still on track to hit that important milestone. As we do, we think we can install more and do so with improved cost efficiency, meaning higher overall incremental margins.

Sunit?

Sunit Patel

Let me comment on special access first. What I have said in the past is when AT&T, SBC, BellSouth merged, and when WorldCom MCI, Verizon merged, we believed two things – t o strategic, structural things occur. First, and obviously visible, much of the alternative metro facilities that were part of those two companies in that they had acquired and continued to build over the years, disappeared into the new AT&T and Verizon.

And if you wanted more detail, you could look at the various filings at the FCC where quite a number of companies pointed out that in quantitative terms the number of locations in the U.S. that went from a couple or three different competitors down to one, or in many cases, simply AT&T or Verizon. Lots of commentary filed contemporaneous with those mergers about the reduction in the number of alternative facilities in the metro. That was well discussed. What we thought was less well-discussed, less focused on, was the elimination of literally hundreds of millions of dollars’ of lobbying at the local, state, and federal level that was in opposition to the local exchange companies, including AT&T and Verizon. So be it.

If you wanted a specific demonstration of the impact of that elimination, just a few weeks ago, the FCC eliminated any reporting requirements on the very special access facilities and pricing that we are discussing here today. That of course makes it a little harder for any competitor to collect information about what is going on.

What we would observe is that starting this year, term and volume discounts were eliminated, we would say expect what is logical. That is, pricing to increase where competition is less. We believe, and we think any observer would see that metro facilities have become more scarce, more valuable. That of course is the reason why we moved so quickly to build and to acquire alternative facilities in the metro. Perhaps a bit too quickly, given some of the operational issues we had last year, though I would add we do exactly the same thing again, we just – if I could I would call myself up and say “Pay more attention to those operational issues last year.” But the value of those alternative facilities continues to increase. That is a constant in our business, and we would say expect more price increases where facilities are less.

Frank Louthan – Raymond James

Jim, can I just ask a follow-up? I am just curious because you are the only competitive carrier that says that they are seeing these price volume discounts going away. The others are all saying that they are still in place, they are not seeing any pressure there. Is there anything different in the way you purchase those facilities, or why would that be the case?

James Q. Crowe

Yeah, I dispute that. I would say take a look at what the wireless carriers – these facilities are used for many purposes, but two key purposes. One, for connecting long-distance only facilities – those who own only long-distance facilities. Or, those who don’t have local facilities where they need them, connecting them to enterprises. They are also the bread and butter of tower backhole. And I would dispute that you are not hearing any complaints. I would say there are very loud, very visible complaints, particularly from the wireless providers other than AT&T and Verizon, about tower backhole, and we and many others hear them all the time, so I would say that is not accurate. I would say if you are a net purchaser of access you have an issue, and we have said that and we will continue to say it.

Frank Louthan – Raymond James

Okay.

Sunit Patel

On your question on equity-friendly, I think our bias continues to be the same in terms of looking at doing transactions that benefit our securities holders now. You know, sentiment has changed a little bit from the beginning of the year to where we are now. What I would say now as I mentioned earlier, the dislocation in the securities markets are such that if you look at, for example, where our bonds are trading these days, the opportunity to put money to work is very high rates of return for our securities holders for near-term maturities and I think I would just leave it at that. But yeah, I think our buyers continue to be doing transactions that we think are going to benefit all of our securities holders.

James Q. Crowe

Just to reinforce Sunit’s point, we have said and continue to say that we do have that equity-friendly bias. When your debt securities are yielding as he mentioned 20%, 40% or higher, the definition of equity-friendly has to be made in the context of the current environment.

Next question?

Operator

We will take our next question from Mike McCormack with JP Morgan.

Michael McCormack – JP Morgan

Okay, thanks, guys. A couple things, first, on the new guidance for top-line growth in Core Communications. It looks like to hit the full year you could have a pretty significant deceleration in growth, somewhere in the 2.5% range. Can you give us a sense for whether or not that is implying that Wholesale Voice is going to be down significantly and Core Network is going to be up?

And secondly, you talk about lengthening sales cycles. I mean, it sounds like the issues historically have been installs and provisioning. Are the sales cycles creating an additional problem here? Thanks.

Sunit Patel

Mike, on the growth rates, I think if you go through the numbers, the sequential growth rate in Core Communication revenue goes up in the fourth quarter compared to the third quarter side. I mean, I just think we can talk about it offline, but – you have said, the growth rate goes up a fair bit in sequential Core Communications revenue.

Michael McCormack – JP Morgan

Yeah, we are looking at just year-of-year growth rates throughout the year.

Sunit Patel

Yeah. No, I think that is right, but the sequential growth rate continues to be higher than what we reported last quarter.

Michael McCormack – JP Morgan

Okay.

James Q. Crowe

Yeah, with respect to your question about lengthening sales cycles, I mean the direct answer to your question is, we, like others, think the outlook is murky. What we have seen is over the last – since the advent of the credit crisis, customers have frozen. We still see buying, but more and more customers are reexamining their buying.

Sunit Patel

Yeah, starting in September, I think.

James Q. Crowe

Yeah. I would say, as we said in my comments, we do not think that or believe that represents a change in underlying demand. We think customers are being more careful. Now as they start being more careful, if we are right, you see a one-time decrease. If it takes two months ago sales cycles were 60 or 90 days and now they are 70 to 100 days, as that filters in it does not have an effect on overall demand or pipeline if we are accurate. And as I said, we and others believe for wholesale and data services, underlying demand remains.

I mean, fundamentally your question goes, I believe, what is the longer-term effect of the credit crunch and perhaps any slowdown in the overall economy. I would say again, our outlook is less clear than it was, but historically the business we are in has tended to be, if anything, a bit contra-cyclical. When things slow down, businesses use communications more to displace travel, to improve supply chains and to lower costs. The consumers historically have tended at the margin to use more entertainment, more communications. There has been historically a slowing of subscriber increases, but it is offset by unit increases.

So if history is a guide, demand should, if anything, increase. But all we can say is today, what we have observed in wholesale and in business is a lengthening of sales cycles. That has not occurred in Europe and content. The rest of what I have said is speculative.

Sunit Patel

Like we say, we will continue to assess it over the next quarter.

James Q. Crowe

You had a question, Mike?

Michael McCormack – JP Morgan

No, I was just trying to sort of weigh the – historically I think the issue has been, you know, sales were not an issue but provisioning obviously had its challenges, and now with the slower sales cycle, I mean, potentially that should alleviate some of those pressures. I am just trying to get a sense for one’s overwhelming the other now and we are seeing a split on the top-line because of that, or if it is just still provisioning issues.

James Q. Crowe

Well, I said earlier this year that we had additional provisioning capacity and we were adding salespeople and that the issue there was just simply getting the salespeople up to speed. I think that is still overall accurate with the addition of the commentary I made.

Neil, did you want to –

Neil Hobbs

No, I think that is accurate, Jim. We have had spare capacity for a couple of months now and we do not believe that we could not accommodate any growth in the marketplace that comes forth right now.

Michael McCormack – JP Morgan

Okay, Sunit, could you just give us any sense on how we should be looking at Wholesale Voice next quarter, or is it just too difficult to judge?

Sunit Patel

I mean, I think Wholesale Voice should continue to show a good performance, sequential performance next quarter.

Michael McCormack – JP Morgan

Last fourth quarter you had a pretty good sequential increase; I am just trying to figure out if we are going to see seasonal benefits or is there something else we should look at?

Sunit Patel

Yeah, I think – I don’t know if it is seasonality, but because you are right, last year the fourth quarter did show strong improvement. I think we continue to expect healthy improvement in that Wholesale Voice business again in the fourth quarter.

Michael McCormack – JP Morgan

Alright, thanks, guys.

Operator

We will move now to Ana Goshko with Banc of America Securities.

Ana Goshko – Banc of America Securities

Hi, thanks very much for taking the question. First, I just wanted to follow up on the lengthening sales cycle comment. I am assuming that it does not have an impact the 3Q ’08 or 4Q ’08 revenue because really, the sales in those quarters should have been closed in the first half of this year. But correct me if I am wrong on that.

And then secondly, I know that your customers, or that customers who purchase telecom services do look at the financial health of their vendors; so given the kind of increasing focus on your maturities, is that an issue that is coming up more with your customers, and if so, how are you selling through that? And then along those same lines, given the state of the financing markets, what is your comfort level now on a minimum cash balance?

James Q. Crowe

Yeah, with respect to sales cycles, I think it is useful to very quickly run through the waterfall that we have shown in quite a number of presentations, from sales through – well, you have sales and that sales cycle can be 30 to 90 days – some, now that is an average. It can be longer and shorter. If we are adding a building, the customer may order and it may take even 120 days.

Again, if we have the inventory in place, the sales cycle can be shorter. It goes into backlog, we install it, again, in a 30- to 90-day period, and so if those sales cycles stretch out in the, call it the second half of the third quarter, you can see a slowdown in revenue growth in the fourth quarter, and I think that is responsible in part for the more conservative guidance we gave. To that product, what you install for a month, you add or subtract increases or decreases in usage, and you add or you subtract churn. We have to date not seen any major changes there but we are being a bit cautious in reflecting that in our guidance because those two components, churn and usage, are more sensitive, and you do see rather quick changes up or down.

And as Sunit and I both reported, to date we have not seen a change in the trend line but we remain cautious and we are carefully monitoring the situation.

Sunit, you want to answer with respect to cred quality?

Sunit Patel

Yeah, I think with respect to our customers and vendors, yeah, we have not had any issues so far. I think things have been fairly normal when we compare this back to the telecom meltdown in 2001 to 2003. We were spending in inordinately high amount of time on that, but that has not been an issue so far, both with customers and vendors.

James Q. Crowe

Next question?

Operator

We go now to Michael Rollins with Citi Investment Research.

Michael Rollins – Citi Investment Research

Hi, thanks for the question. Actually, two questions. First, I was not sure if I heard before a dollar specification on the currency impact for 3Q and what you are anticipating for 4Q, so if you could just describe it in dollar terms, and if that is all in international or if it is spread just between the different customer segments?

The other question I had for you is if you look at the SG&A in dollars, how low can you get that to and continue to maintain the sales productivity that you are looking to achieve, the service levels that you are looking to achieve, as you look at streamlining the organization over the next 12 months? Thanks.

James Q. Crowe

Let me answer the second question, Sunit, while you are thinking about the first.

I think we have said previously that 60-70% of our variable SG&A – I suppose in the long term all of the SG&A is variable, but if your think fixed semi-variable and variable, the variable portion of our SG&A, which is people and directly related costs – benefits, travel, entertainment, communications. Of that variable portion, about 60-70%, in that kind of range, is associated not with the current book of business, but rather with selling and provisioning and installing new service. So there is a fair amount of variability in that piece, and the important matter is to make sure that you are accurate about your forward sales funnel and that you size that portion of your SG&A realistically to what you see in the forward sales funnel.

James Q. Crowe

Next question?

Operator

We will go now to Michael Rollins with the Citi Investment Research.

Michael Rollins – Citi Investment Research

Hi. Thanks. The question, actually, two questions. First, I wasn’t sure if I had heard before a dollar specification on the currency impact for Q3 and what you are anticipating for Q4. So, if you could just describe it in a dollar terms, and if that’s all in international or if it’s spread just between the different customer segments.

The other question I have for you is if you look at the SG&A in dollars, how well can you get that to and continue to maintain the sales productivity that you are looking to achieve, the service levels that you are looking to achieve as you look at streamlining the organization over the next 12 months? Thanks.

James Q. Crowe

Let me answer the second question, Sunit, while you are thinking about the first. I think we have said previously that 60% to 70% of our variable SG&A, I supposed in the long term, all of the SG&A is variable but if you think of fixed, semi-variable, and variable, the variable portion of our SG&A which is people and directly related costs, benefits, travel, entertainment, communications.

Of that variable portion, about 60% to 70% and that kind of range is associated with not with the current bulk of business but rather with selling and provisioning and installing new service. So, there is a fair amount of variability in that piece and the important matter is to make sure that you are accurate about your forward sales funnel and that you size that portion of your SG&A realistically to what you see of forward sales funnel.

In addition, capital expenditure with the exception of maintenance CapEx which I think we have said is in, what is in it, 150 to 200 range, is also success-based and variable. So, between the two, there is a substantial portion of the SG&A which needs to be accurately geared to your view of your forward sales funnel and it is a fairly large number.

It is one of the, I suppose, benefits for all companies that are in that recurring revenue business, that is, if they are not overly optimistic, or on the other side, pessimistic about their future. It is a fairly durable business model. Does that answer your question?

Michael Rollins – Citi Investment Research

Well, I supposed I am trying through the SG&A in the quarter and the convert was about $388 million and it has been coming down over the last two quarters and so, I am just trying to think about as you are gearing to your sales objectives, is there a lot more efficiency that you expect to extract from this line item or are we getting to the point where you are at in an inefficient spot in your operations where SG&A from here may not be able to get the same kind of improvements we have seen over the last call at four or five quarters?

Sunit Patel

Yes, Mike, I can take this better. I think the SG&A reduction is along the lines of what we have talked about for quite a while in terms of this year. So, I think all we have been doing is executing well along the plan that we have outlined for about a year.

Looking forward, again, when you put seven companies together and as you can barely improve your business processes and as Jim said, more accurately target the expenses between the S and the G&A. Remember the S part of SG&A is pretty small. If you look at our resource-based between employees and outsource people, the S part of G&A is pretty small from one perspective in terms of direct sales people.

So, Jim's point, when you looked at the overall SG&A expense, we have continued to increase more effort directed to the S part of that SG&A and have been reducing the G&A and we continue to find opportunities for improvement there. So, I think that there’s plenty of opportunity for us to continue to improve our operating expenses and I think we’ll continue to do that. We still think there’s a favored opportunity. I’ll leave it at that.

James Q. Crowe

Yes, and another thing I’d add is we have said that sometime around the end of the year and you can't be precise to the month, but sometime around the end of the year, we expected to complete the integration activities as described by Sunit and that, at that point, what you ‘ve seen in the past which is every dollar and new revenue, the gross margin that is about 80% in the core network services has been dropping to the EBITDA line, in fact, more than that given improvements in network grooming.

Sometime around the end of the year, we expect we would have perhaps $0.15 to $0.20 of SG&A for each incremental dollar or revenue and that of course is not going to happen on January 1st. That will increase run rate over some period of time, the better we get at unity, the better we are at overall cost management. Of course, it is going to be at $0.15.

Sunit Patel

Yes, but then in all terms just, given everything we are doing, we still feel there is continued opportunity for cost reduction and at the same time increasing our efforts on the selling side.

Michael Rollins – Citi Investment Research

Thanks, Sunit. Can you just hit on the foreign currency question? That would be great.

Sunit Patel

Sure. I think you can look at our sequential growth rate as I said, on a constant currency basis, it’s about 1.8%. On the reported basis, it’s about 1.5%. So, the difference is in exactly about $3 million.

Michael Rollins – Citi Investment Research

And do you have an estimate on what you put on the guidance for the currency changes in Q4?

Sunit Patel

We have not really provided specific guidance on Q4. We have talked about revenue in overall terms for the year, but I think our assumption is exactly, we do not typically try to predict rates out of quarter.

Michael Rollins – Citi Investment Research

Thanks very much.

Operator

We will go next to David Dixon with FBR Capital Markets.

David Dixon – FBR Capital Markets

Thanks and good morning. I wanted to discuss three quick questions and get some feedback please, just from business strategy standpoint, secondly, on technology developments, and thirdly, on cost. Firstly, I wonder if you could provide an update on the transition of your sales force from a wholesale to retail focus organically and then talk about perhaps the value of the foreign companies that maybe further advancing in this area to accelerate that strategic transition.

And secondly, on technology, in parallel with the regulatory developments to simplified access rates Simon (ph 01:05:59) talked about earlier, we are seeing a shift from TDM-based to IT- based in connections where any connection points could be dramatically reduced. I wonder if you could discuss the (inaudible 01:05:10) on demand for your wholesale voice transit business.

And then thirdly, just on cost, the cost cutting efforts have been quite significant. I wonder if you could just talk a little bit about the opportunity or discuss some recent actions you might have taken to leverage the impact of the downturn to restructure some of your maintenance and support contracts on your hardware-base. Thanks very much.

James Q. Crowe

Yes, with respect to that first question, the transition from a wholesale to a retail base, let me put in context my answer, roughly, roughly 70% overtake of our revenue is in wholesale content in Europe where there is no transition. That is our historic sales force selling to our historic-based customers.

I think your question may refer to the business markets group. Roughly 30% of our core network services business, 25% of our overall communications revenue.

David Dixon – FBR Capital Markets

That is correct.

James Q. Crowe

And we acquired a series of companies with a sales force. Incidentally, that sales force is, give or take, about 45% of our quota-bearing head count. When we acquired that sales force, they were selling to what you are referring to as retail or what we would call enterprise companies.

The repositioning is not a repositioning from wholesale to retail. It is a repositioning from the focus on everything from 500 to larger customers to those, as I said earlier, who tend to buy more per month and repositioning on that more than selling anywhere in a city.

So, we target 80% incremental margins. To do that requires discipline, selling to the right accounts with the right services in the right locations. And the repositioning is to make certain that we have sales people who are trained in our products, trained in our approach, and trained in our target accounts.

Neil, do you have a comment?

Neil Hobbs

No, I think you have summarized it, Jim. I would say that our approach is to have a professional sales force using professional techniques irrelevant of what marketplace they are operating in and not (inaudible 01:09:10) implementing in business markets group.

James Q. Crowe

Your comment, interestingly, or your second question actually bears a bit on the first. There is a convergence, not just in technology but in services towards what Betty Miller (ph 01:09:29) who said in her calls IP tone. And more and more, what our largest customers purchase to our smaller end enterprise customers are very similar sets of services.

Now, what we referred to as speed and feed change. That is the speed of the interface, slower-higher unit cost but from a technology point of view, as enterprise has moved integrated access, meaning you buy an IP op or optical pipe over which you could converge all your voice data video services. What you sell, enterprises is increasingly looking like what you sell to content providers and increasingly, what you sell to wholesale providers. That is the fundamental of our strategy.

By the way, I did not understand your question about converged technology. When you say TDM to IP, could you give me that question and maybe add a little more detail?

David Dixon – FBR Capital Markets

Sure, Jim. What I was thinking back specifically there was the handoff some TDM for traffic is a lot more decentralized now and distributed and in an IP environment where migrating to perhaps a more simplified opportunity and lower cost opportunity where you can do the handoff a lot more efficiently perhaps in your local region, it is getting to an internet exchange point.

So, just thinking about the simplicity migration across the IP for carriers and the impact that might have on the host of voice transmit business going forward.

James Q. Crowe

I got you. The wholesale voice transmit business, let me make sure, voice transmit and voice termination might be two different things but, in general, IP optical interfaces are getting more and more market based and standard. Market based is important because they do not look today the way they did look four of five years ago. They move. They change.

Today, we sell 2.5 and 10 gig waves. That was sufficient not all that long ago to cover the needs of New York City. Now, we have customers, enterprise, and user kind of enterprise customers who buy 2.5 and 10 gig waves. With respect to voice, voice termination, that is, people handing us their minutes, generally in TDM form, cellular is a big part of it. And then we convert to IP, move it over our network and terminate it over our local infrastructure.

You are correct. Some cost comes out if they hand it to us in an IP form. And that is occurring although I suspect there will be a fairly long tail on that. With respect to transit that at least in our world means between switches, inter-machine trunking if you were a voice. That is a lot of IP today. Even for TDM or circuit-based switches, most of the vendors are selling front ends that take even older switches and put an IP front ends. So, you can use IP optical front.

So, that transition has happened a lot but for terminating, you are right, we can take some cost out.

David Dixon – FBR Capital Markets

Jim, sorry, just to circle back on that. So, you do not see that there is an increased disintermediation risk in an IP environment where the handoff might be done more directly between the originators and the termination carrier?

James Q. Crowe

Oh, I think on a much broader basis that over time, the real disintermediation occurs when voice from enterprises, voice from individuals leaves either the building or the home in IP form. When that happens, it does not make much difference whether it is voice, web pages, or video over the internet. It is all going to be the same over an IP optical pipe. That is what we have positioned our company for.

I think that is going to have some, I mean, I am far from the only ones who observed this. There is a lot of people on this phone call, analysts who have observed that for cellular and for traditional voice providers to the residents and to the business, that is going to have an effect because, take your originating price per minute, you know, minute or a cent or something. One cent per minute at the originating end in TDM form, that is going to go to a thousandth of a cent, if it is in IP form.

That is something that we expect and have believed for quite a while but if you got a big business providing residential voice on a circuit basis or cellular on a circuit basis, you have got to manage that transition.

David Dixon – FBR Capital Markets

And then circling back on cost?

Sunit Patel

Yes, on the cost, Neil Hobbs can talk more about this but as we have indicated in the past specifically with respect to hardware management but just in general, we have a purchasing and supply chain management organization that looks at all our supply contracts on a regular basis. In this standard time, we also have some more lenders. Then we are taking more aggressive look at it across the board, but I will let Neil talk in general about how we are looking at our cost with its off-shoring and look in the vendor management he has groups of. He can wrap it up.

Neil Hobbs

I think as we see the opposite of sales cycles at (inaudible 01:15:33), we believe that on the other side of our business, it is a buyer's market and it is an opportunity for us to capitalize on that state of the marketplace.

David Dixon – FBR Capital Markets

And, Neil, would that be something that you would have all ready taken steps to take advantage of or is that something that you see going forward on the course?

Operator

We will go next to Donna Jaegers with D.A. Davidson.

Donna Jaegers – D.A. Davidson

Thanks for taking my questions, just two quick ones. You mentioned seeing stronger demand on the Wireless Backhaul market. How much, given the capital intensity of running fiber out to the towers, how much of this market can you guys really address?

And then my second question has to do with Alltel, when you guys used to call up the top ten customers, Alltel was always on that list and at that time, I think, top ten accounted for about 30% or so of your sales, can we conclude that Alltel is around 3% of your sales?

James Q. Crowe

I do not think they are quite that size but they are in the top 10. Alltel, I mean, we have taken our look at it. We believed that given the mix of in-service territory and out-service territory, meaning, in Verizon, out of Verizon. For IP optical transport products, puts and takes, we believe, are reasonably balanced. Wholesale voice services where there are also our customer depending on Verizon's desires, we could see a reduction in wholesale voice. However, that again is a lower margin, lower impact product and is volatile.

With respect to wireless, your question about wireless? I think what I said in my remarks and I want to repeat is that we are seeing greater demand between wire mobile switching centers. That is our big opportunity, inter-machine trunking and network grooming, et cetera, transit between providers. That is the big growth area.

Your point about the towers, I think, is right on. We have said for some time that the tower backhaul market is a future market. Meaning, these numbers mask a great wide range of demand. But a tower, if it has a dozen T1, it is a pretty big tower in the voice world, given the growth in wireless data which is very high. There are other people on the call who track this very closely, as you know, unit growth rates are very high. Tower backhaul needs are expected to grow DS3's, a 45 megabit pipe and eventually into the OC-3s.

That, by the way, we believe, explains why wireless providers are paying quite a bit of attention to special access pricing. I say again, special access is the bread and butter of tower backhaul. You got a few T1s and you are handling it with a microwave or a microwave and a copper-based T1, big deal. You start seeing wireless data demand, that is a whole another matter and then it becomes a substantial piece in your cost.

Today, that is the future market, 10,000 towers really are the key in the US. Each one, last time I looked at 3+ tenants per tower. What we would observe is no one of the tower tenants, that is, the service providers, is the natural provider because they are competing with the other two-point, whatever it is. A third party makes sense. And if you are going to build as demand grows and the crossover between, let us call it copper and microwave, a crossover occurs and it favors fiber, you are far better off while you are building including enterprise buildings, wireless towers, wholesale location, content locations, internet traffic exchanges, data centers, et cetera.

So, we would agree with you, Donna. It is not today but over time, we think we are in a better position than most because we can include that set of demand with a whole lot of others sets of demand not simply address tower backhaul.

Donna Jaegers – D.A. Davidson

Great. Thanks, Jim.

James Q. Crowe

Next question?

Operator

We got Tim Horan with Oppenheimer.

Tim Horan – Oppenheimer & Co.

Thanks, good morning, a couple of questions. Sunit, can you maybe go through what SBC is using, guys, now, and do you think this revenue run rate and maybe what the profitability is on the business? And secondly, Sunit, maybe you can go through why you are seeing more weakness you think on a smaller account front because we are not really hearing that from AT&T out there and then just quick follow up for Jim?

Sunit Patel

Yes, I think, on the smaller accounts, we have been seeing now for, or I will let Neil handle that and I think w respect to the contract itself, revenues have been more stable but then honoring our commitment. And I think we might start seeing more movement. But in general, the profitability is good at (inaudible 01:21:29). And so, it depends also on which of those revenues are used at driven meeting days, days the customers are on their end in which case that makes it sticky.

So far, what we have seen over the last couple of years is that most of the decline has been on the voice side of the revenues. The data side has not been going down as much. And looking forward, we are looking at various opportunities in terms of what we can do to secure their revenue base and more but will let Neil, perhaps talk.

James Q. Crowe

We have set 50% incremental gross margin, just to repeat, we said publicly up or down.

Neil Hobbs

As Jim said earlier we have been following a strategy growth in our business market for over a year now that really looks at our ability to service a customer and that customer's ability to buy on net services from us that we supply.

So really, the weakening has been we believe that some of that inherited customer-based that we got from acquisitions were better suited by other providers that can suit their requirements better. And that is really why you see a weakening from that site.

James Q. Crowe

Simply, we do not sell into it and that is churn that we would encourage. It is not unexpected. It is not undesired. We think that end of the market for us is not a place we are going to get a kind of incremental margins over time that we want.

Tim Horan – Oppenheimer & Co.

Thanks and on the AT&T revenue run rate?

Neil Hobbs

I think that is what I was talking about, right? What is?

Tim Horan – Oppenheimer & Co.

Oh, I am sorry, I did not understand it.

Neil Hobbs

Are you saying what was the revenue?

Tim Horan – Oppenheimer & Co.

No, sorry. Maybe what do you think the run rate is going to be at from this point?

James Q. Crowe

We have said figure 30%, 40% annual declines on going forward. Historically, it has been less than that, but if you want what we have planned for internal purposes. We are thinking in terms of the 30% 40% annual has declined.

Tim Horan – Oppenheimer & Co.

Okay. So, do you think on the other revenues, is this is decent run rate going forward where we are at now?

Sunit Patel

It is the same thing. I think if you look at the year-over-year decline, it was 33% in the third quarter. That is, like Jim mentioned, for the other than SBC revenue taken as a whole, we think it is about at 30% to 40% decline a year.

Tim Horan – Oppenheimer & Co.

Okay, thank you.

Operator

We will go next to Michael Funk with Merrill Lynch.

Michael Funk – Merrill Lynch

Great, thank you very much. Historically, discuss the importance of when revenue has actually online from the timing of the revenues during the quarter. Can you please discuss the trajectory of (inaudible 01:24:31) services revenues during the third quarter and specifically the exit rate when thinking about the fourth quarter revenues there?

James Q. Crowe

I am not sure I understand your question. Are you asking what we expect to see for fourth quarter CNS, core network services?

Michael Funk – Merrill Lynch

I am asking specifically, historically, you have talked about when revenues come online and of course, the longer that you have the revenues during the quarter, the grade of the run rate for the following quarter, right? You have talked about historically? I am trying to think about the timing of revenues coming online during the third quarter, how that trended and where you were for an exit rate at the end of third quarter?

James Q. Crowe

Yes. I am not sure I understand the question.

Sunit Patel

Are you saying during what months did the revenue come in the third quarter and therefore, what does that mean for the fourth quarter?

Michael Funk – Merrill Lynch

That is correct.

Sunit Patel

Okay. So, I think remember first that core network services, there are really two components. There is the recurring component which is driven by when you turn up the revenue in a particular month to your question and then there is the usage component which can vary a fair bit.

So, I think the guidance we have indicated, they that it takes into count everything. I think probably more important if you look at the sequential growth rate we have reported. Now, there is always volatility quarter to quarter because the usage part of that CNS services drives some of that. But if you look at the remarks that I had, basically what we were saying is that the sequential core network services revenue grew one and up per center on reported based is 1.89% on the constant currency basis. And the second quarter, it was about the same, 1.8%. And the fourth quarter will depend to some extent on what we have turned out during, as you said, when in the particular quarter and then some of it, I mean, in the quarter and some of it will depend on usage.

James Q. Crowe

Yes, let me try this. I have been thinking about your question. Whether we turn up CNS and let us take an example, in July, August, or September, all of it affects the revenue for that quarter which a turn out had been in July, for instance, you get the bill for, this is recurring, not usage, you get the bill three times in August 2 and September 1.

For the fourth quarter, what matter is it is not when you turn it up, it is the exit run rate of CNS recurring revenue. You take that and then what matter is you turn up CNS in October, November, December. So you take the exit run rate plus three times or three month's worth of whatever we turn up in October 2 and November 1 and December, if I understood your question.

When we turn it up in the third quarter, it is what we exited a quarter with.

Michael Funk – Merrill Lynch

And those are the two parts of the question, I think. First, when do you turn it up during the third quarter thinking about the third quarter revenues specifically but then also the exit rate?

James Q. Crowe

Yes, the exit run rate. I think, this is one we would be happy to talk and since it is math, we are recurring revenue business, we would be happy to talk with you offline.

Michael Funk – Merrill Lynch

Sure, I would appreciate that.

James Q. Crowe

Next question?

Operator

We are going to try Jonathan Schildkraut with Jefferies.

Jonathan Schildkraut – Jefferies & Co.

Thanks guys for taking this question and extending the call to accommodate some of us. I just had a question on process on the debt purchases, how does that work? Can you go into the open market and repurchase debt or does somebody have to come to you and make an offer? Just kind of get understanding of how the process starts and get to execute it? Thank you.

James Q. Crowe

Let me, so that you can amplify, but these are so called, if you are referring to an exchange of equity or debt, these are so called 3(a)(9) transactions under the Securities and Exchange Act. They have a fair amount of regulatory requirement and detail. And we checked with our securities attorneys pretty carefully. I do not want to give the detail other than to say we are careful as always to observe regulation. We do not talk about what we will or would not do on a forward basis. We report it to everyone as we need to. But this is something that there is a fair amount of regulatory structure around.

Is that is the last one? Well, I guess that is the last question. I want to thank everybody for listening. No doubt, these are uncertain times both for businesses and individuals. As we and many other companies noted, visibility is more limited than it has been in the past.

I would point out, though, that our company and its employees, we have been through other periods of uncertainty and from our perspective, the uncertainties during the early 2000 is in many ways, were larger than what they are today. It gets pretty clear we are in a better position and the industry is in the better position today than we were at that time. Industry pricing and demand is better today. We and others have observed that.

We certainly have a much larger, much more diversified and growing revenue base back then. Our revenue base was declining. We clearly have a broader set of services and products that are right square in the middle of the sweet spot of the market and most importantly we have a rapidly improving and positive free cash flow. I think it is fair to say by any operating measure, we are stronger than we have been at any time in our history. And we have the people and assets to benefit from what will certainly be opportunities that always come from uncertainty.

I want to close by thanking all of our employees for their hard work and especially for the continued focus on meeting the needs of our customers. My confidence on our ability to successfully navigate in these uncertain times is a direct result in my confidence in Level 3's men and women. Thanks for listening. Operator, that ends the call.

Operator

This concludes today's Level 3 Communications, Incorporated, Third Quarter 2008 Earnings Conference Call. Thank you for attending and have a good day.

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