Troubled DSL provider Covad Communications, which Saturday announced that it would cut an additional 400 jobs — about 50 percent of its workforce — in an attempt to cut costs, Monday revealed that it ended its fourth quarter and calendar 2000 with 274,000 total lines in service.
The company said the number exceeded its expectations of 270,000 lines, a strong increase over the 205,000 lines it recorded in the third quarter. But the bigger picture may be that it also conceded it is not recognizing revenue on 92,000 of those lines — about 33 percent. The Street had been expecting that number to be in the area of 70,000. Covad said the number of ISPs for which it is not receiving revenue has increased from 14 to 19, and four of those ISPs — Flashcom Communications, Zyan Communications, Relay Point and FastPoint — filed for Chapter 11 protection in December.
About 97 percent of Covad’s lines were sold through Covad resellers while Covad sold 3 percent of its lines directly to end users. The lines split about 50-50 between business lines and consumer lines.
Goldman Sachs lowered its fourth quarter 2000 revenue estimates for the company for a second time Monday morning, adding that it believes the company’s situation could worsen given an overall slowing market and Covad’s limited cash reserves.
“In addition to having negative implications for 4Q00 financial results, we are concerned that the additional 20,000 delinquent lines may not have been fully accounted for in recently released guidance and could be indicative of management’s limited visibility into the health of its ISP channel partners,” Goldman Sachs said Monday. “Such difficulty in assessing the health of its partners represents another challenge for Covad as it strives to conserve cash in a slowing macro environment, while maintaining a business where intense competition with ILECs could limit growth and margin opportunities.”
Goldman Sachs said it is now anticipating Q4 revenue of $61 million and an EBITDA loss of $168 million as opposed to its previous estimate of $65 million in revenues and an EBITDA loss of $164 million. It added that it now assumes gross margins for the quarter will be negative 12 percent versus its prior estimate of negative 5 percent. While Goldman Sachs said it would not revise its 2001 estimates until it gets a clearer picture based on Covad’s fourth quarter call, the company did say that it feels the situation will get worse.
“Given the worsening diagnosis of the health of its channel partners, the competitive environment of wholesale DSL and the company’s limited cash reserves, we are highly skeptical that Covad is fully funded into 2002,” Goldman Sachs said. “Thus Covad’s situation is dire as we believe its additional cash needs to fully fund the company’s current plan could be in the range of $1.5 billion, and we are unlikely to see any meaningful improvement in Covad’s ability to access capital markets in the near-term.”
However, Covad countered Goldman Sachs’ estimates of its financial strength.
“We are funded into 2002 and we expect to be profitable in 2003,” said Suluh Lukoskie, a company spokesperson.
Bob Lane, program manager with The Yankee Group’s Consumer Market Convergence Planning Service, was also more upbeat concerning the company’s long-term prospects, noting that weakness in the ISP market — which Covad uses for its channel sales — is a known factor. He added that about one third of the lines for which Covad is not recognizing revenue are related to the four ISPs which filed for bankruptcy protection last month.
“This isn’t a problem with underlying customers paying,” Lane said. “Customers are paying the ISPs. The ISPs, however, are unable to pay Covad. It doesn’t signal a weakness in the market but it is forcing people to rethink their channel sales market and refocus on ISPs wit
h stronger balance sheets. What this means generally for the DSL market is that they’ll have to treat their channel marketers more as strategic partners than just as sales channels. They need to be more selective in who they use and it probably means that they’ll have relationships with fewer of them and they’ll tend to be more exclusive.”
He added, “Consumer demand for broadband remains high. Carriers are going to have to be out there to meet this demand. The long-term prospects for these companies are that there’s demand for these products they offer. They just need to make sure that the middle man is financially strong enough that they can rely on those revenues.”
Lane said he was encouraged by the strong ramp of Covad’s line sharing program. The company said Monday that it installed 17,000 line shared lines in the fourth quarter as compared to 400 in the third quarter. It also said it expects the number of line shared lines to increase as operational processes improve with incumbent local telephone companies.
“I think that one of the things that’s going on out there is that they’re beginning to see the relief from line sharing,” Lane said. “It is essential for this market. It will increase Covad’s margins per line…In this business their biggest expense is paying for the monthly leasing of lines from the incumbents. Anything that can decrease that will be better for Covad and for DSL carriers as an industry. This rapid increase that we’ve seen in line sharing is a good sign.”
Covad also reported that its Covad Safety Net program is helping end users transition from troubled ISPs to the Covad.net service or another ISP. It said that in the nearly three weeks since the program was unveiled it has transitioned about 1,500 lines, representing 30 percent of lines from two ISPs.
“The safety net transition program is going as expected and we are in the process of transitioning more lines in the first quarter,” Lukoskie said.
While Lane did not comment directly on Covad’s program, he said it was clear the company had to take action.
“They had to figure out a method of moving customers to ISPs from which they can recognize revenues,” he said. “As they can transition lines to stronger carriers they can begin to recognize that revenue again. As soon as they can do that they can start booking those revenues on a monthly basis.”
However, he noted that as the company transitions its customers it must take care not to disrupt the market for retailing lines. “They have to be careful not to pull the rug out from under carriers,” he said. He added that speed is of the essence because the picture for transitioning becomes much cloudier once it is under the purview of bankruptcy courts.
On the whole, Covad Chairman Chuck McMinn maintained an optimistic line concerning the company’s announcement.
“We continue to excel operationally on many fronts,” he said. “We beat line expectations for the quarter, we have transitioned to a line shared process in our consumer business and we are converting distressed lines through our Covad Safety Net program. This continued strong operational performance combined with a strict focus on maximizing efficiency in the business, will help us demonstrate significant progress along our new plan for 2001.”
