Covad Ends Year with More Lines,
But Fewer ISPs Pay Up

The DSL provider ends its fiscal year with upbeat news that more total lines are in service than expected, but Covad needs to scrutinize the financial vitality of its ISP channel partners in order to survive the future.

by Thor Olavsrud of internetnews.com [January 9, 2001]

Troubled DSL provider Covad Communications, which last week announced that it would cut an additional 400 jobs—about 50 percent of its workforce—in an attempt to cut costs, this week 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.

What an analyst wants
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 increased from 14 to 19 channel partners, and three of those ISPs—Flashcom Communications, Zyan Communications, and Relay Point and filed for Chapter 11 protection in December.

About 97 percent of Covad's lines were sold through its resellers, while Covad sold 3 percent of its lines directly to end-users. The high-speed lines in service are split about 50-50, between business lines and consumer connections.

Goldman Sachs lowered its fourth quarter 2000 revenue estimates for the company for a second time this week, 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," a Goldman Sachs spokesperson said.

"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."

Lowered expectations
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."

Counter claims
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.

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