SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): December 7, 1998
Level 3 Communications, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 47-0210602
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3555 Farnam Street, Omaha, Nebraska 68131
(Address of principal executive offices) (Zip code)
402-536-3677
(Registrant's telephone number including area code)
Not applicable
(Former name and former address, if changed since last report)
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Item 5. Other Events
The reports that Level 3 Communications, Inc. files with the SEC and
our other communications may contain forward-looking statements that involve
risks and uncertainties. We consider a forward-looking statement to be those
statements that describe our intentions, beliefs, and current expectations with
respect to our future operating performance. Our actual results could differ
materially from those anticipated in our forward-looking statements as a result
of certain factors. These factors include those that we describe below. The
risks and uncertainties described below are not the only ones facing our
company. Additional risks and uncertainties that we do not know about or that we
currently believe are immaterial may also impair our business operations. The
following factors amend and restate the risk factors disclosed in our Current
Report on Form 8-K/A filed with the SEC on April 30, 1998.
Dependence on New Business Plan
Our business plan requires that we create our end-to-end Internet
Protocol, or IP, based network. The network's creation will cause us to generate
substantial operating losses. These activities will also require us to spend a
significant amount of capital. Since we have only recently begun to implement
our business plan, it is extremely difficult for investors to evaluate the
plan's risks and rewards. Our success will depend upon a shift in providing our
customers' communications services (traditional voice, fax and other services)
over our IP-based network instead of the public switched telephone network. We
can not assure investors that our network will be able to compete successfully
with the current public switched telephone network or other networks. Our
success will also depend on our ability to do each of the following in a timely
manner, at reasonable costs and on terms and conditions that are acceptable to
us:
o assess the competitive advantages of entering new markets;
o raise substantial additional capital;
o design fiber optic network backbone routes;
o install fiber optic cable and facilities, including switches/routers;
o obtain rights-of-way, the right to have access to buildings and any
required government authorizations, franchises and permits;
o attract customers; and
o identify, finance and complete suitable acquisitions and, potentially,
joint ventures.
To manage our growth, we must create complex operating and administrative
procedures and systems. These include systems relating to ordering, provisioning
and billing for communications and information services. We will also be
required to improve and upgrade these systems continually. We must also continue
attracting and retaining a large number of qualified managerial, professional
and technical personnel. If we fail to do these things, we may be unable to
implement and manage successfully our business plan.
Since our new business plan is a significant expansion of our
communications and information services business, we believe that our historical
financial results for periods ending prior to January 1, 1998 will not provide
investors with a meaningful indicator of our future financial condition or
results of operations.
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Substantial Operating Losses Expected
The development of our business plan requires significant capital
expenditures. We expect to incur a large portion of these capital expenditures
before we receive any significant related revenues from our business plan.
Because of these capital expenditures and the related early operating expenses,
we expect substantial negative operating cash flow and net losses for the
foreseeable future. In addition, we may never establish a significant customer
base for our communications and information services business, and even if we
do, we may continue to sustain substantial negative operating cash flow and net
losses. As a result, our operations may never achieve or sustain profitability
in the future.
Substantial Capital Requirements
The implementation of our business plan and our ability to meet our
projected growth depends on our ability to secure substantial additional
financing. We expect to meet our need for additional capital with the proceeds
from the sale of our equity and debt securities and credit facilities. In
addition, to fund our business plan, we may (1) sell existing businesses or
investments and/or (2) sell or lease fiber optic capacity or access to our
conduits. We estimate that the implementation of our business plan, as currently
structured, will require between $8 and $10 billion over the next 10 years. The
implementation of our business plan and our future financial results could be
adversely affected if we are not successful in:
o producing sufficient cash flow from our operations;
o raising sufficient debt or equity capital on terms that we consider
acceptable; and
o selling or leasing fiber optic capacity or access to our conduits.
In addition, if the actual costs and expenses of our business plan's
implementation exceed our current estimates, our future financial results could
be adversely affected. In addition, if the amount of additional financing we
need is higher than we currently estimate, our future financial results could be
adversely affected. If we fail to generate sufficient funds, we may be required
to delay or abandon some of our future expansion or spending plans. This could
materially adversely affect the timing of our business plan's implementation.
The additional financing we need may not be available at the time we
require it. In addition, that financing may only be available on terms that we
find unacceptable. If we are unable to obtain additional capital when we need
it, we may be required to scale back significantly our business plan. In
addition, if our cash flow from our existing business is not sufficient without
additional financing, we may be required to reduce the scope of our plans and
operations. Also, the terms on which we would be able to obtain future
additional financing may restrict our ability to obtain even more capital or
engage in other business activities that may be in our interest. Our financing
needs may vary significantly from our current expectations if:
o we are unable to generate anticipated cash flows; or
o we require more funds for capital expenditures than we currently
anticipate, particularly as a result of future network infrastructure
installation requirements.
If our operations do not produce positive cash flow in sufficient
amounts to pay our financing obligations, our future financial results will be
materially and adversely affected.
Difficulties in Constructing, Operating and Upgrading Our Network
Our ability to generate positive cash flows from operations will depend
in large part upon our ability to:
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o construct our network successfully - both on time and on budget;
o attract customers to our IP based network; and
o achieve substantial traffic volumes on our network.
Our network's construction will be affected by a variety of uncertainties and
contingencies, including whether the installation of the parts of our network
will be completed in a timely manner. The construction, operation and any
upgrading of our network is a significant undertaking that requires the
deployment of substantial capital resources. Administrative, technical,
operational and other problems that could arise may be more difficult to address
and solve due to the significant size and complexity of the planned network. In
addition, certain technology that we are developing is largely unproven and may
not be compatible with existing technology. Technical problems may arise with
our network once it is built. These problems may include ones related to
increases in the network's traffic volume. Many of these factors and problems
are beyond our control. As a result, the entire network may not be completed as
planned for the costs and in the time frame that we currently estimate. Although
we believe that the network's cost estimates and the build-out schedule are
reasonable, the actual costs or time required to complete the network may
substantially exceed our current estimates.
The successful and timely completion of our network will depend, in
part, on our ability to:
o manage the construction of route segments effectively and cost efficiently;
o obtain additional rights-of-way;
o install network connections, interconnections and build outs;
o attract qualified technicians capable of dealing with the network's
expected technologies; and
o have our suppliers and third party contractors timely perform their
obligations.
Our future financial conditions and results of operations will be
materially adversely affected as a result of a significant delay in the
completion of our network.
After its initial completion, future expansions and adaptations of our
network's electronic and software components may be necessary in order to
respond to:
o a growing number of customers;
o increased demands by our customers to transmit larger amounts of data;
o changes in our customers' service requirements; and
o technological advances by our competitors.
Any expansion or adaptation of our network will require substantial
additional financial, operational and managerial resources. If we are unable to
expand or adapt our network to respond to these developments on a timely basis
and at a commercially reasonable cost, then our future financial condition and
results of operations will be materially adversely affected.
Need to Develop Voice Technology for IP Networks
We are designing our network to be optimized for IP-based
communications, rather than circuit-switched based communications. While
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generally adequate for data transmission needs, existing IP networks usually are
not configured to provide the voice quality and real-time communications
requirements of a traditional telephone call or fax transmission. With current
technology, this quality can only be achieved by providing a very large amount
of communications capacity. There are also currently concerns about the
reliability and security of IP-voice networks. To complete a call, existing
voice-over IP services generally require:
o a combination of substantial capacity; and
o either customized end-user equipment, the dialing of "access codes" or
other special procedures.
We are in the process of developing technology to enable us to
transmit telephone calls seamlessly over our own router-based IP network and the
circuit-based public switched telephone network. We do not believe that this
technology is currently commercially available. Our efforts to develop or
acquire (including through obtaining licenses) this technology in a timely
manner and at an acceptable cost may not be successful. In addition, developing
or acquiring this technology may require significant resources and management
attention. Our failure to develop or acquire this technology in a timely and
cost efficient manner could have a material adverse effect on our business,
financial condition and results of operations. We believe that the design of our
network should address the other significant issues associated with IP-voice
transmission (latency, reliability and security). If our assessment of the
adequacy of the solutions for these other issues is incorrect, our ability to
offer IP-voice services will be impaired.
Development of Effective Processes and Systems
We, along with our vendors, are developing automated processes and
systems for:
o implementing customer orders for services;
o provisioning, installing and delivering these services; and
o monthly billing for these services.
Since our business plan provides for rapid growth in the number and volume of
products and services we offer, we need to develop these processes and systems
on a schedule sufficient to meet our proposed service rollout dates. In
addition, we will require these processes and systems to expand and adapt with
our rapid growth. The development of these processes and systems is a
complicated undertaking requiring significant resources and expertise. The
failure to develop effective internal processes and systems could have a
material adverse effect on our ability to implement our business plan.
Dependence on Hiring and Retaining Qualified Personnel; Key Personnel
We believe that our future success will depend in large part on our
ability to attract and retain highly skilled, knowledgeable, sophisticated and
qualified managerial, professional and technical personnel. Our businesses are
managed by a small number of key executive officers, particularly James Q.
Crowe, Chief Executive Officer, R. Douglas Bradbury, Chief Financial Officer,
and Kevin J. O'Hara, Chief Operating Officer. The loss of any of these key
executive officers could have a material adverse effect on us. We have
experienced significant competition in attracting and retaining personnel who
possess the skills that we are seeking. As a result of this significant
competition, we may experience a shortage of qualified personnel in the future,
especially given our substantial hiring needs.
Products and Services
To satisfy our long-term strategic growth objectives, we must offer,
market and sell competitive products and services. To provide our products and
services competitively, we will need to:
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o obtain the needed capital to implement our network;
o continue to capitalize on additional favorable regulatory developments;
o recruit and retain an effective sales force;
o differentiate our products and services from existing and future
competitors'; and
o assess and access markets.
We may be unable to meet these needs. If we fail to meet these needs, that
failure could have a material adverse effect on our business, financial
condition and results of operations.
Rapid Expansion Plans; Management of Growth; Strategic Transactions
Part of our business plan is to achieve rapid growth by building our
network and using this network to exploit opportunities expected to arise from
market, regulatory and technological changes and other industry developments.
Our business plan also contemplates exploring opportunities for strategic
acquisitions and joint ventures, which could be material. As a result of our
strategy, our management expects that we will experience rapid expansion for the
foreseeable future. This growth will increase our operating complexity. Our
ability to manage our expansion effectively will depend on, among other things:
o the expansion, training and management of our employee base, including
attracting and retaining highly skilled personnel;
o the development, introduction and marketing of new products and services;
o the successful integration of acquired operations and joint ventures;
o the development of financial and management controls; and
o the control of our expenses related to our business plan.
Our failure to satisfy any of these requirements, or otherwise manage our growth
effectively, could have a material adverse effect on our business, financial
condition and results of operations.
To manage growth effectively, we must develop our sales force, external
installation and repair capability, customer service teams and information
systems. Managing our growth will also be complicated by the significant size
and complexity of our planned network. That size and complexity may place heavy
demands upon our direct sales force, installation and repair capabilities,
customer service and support organization, business support systems, third party
vendors and management. If we are unable to manage our growth effectively, our
business and results of operations could be materially adversely affected.
In addition, we may be unable to (1) identify suitable candidates for
acquisition or joint ventures, especially given the intense competition in the
telecommunications industry or (2) obtain the financing necessary to complete
those transactions. If we pursue acquisitions and joint ventures, our resources
and management time will be diverted and we will have to integrate these
operations with our existing network and services.
Lack of Interconnection and Peering Arrangements
Our success will depend upon the cost effective development and
expansion of our network infrastructure and support services to provide
sufficient geographic reach, capacity, reliability and security. The development
and expansion of our network will require that we enter into agreements, on
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acceptable terms and conditions, with various providers of infrastructure
capacity. In particular, we need to obtain "interconnection agreements" with the
current providers of local telephone services or incumbent local exchange
carriers ("ILECs") and "peering agreements" with the providers of services to
access the public Internet or Internet Service Providers ("ISPs").
Interconnection Agreements. As of November 10, 1998, we had
interconnection agreements in 13 of the 15 cities in which we plan to launch
services in 1998. As we expand our operations in current and additional markets,
we may have to negotiate new interconnection agreements or renegotiate our
existing interconnection agreements. If we are unsuccessful in (1) negotiating
these agreements or (2) renewing existing interconnection agreements, our
ability to become a single source provider of communications and information
services will be materially adversely affected.
Peering Agreements. We will need to obtain peering agreements with ISPs
so that we can exchange traffic with those ISPs without having to pay transit
costs. The basis on which the large national ISPs make peering available or
impose settlement charges is evolving as the provision of Internet access and
related services has expanded. Recently, ISPs that have previously offered
peering have reduced or eliminated peering relationships and are establishing
new, more restrictive criteria for peering. If major national ISPs increase the
costs and impose other requirements associated with maintaining peering, then we
may have to comply with those additional requirements in order to continue to
maintain our peering relationships. If we fail to establish peering
relationships, we would incur additional operating expenditures relating to
having to pay transit costs. Having to pay transit costs could have a material
adverse effect on our business, financial condition and results of operations.
Need to Obtain and Maintain Permits and Rights-of-Way
To acquire and develop our network, we must obtain local franchises and
other permits. We also must obtain rights to use underground conduit and aerial
pole space and other rights-of-way and fiber capacity. These rights are obtained
from entities such as ILECs and other utilities, railroads, long distance
companies, state highway authorities, local governments and transit authorities.
We may be unable, on acceptable terms, to maintain our existing franchises,
permits and rights or obtain and maintain the other franchises, permits and
rights needed to implement our business plan. The cancellation or non-renewal of
these arrangements could materially adversely affect our business in the
affected metropolitan area. In addition, our inability to enter into and
maintain any of these required contractual arrangements for any portion of our
network may affect our ability to develop our fuller network.
Dependence on Suppliers
Lease of Communications Capacity. Until we complete the company-owned
portion of our network, we will lease substantially all of our intercity
communications capacity in North America and possibly elsewhere. On March 23,
1998, we leased from Frontier Communications International Inc. approximately
8,300 miles of OC-12 network capacity that is currently under construction and
which connects 15 U.S. cities. In addition, we intend to lease a significant
amount of capacity from ILECs and the companies that compete with the ILECs or
competitive local exchange carriers ("CLECs") to connect our customers to our
gateway sites. We intend to lease this local capacity even after we complete the
company-owned portion of our intercity network. As a result, we will be
dependent upon the services of these other providers. In addition, we may
experience delays and additional costs if:
o any of these relationships are terminated; or
o one or all of these facilities experiences a technical or other similar
failure; and
we are unable to reach suitable agreements with alternate providers quickly.
These events could have a material adverse effect on our business, financial
condition, competitive position and results of operations.
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In Europe, we will initially lease substantially all of our intercity
communications capacity. The supply of this capacity for lease is much more
limited than in the United States. If we are unable to lease this capacity at a
competitive price, our European operations may be materially adversely affected.
Equipment and Materials. We will be dependent on the third-party
suppliers of fiber, conduit, computers, software, switches/routers and related
components that we will assemble and integrate into our network. As a result of
the large scale of our proposed network, our estimated purchases of fiber and
conduit represent a significant portion of our suppliers' current production. We
may also depend on the services of third parties for customer site
installations, routine maintenance, on-call repair and certain other services.
If any of these relationships is terminated and we are unable to reach suitable
alternative agreements quickly, we may experience delays and additional costs.
If that happens, our business, financial condition, competitive position and
results of operations could be materially adversely affected.
Competition; Rapid Technological Changes
Competition
Our industry - the communications and information services industry -
is highly competitive. Many of our existing and potential competitors have
financial, personnel, marketing and other resources significantly greater than
ours. Many of these competitors have the added competitive advantage of an
existing customer base. Significant new competitors could arise as a result of:
o increased consolidation and strategic alliances in the industry resulting
from recent Congressional and Federal Communications Commission ("FCC")
actions;
o allowing foreign carriers to compete in the U.S. market;
o further technological advances; and
o further deregulation and other regulatory initiatives.
In the special access and private line services market, our primary
competitors are long distance companies, current providers of local service and
other competitors to these local service providers. In the market for
collocation services, we will compete with the current providers of local
service and their competitors. Most of these competitors are currently providing
these services to a significant, established customer base. We may face a
competitive disadvantage as a result of the high costs to a customer of changing
collocation sites. The market for Web hosting services is also extremely
competitive. In this market, we will compete with the providers of Internet
services and many others, including long distance companies, companies that
exclusively provide Web hosting services and a number of companies in the
computer services industry.
For virtual private network services and voice services, we will
compete primarily with national and regional network providers. Our ability to
compete effectively in this market will depend on our ability to maintain high
quality services at competitive prices.
There are currently three U.S. long distance fiber optic networks that
are owned by each of AT&T, MCI WorldCom and Sprint, as well as numerous local
networks. We know that others, including Qwest Communications International
Inc., IXC Communications, Inc. and The Williams Companies, Inc., are building
additional networks that, when constructed, could employ advanced technology
similar to that of our network. These networks will also offer significantly
more capacity than is currently available in the marketplace. The additional
capacity that is expected to become available in the next several years may
cause significant decreases in the prices for services.
In the international services market, our competitors include not only
the U.S. carriers but also the established operators and new entrants in markets
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recently opened to competition. These include such large European and Asian
carriers such as British Telecom, Cable & Wireless, Deutsche Telekom, France
Telecom, Telefonica, Koninklijke KPN NV, Kokusai Denshin Denwa Company, Ltd.,
Nippon Telegraph and Telephone Corporation, Telia, and Swisscom, some of which
are still partially government-owned. In addition, there are other
facilities-based and resale carriers, many of which are constructing new and
expanded networks. We expect additional competitors to enter these markets
independently and as participants in joint ventures and inter-carrier alliances.
In the long distance market, our primary competitors will include AT&T,
MCI WorldCom and Sprint, all of whom have extensive experience in the long
distance market. In addition, Congressional legislation enacted in 1996 will
ultimately, upon satisfaction of prescribed competitive conditions, allow the
large telecommunications companies such as BellAtlantic and SBC Communications
and others to enter the long distance market. In local markets we will compete
with current providers of local service and other competitors to these local
service providers, many of whom have extensive experience in their local
markets.
If we are unable to compete successfully, our business, financial
condition and results of operations could be materially adversely affected.
Rapid Technological Changes
The communications and information services industry is subject to
rapid and significant changes in technology. For instance, recent technological
advances permit substantial increases in transmission capacity of both new and
existing fiber. In addition, the introduction of new products or technologies
may reduce the cost or increase the supply of certain services similar to those
that we plan to provide. As a result, our most significant competitors in the
future may be new entrants to the communications and information services
industry. These new entrants may not be burdened by an installed base of
outdated equipment. We cannot predict the effect of technological changes and
the resulting competition on our operations. These changes could have a material
adverse effect on our business, financial condition and results of operations.
Pricing Pressure and Industry Capacity
The long distance transmission industry has generally been
characterized as having overcapacity and declining prices since the AT&T
divestiture in 1984. Although we believe that increasing demand for capacity in
the last several years has resulted in a shortage of network capacity and slowed
the decline in prices, we anticipate that prices for communications and
information services will continue to decline over the next several years due
primarily to:
o the installation by us and our competitors, certain of whom are expanding
capacity and constructing or considering new networks, of fiber networks
that provide much more transmission capacity than may be needed over the
short or medium term;
o recent technological advances that permit substantial increases in the
transmission capacity of both new and existing fiber;
o strategic alliances or similar arrangements that increase the parties'
purchasing power, such as long distance capacity purchasing alliances among
certain RBOCs; and
o increased capacity of satellite, microwave and radio facilities.
These price declines may be particularly severe if there is a change in recent
trends causing increased demand for capacity, such as Internet usage. Rapid
growth in the use of the Internet is a recent phenomenon, and there can be no
assurance that this growth will continue at the same rate or at all. This
pricing pressure could have a material adverse effect on our business, financial
condition and results of operations, including our ability to complete our
network.
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Government Regulation
Communications services are subject to significant regulation at the
federal, state, local and international levels. These regulations affect us and
our existing and potential competitors. Delays in receiving required regulatory
approvals, completing interconnection agreements with ILECs or the enactment of
new and adverse regulations or regulatory requirements may have a material
adverse effect on us. In addition, future legislative, judicial, and regulatory
agency actions could alter negatively competitive conditions in the markets in
which we intend to operate.
The FCC exercises jurisdiction over interstate and international access
service - telecommunications services originating or terminating in the U.S. --
including both long distance services and the use of local network facilities to
originate and terminate interstate or international calls. Under current FCC
regulations, we are not required to obtain advance authorization to offer (1)
domestic long distance from state to state or (2) interstate access services.
However, we currently must file tariffs disclosing the rates, terms, and
conditions of our interstate long distance and access services, and comply with
certain other FCC requirements. We are required and have obtained FCC
authorization to provide international long distance service. Consequently, we
will have to file tariffs and comply with certain reporting requirements for
certain of our services. As a carrier providing FCC-regulated services, we will
be required to pay various federal regulatory fees and assessments, but we
currently do not expect that these fees will have a material effect on our
profitability.
State regulatory commissions exercise jurisdiction over intrastate
telecommunications services, including both local service and long distance
services offered within a state. We will be required to obtain regulatory
authorization and/or file tariffs or price lists with state agencies in most
states before we begin offering services in those states. We will also be
required to (1) comply with state regulations governing the pricing and
provision of telecommunications service, which vary considerably from state to
state, and (2) pay various regulatory fees and taxes assessed by states on
telecommunications services and providers.
A variety of governmental authorities regulate our access to public
rights-of-way, including highways, streets and underground conduits. Our
facilities will also be subject to numerous local regulations such as building
codes and licensing. These regulations vary greatly on a city by city and county
by county basis.
We are also subject to requests for franchise fees from municipalities.
In certain markets, municipalities assert that we must pay these fees even
though the current local service provider or ILECs (or, in certain cases, some
competitors to the ILEC) pay less or even nothing for equivalent capacity.
If our tariffs are not filed, updated, or otherwise do not fully comply
with the tariff filing rules of the FCC or state regulatory agencies, third
parties or regulators could challenge our tariffs. These challenges could delay
our ability to begin offering services in the location that is challenged. These
challenges could also cause us to incur substantial legal and administrative
expenses and potentially delay or prevent us from providing these services.
Recent federal legislation provides for a significant deregulation of
the U.S. telecommunications industry, including the local exchange, long
distance and cable television industries. This legislation remains subject to
judicial review and additional FCC rulemaking. As a result, we can not predict
the legislation's effect on our future operations. Many regulatory actions are
under way or are being contemplated by federal and state authorities regarding
important items such as: (1) interconnection pricing; (2) provision of advanced
telecommunications; (3) network unbundling; (4) the entry of the Bell companies
into interstate long distance; (5) reform of the pricing system by which long
distance carriers compensate local exchange carriers for use of their networks;
and (6) other issues that could result in significant changes to the
telecommunications industry. These changes could have a material adverse effect
on our business, financial condition and results of operations.
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The recent federal legislation subjects "nondominant telecommunications
carriers," such as us, to certain federal regulatory requirements once we begin
to provide local service in a market. This federal regulation requires that all
ILECs and their competitors (including us) must:
o interconnect with other carriers;
o provide nondiscriminatory access to rights-of-way;
o offer reciprocal compensation for termination of traffic;
o provide dialing parity and telephone number portability; and
o ensure that their services can be used by people with disabilities.
Regulation of Internet Service Providers. The FCC has to date treated
Internet service providers or ISPs as "enhanced service providers." Enhanced
service providers are currently exempt from federal and state regulations
governing common carriers, including the obligation to pay access charges and
contribute to the universal service fund. The FCC is currently examining the
status of ISPs and the services they provide. On April 10, 1998, the FCC issued
a Report to Congress which stated, among other things, that the provision of
transmission capacity to ISPs is subject to common carrier regulation. The FCC
indicated that it would reexamine its policy of not requiring an ISP to
contribute to the universal service mechanisms when the ISP provides its own
transmission facilities and engages in data transport over those facilities to
provide an information service. If a contribution is required, it would be
related to the ISP's provision of the underlying telecommunications services and
not its Internet access services.
In the report, the FCC also indicated that it would examine the
question of whether certain forms of "phone-to-phone IP telephony" are
information services or telecommunications services. The FCC noted that it did
not have an adequate record on which to make any definitive pronouncements on
that issue, but that the record the FCC had reviewed suggests that certain forms
of phone-to-phone IP telephony (1) appear to have the same functionality as
traditional or regular telecommunications services that do not use IP technology
and (2) lack the characteristics that would cause them to be treated for FCC
regulatory purposes as information services. If the FCC were to determine that
certain services are subject to FCC regulations, the FCC noted it may find it
reasonable that facilities-based (and possibly other) ISPs pay access charges
and make universal service contributions similar to non-IP-based
telecommunications service providers. The FCC also noted that other forms of IP
telephony appeared to be information services. Given the current status of the
FCC's review, we cannot predict the outcome or timing of these proceedings. If
the FCC were to determine that ISPs, or the services they provide, are subject
to FCC regulation, including the payment of access charges and contribution to
the universal service funds, it could have a material adverse effect on our
business, financial condition, competitive position and results of operations.
The FCC has also been considering whether local carriers are obligated
to pay compensation to each other for the transport and termination of calls to
ISPs when a local call is placed from an end user of one carrier to an ISP
served by the competing local exchange carrier. Twenty-three states have ruled
that such a call generates a reciprocal compensation obligation. The FCC,
however, may determine that the call does not terminate at the ISP, but rather
that it terminates at a host computer site in the Internet. In that case, the
FCC may determine reciprocal compensation does not apply and carriers may be
unable to recover their costs or will be compensated at a significantly lower
rate. If the FCC were to make such a determination, it could have a material
adverse effect on the communications portion of our company, but not on our
company as a whole.
Under authority of the recent federal legislation, the FCC has adopted
significant changes in its universal service subsidy program. Providers of
interstate telecommunications service, as well as certain others, must pay for
these programs. Our contribution to the universal service fund will be based on
our telecommunications service end-user revenues. The FCC's final categorization
of our services for regulatory purposes as telecommunications services or
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information services will affect the amount of our contribution, if any.
Currently, the FCC assesses contributions on the basis of a provider's revenue
for the previous year. Some states also collect contributions to state universal
service funds on the basis of revenues from the previous year, while other
states assess contributions on a current-year basis. Not all states have
established state contribution obligations. Since we had no telecommunications
service revenues in 1997, we will not be liable for universal service
contributions in any material amount during 1998. We expect to pay these charges
in subsequent years. As we have discussed, because of uncertainties concerning
the size of the universal fund and the classification of our services, we are
currently unable to quantify either the amount of any required contribution or
the effect that these required payments will have on our financial condition.
The FCC has also announced that it will soon revise its rules for subsidizing
service provided to consumers in high cost areas, which may result in further
substantial increases in the overall cost of the universal service program.
Regulation of Advanced Technologies. On August 7, 1998, the FCC
released an Order denying requests by the companies formed as a result of the
break up of AT&T that it use Section 706 of the Telecom Act to not regulate
advanced telecommunications services. Instead, the FCC determined that advanced
services are telecommunications services and that the current providers of local
services or ILECs, providing advanced services are still subject to the
unbundling and resale obligations of Section 251(c) and the in-region interLATA
restrictions of Section 271 of the Telecommunications Act of 1996.
At the same time, the FCC issued a Notice of Proposed Rulemaking in
which it proposes that ILECs be permitted to offer advanced services through
separate affiliates. Subject to certain restrictions imposed by the FCC, these
separate affiliates would not be subject to the obligations imposed on ILECs to
unbundle their networks or to offer their retail services to competitors on a
discounted basis. If approved, these rules would permit ILECs to establish
separate subsidiaries through which the ILECs could provide certain services on
a largely deregulated basis in competition with us. In order to assist
competitors to the current local service providers or ILECs to gain access to
ILEC facilities necessary to provide advanced services, the FCC also proposes to
strengthen collocation and loop unbundling requirements. It is uncertain whether
or not these FCC proposals will assist us in gaining access to essential
facilities needed to provide advanced services.
Canadian Regulation. While both local and long distance services are
now open to competition in all regions of Canada other than certain low density
population areas, only "Canadian carriers" are permitted to provide
facilities-based local or long distance services. As currently structured, our
operating subsidiaries would not qualify as Canadian carriers. In addition, the
regional telephone companies and the former monopoly provider of
facilities-based Canada-overseas international services still have majority
control of many significant market sectors. Although full competition is
permitted in the Canadian international services market as of October 1998,
Canadian carrier foreign ownership restrictions still apply to the provision of
facilities-based international services, but not to the ownership of
international submarine cables. Because we are not eligible to be a Canadian
carrier, and thus cannot control a facilities-based telecommunications service
provider in Canada, we cannot under current law enter the Canadian market as a
provider of facilities-based domestic services. In addition, we cannot provide
facilities-based international services. We can, however, own international
submarine cable and earth station facilities and resell domestic facilities
and/or resources to provide international services in Canada.
The Canadian Radio-Television and Telecommunications Commission
("CRTC"), the equivalent of the FCC in Canada, generally regulates the provision
of telecommunications services in Canada. The outcome of certain pending
significant regulatory issues is uncertain. While there is essentially no
regulation for domestic resold services, international resellers must obtain an
international service provider license and will be subject to certain
conditions. While resold local services are theoretically open to competition,
resellers are at a competitive disadvantage, because they cannot obtain the
interconnection benefits accorded to facilities-based local operators. The CRTC
has ruled that resellers cannot be classified as CLECs, and thus are not
entitled to CLEC interconnection terms and conditions. The CRTC has also
affirmed this decision on appeal. This effectively precludes
non-Canadian-controlled companies, such as us, from operating as a CLEC. We will
also be subject to contribution payment requirements for interconnection of long
distance circuits (including circuits used to provide phone-to-phone IP
telephony) to the public switched network and for international services. We may
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not be able to implement our planned entry into the Canadian market on
competitive terms and conditions because:
o many critical issues remain the subject of pending proceedings and
legislation whose outcome is uncertain;
o the regional telephone companies and the current monopoly international
carrier continue to retain substantial advantages in many service sectors;
and
o these competitors are likely to face decreased regulation as competition
matures.
Other Foreign Regulation. We have obtained licenses in several European
markets and are in the process of obtaining licenses in a number of European and
Asian markets that recently opened their markets to competition. We may not
receive these licenses in a timely manner because many of the regulatory
agencies are recently established and, as a result, may have less familiarity
with the regulatory process than U.S. regulators. As a result, we may also not
be able to construct facilities, obtain telephone numbers and carrier selection
codes, gain access to unbundled local loops and leased lines, and secure
right-of-way privileges as required. In addition, the final regulatory schemes
developed by these countries, when fully implemented, may subject us to
burdensome:
o regulation;
o regulatory fees;
o universal service fees or contributions;
o interconnection rates, terms, or conditions;
o rights-of-way restrictions or fees; or
o customer privacy requirements.
As a general matter, it is difficult to predict the effect of these foreign
regulatory schemes on our business or operations. These schemes may have a
material adverse effect on our business, financial condition and results of
operations.
Telephone services provided over the Internet are currently unregulated
under European law. To the extent that phone-to-phone IP telephony had the same
functionality as non-IP telecommunications services, these services may be
regulated by European Union Member States in the future. It is also not clear
that providers of IP-based non-regulated services would be entitled to the same
interconnection arrangements as public telecommunications operators that use
more traditional network configurations. We have experienced and may experience
further delays in acquiring licenses and negotiating interconnection agreements
as a result of regulators' concerns as to the regulatory status of IP-telephony
and the nature of the equipment used. These uncertainties as to the status of
IP-telephony may have a material adverse effect on our business, financial
condition and results of operations.
Risk of Network Failure; Liability for Transmissions
Our operations will depend on our ability to protect our network
against damage from natural disasters, power loss, communications failures and
similar events. Despite the proposed redundancy of our network, and other
precautions that we expect to take, the occurrence of a natural disaster or
other unanticipated problem could cause service interruptions on our network.
Our network will use a collection of communications equipment,
software, operating protocols and proprietary applications for the high speed
transportation of large quantities of data among multiple locations. Given the
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complexity of our proposed network, it may be possible that data will be lost or
distorted. Much of our customers' communications needs will be extremely time
sensitive, and delays in data delivery may cause significant losses to a
customer using our network. Our network may also contain undetected design
faults and software "bugs" that, despite our testing, may be discovered only
after the network has been installed and is in use. The failure of any equipment
or facility on the network could result in the interruption of customer service
until we effect necessary repairs or install replacement equipment. These
failures, faults or errors could cause delays or require modifications that
could have a material adverse effect on our business, financial condition,
competitive position, customer base and results of operations.
Security Risks
Our network will be vulnerable to unauthorized access, computer viruses
and other disruptive problems which could result in liability to us and a loss
of existing customers or could deter potential customers from using our network.
In addition, as a result of these factors, our customers could experience
interruptions, delays and cessations of service. Our efforts to eliminate
computer viruses and alleviate other security problems may require
interruptions, delays or cessation of service to our customers. This could have
a material adverse effect on our business, financial condition, competitive
position and results of operations. In addition, the actions necessary to
eliminate these problems could be prohibitively expensive.
Intellectual Property and Proprietary Rights
Our success may depend, in part, on our ability to develop and maintain
proprietary rights in certain technology that will underlie our network. To
protect our proprietary rights in the technology that may be utilized in the
network, we will rely on a combination of trade secret and copyright protection
as well as patents. We also will rely on trademark protection concerning various
names, marks, logos and other devices that serve to identify us as the source
for our services.
While we do not know of any technologies that are patented by others
that we believe are necessary for us to provide voice-over IP services, this
necessary technology may in fact be patented by other parties either now or in
the future. If this technology were held under patent by another person, we
would have to negotiate a license for the use of that technology. We may not be
able to negotiate such a license at a price that is acceptable to us. The
existence of such a patent, or our inability to negotiate a license for any such
technology on acceptable terms, could have a material adverse effect on our
business, financial condition, competitive position and results of operations.
Intellectual property litigation is complex and there can be no
assurance of its outcome. Any future intellectual property litigation,
regardless of outcome, could result in substantial expense to and significant
diversion of the efforts of our technical and management personnel. An adverse
determination in any such proceeding could:
o subject us to significant liabilities to third parties;
o require disputed rights to be licensed from such parties, if licenses to
such rights could be obtained; and/or
o require us to cease using the technology.
If we are forced to stop using this technology, we may not be able to develop or
obtain an alternative. As a result, an adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
us from offering or selling certain of our products. Our inability to sell these
products could have a material adverse effect on our business, financial
condition, competitive position and results of operations.
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Covenants
The covenants in the indenture relating to our 9 1/8% Senior Notes due
2008 permit us, subject to certain limitations, to use our funds in a broad
range of activities and investments, including entering into joint ventures that
we do not control. Some of these activities may result in significant cash
expenditures or result in significant losses.
Year 2000 Issues
We are conducting a review of our computer systems, including the
computer systems used in our computer outsourcing business, to identify systems
that could be affected by the "Year 2000" computer issue. We are also developing
and implementing a plan to resolve the issue. The Year 2000 issue results from
computer programs written with date fields of two digits, rather than four
digits, resulting in the inability of the program to distinguish between the
year 1900 and 2000. We expect that our Year 2000 compliance project will be
completed before the Year 2000 date change. During the execution of this
project, we have and will continue to incur internal staff costs as well as
consulting and other expenses. These costs will be expensed, as incurred, in
compliance with generally accepted accounting principles. The expenses
associated with this project, as well as the related potential effect on our
earnings, are not expected to have a material effect on our future operating
results or financial condition. If any required plan to resolve the Year 2000
problem is unsuccessful, however, that result could have a material adverse
effect on our business, financial condition, competitive position and results of
operations.
We have initiated communications with our significant suppliers and
customers, including those of our computer outsourcing business and, in
particular, vendors of our computer outsourcing operating environments, to
determine the extent to which we are vulnerable to the failure by these parties
to fix Year 2000 compliance issues. We can give no assurance, however, that the
systems will be made Year 2000 compliant in a timely manner or that the
noncompliance of these systems would not have a material adverse effect on our
business, financial condition, competitive position and results of operations.
PKS Systems Integration LLC, a subsidiary of PKS Information Services,
Inc., provides a wide variety of information technology services to its
customers. In fiscal year 1997, approximately 80% of our PKS Systems revenue
related to projects involving Year 2000 assessment and renovation services.
These contracts generally require PKS Systems to identify date affected fields
in certain application software of its customers and, in many cases, PKS Systems
undertakes efforts to fix those date-affected fields so that Year 2000 data may
be processed. Thus, Year 2000 issues affect many of the services PKS Systems
provides to its customers. These activities of PKS Systems expose us to
potential risks that may include problems with services provided by PKS Systems
to its customers and the potential for claims arising under PKS Systems'
customer contracts. PKS Systems attempts to contractually limit its exposure to
liability for Year 2000 compliance issues. However, these contractual
limitations may not be effective.
The expenses associated with this project by PKSIS, as well as the
related potential effect on PKSIS's earnings, are not expected to have a
material effect on its future operating results or financial condition. However,
the Year 2000 problem, and any loss incurred by any customers of PKSIS as a
result of it, could have a material adverse effect on our financial condition
and results of operations.
Risks of Foreign Investment
We expect to expand our operations into international markets in
Canada, Western Europe and Asia. Risks relating to foreign operations include
loss of revenue, property and equipment from expropriation, nationalization and
confiscatory taxation. We will also be exposed to the risk of:
o changes to laws and policies that govern foreign investment in countries
where we expect to operate; and
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o to a lesser extent, changes in U.S. laws and regulations relating to
investing in or trading with countries in which we may have investments.
Certain of the countries in which we expect to operate may be subject
to a substantially greater degree of social, political and economic instability
than is the case in other countries. This instability may result from, among
other things, the following:
o authoritarian governments or military involvement in political and economic
decision making, and changes in government through coups or other
extra-constitutional means;
o social unrest associated with demands for improved economic, social and
political conditions;
o internal insurgencies and terrorist activities; and
o hostile relations with neighboring countries.
Risks associated with social, political and economic instability in a particular
country could have a material adverse effect on our results of operations and
financial condition and could result in the loss of our assets in that country.
Foreign Currency Exchange Rates; Repatriation
Our international expansion will cause our results of operations and
the value of our assets to be affected by the exchange rates between the U.S.
dollar and the currencies of the additional countries in which we have
operations and assets. In some of these countries, prices of our products and
services will be denominated in a currency other than the U.S. dollar. As a
result, we may experience economic losses solely as a result of foreign currency
exchange rate fluctuations, including a foreign currency's devaluation against
the dollar. We may also in the future acquire interests in companies that
operate in countries where the removal or conversion of currency is restricted.
In addition, these restrictions could be imposed in countries where we conduct
business after we begin our operations. The possibility of this change could
occur especially in situations where there is a deterioration in a country's
balance of payments or where the local currency is being heavily converted into
other currencies.
Environmental Risks
Our operations and properties are subject to a wide variety of laws and
regulations relating to environmental protection, human health and safety. These
laws and regulations include those concerning the use and management of
hazardous and non-hazardous substances and wastes. Although we have made and
will continue to make significant expenditures relating to our environmental
compliance obligations, there may be times when we are not in compliance with
all these requirements.
In connection with certain historical operations, we are a party to, or
otherwise involved in, legal proceedings under state and federal law involving
investigation and remediation activities at approximately 110 contaminated
properties. We could be held liable, jointly and severally, and without regard
to our own fault, for such investigation and remediation. We do not believe that
the costs associated with these properties will be material based on:
o presently available information regarding the nature and volume of our
wastes allegedly disposed or released at these properties;
o the number of other financially viable, potentially responsible parties;
and
o the total estimated clean-up costs.
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The discovery of additional environmental liabilities related to our
historical operations or changes in existing environmental requirements could
have a material adverse effect on our business, results of operations or
financial condition.
Risks Related to Our Coal Operations
In 1997, $222 million of our $332 million in net revenues were
attributable to our coal mining operations. The level of cash flows generated in
recent periods by our coal operations will not continue after the year 2000.
These cash flow levels will decrease because the delivery requirements under our
current long-term contracts decline significantly after that date. Moreover,
without those contracts, our coal mining operations would not be able to operate
profitably by selling their production on the spot markets. A substantial
majority of our coal mining revenues are provided by three customer contracts.
Our coal operations are subject to extensive laws and regulations that
impose stringent operational, maintenance, financial assurance, environmental
compliance, reclamation, restoration and closure requirements. These
requirements include those (1) governing air and water emissions, (2) waste
disposal, (3) worker health and safety, (4) benefits for current and retired
coal miners, and (5) other general permitting and licensing requirements. We may
not at all times be in compliance with all of these requirements. Liabilities or
claims associated with this non-compliance could require us to incur material
costs or suspend production. Mine reclamation costs that exceed our reserves for
these matters also could require us to incur material costs.
Anti-Takeover Provisions in Level 3's Charter and By-Laws
Our Certificate of Incorporation and By-laws contain provisions that
could make it more difficult or even prevent a third party from acquiring the
company without the approval of our incumbent Board of Directors. These
provisions, among other things:
o divide our Board of Directors into three classes, with members of each
class to be elected in staggered three-year terms;
o prohibit stockholder action by written consent in place of a meeting;
o limit the right of stockholders to call special meetings of stockholders;
o limit the right of stockholders to present proposals or nominate directors
for election at annual meetings of stockholders; and
o authorize our Board of Directors to issue preferred stock in one or more
series without any action on the part of stockholders.
These provisions could limit the price that investors might be willing to pay in
the future for shares of our common stock and significantly impede the ability
of the holders of our Common Stock to replace management. In addition, we have
adopted a "poison pill" rights plan, which has certain anti-takeover effects.
Our rights plan, if triggered, will cause substantial dilution to a person or
group that attempts to acquire our company on terms not approved by our Board of
Directors. Provisions and agreements that inhibit or discourage takeover
attempts could reduce the market value of our common stock.
Possible Volatility of Stock Price
The market price for our common stock is subject to significant
fluctuations in response to a many factors that are unrelated to our operating
performance, including:
o variations in our quarterly operating results;
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o changes in estimates of our results of operations;
o perceptions about market conditions in the telecommunications industry; and
o the effect of general economic conditions.
In addition, in recent months the stock market generally has experienced
significant price and volume fluctuations. Those market fluctuations could have
a material adverse effect on the market price or liquidity of our common stock.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Level 3 Communications, Inc.
December 7, 1998 By: /s/ Neil J. Eckstein
Date Neil J. Eckstein, Vice President
