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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 1
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): April 7, 1998
LEVEL 3 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 0-15658 47-0210602
(State or other jurisdiction (Commission File Number) (IRS Employer
of incorporation) Identification Number)
3555 Farnam Street
Omaha, NE 68131
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (402) 536-3624
Peter Kiewit Sons', Inc.
(Former name or former address, if changed from last report)
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EXPLANATORY NOTE
The following is an amendment and restatement of the Current Report on Form
8-K originally filed by the registrant on April 16, 1998.
ITEM 5. OTHER EVENTS
1. INFORMATION FOR SECURITY HOLDERS
The registrant, Level 3 Communications, Inc. (the "Company" or "Level 3") is
filing this Current Report at its option to provide the following information
concerning the Company not otherwise called for by Form 8-K that may be of
importance to security holders. Capitalized terms used in this Current Report
without definition have the meaning ascribed to those terms under the heading
"Glossary of Terms."
Level 3 engages in the information services, communications and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, the Company announced a plan (the
"Business Plan") to increase substantially its information services business
and to expand the range of services it offers by building an advanced,
international, facilities-based communications network based on Internet
Protocol ("IP") technology.
HISTORY
The Company was incorporated as Peter Kiewit Sons', Inc. in Delaware in 1941
to continue a construction business founded in Omaha, Nebraska in 1884. In
subsequent years, the Company invested a portion of the cash flow generated by
its construction activities in a variety of other businesses. The Company
entered the coal mining business in 1943, the telecommunications business
(consisting of MFS Communications Company, Inc. ("MFS") and, more recently, an
investment in C-TEC Corporation ("C-TEC") and its successors RCN Corporation,
Commonwealth Telephone Enterprises, Inc. and Cable Michigan, Inc.) in 1988,
the information services business in 1990 and the alternative energy business,
through CalEnergy Company, Inc. ("CalEnergy"), in 1991. Level 3 also has made
investments in several development-stage ventures.
In the last three years, the Company has distributed to its stockholders a
portion of its telecommunications business, split off its construction
business and sold its investments in the alternative energy sector. In 1995,
the Company distributed to the holders of Class D Stock (as defined) all of
its shares of MFS. In the seven years from 1988 to 1995, the Company invested
approximately $500 million in MFS; at the time of the distribution to
stockholders in 1995, the Company's holdings in MFS had a market value of
approximately $1.75 billion. In December 1996, MFS was purchased by WorldCom,
Inc. ("WorldCom") in a transaction valued at $14.3 billion.
In December 1997, the Company's stockholders ratified the decision of the
Board to effect the separation of the construction and mining management
business from the Company's other businesses (the "Split-Off"). As a result of
the Split-Off, which was completed on March 31, 1998, the Company no longer
owns any interest in the Construction Group (as defined). In conjunction with
the Split-Off, the Company changed its name to "Level 3 Communications, Inc.,"
and PKS Holdings, Inc. ("New PKS"), the company formed in the Split-Off to
hold the Construction Group's business, changed its name to "Peter Kiewit
Sons', Inc."
In January 1998, the Company completed the sale to CalEnergy of its energy
investments, consisting primarily of a 24% equity interest in CalEnergy. The
Company received proceeds of approximately $1.16 billion from this sale, and
as a result expects to recognize an after-tax gain of approximately $324
million in 1998.
BUSINESS PLAN
Since late 1997, the Company has substantially increased the emphasis it
places on and the resources devoted to its communications and information
services business. The Company intends to become a facilities-based provider
(that is, a provider that owns or leases a substantial portion of the plant,
property and equipment necessary to provide its services) of a broad range of
integrated communications services. To reach this goal, the Company plans to
expand substantially the business of its subsidiary PKS Information Services,
Inc. ("PKSIS") and to create, through a combination of construction, purchase
and leasing of facilities and other assets, an international, end-to-end,
facilities-based communications network (the "Level 3 Network"). The Company
is designing the Level 3 Network based on IP technology in order to leverage
the efficiencies of this technology to provide lower cost communications
services.
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Market and Technology Opportunity. The Company believes that, as technology
advances, a comprehensive range of both consumer and business communications
and information services will be provided over networks utilizing IP
technology. These services will include traditional voice services and fax
transmission, as well as other data services such as Internet access and
virtual private networks. The Company believes this shift has begun, and over
time should accelerate, for the following reasons:
. Efficiency. As a packet-switched technology, IP technology generally uses
network capacity more efficiently than the traditional circuit-switched
public switched telephone network (the "PSTN"). Therefore, certain
services can be provided for lower cost over a network using IP
technology, particularly those services which are not timing sensitive,
such as e-mail and file transfer.
. Flexibility. IP technology is based on an open protocol (a non-
proprietary, published standard) which allows for market driven
development of new uses and applications for IP networks. In contrast,
the PSTN is based on proprietary protocols, which are governed and
maintained by international standards bodies that are generally
controlled by government-affiliated entities.
. Improving Technologies. The Company believes that IP's open protocol will
likely lead to technological advances that will address the problems
currently associated with IP-based applications, including the difficulty
achieving seamless interconnection with the PSTN, latency (delay through
the network which can negatively affect timing sensitive communications
such as voice and fax) and concerns about adequate security and
reliability.
. Standardized Interface. Web browsers (developed for the Internet and
usable with many IP networks) can provide a standardized interface to
data and applications on an IP network and thus make it easier for end
users to access and use these resources.
Level 3's Strategy. The Company seeks to capitalize on the benefits of IP
technology by pursuing the Business Plan. Key elements of the Company's
strategy include:
. Deploy an Advanced Network Infrastructure. The Company is creating the
Level 3 Network, an advanced, international, facilities-based
communications network based on IP technology, through a combination of
construction, purchase and lease of network assets. Level 3 is designing
its network to provide high quality communications services at lower cost
and to incorporate more readily future technological improvements
relative to older, less adaptable networks.
. Provide Seamless Interconnection to the PSTN. The Company is developing
technology to allow seamless interconnection of the Level 3 Network with
the PSTN. A seamless interconnection will allow customers to use the
Company's IP-based services, including voice and fax, without modifying
existing telephone and fax equipment or existing dialing procedures (that
is, without the need to dial access codes or follow other similar special
procedures).
. Offer a Comprehensive Range of Services. As the Business Plan is
implemented, the Company intends to provide a comprehensive range of
communications services over the Level 3 Network including private line,
collocation, Web hosting, Internet access, virtual private network and
voice and fax transmission services.
. Accelerate Market Roll-out. In order to begin the implementation of the
Business Plan as rapidly as possible and enable the Company to begin
offering services in late 1998, the Company has leased approximately
8,300 miles of capacity over a new fiber optic network under construction
in North America. This leased line network will be displaced over time by
an intercity network owned by the Company.
. Expand Target Market Opportunities. The Company will use a direct sales
force to address large businesses. In addition, the Company will use
alternative distribution channels to gain access to a substantially
larger base of potential customers than the Company could otherwise
initially address through its direct sales force. Through the combination
of a direct sales force and alternative distribution channels, the
Company believes that it will be able to increase more rapidly revenue-
producing traffic on its network.
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. Develop Advanced Business Support Systems. The Company has begun to
develop a substantial, scalable business support system ("BSS")
infrastructure specifically designed to enable the Company to offer
services efficiently to its targeted customers.
. Leverage Existing Information Services Capabilities. The Company intends
to expand its existing capabilities in computer network systems
integration, consulting, outsourcing and software reengineering, with
particular emphasis on the conversion of legacy software systems to
systems that are compatible with IP networks and Web browser access.
. Attract and Motivate High Quality Employees. The Company has developed
programs designed to attract and retain sufficient numbers of employees
with the technical skills necessary to implement the Business Plan. The
programs include the Company's Shareworks program and its Outperform
Stock Option program.
Competitive Advantages. The Company believes that it has the following
competitive advantages that will assist it in implementing the Business Plan:
. Experienced Management Team. Level 3 has assembled a management team that
it believes is well suited to implement the Business Plan. Most of Level
3's senior management were involved in leading the development and
marketing of products offered by other telecommunications companies, the
design, construction and management of intercity and metropolitan
networks as well as the deployment of international networks.
. Opportunity to Create a New Network Infrastructure. Since the Level 3
Network will be newly designed, the Company will be able to design and
deploy a communications network that takes advantage of recent
innovations, contains many features that are not present in older
communications networks and provides flexibility to incorporate future
developments and innovations. For example, Level 3 is designing and will
construct its intercity fiber optic network using multiple conduits. The
Company believes that this will allow it to deploy future technological
innovations in fiber optic cable and expand capacity. In addition, the
Company is maximizing the use of open, non-proprietary interfaces in the
design of its network software and hardware. This approach is intended to
allow lower-cost improvements to these network assets.
. Integrated End-to-End Network Platform. Level 3's strategy is to deploy
network infrastructure in major metropolitan areas and to link these
networks with significant intercity networks in North America and Europe.
The integration of the local and intercity networks will enable the
Company to expand the scope and reach of its "on-net" customer coverage,
as well as facilitate the uniform deployment of technological innovations
as the Company manages its future upgrade paths.
. Development of Advanced Business Support Systems. The Company has begun
to develop a substantial, scalable business support system infrastructure
specifically designed to enable the Company to offer services efficiently
to its targeted customers. The Company believes that it has the
opportunity to develop a competitive advantage relative to traditional
telecommunications companies which often operate extensive legacy
business support systems with compartmentalized architectures that limit
their ability to scale rapidly and introduce enhanced services and
features.
. Systems Integration Capabilities. The Company currently offers computer
outsourcing and systems integration services. The Company believes that
its ability to offer these services, particularly services relating to
allowing a customer's legacy systems to be accessed with Web browsers,
will provide additional opportunities for selling the products and
services to be offered under the Business Plan.
THE LEVEL 3 NETWORK
An important element of the Business Plan is the development of the Level 3
Network, an international, end-to-end network optimized for IP technology. The
Company will initially offer its communications services using local and
intercity facilities that are leased from third parties to enable the Company
to offer services during
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the construction of its own facilities. Over time, the portion of the
Company's network that is owned by the Company will increase and the portion
of the facilities leased will decrease. Over the next four to six years, the
Company's network is expected to encompass (i) backbone facilities in
approximately 40 North American markets, (ii) leased backbone facilities in
approximately 10 additional North American markets, (iii) an intercity network
covering approximately 15,000 miles in North America, (iv) backbone facilities
in approximately 13 European and 4 Asian markets and (v) an intercity network
covering approximately 2,000 miles across Europe. For a discussion of the
risks associated with the deployment of the Level 3 Network, see "Risk
Factors--Difficulties in Constructing, Operating and Upgrading the Level 3
Network."
Intercity Network. The Company's approximately 15,000 mile fiber optic
intercity network in North America (the "North American Intercity Network")
will consist of the following:
. Rights-of-Way ("ROW") from a number of third parties including railroads,
highway commissions and utilities. The Company intends to procure these
rights from sources which maximize the security and quality of the
Company's installed network. On April 2, 1998, the Company announced that
it had reached a definitive agreement with Union Pacific Railroad Company
("Union Pacific") granting Level 3 the use of approximately 7,800 miles
of ROWs along Union Pacific's rail routes for the construction of the
North American Intercity Network. The Company expects that the Union
Pacific agreement will satisfy substantially all of its anticipated ROW
requirements west of the Mississippi River and approximately 50% of the
ROW requirements for the North American Intercity Network.
. Multiple conduits connecting approximately 50 North American cities. The
Company believes that the availability of spare conduit will allow it to
deploy future technological innovations and expand capacity in a more
rapid and cost-effective manner.
. Initial installation of optical fiber strands designed to accommodate
dense wave division multiplexing transmission technology. This fiber
allows deployment of equipment which transmits signals on 32 or more
individual wavelengths of light per strand, thereby significantly
increasing the capacity of the Company's network relative to older
networks which generally use optical fiber strands that transmit fewer
wavelengths of light per strand.
. High speed SONET transmission equipment employing self-healing protection
switching and designed for high quality and reliable transmission.
. A design that maximizes the use of open, non-proprietary hardware and
software interfaces to allow less costly upgrades as hardware and
software technology improves.
The Company intends to provide initial service over a leased line network
which is currently being deployed. On March 23, 1998, the Company and Frontier
Communications International Inc. ("Frontier") entered into an agreement (the
"Frontier Agreement"), enabling the Company to lease capacity on Frontier's
new 13,000 mile SONET fiber optic, IP-capable network, for a period of up to
five years. The leased network will initially encompass approximately 8,300
miles of OC-12 network capacity, initially connecting 15 of the larger cities
across the United States. While requiring an aggregate minimum payment of $165
million over its five-year term, the Frontier Agreement does not impose
monthly minimum consumption requirements on the Company, allowing the Company
to order, alter or terminate circuits as it deems appropriate.
This leased line network will be displaced over time by an intercity network
owned by the Company. Deployment of the North American Intercity Network will
be accomplished through simultaneous construction efforts in multiple
locations, with different portions being completed at different times. The
North American Intercity Network is expected to be completed by the end of
2001.
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The following diagram depicts the currently planned North American Intercity
Network when fully constructed:
[DIAGRAM OF UNITED STATES SHOWING PLANNED
NORTH AMERICAN INTERCITY NETWORK
APPEARS HERE]
The Company also intends to deploy an approximately 2,000 mile fiber optic
intercity network in Europe with characteristics similar to those of the North
American Intercity Network. As is the case with the North American Intercity
Network, the Company will provide initial service in Europe over a leased line
network that will be displaced over time by the intercity network owned by the
Company. In Asia, the Company intends to provide service over a leased line
network.
Local Market Infrastructure. The Company's local facilities will include
fiber optic networks, in a SONET ring configuration, connecting Level 3's
intercity network gateway sites to ILEC central offices, long distance carrier
POPs, buildings housing communication-intensive end users and Internet peering
and transit facilities.
The Company is establishing 30,000 to 80,000 square foot gateway sites in 15
of the larger U.S. cities, with smaller facilities in 35 other cities. These
facilities are being designed to house the Company's transmission and IP
routing/switching facilities and to accommodate collocation of equipment by
high-volume Level 3 customers, such as ISPs, in an environmentally controlled,
secure site with direct access to the Level 3 Network. The Company has entered
into leases for gateway sites in New York City, Washington, D.C.,
Philadelphia, Atlanta, Dallas, Houston, Chicago, Detroit, Denver, Seattle, San
Francisco, San Jose, Los Angeles and San Diego, and the Company is negotiating
a lease for such a facility in Boston. By the end of 1998, the Company expects
to offer a limited set of services (special access and private line,
collocation, Web hosting and Internet access) at its gateway sites in these
cities.
Initial construction of the network in the largest 15 cities is expected to
be completed in the first and second quarter of 1999, with phased completion
of the U.S. local infrastructure occurring by 2001.
As of March 31, 1998, the Company had submitted applications for collocation
in 56 ILEC central offices in 15 cities; the Company is currently engaging in
construction in 52 of these central offices. The Company has initiated
interconnection negotiations with each of the RBOCs.
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The Company is currently in negotiations for master leases with CLECs and
ILECs to obtain leased capacity from those providers so that the Company can
provide its clients with local transmission capabilities before its own local
networks are complete and in locations not directly accessed by the Company's
owned facilities.
IP Network and Interconnection. The Company is designing the Level 3 Network
to be optimized for IP-based communications, rather than circuit-switch based
communications such as that utilized by the PSTN. The network is being
designed to provide the Company with the ability to adapt its facilities,
hardware and software to future technology developments in packet-switch based
communications systems.
There are many IP networks currently in operation. While generally adequate
for data transmission needs, these networks usually are not configured to
provide the voice quality, real-time communications requirements of a
traditional telephone call. With current technology, this quality can only be
achieved by providing a substantial cushion of communications capacity.
Existing voice-over IP services generally require a combination of substantial
capacity and either customized end-user equipment or the dialing of "access
codes" or the following of other special procedures to initiate a call. There
are also concerns about the reliability and security of existing IP-voice
networks.
The Company is developing technology to enable it to transmit traffic
seamlessly between its own router-based IP network and the circuit-based PSTN.
This technology is expected to provide the Level 3 Network with the same
ubiquity of the PSTN. Specifically, the Company's technology is expected to
provide Level 3 with (i) the ability to originate PSTN telephone traffic from
an ILEC's switch (when the origination point is not on the Level 3 Network),
(ii) route the traffic over the Level 3 Network and (iii) deliver the traffic
either (a) directly to its destination (if the destination is on the Level 3
Network) or (b) to an interconnection point where the traffic is transferred
back to the PSTN (the routing of traffic to this interconnection point will be
determined based on a least-cost routing criteria). When this capability is
fully developed, Level 3 expects to be able to obtain the benefits of packet-
switch based communications protocols on its network, while allowing its
customers to use their existing equipment, telephone numbers and dialing
procedures without additional access for routing the call to the Level 3
Network. Level 3 believes that by building its own network with significant
excess capacity and the latest technological advances in network design and
equipment and having the ability to route calls over the PSTN in the event of
service disruptions, the other significant issues associated with IP-voice
transmission (latency, reliability and security) should be satisfactorily
addressed.
On April 23, 1998, the Company acquired XCOM Technologies, Inc. ("XCOM"), a
privately held company located in Cambridge, Massachusetts. XCOM has developed
technology which the Company believes will provide certain key components
necessary for the Company to develop an interface between its IP-based network
and the PSTN. In 1997, XCOM had revenues of approximately $3 million. See
"Risk Factors--Need to Develop Voice Technology for IP Networks."
COMMUNICATION AND INFORMATION SERVICES
In connection with the Business Plan, the Company is substantially
increasing the emphasis it places on and the resources devoted to its
communications and information services business. The Company intends to build
on the strengths of its information services business and the benefits of the
Level 3 Network to offer a broad range of other services to business and other
end users.
Level 3 currently offers, through its subsidiary PKSIS, computer operations
outsourcing and systems integration services to customers located throughout
the United States as well as abroad. The computer outsourcing services offered
by the Company include networking and computing services necessary for older
mainframe-based systems and newer client/server-based systems. The Company
provides its outsourcing services to clients that want to focus their
resources on core businesses, rather than expend capital and incur overhead
costs to operate their own computing environments. Level 3 believes that it is
able to utilize its expertise and
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experience, as well as operating efficiencies, to provide its outsourcing
customers with levels of service equal to or better than those achievable by
the customers themselves, while at the same time reducing the customers' cost
for such services. This service is particularly useful for those customers
moving from older computing platforms to more modern client/server networks.
The Company's systems integration services help customers define, develop
and implement cost-effective information services. In addition, the Company
offers reengineering services that allow companies to convert older legacy
software systems to modern networked computing systems, with a focus on
reengineering software to enable older software application and data
repositories to be accessed by Web browsers over the Internet or over private
or limited access IP networks. Through its Suite 2000SM line of services, the
Company provides customers with a multi-phased service for converting programs
and applications so that date-related information is accurately processed and
stored before and after the year 2000. The Company also provides customers
with a combination of workbench tools and methodologies that provide a
complete strategy for converting mainframe-based application systems to
client/server architecture, while at the same time ensuring Year 2000
compliance. See "Risk Factors--Year 2000 Issues."
As the Business Plan is implemented, the Company intends to offer a
comprehensive range of communications services, including the following:
. Special Access and Private Line. Special access and private line services
are established as a permanent physical connection between locations for
the exclusive use of the customer. The Company intends to offer the
following types of special access and private line services:
. Carrier-to-Carrier Special Access. This type of link connects
carriers (long distance providers, wireless providers, ILECs and
CLECs) to other carriers.
. End-user to Long Distance Provider Special Access. This type of link
connects an end-user, such as a large business, with the local POP of
its chosen long distance provider.
. Private Line. This type of link is a dedicated line connecting two
end-user locations for voice and data applications, including ISPs.
The Company expects that its local special access and private line
services will be initially available at transmission speeds from 64 kbps
to 45 Mbps and its long distance services will be offered at speeds from
64 kbps to 45 Mbps. The Company intends initially to market its special
access and private line services to medium to large corporate customers,
resellers and ISPs.
. Collocation. The Company intends to offer its customers and other service
providers the ability to locate their communications and networking
equipment at Level 3's gateway sites in a safe and secure technical
operating environment. The demand for these collocation services has
increased as companies expand into geographic areas in which they do not
have appropriate space or technical personnel to support their equipment
and operations. At its collocation sites, the Company will provide
customers with AC/DC power, optional UPS power, emergency back-up
generator power, HVAC, fire protection and security. Level 3 will also
provide high-speed, reliable connectivity to the Level 3 Network and
other networks, including both local and wide area networks, the PSTN and
Internet. These sites will be monitored and maintained 24 hours a day.
. Internet Access. The Company plans to offer Internet access to business
customers, other carriers and ISPs. These services will include high-
capacity Internet connections ranging from 33.6 kbps to 45 Mbps. The
Company is seeking full peering arrangements with several existing
Internet providers that, when in place, will allow Level 3 to provide
superior Internet throughput to its customers relative to other providers
which must exchange Internet traffic at the increasingly congested MAEs
and NAPs.
. Web Hosting. The Company plans to offer three categories of Web hosting
services. First, the Company intends to offer small to large businesses
the opportunity to collocate Web-server computers, owned by such
businesses at the Company's larger gateway sites enabling them to take
advantage of the marketing, customer service, internal company
information ("intranets") and other benefits offered by such Web
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presence. By collocating its Web-server at a Company facility, a customer
will have the ability to deploy a high-quality, high-reliability Internet
presence without investing capital in data center space, multiple high-speed
connections or other capital intensive infrastructure. Although the customer
will be responsible for maintaining the content and performance of its
server, the Company's technicians will be available to monitor basic server
operation. Second, the Company plans to offer customers use of Level 3 Web-
server computers, services, support staff, and the redundant infrastructure
consisting of multiple routers and connections to Internet backbones. Third,
the Company plans to offer IP Services such as email, news feeds and Domain
Name Services (DNS).
. Virtual Private Network ("VPN"). Many companies have private data
communication networks, which are often referred to as wide area networks
("WANs") and built on expensive leased lines, to transfer proprietary
data between office locations. Additionally, many companies require that
their employees have remote access to these private networks from home or
while traveling. The Level 3 Network will offer companies a cost-
effective replacement alternative to WANs through VPNs, which are meant
to provide secure transmission of private IP traffic using shared network
capacity. VPN products are also the basis for offering intranet and
extranet service. Intranets are corporate/organizational networks that
rely on Internet-based technologies to provide secure links between
corporate offices. Extranets can expand these networks to selected
business partners through secured links on the shared network capacity.
Increasingly, companies are finding that intranets and extranets can
enhance corporate productivity more easily and less expensively than
proprietary systems. After sufficient deployment of the Level 3 Network
has been achieved, the Company intends to offer VPN services, enabling
the Company's customers to connect multiple locations with IP-based
technology at defined levels of quality, reliability and security.
. Voice. The Company seeks to offer voice services, including both real-
time voice and fax transmission services, which are accessed using
existing telephone and fax equipment and existing dialing procedures. The
Company expects that these services will be offered at a quality level
equal to that of the PSTN. For a discussion of the Company's efforts to
develop the technology to provide these voice services, see "--The Level
3 Network--IP Network and Interconnection."
The Company currently expects to offer special access and private line,
collocation, Web hosting and Internet access at the largest 15 U.S. cities by
the end of 1998.
DISTRIBUTION STRATEGY
The Company's distribution strategy is to utilize a direct sales force as
well as alternative distribution channels. Through the combination of a direct
sales force and alternative distribution channels, the Company believes that
it will be able to more rapidly access markets and increase revenue-producing
traffic on its network. To implement its distribution strategy, the Company is
developing an in-house direct sales force and has identified a variety of
possible alternative distribution channels.
The Company intends to utilize its direct sales force to market its products
and services directly to large communications-intensive businesses. In
addition, the direct sales force will target national and international
accounts. These communications-intensive customers would typically be
connected directly to the Level 3 Network using unswitched, dedicated
facilities.
As part of its distribution strategy, the Company has identified several
potential alternative distribution channels. These include agents, resellers
and wholesalers.
. Agents are independent organizations that would sell Level 3's products
and services under the Level 3 brand name to end-users in exchange for
revenue based commissions. The Company intends to identify agents that
generally would be focused on specific market segments (such as small and
medium sized businesses) and have existing customer bases. Sales through
this alternative distribution channel would require Level 3 to provide
the same type of services that would be provided in the case of sales
through
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its own direct sales force such as order fulfillment, billing and
collections, customer care and direct sales management.
. Resellers are independent companies that would purchase Level 3's
products and services and then "repackage" these services for sale to
their customers under their own brand name. The Company believes that
resellers would require access to certain of the Company's business
operating systems in connection with the sale of the Company's services
to the resellers' customers. Sales through this distribution channel
generally would not require Level 3 to provide order fulfillment, billing
and collection and customer care.
. Wholesalers are independent companies that would purchase from the
Company unbundled network and service capabilities in large quantities in
order to market their own products and services under a brand name other
than Level 3. The Company believes that wholesalers would have minimal
dependence on the Company's business support systems in connection with
the sale of services to their customers.
The Company anticipates that participants in its alternative distribution
channels will sell services directly to medium and small businesses and
consumers. The Company expects these medium and small businesses and consumers
to access the Level 3 Network by using local switched services that are
provided by CLECs or ILECs or by utilizing newly emerging alternatives
including various Digital Subscriber Line (DSL) modem technologies, cable
modems and wireless access technologies.
BUSINESS SUPPORT SYSTEM
In order to pursue its direct sales and alternative distribution strategies,
the Company is developing a set of integrated software applications designed
to automate the Company's operational processes. Through the development of a
robust, scaleable BSS, the Company believes that it has the opportunity to
develop a competitive advantage relative to traditional telecommunications
companies. Whereas traditional telecommunications companies operate extensive
legacy business support systems with compartmentalized architectures that
limit their ability to scale rapidly and introduce enhanced services and
features, the Company is developing a BSS with an architecture designed
to maximize both reliability and scaleability. The Company has entered into an
agreement with a third party to provide systems integration services in
connection with the development of the Company's BSS. See "Risk Factors--
Development of Effective Processes and Systems."
Key design requirements for the BSS development program are:
. integrated modular applications to allow the Company to upgrade specific
applications as new products are available;
. a scaleable architecture that will allow certain functions that would
otherwise have to be performed by Level 3 employees to be performed by
the Company's alternative distribution channel participants;
. phased completion of software releases designed to allow the Company to
test functionality on an incremental basis;
. ""Web enabled" applications so that on-line access to all order entry,
network operations, billing, and customer care functions is available to
all authorized users, including Level 3's customers and resellers;
. use of a three-tiered, client/server architecture that is designed to
separate data and applications, and is expected to enable continued
improvement of software functionality at minimum cost; and
. maximum use of pre-developed or "shrink wrapped" applications, which will
interface to the selected enterprise resource planning (ERP) suite.
The Company expects that the first release of the BSS, currently scheduled
for the end of 1998, will contain functionality necessary to support the set
of services to be offered at that time. See "--Communication and Information
Services." Subsequent releases are scheduled to support the planned rollout of
the complete set of the Company's services.
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INTERCONNECTION AND PEERING
As a result of the Telecommunications Act of 1996 (the "Telecom Act"),
properly certificated companies may, as a matter of law, interconnect with
ILECs on terms designed to help ensure economic, technical and administrative
equality between the interconnected parties. The Telecom Act provides, among
other things, that ILECs must offer competitors the services and facilities
necessary to offer local switched services. See "--Regulation."
The Company is currently negotiating agreements for the interconnection of
the Level 3 Network with the networks of the ILEC covering each market in
which the Company is constructing its network. The Company may be required to
negotiate new or renegotiate existing interconnection agreements as Level 3
enters new markets in the future.
Peering agreements between the Company and ISPs will be necessary in order
for the Company to 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, companies that
have previously offered peering have cut back or eliminated peering
relationships and are establishing new, more restrictive criteria for peering.
Furthermore, if increasing requirements associated with maintaining peering
with the major national ISPs develop, the Company may have to comply with
those additional requirements in order to maintain any peering relationships
it negotiates. See "Risk Factors--Lack of Interconnection and Peering
Arrangements."
EMPLOYEE RECRUITING AND RETENTION
The Company believes that its ability to implement the Business Plan will
depend in large part on its ability to attract and retain qualified employees.
The Company expects to hire another 700 employees by the end of 1998, and to
have over 5,000 employees once the North American Intercity Network has been
fully deployed. In order to attract and retain highly qualified employees, the
Company believes that it is important to provide (i) a work environment that
encourages each individual to perform to his or her potential, (ii) a work
environment that facilitates cooperation towards shared goals and (iii) a
compensation program designed to attract the kinds of individuals the Company
seeks and to align employees' interests with the Company's. The Company
believes the Business Plan and its announced relocation to new facilities,
currently being constructed in the Denver metropolitan area, help provide such
a work environment. With respect to compensation programs, while the Company
believes financial rewards alone are not sufficient to attract and retain
qualified employees, the Company believes a properly designed compensation
program is a necessary component of employee recruitment and retention. In
this regard the Company's philosophy is to pay annual cash compensation which,
if the Company's annual goals are met, is moderately greater than such
compensation paid by competitors. The Company's non-cash benefit programs
(including medical and health insurance, life insurance, disability insurance,
etc.) are designed to be comparable to those offered by its competitors. See
"Risk Factors--Dependence on Hiring and Retaining Qualified Personnel; Key
Personnel."
The Company believes that the qualified candidates it seeks place particular
emphasis on equity-based long term incentive ("LTI") programs. The Company
currently has two complementary programs: (i) the equity-based "Shareworks"
program, which helps ensure that all employees have an ownership interest in
the Company and are encouraged to invest risk capital in the Company's stock;
and (ii) an innovative Outperform Stock Option ("OSO") program applicable to
the Company's middle and senior management. The Shareworks program currently
enables employees to contribute up to 7% of their compensation toward the
purchase of restricted Common Stock. If an employee remains employed by the
Company for three years from the date of purchase, the shares will vest and be
matched by the Company with a grant of an equal number of shares of Common
Stock. The Shareworks program also provides that the Company's employees will
be eligible annually for grants by the Company of restricted Common Stock of
up to 3% of the employees' compensation, which shares will vest three years
from the grant date.
With respect to middle and senior management, the Company has adopted the
OSO program which differs from LTI programs generally adopted by the Company's
competitors that make employees eligible for
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conventional non-qualified stock options ("NQSOs"). While widely adopted, the
Company believes such NQSO programs reward eligible employees when company
stock price performance is inferior to investments of similar risks, dilute
public stockholders in a manner not directly proportional to performance and
fail to provide a preferred return on stockholders' invested capital over the
return to option holders. The Company believes that the OSO program is
superior to an NQSO-based program with respect to these issues while, at the
same time, providing eligible employees a success-based reward balancing the
associated risk.
The OSO program was designed by the Company so that its stockholders receive
a market return on their investment before OSO holders receive any return on
their options. The Company believes that the OSO program aligns directly
management's and stockholders' interests by basing stock option value on the
Company's ability to outperform the market in general, as measured by the
Standard & Poor's ("S&P") 500 Index. Participants in the OSO program do not
realize any value from options unless the Common Stock price outperforms the
S&P 500 Index. When the stock price gain is greater than the corresponding
gain on the S&P 500 Index, the value received for options under the OSO plan
is based on a formula involving a multiplier related to how much the Common
Stock outperforms the S&P 500 Index. To the extent that the Common Stock
outperforms the S&P 500, the value of OSOs to an option holder may exceed the
value of NQSOs.
Subsequent to the Split-Off, the Company adopted the recognition provisions
of Statement of Financial Accounting Standards No. 123, Accounting for Stock
Based Compensation ("SFAS No. 123"). Under SFAS No. 123, the fair value of an
OSO (as computed in accordance with accepted option valuation models) on the
date of grant is amortized over the vesting period of the OSO. The recognition
provisions of SFAS No. 123 are applied prospectively upon adoption. As a
result, they are applied to all stock awards granted in the year of adoption
and are not applied to awards granted in previous years unless those awards
are modified or settled in cash after adoption of the recognition provisions.
While the Company has not yet determined the total effect of adopting the
recognition provisions of SFAS No. 123, it believes that adoption will result
in material non-cash charges to operations in 1998 and thereafter. The amount
of the non-cash charge will be dependent upon a number of factors, including
the number of options granted and the fair value estimated at the time of
grant.
COMPETITION
The communications and information services industry is highly competitive.
Many of the Company's existing and potential competitors in the communications
and information services industry have financial, personnel, marketing and
other resources significantly greater than those of the Company, as well as
other competitive advantages including existing customer bases. Increased
consolidation and strategic alliances in the industry resulting from the
Telecom Act, the opening of the U.S. market to foreign carriers, technological
advances and further deregulation could give rise to significant new
competitors to the Company.
In the special access and private line services market, the Company's
primary competitors will be IXCs, ILECs and CLECs. In the market for
collocation services, the Company will compete with ILECs and CLECs. Most of
these competitors have a significant base of customers for whom they are
currently providing collocation services. Due to the high costs to a customer
of switching collocation sites, the Company may have a competitive
disadvantage relative to these competitors. The market for Web hosting
services is extremely competitive. In this market, the Company will compete
with ISPs and many others, including IXCs, companies that provide only Web
hosting services and a number of companies in the computer industry.
For virtual private network services and voice services, the Company will
compete primarily with national and regional network providers. There are
currently four principal facilities-based long distance fiber optic networks
(AT&T, MCI, Sprint and WorldCom, although a proposed merger between WorldCom
and MCI is pending), as well as numerous ILEC and CLEC networks. The Company
is aware that others, including Qwest Communications International, Inc.
("Qwest"), IXC Communications, Inc. ("IXC") and The Williams Companies, Inc.
("Williams"), are building additional networks that, when constructed, could
employ advanced technology similar to that of the Level 3 Network and will
offer significantly more capacity than is currently
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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. The ability of the Company to compete effectively in
this market will depend upon its ability to maintain high quality services at
prices equal to or below those charged by its competitors. In the long
distance market, the Company's primary competitors will include AT&T, MCI,
Sprint and WorldCom, all of whom have extensive experience in the long
distance market. In addition, the Telecom Act will allow the RBOCs and others
to enter the long distance market. In local markets the Company will compete
with ILECs and CLECs, many of whom have extensive experience in the local
market. While the Company believes that IP technology will prove to be a
viable technology for the transmission
of voice services, technology is not yet in place that will enable the Company
to provide voice services at an acceptable level of quality. There can be no
assurance that the Company can develop or acquire such technology. See "Risk
Factors--Need to Develop Voice Technology on IP Networks."
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, and the introduction of new products or emergence of new technologies
may reduce the cost or increase the supply of certain services similar to
those which the Company plans on providing. Accordingly, in the future the
Company's most significant competitors may be new entrants to the
communications and information services industry, which are not burdened by an
installed base of outmoded equipment.
REGULATION
The Company's communications services business will be subject to varying
degrees of federal, state, local and international regulation.
Federal Regulation
The FCC regulates interstate and international telecommunications services.
The FCC imposes extensive regulations on common carriers such as ILECs that
have some degree of market power. The FCC imposes less regulation on common
carriers without market power, such as the Company. The FCC permits these
nondominant carriers to provide domestic interstate services (including long
distance and access services) without prior authorization; but it requires
carriers to receive an authorization to construct and operate
telecommunications facilities, and to provide or resell telecommunications
services, between the United States and international points. The Company has
obtained FCC authorization to provide international services on a facilities
and resale basis. The Company will be required to file tariffs for its
interstate and international long distance services with the FCC before
commencing operations.
Under the Telecom Act, any entity, including cable television companies, and
electric and gas utilities, may enter any telecommunications market, subject
to reasonable state regulation of safety, quality and consumer protection.
Because implementation of the Telecom Act is subject to numerous federal and
state policy rulemaking proceedings and judicial review, there is still
uncertainty as to what impact it will have on the Company. The Telecom Act is
intended to increase competition. The Telecom Act opens the local services
market by requiring ILECs to permit interconnection to their networks and
establishing ILEC obligations with respect to:
. Reciprocal Compensation. Requires all ILECs and CLECs to complete calls
originated by competing carriers under reciprocal arrangements at prices
based on a reasonable approximation of incremental cost or through mutual
exchange of traffic without explicit payment.
. Resale. Requires all ILECs and CLECs to permit resale of their
telecommunications services without unreasonable restrictions or
conditions. In addition, ILECs are required to offer wholesale versions
of all retail services to other telecommunications carriers for resale at
discounted rates, based on the costs avoided by the ILEC in the wholesale
offering.
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. Interconnection. Requires all ILECs and CLECs to permit their competitors
to interconnect with their facilities. Requires all ILECs to permit
interconnection at any technically feasible point within their networks,
on nondiscriminatory terms, at prices based on cost (which may include a
reasonable profit). At the option of the carrier seeking interconnection,
collocation of the requesting carrier's equipment in the ILECs' premises
must be offered, except where the ILEC can demonstrate space limitations
or other technical impediments to collocation.
. Unbundled Access. Requires all ILECs to provide nondiscriminatory access
to unbundled network elements (including network facilities, equipment,
features, functions, and capabilities) at any technically feasible point
within their networks, on nondiscriminatory terms, at prices based on
cost (which may include a reasonable profit).
. Number Portability. Requires all ILECs and CLECs to permit users of
telecommunications services to retain existing telephone numbers without
impairment of quality, reliability or convenience when switching from one
telecommunications carrier to another.
. Dialing Parity. Requires all ILECs and CLECs to provide "1+" equal access
to competing providers of telephone exchange service and toll service,
and to provide nondiscriminatory access to telephone numbers, operator
services, directory assistance, and directory listing, with no
unreasonable dialing delays.
. Access to Rights-of-Way. Requires all ILECs and CLECs to permit competing
carriers access to poles, ducts, conduits and rights-of-way at regulated
prices.
ILECs are required to negotiate in good faith with carriers requesting any
or all of the above arrangements. If the negotiating carriers cannot reach
agreement within a prescribed time, either carrier may request binding
arbitration of the disputed issues by the state regulatory commission. Where
an agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunication regulatory
commissions.
In August 1996, the FCC released a decision (the "Interconnection Decision")
establishing rules implementing the above-listed requirements and providing
guidelines for review of interconnection agreements by state public utility
commissions. On July 18, 1997, the United States Court of Appeals for the
Eighth Circuit (the "Eighth Circuit") vacated certain portions of the
Interconnection Decision, including provisions establishing a pricing
methodology and a procedure permitting new entrants to "pick and choose" among
various provisions of existing interconnection agreements between ILECs and
their competitors. On October 14, 1997, the Eighth Circuit issued a decision
vacating additional FCC rules that will likely have the effect of increasing
the cost of obtaining the use of combinations of an ILEC's unbundled network
elements. The Supreme Court has decided to review the Eighth Circuit's
decisions, and is expected to do so during its 1998-99 term, but the Company
cannot predict what the result of this review will be. The Eighth Circuit's
decisions create uncertainty about the rules governing pricing, terms and
conditions of interconnection agreements, and could make negotiating and
enforcing such agreements more difficult and protracted. There can be no
assurance that the Company will be able to obtain or enforce interconnection
agreements on terms acceptable to the Company.
The Telecom Act also codifies the ILECs' equal access and nondiscrimination
obligations and preempts inconsistent state regulation. The Telecom Act
contains special provisions that modify previous court decrees that prevented
RBOCs from providing long distance services and engaging in telecommunications
equipment manufacturing. These provisions permit a RBOC to enter the long
distance market in its traditional service area if it satisfies several
procedural and substantive requirements, including obtaining FCC approval upon
a showing that the RBOC has entered into interconnection agreements (or, under
some circumstances, has offered to enter into such agreements) in those states
in which it seeks long distance relief, the interconnection agreements satisfy
a 14-point "checklist" of competitive requirements, and the FCC is satisfied
that the RBOC's entry into long distance markets is in the public interest. To
date, several petitions by RBOCs for such entry have been denied by the FCC,
and none have been granted. The Telecom Act permitted the RBOCs to enter the
out-of-region long distance market immediately upon its enactment.
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On December 31, 1997, the U.S. District Court for the Northern District of
Texas issued a decision (the "SBC Decision") finding that Sections 271 to 275
of the Telecom Act are unconstitutional. These sections of the Telecom Act
impose restrictions on the lines of business in which the RBOCs may engage,
including establishing the conditions they must satisfy before they may
provide in-region interLATA telecommunications services. The SBC Decision has
been stayed pending appeal, and will be reviewed by higher courts, but there
can be no assurance as to the results of any appeal. If the SBC Decision is
upheld on appeal, the RBOCs would be able to provide interLATA services
immediately without satisfying the statutory conditions. This would likely
have an unfavorable effect on the Company's business by allowing the RBOCs to
compete more effectively against the Company by offering combined packages of
local and long-distance services, while maintaining their local monopolies,
which they are currently unable to do. See "--Competition."
In October 1996, the FCC adopted an order in which it eliminated the
requirement that non-dominant carriers such as the Company maintain tariffs on
file with the FCC for domestic interstate services. This order applies to all
non-dominant interstate carriers, including AT&T. The order does not apply to
the RBOCs or other local exchange providers. The FCC order was issued pursuant
to authority granted to the FCC in the Telecom Act to "forbear" from
regulating any telecommunications services provider if the FCC determines that
the public interest will be served. On February 13, 1997, the United States
Court of Appeals for the District of Columbia Circuit stayed the
implementation of the FCC order pending its review of the order on the merits.
Currently, that temporary stay remains in effect.
If the stay is lifted and the FCC order becomes effective,
telecommunications carriers such as the Company will no longer be able to rely
on the filing of tariffs with the FCC as a means of providing notice to
customers of prices, terms and conditions on which they offer their interstate
services. The obligation to provide non-discriminatory, just and reasonable
prices remains unchanged under the Communications Act of 1934. While tariffs
provided a means of providing notice of prices, terms and conditions, the
Company intends to rely primarily on its sales force and direct marketing to
provide such information to its customers.
The Company's costs of providing long distance services, as well as its
revenues from providing local services, will both be affected by changes in
the "access charge" rates imposed by ILECs on long-distance carriers for
origination and termination of calls over local facilities. In two orders
released on December 24, 1996, and May 16, 1997, the FCC made major changes in
the interstate access charge structure. In the December 24th order, the FCC
removed restrictions on ILECs' ability to lower access prices and relaxed the
regulation of new switched access services in those markets where there are
other providers of access services. If this increased pricing flexibility is
not effectively monitored by federal regulators, it could have a material
adverse effect on the Company's ability to price its interstate access
services competitively. The May 16th order substantially increased the amounts
that ILECs subject to the FCC's price cap rules ("price cap LECs") recover
through monthly flat-rate charges and substantially decreased the amounts that
these LECs recover through traffic sensitive (per-minute) access charges. In
the May 16th order, the FCC also announced its plan to bring interstate access
rate levels more in line with cost. The plan will include rules that are
expected to be established sometime in 1998 that may grant price cap LECs
increased pricing flexibility upon demonstrations of increased competition (or
potential competition) in relevant markets. The manner in which the FCC
implements this approach to lowering access charge levels could have a
material effect on the Company's revenues and costs. Several parties have
appealed the May 16th order. Those appeals have been consolidated and
transferred to the Eighth Circuit where they are currently pending. One issue
on appeal is whether the FCC has a reasonable basis for not requiring ISPs to
pay access charges.
Beginning in June 1997, every RBOC advised CLECs that they did not consider
calls in the same local calling area from their customers to CLEC customers,
who are ISPs, to be local calls under the interconnection agreements between
the RBOCs and the CLECs. The RBOCs claim that these calls are exchange access
calls for which exchange access charges would be owed. The RBOCs claimed,
however, that the FCC exempted these calls from access charges so that no
compensation is owed to the CLECs for transporting and terminating such calls.
As a result, the RBOCs threatened to withhold, and in many cases did withhold,
reciprocal compensation
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for the transport and termination of such calls. To date, fifteen state
commissions have ruled on this issue in the context of state commission
arbitration proceedings or enforcement proceedings. In every state, to date,
the state commission has determined that reciprocal compensation is owed for
such calls. Several of these cases are presently on appeal. The Company cannot
predict the outcome of these appeals, or of additional pending cases. If these
calls were to be determined not to be local calls and not subject to access
charges, it could have an adverse effect on the Company.
The FCC has to date treated ISPs as "enhanced service providers," exempt
from federal and state regulations governing common carriers, including the
obligation to pay access charges and contribute to the universal service fund.
Nevertheless, regulations governing disclosure of confidential communications,
copyright, excise tax, and other requirements may apply to the Company's
provision of Internet access services. The Company cannot predict the
likelihood that state, federal or foreign governments will impose additional
regulation on the Company's Internet business, nor can it predict the impact
that future regulation will have on the Company's operations.
In December 1996, the FCC initiated a Notice of Inquiry regarding whether to
impose regulations or surcharges upon providers of Internet access and
information services (the "Internet NOI"). The Internet NOI sought public
comment upon whether to impose or continue to forebear from regulation of
Internet and other packet-switched network service providers. The Internet NOI
specifically identifies Internet telephony as a subject for FCC consideration.
On April 10, 1998, the FCC issued a Report to Congress on its implementation
of the universal service provisions of the Telecom Act. In that Report, the
FCC stated, among other things, that the provision of transmission capacity to
ISPs constitutes the provision of telecommunications and is, therefore,
subject to common carrier regulations. 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 in order to provide an
information service. Any such contribution by a facilities-based ISP would be
related to the ISP's provision of the underlying telecommunications 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. It noted that the FCC did not have an
adequate record on which to make any definitive pronouncements on that issue
at this time, but that the record the FCC had reviewed suggests that certain
forms of phone-to-phone IP telephony appear to have similar functionality to
non-IP telecommunications services and lack the characteristics that would
render them information services. If the FCC were to determine that certain IP
telephony services are subject to FCC regulations as telecommunications
services, the FCC noted it may find it reasonable that the 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 appear to be information services. The Company cannot predict the
outcome of these proceedings or other FCC proceedings that may effect the
Company's operations or impose additional requirements, or regulations or
charges upon the Company's provision of Internet access services.
On May 8, 1997, the FCC issued an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new universal service funds to support telecommunications and
information services provided to qualifying schools and libraries (with an
annual cap of $2.25 billion) and to rural health care providers (with an
annual cap of $400 million). The FCC also expanded the federal subsidies for
local exchange telephone services provided to low-income consumers. Providers
of interstate telecommunications service, such as the Company, as well as
certain other entities, must pay for these programs.
The Company's contribution to these universal service funds will be based on
its telecommunications service end-user revenues. The extent to which the
Company's services are viewed as telecommunications services or as information
services will impact the amount of the Company's contributions, if any. As
indicated in the preceding paragraph, that issue has not been resolved.
Currently, the FCC assesses such payments on the basis of a provider's revenue
for the previous year. Since the Company had no significant telecommunications
service revenues in 1997, it will not be liable for subsidy payments in any
material amount during 1998. With respect to subsequent years, however, the
Company is currently unable to quantify the amount of subsidy payments that it
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will be required to make and the effect that these required payments will have
on its financial condition because of uncertainties concerning the size of the
universal fund and uncertainties concerning the classification of its
services. In the May 8th order, the FCC 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 subsidy program. Several parties have appealed the May 8th order. Such
appeals have been consolidated and transferred to the Fifth Circuit Court of
Appeals where they are currently pending. The FCC's universal service program
may also be altered as a result of the agency's reconsideration of its
policies, or by future Congressional action.
State Regulation
The Telecom Act is intended to increase competition in the
telecommunications industry, especially in the local exchange market. With
respect to local services, ILECs are required to allow interconnection to
their networks and to provide unbundled access to network facilities, as well
as a number of other procompetitive measures. Because the implementation of
the Telecom Act is subject to numerous state rulemaking proceedings on these
issues, it is currently difficult to predict how quickly full competition for
local services, including local dial tone, will be introduced.
State regulatory agencies will have jurisdiction when Company facilities and
services are used to provide intrastate services. A portion of the Company's
traffic may be classified as intrastate and therefore subject to state
regulation. The Company expects that it will offer more intrastate services
(including intrastate switched services) as its business and product lines
expand and state regulations are modified to allow increased local services
competition. To provide intrastate services, the Company generally must obtain
a certificate of public convenience and necessity from the state regulatory
agency and comply with state requirements for telecommunications utilities,
including state tariffing requirements. The Company has obtained certification
for interexchange and local telecommunications services in California,
Illinois, Maryland, Massachusetts, New Hampshire, New York, Rhode Island,
Texas and Virginia. The Company has authority to provide interexchange service
in Michigan and New Jersey. The Company currently has pending applications for
interexchange and local exchange services in Colorado, Georgia, Pennsylvania
and Washington and applications for local exchange authority in Washington,
D.C., Michigan and New Jersey.
Local Regulation
The Company's networks will be subject to numerous local regulations such as
building codes and licensing. Such regulations vary on a city-by-city, county-
by-county and state-by-state basis. To install its own fiber optic
transmission facilities, the Company will need to obtain rights-of-way over
private and publicly owned land. There can be no assurance that such rights-
of-way will be available to the Company on economically reasonable or
advantageous terms.
Canadian Regulation
The CRTC generally regulates long distance telecommunications services in
Canada. Regulatory developments over the past several years have terminated
the historic monopolies of the regional telephone companies, bringing
significant competition to this industry for both domestic and international
long distance services, even in Saskatchewan, which will not be subject to
CRTC regulation until October 25, 1998, but also lessening regulation of
domestic long distance companies. Resellers, which, as well as facilities-
based carriers, now have interconnection rights, but which are not obligated
to file tariffs, may not only provide transborder services to the U.S. by
reselling the services provided by the regional companies and other entities
but also may resell the services of the monopoly international carrier,
Teleglobe Canada ("Teleglobe"), including offering international switched
services provisioned over leased lines. Although the CRTC formerly restricted
the practice of "switched hubbing" over leased lines through intermediate
countries to a third country, the CRTC recently lifted this restriction except
for routing of traffic through the U.S. Teleglobe has asked the CRTC to stay
this decision. The Teleglobe monopoly on international services and submarine
cable landing rights is scheduled to
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terminate as of October 1, 1998, pursuant to Canada's commitments under the
WTO Agreement, although the provision of Canadian international facilities-
based services may remain restricted to "Canadian carriers" with majority
ownership by Canadians. Ownership of non-international facilities will almost
certainly be limited to Canadian carriers. The Company cannot, under current
or foreseen law, enter the Canadian market as a provider of facilities-based
domestic services, and it is possible that this limitation will apply to the
provision of international facilities-based services as well. Pending
proceedings address legislative and regulatory changes that will implement
Canada's commitments under the WTO Agreement by changing Teleglobe's status,
and these proceedings may also subject resellers to additional regulation.
Other pending proceedings address the scope of contribution charges payable to
the telephone companies to offset some of the capital and operating costs of
interconnection as well as deregulation of the long distance services of the
incumbent regional telephone companies.
While competition is now emerging in other Canadian telecommunications
market segments, the Company believes that the regional companies continue to
retain a substantial majority of the local and calling card markets. Beginning
in May 1997, the CRTC released a number of decisions opening to competition
the Canadian local telecommunications services market, which decisions were
made applicable in the territories of all Stentor member companies except
SaskTel (although Saskatchewan has subsequently announced plans for local
service competition in that province). As a result, networks operated by CLECs
may now be interconnected with the network of the ILECs. Facilities-based
ILECs are subject to the same majority Canadian ownership "Canadian carrier"
requirements as facilities-based long distance carriers. CLECs have the same
status as ILECs, but they do not have universal service or customer tariff-
filing obligations. CLECs are subject to certain consumer protection
safeguards and other CRTC regulatory oversight requirements. CLECs must file
interconnection tariffs for services to interexchange service providers
("IXs") and wireless service providers. Certain ILEC services must be provided
to CLECs on an unbundled basis and subject to mandatory pricing, including
central office codes, subscriber listings, and local loops in small urban and
rural areas. For a five-year period, certain other important CLEC services
must be provided on an unbundled basis at mandated prices. ILECs, which,
unlike CLECs, remained fully regulated, will not be subject to rate of return
regulation for an initial four-year period beginning May 1, 1997, but their
services must not be priced below cost. IX contribution payments are now
pooled and distributed among ILECs and CLECs according to a formula based on
their respective proportions of residential lines, with no explicit
contribution payable from local business exchange or directory revenues. CLECs
must pay an annual telecommunications fee based on their proportion of total
CLEC operating revenues. All bundled and unbundled local services (including
residential lines and other bulk services) may now be resold, but ILECs need
not provide these services to resellers at wholesale prices. Transmission
facilities-based local and long distance carriers (but not resellers) are
entitled to co-locate equipment in ILEC central offices pursuant to terms and
conditions of tariffs and intercarrier agreements. Certain local competition
issues are still to be resolved, including rate determinations, permanent
local number portability technical issues, and certain other interconnection
issues, as well as the opening of CLEC status to carriers other than those
that are transmission-facilities based (and therefore are Canadian carriers
with majority ownership by Canadians).
THE COMPANY'S OTHER BUSINESSES
The Company's other businesses include its investment in the three public
companies resulting from the restructuring of C-TEC (the"C-TEC Companies"),
coal mining, the SR91 Tollroad and certain other assets. The Company recently
completed the sale of its interests in United Infrastructure Company,
CalEnergy and Kiewit Investment Management Corp.
C-TEC Companies
On September 30, 1997, C-TEC completed a tax-free restructuring, which
divided C-TEC into three public companies: C-TEC, which changed its name to
Commonwealth Telephone Enterprises, Inc. ("Commonwealth Telephone"), RCN
Corporation ("RCN") and Cable Michigan, Inc. ("Cable Michigan"). The Company's
interests in the C-TEC Companies are held through a holding company (the "C-
TEC Holding Company"). The Company owns 90% of the common stock of the C-TEC
Holding Company, and preferred stock of the C-TEC
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Holding Company with a liquidation value of approximately $481 million as of
April 1, 1998. The remaining 10% of the common stock of the C-TEC Holding
Company is held by David C. McCourt, a director of the Company who was
formerly the Chairman of C-TEC. In the event of a liquidation of the C-TEC
Holding Company, the Company would first receive the liquidation value of the
preferred stock. Any excess of the value of the C-TEC Holding Company above
the liquidation value of the preferred stock would be split according to the
ownership of the common stock.
Commonwealth Telephone. Commonwealth Telephone is a Pennsylvania public
utility providing local telephone service to a 19-county, 5,191 square mile
service territory in Pennsylvania. Commonwealth Telephone services
approximately 259,000 main access lines. Commonwealth Telephone also provides
network access and long distance services to IXC's. Commonwealth Telephone's
business customer base is diverse in size as well as industry, with very
little concentration. Commonwealth Communications Inc. provides
telecommunications engineering and technical services to large corporate
clients, hospitals and universities in the northeastern United States. Another
subsidiary, Commonwealth Long Distance operates principally in Pennsylvania,
providing switched services and resale of several types of services, using the
networks of several long distance providers on a wholesale basis. As of March
31, 1998, the C-TEC Holding Company owned approximately 48.4% of the
outstanding common stock of Commonwealth Telephone.
RCN. RCN is a full service provider of local, long distance and cable
television services primarily to residential users in densely populated areas
in the Northeast. RCN operates as a competitive telecommunications service
provider in New York City and Boston. RCN also owns cable television
operations in New York, New Jersey and Pennsylvania; a 40% interest in
Megacable, S.A. de C.V., Mexico's second largest cable television operator;
and has long distance operations (other than the operations in certain areas
of Pennsylvania). RCN is developing advanced fiber optic networks to provide a
wide range of telecommunications services, including local and long distance
telephone, video programming and data services (including high speed Internet
access), primarily to residential customers in selected markets in the Boston
to Washington, D.C. corridor. During the first quarter of 1998, RCN acquired
Ultranet Communications, Inc. and Erols Internet, Inc., two ISPs with
operations in the Boston to Washington, D.C. corridor. As of March 31, 1998,
the C-TEC Holding Company owned approximately 46.1% of the outstanding common
stock of RCN.
Cable Michigan. Cable Michigan is a cable television operator in the State
of Michigan which, as of December 31, 1997, served approximately 204,000
subscribers including approximately 39,400 subscribers served by Mercom.
Clustered primarily around the Michigan communities of Grand Rapids, Traverse
City, Lapeer and Monroe (Mercom), Cable Michigan's systems serve a total of
approximately 400 municipalities in suburban markets and small towns. As of
March 31, 1998, the C-TEC Holding Company owned approximately 48.5% of the
outstanding common stock of Cable Michigan.
Coal Mining
The Company is engaged in coal mining through its subsidiary, KCP Inc.
("KCP"). KCP has a 50% interest in three mines, which are operated by a
subsidiary of New PKS. Decker Coal Company ("Decker") is a joint venture with
Western Minerals, Inc., a subsidiary of The RTZ Corporation PLC. Black Butte
Coal Company ("Black Butte") is a joint venture with Bitter Creek Coal
Company, a subsidiary of Union Pacific Resources Group Inc. Walnut Creek
Mining Company ("Walnut Creek") is a general partnership with Phillips Coal
Company, a subsidiary of Phillips Petroleum Company. The Decker mine is
located in southeastern Montana, the Black Butte mine is in southwestern
Wyoming, and the Walnut Creek mine is in east-central Texas. The coal mines
use the surface mining method. For a discussion of certain risks associated
with the coal mining business, see "Risk Factors--Risks Related to the
Company's Coal Operations."
The coal produced from the KCP mines is sold primarily to electric
utilities, which burn coal in order to produce steam to generate electricity.
Approximately 89% of sales are made under long-term contracts, and the
remainder are made on the spot market. Approximately 79%, 80% and 80% of KCP's
revenues in 1997, 1996 and 1995, respectively, were derived from long-term
contracts with Commonwealth Edison Company
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("Commonwealth Edison") (with Decker and Black Butte) and The Detroit Edison
Company (with Decker). The primary customer of Walnut Creek is the Texas-New
Mexico Power Company ("TNP"). KCP also has other sales commitments, including
those with Sierra Pacific, Idaho Power, Solvay Minerals, Pacific Power &
Light, Minnesota Power, and Mississippi Power, that provide for the delivery
of approximately 13 million tons through 2005. The level of cash flows
generated in recent periods by the Company's coal operations will not continue
after the year 2000 because the delivery requirements under the Company's
current long-term contracts decline significantly.
Under a mine management agreement, KCP pays a subsidiary of New PKS an
annual fee equal to 30% of KCP's adjusted operating income. The fee in 1997
was $32 million.
Competition. The coal industry is highly competitive. KCP competes not only
with other domestic and foreign coal suppliers, some of whom are larger and
have greater capital resources than KCP, but also with alternative methods of
generating electricity and alternative energy sources. In 1996, KCP's
production represented 1.5% of total U.S. coal production. Demand for KCP's
coal is affected by economic, political and regulatory factors. For example,
recent "clean air" laws may stimulate demand for low sulfur coal. KCP's
western coal reserves generally have a low sulfur content (less than one
percent) and are currently useful principally as fuel for coal-fired, steam-
electric generating units.
KCP's sales of its western coal, like sales by other western coal producers,
typically provide for delivery to customers at the mine. A significant portion
of the customer's delivered cost of coal is attributable to transportation
costs. Most of the coal sold from KCP's western mines is currently shipped by
rail to utilities outside Montana and Wyoming. The Decker and Black Butte
mines are each served by a single railroad. Many of their western coal
competitors are served by two railroads and such competitors' customers often
benefit from lower transportation costs because of competition between
railroads for coal hauling business. Other western coal producers,
particularly those in the Powder River Basin of Wyoming, have lower stripping
ratios (that is, the amount of overburden that must be removed in proportion
to the amount of minable coal) than the Black Butte and Decker mines, often
resulting in lower comparative costs of production. As a result, KCP's
production costs per ton of coal at the Black Butte and Decker mines can be as
much as four and five times greater than production costs of certain
competitors. KCP's production cost disadvantage has contributed to its
agreement to amend its long-term contract with Commonwealth Edison to provide
for delivery of coal from alternate source mines rather than from Black Butte.
Because of these cost disadvantages, KCP does not expect that it will be able
to enter into long-term coal purchase contracts for Black Butte and Decker
production as the current long-term contracts expire. In addition, these cost
disadvantages may adversely affect KCP's ability to compete for spot sales in
the future.
The Company is required to comply with various federal, state and local laws
and regulations concerning protection of the environment. KCP's share of land
reclamation expenses in 1997 was $3.6 million. KCP's share of accrued
estimated reclamation costs was $100 million at the end of 1997. The Company
does not expect to make significant capital expenditures for environmental
compliance with respect to the coal business in 1998. The Company believes its
compliance with environmental protection and land restoration laws will not
affect its competitive position since its competitors in the mining industry
are similarly affected by such laws. However, failure to comply with
environmental protection and land restoration laws, or actual reclamation
costs in excess of the Company's accruals, could have an adverse effect on the
Company's business, results of operations, or financial condition.
SR91 Tollroad
The Company has invested $12 million for a 65% equity interest and lent $4.3
million to California Private Transportation Company L.P. (the "CPTC"), which
developed, financed, and currently operates the 91 Express Lanes, a ten mile,
four-lane tollroad in Orange County, California. The fully automated highway
uses an electronic toll collection system and variable pricing to adjust tolls
to demand. Capital costs at completion were $130 million, $110 million of
which was funded with debt that was not guaranteed by Level 3. However,
certain
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defaults by Level 3 on its outstanding debt and certain judgements against
Level 3 can result in default under this debt of CPTC. Revenue collected over
the 35-year franchise period is used for operating expenses, debt repayment,
and profit distributions. The tollroad opened in December 1995 and achieved
operating break-even in 1996. Approximately 100,000 customers have registered
to use the tollroad, and weekday volumes typically exceed 29,000 vehicles per
day.
EMPLOYEES
As of March 31, 1998, the Company employed approximately 1,100 people.
PROPERTIES
The Company has announced that it has acquired 46 acres in the Northwest
corner of the Interlocken office park within the City of Broomfield, Colorado,
and within Boulder County, Colorado limits and will build a campus facility
that is expected to eventually encompass over 500,000 square feet of office
space. It is anticipated that the first phase of this facility will be
constructed by the end of June 1999. In addition, the Company has leased
approximately 50,000 square feet of temporary office space in Louisville,
Colorado to allow for the relocation of the majority of its employees (other
than those of PKSIS) while its permanent facilities are under construction.
Properties relating to the Company's coal mining segment are described under
"--The Company's Other Businesses--Coal Mining" above. In connection with
certain existing and historical operations, the Company is subject to
environmental risks. See "Risk Factors--Environmental Risks."
PKSIS maintains its corporate headquarters in Omaha, Nebraska and leases
approximately 35,000 square feet of office space in Omaha. The computer
outsourcing business of PKSIS is located at an 89,000 square foot office space
in Omaha and will soon also be located at a 60,000 square foot computer center
in Tempe, Arizona which is currently being constructed. PKSIS maintains
additional office space in Phoenix, Atlanta, Omaha and Parsippany for its
systems integration business.
LEGAL PROCEEDINGS
The Company and its subsidiaries are parties to many pending legal
proceedings. Management believes that any resulting liabilities for legal
proceedings, beyond amounts reserved, will not materially affect the Company's
financial condition, future results of operations, or future cash flows.
HISTORY AND INDUSTRY DEVELOPMENT
Telecommunications Industry. Prior to its court-ordered breakup in 1984 (the
"Divestiture"), AT&T largely monopolized the telecommunications services in
the United States even though technological developments had begun to make it
economically possible for companies (primarily entrepreneurial enterprises) to
compete for segments of the communications business.
The present structure of the U.S. telecommunications market is largely the
result of the Divestiture. As part of the Divestiture, seven local exchange
holding companies were created to offer services in geographically defined
areas called LATAs. The RBOCs were separated from the long distance provider,
AT&T, resulting in the creation of two distinct market segments: local
exchange and long distance. The Divestiture provided for direct, open
competition in the long distance segment.
The Divestiture did not provide for competition in the local exchange
market. However, several factors served to promote competition in the local
exchange market, including: (i) customer desire for an alternative to the
RBOCs, also referred to as the ILECs; (ii) technological advances in the
transmission of data and video requiring greater capacity and reliability than
ILEC networks were able to accommodate; (iii) a monopoly position and rate of
return-based pricing structure which provided little incentive for the ILECs
to upgrade their networks; and (iv) the significant fees, called "access
charges," long distance carriers were required to pay to the ILECs to access
the ILECs' networks.
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The first competitors in the local exchange market, designated as CAPs by
the FCC, were established in the mid-1980s. Most of the early CAPs were
entrepreneurial enterprises that operated limited networks in the central
business districts of major cities in the United States where the highest
concentration of voice and data traffic is found. Since most states prohibited
competition for local switched services, early CAP services primarily
consisted of providing dedicated, unswitched connections to long distance
carriers and large businesses. These connections allowed high-volume users to
avoid the relatively high prices charged by ILECs for dedicated, unswitched
connections or for switched access.
As CAPs proliferated during the latter part of the 1980s, certain federal
and state regulators issued rulings which favored competition and promised to
open local markets to new entrants. These rulings allowed CAPs to offer a
number of new services, including, in certain states, a broad range of local
exchange services, including local switched services. Companies providing a
combination of CAP and switched local services are sometimes referred to as
CLECs. This pro-competitive trend continued with the passage of the Telecom
Act, which provided a legal framework for introducing competition to local
telecommunications services throughout the United States.
Over the last three years, several significant transactions have been
announced representing consolidation of the U.S. telecom industry. Among the
ILECs, Bell Atlantic Corporation and NYNEX Corporation merged in August 1997
and Pacific Telesis Group and SBC Communications Inc. merged in April 1997.
Major long distance providers have sought to enhance their positions in local
markets, through transactions such as AT&T's acquisition of Teleport
Communications Group and WorldCom's mergers with MFS and Brooks Fiber
Properties and to otherwise improve their competitive positions, through
transactions such as WorldCom's planned merger with MCI.
Many international markets resemble that of the United States prior to the
Divestiture. In many countries, traditional telecommunications services have
been provided through a monopoly provider, frequently controlled by the
national government, such as a Post, Telegraph and Telephone Company ("PTT").
In recent years, there has been a trend toward liberalization of many of these
markets, particularly in Europe. Led by the introduction of competition in the
United Kingdom, the European Union mandated open competition as of January
1998. Similar trends are emerging, albeit more slowly, in Asia.
Internet Industry. The Internet is a global collection of interconnected
computer networks that allows commercial organizations, educational
institutions, government agencies and individuals to communicate
electronically, access and share information and conduct business. The
Internet originated with the ARPAnet, a restricted network that was created in
1969 by the United States Department of Defense Advanced Research Projects
Agency (DARPA) to provide efficient and reliable long-distance data
communications among the disparate computer systems used by government-funded
researchers and academic organizations. The networks that comprise the
Internet are connected in a variety of ways, including by the public switched
telephone network and by high speed, dedicated leased lines. Communications on
the Internet are enabled by IP, an inter-networking standard that enables
communication across the Internet regardless of the hardware and software
used.
Over time, as businesses have begun to utilize e-mail, file transfer and,
more recently, intranet and extranet services, commercial usage has become a
major component of Internet traffic. In 1989, the U.S. government effectively
ceased directly funding any part of the Internet backbone. In the mid-1990s,
contemporaneous with the increase in commercial usage of the Internet, a new
type of provider called an ISP became more prevalent. ISPs offer access, e-
mail, customized consent and other specialized services and products aimed at
allowing both commercial and residential customers to obtain information from,
transmit information to, and utilize resources available on the Internet.
ISPs generally operate networks composed of dedicated lines leased from
Internet backbone providers using IP-based switching and routing equipment and
server-based applications and databases. Customers are connected to the ISP's
POP by facilities obtained by the customer or the ISP from either ILECs or
CLECs through a dedicated access line or the placement of a circuit-switched
local telephone call to the ISP.
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IP Communications Technology. There are two widely used switching
technologies in currently deployed communications networks: circuit-switching
systems and packet-switching systems. Circuit-switch based communications
systems establish a dedicated channel for each communication (such as a
telephone call for voice or fax), maintain the channel for the duration of the
call, and disconnect the channel at the conclusion of the call. Packet-switch
based communications systems format the information to be transmitted, such as
e-mail, voice, fax and data into a series of shorter digital messages called
"packets." Each packet consists of a portion of the complete message plus the
addressing information to identify the destination and return address.
Packet-switch based systems offer several advantages over circuit-switch
based systems, particularly the ability to commingle packets from several
communications sources together simultaneously onto a single channel. For most
communications, particularly those with bursts of information followed by
periods of "silence," the ability to commingle packets provides for superior
network utilization and efficiency, resulting in more information being
transmitted through a given communication channel. There are, however, certain
disadvantages to packet-switch based systems as currently implemented. Rapidly
increasing demands for data, in part driven by the Internet traffic volumes,
are straining capacity and contributing to latency (delays) and interruptions
in communications transmissions. In addition, there are concerns about the
adequacy of the security and reliability of packet-switch based systems as
currently implemented.
Many initiatives are under way to develop technology to address these
disadvantages of packet-switch based systems. The Company believes that the IP
standard, which is an "open networking standard" broadly adopted in the
Internet and elsewhere, should remain a primary focus of these development
efforts. The Company expects the benefits of these efforts to be improved
communications throughout, reduced latency and declining networking hardware
costs.
TELECOMMUNICATIONS SERVICES MARKET
Overview of U.S. Market. The traditional U.S. market for telecommunications
services can be divided into three basic sectors: long distance services,
local exchange services and Internet access services. In 1997, it is estimated
that local exchange services accounted for revenues of $92.4 billion, long
distance services generated revenues of $104.6 billion and Internet services
revenues totaled $6.3 billion. Revenues for both local exchange and long
distance services include amounts charged by long distance carriers and
subsequently paid to ILECs (or, where applicable, CLECs) for long distance
access.
Long Distance Services. A long distance telephone call can be envisioned as
consisting of three segments. Starting with the originating customer, the call
travels along a local exchange network to a long distance carrier's POP. At
the POP, the call is combined with other calls and sent along a long distance
network to a POP on the long distance carrier's network near where the call
will terminate. The call is then sent from this POP along a local network to
the terminating customer. Long distance carriers provide only the connection
between the two local networks, and pay access charges to LECs for originating
and terminating calls.
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The following diagram is a simplified illustration of a typical long
distance call:
[DIAGRAM OF A TYPICAL LOCAL CALL APPEARS HERE]
Local Exchange Services. A local call is one that does not require the
services of a long distance carrier. In general, the local exchange carrier
connects end user customers within a LATA and also provides the local portion
of most long distance calls.
The following diagram is a simplified illustration of a typical local call:
[DIAGRAM OF A TYPICAL LONG DISTANCE CALL APPEARS HERE]
Internet Service. Internet services are generally provided in at least two
distinct segments. A local network connection is required from the ISP
customer to the ISP's local facilities. For large, communication-intensive
users and for content providers, these connections are typically unswitched,
dedicated connections provided by ILECs or CLECs, either as independent
service providers or, in some cases, by a company which is both a CLEC and an
ISP. For residential and small/medium business users, these connections are
generally PSTN connections obtained on a dial-up access basis as a local
exchange telephone call. Once a local connection is made to the ISP's local
facilities, information can be transmitted and obtained over a packet-switched
IP data network, which may consist of segments provided by many interconnected
networks operated by a number of ISPs. This collection of interconnected
networks makes up the Internet. A key feature of Internet architecture and
packet-switching is that a single dedicated channel between communication
points is never established, which distinguishes Internet-based services from
the PSTN.
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The following diagram is a simplified illustration of a typical Internet
access service:
[DIAGRAM OF A TYPICAL INTERNET ACCESS SERVICE APPEARS HERE]
Overview of International Market. The traditional market for
telecommunications services outside of the United States can also be divided
into three basic sectors: long distance services, local exchange services and
Internet access services. In 1997, it is estimated that local exchange
services accounted for revenues of $116.6 billion, long distance services
generated revenues of $193.7 billion and Internet services revenues totaled
$4.8 billion.
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GLOSSARY OF TERMS
access Telecommunications services that permit long
distance carriers to use local exchange
facilities to originate and/or terminate long
distance service.
access charges The fees paid by long distance carriers to LECs
for originating and terminating long distance
calls on the LECs' local networks.
ATM Asynchronous Transfer Mode. An information
transfer standard for routing traffic which uses
packets (cells) of a fixed length.
AT&T AT&T Corp.
backbone A centralized high-speed network that
interconnects smaller, independent networks. It
is the through-portion of a transmission network,
as opposed to spurs which branch off the through-
portions.
bandwidth The number of bits of information which can move
through a communications medium in a given amount
of time; the capacity of a telecommunications
circuit/network to carry voice, data and video
information. Typically measured in kbps and Mbps.
bit A contraction of the term Binary Digit, it is the
basic unit in data communications. Bits are
typically represented by ones or zeros.
CAP Competitive Access Provider. A company that
provides its customers with an alternative to the
local exchange company for local transport of
private line and special access
telecommunications services.
capacity The information carrying ability of a
telecommunications facility.
carrier A provider of communications transmission
services by fiber, wire or radio.
Central Office Telephone company facility where subscribers'
lines are joined to switching equipment for
connecting other subscribers to each other,
locally and long distance.
CLEC Competitive Local Exchange Carrier. A company
that competes with LECs in the local services
market.
collocation Collocation refers to the physical location of a
telecommunication carrier's equipment in ILEC or
CLEC premises to facilitate the interconnection
of their respective switching/routing equipment.
common carrier A government-defined group of private companies
offering telecommunications services or
facilities to the general public on a non-
discriminatory basis.
conduit A pipe, usually made of metal, ceramic or
plastic, that protects buried cables.
dedicated lines Telecommunications lines reserved for use by
particular customers.
dialing parity The ability of a competing local or toll service
provider to provide telecommunications services
in such a manner that customers have the ability
to route automatically, without the use of any
access code, their telecommunications to the
service provider of the customers' designation.
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DS-3 A data communications circuit capable of
transmitting data at 45 Mbps. Currently used only
by business/institutions and carriers for high-
end applications.
DSL Digital Subscriber Line. An information transfer
standard for transmitting digital voice and data
over telephone lines at speeds up to 1.544 Mbps.
equal access The basis upon which customers of interexchange
carriers are able to obtain access to their
Primary Interexchange Carriers' (PIC) long
distance telephone network by dialing "1", thus
eliminating the need to dial additional digits
and an authorization code to obtain such access.
facilities-based carriers Carriers that own and operate their own network
and equipment.
FCC Federal Communications Commission.
fiber optics A technology in which light is used to transport
information from one point to another. Fiber
optic cables are thin filaments of glass through
which light beams are transmitted over long
distances carrying enormous amounts of data.
Modulating light on thin strands of glass
produces major benefits including high-bandwidth,
relatively low cost, low power consumption, small
space needs and total insensitivity to
electromagnetic interference.
HTML Hypertext Markup Language. A method of organizing
information on a web page.
ILEC Incumbent Local Exchange Carrier. A company
historically providing local telephone service.
Often refers to one of the Regional Bell
Operating Companies (RBOCs). Often referred to as
"LEC" (Local Exchange Carrier).
interconnection Interconnection of facilities between or among
local exchange carriers, including potential
physical collocation of one carrier's equipment
in the other carrier's premises to facilitate
such interconnection.
InterLATA Telecommunications services originating in a LATA
and terminating outside of that LATA.
Internet A global collection of interconnected computer
networks which use a specific communications
protocol.
IntraLATA Telecommunications services originating and
terminating in the same LATA.
IP Internet Protocol. Network protocols that allow
computers with different architectures and
operating system software to communicate with
other computers on the Internet.
ISDN Integrated Services Digital Network. An
information transfer standard for transmitting
digital voice and data over telephone lines at
speeds up to 128 Kbps.
ISPs Internet Service Providers. Companies formed to
provide access to the Internet to consumers and
business customers via local networks.
IXC
Interexchange Carrier. A telecommunications
company that provides telecommunications services
between local exchanges on an interstate or
intrastate basis.
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Kbps Kilobits per second, which is a measurement of
speed for digital signal transmission expressed
in thousands of bits per second.
LATA Local Access and Transport Area. A geographic
area composed of contiguous local exchanges,
usually but not always within a single state.
There are approximately 200 LATAs in the United
States.
leased line Telecommunications line dedicated to a particular
customer along predetermined routes.
LEC Local Exchange Carrier. A telecommunications
company that provides telecommunications services
in a geographic area in which calls generally are
transmitted without toll charges. LECs include
both RBOCs and competitive local exchange
carriers.
local exchange A geographic area determined by the appropriate
state regulatory authority in which calls
generally are transmitted without toll charges to
the calling or called party.
local loop A circuit that connects an end user to the LEC
central office within a LATA.
long distance carriers Long distance carriers provide services between
(interexchange carriers) local exchanges on an interstate or intrastate
basis. A long distance carrier may offer services
over its own or another carrier's facilities.
Mbps Megabits per second. A transmission rate. One
megabit equals 1,024 kilobits.
MCI MCI Communications, Inc.
multiplexing An electronic or optical process that combines a
large number of lower speed transmission lines
into one high speed line by splitting the total
available bandwidth into narrower bands
(frequency division), or by allotting a common
channel to several different transmitting
devices, one at a time in sequence (time
division).
NAP Network Access Point. A location at which ISPs
exchange each other's traffic.
OC-12 A data communications circuit consisting of
twelve DS-3s capable of transmitting data at 540
Mbps.
peering The commercial practice under which ISPs exchange
each other's traffic without the payment of
settlement charges. Peering occurs at both public
and private exchange points.
POP Point of Presence. Telecommunications facility
where the Company locates network equipment used
to connect customers to its network backbone.
private line A dedicated telecommunications connection between
end user locations.
PSTN Public Switched Telephone Network. That portion
of a local exchange company's network available
to all users generally on a shared basis (i.e.,
not dedicated to a particular user). Traffic
along the public switched network is generally
switched at the local exchange company's central
offices.
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RBOCs Regional Bell Operating Companies. Originally,
the seven local telephone companies (formerly
part of AT&T) established as a result of the AT&T
Divestiture. Currently consists of five local
telephone companies as a result of the mergers of
Bell Atlantic with NYNEX and SBC with Pacific
Telesis.
reciprocal compensation The same compensation of a new competitive local
exchange carrier for termination of a local call
by the local exchange carrier on its network, as
the new competitor pays the local exchange
carrier for termination of local calls on the
local exchange carrier network.
resale Resale by a provider of telecommunications
services (such as a LEC) of such services to
other providers or carriers on a wholesale or a
retail basis.
router Equipment placed between networks that relays
data to those networks based upon a destination
address contained in the data packets being
routed.
SONET Synchronous Optical Network. An electronics and
network architecture for variable bandwidth
products which enables transmission of voice,
data and video (multimedia) at very high speeds.
SONET ring architecture provides for virtually
instantaneous restoration of service in the event
of a fiber cut by automatically rerouting traffic
in the opposite direction around the ring.
special access services The lease of private, dedicated
telecommunications lines or "circuits" along the
network of a local exchange company or a CAP,
which lines or circuits run to or from the long
distance carrier POPs. Examples of special access
services are telecommunications lines running
between POPs of a single long distance carrier,
from one long distance carrier POP to the POP of
another long distance carrier or from an end user
to a long distance carrier POP.
Sprint Sprint Corporation.
switch A device that selects the paths or circuits to be
used for transmission of information and
establishes a connection. Switching is the
process of interconnecting circuits to form a
transmission path between users and it also
captures information for billing purposes.
switched service carriers A carrier that sells switched long distance
service and generally refers to a carrier that
owns its switch.
TCP/IP Transmission Control Protocol/Internet Protocol.
A suite of network protocols that allows
computers with different architectures and
operating system software to communicate with
other computers. A type of IP.
unbundled Services, programs, software and training. Sold
separately from the hardware.
unbundled access Access to unbundled elements of a
telecommunications services provider's network
including network facilities, equipment,
features, functions and capabilities, at any
technically feasible point within such network.
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VPN Virtual Private Network. A network capable of
providing the tailored services of a private
network (i.e., low latency, high throughput,
security and customization) while maintaining the
benefits of a public network (i.e., ubiquity and
economies of scale).
WAN Wide Area Network. A data communications network
designed to interconnect personal computers,
workstations, mini computers, file servers and
other communications and computing devices across
a broad geographic region.
Web Site A server connected to the Internet from which
Internet users can obtain information.
wireless A communications system that operates without
wires. Cellular service is an example.
World Wide Web or Web A collection of computer systems supporting a
communications protocol that permits multimedia
presentation of information over the Internet.
xDSL A term referring to a variety of new Digital
Subscriber Line technologies. Some of these
varieties are asymmetric with different data
rates in the downstream and upstream directions.
Others are symmetric. Downstream speeds range
from 384 kbps (or "SDSL") to 1.5-8 Mbps (or
"ADSL").
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
audited consolidated financial statements (including the notes thereto), filed
as part of Amendment No. 1 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 27, 1997.
RECENT DEVELOPMENTS
Split-Off
In October 1996, the Board of Directors of the Company (the "Board")
directed management of the Company to pursue a listing of the Company's Class
D Diversified Group Convertible Exchangeable Common Stock, par value $.0625
per share (the "Class D Stock"), as a way to address certain issues created by
the Company's then two-class capital stock structure and the need to attract
and retain the best management for the Company's businesses. During the course
of its examination of the consequences of a listing of the Class D Stock,
management concluded that a listing of the Class D Stock would not adequately
address these issues, and instead began to study a separation of the
construction and mining business (the "Construction Group") from the other
businesses of the Company (the "Diversified Group"), thereby forming two
independent companies. At the regular meeting of the Board on July 23, 1997,
management submitted to the Board for consideration a proposal for separation
of the Construction Group and the Diversified Group through a split-off of the
Construction Group. At a special meeting on August 14, 1997, the Board
approved the Split-Off.
The separation of the Construction Group and the Diversified Group was
contingent upon a number of conditions, including the favorable ratification
by a majority of the holders of both the Company's Class C Construction &
Mining Group Restricted Redeemable Convertible Exchangeable Common Stock, par
value $.0625 per share (the "Class C Stock"), and the Class D Stock, and the
receipt by Company of an Internal Revenue Service ruling or other assurance
acceptable to the Board that the separation would be tax-free to U.S.
stockholders. On December 8, 1997, the holders of Class C Stock and Class D
Stock approved the Split-Off and on March 5, 1998, the Company received a
favorable ruling from the Internal Revenue Service. The Split-Off occurred on
March 31, 1998. In connection with the Split-Off, (i) the Company exchanged
each outstanding share of Class C Stock for one share of common stock of PKS
Holdings, Inc. ("New PKS"), the company formed to hold the Construction Group,
to which eight-tenths of a share of the Company's Class R Convertible Common
Stock, par value $.01 per share (the "Class R Stock"), was attached, (ii) New
PKS was renamed "Peter Kiewit Sons', Inc.," (iii) the Company was renamed
"Level 3 Communications, Inc." and (iv) Class D Stock was designated as Common
Stock, par value $.01 per share ("Common Stock"). As a result of the Split-
Off, the Company no longer owns any interest in New PKS or the Construction
Group.
Conversion of Class R Stock
The Board has approved in principle a plan to force conversion of all
outstanding shares of Class R Stock into Common Stock. Due to certain
provisions of the Class R Stock, conversion will not be forced prior to May
1998, and the final decision to force conversion will be made by the Board at
that time. The Board may choose not to force conversion if it decides that
conversion is not in the best interests of the stockholders of the Company.
If, as currently anticipated, the Board determines to force conversion of the
Class R Stock on or before June 30, 1998, certain adjustments will be made to
the cost sharing and risk allocation provisions of the separation agreements
between the Company and Construction Group.
If the Board determines to force conversion of the Class R Stock, each share
of Class R Stock will be convertible into $25 worth of Common Stock, based
upon the average trading price of the Common Stock on the Nasdaq National
Market for the last fifteen trading days of the month prior to the
determination by the Board to force conversion.
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Conversion of Class C Stock in January 1998
Prior to the Split-Off, as of January 1 of each year, holders of Class C
Stock had the right to convert Class C Stock into Class D Stock, subject to
certain conditions. In January 1998, holders of Class C Stock converted 2.3
million shares, with a redemption value of $122 million, into 10.5 million
shares of Class D Stock.
Listing of Common Stock
Effective April 1, 1998, the Common Stock began trading on The Nasdaq
National Market under the symbol "LVLT."
C-TEC Restructuring
On September 30, 1997, C-TEC consummated a restructuring of C-TEC into three
publicly traded companies (the "C-TEC Companies"). As a result of this
restructuring, the Company owns less than 50% of the outstanding shares and
voting rights of each C-TEC Company, and therefore has accounted for each C-
TEC Company using the equity method as of the beginning of 1997. In accordance
with generally accepted accounting principles, C-TEC's financial position,
results of operations and cash flows are consolidated in the 1996 and 1995
financial statements.
CalEnergy Transaction
In January 1998, the Company and CalEnergy Company, Inc. ("CalEnergy")
closed the sale of the Company's energy assets to CalEnergy (the "CalEnergy
Transaction"). The Company received proceeds of approximately $1.16 billion
and expects to recognize an after-tax gain of approximately $324 million in
1998. The after-tax proceeds from this transaction of approximately $967
million will be used to fund in part the Business Plan.
Stock Options
The Company recently adopted an outperform stock option program. For a
discussion of the accounting treatment for options granted under this program
and their effect on results of operations for future periods, See "Employee
Recruiting and Retention."
RESULTS OF OPERATIONS
Since the Business Plan represents a significant expansion of the Company's
communications and information services business, the Company does not believe
that the Company's financial condition and results of operations for prior
years will serve as a meaningful indication of the Company's future financial
condition or results of operations. The Company expects to incur substantial
net operating losses for the foreseeable future, and there can be no assurance
that the Company will be able to achieve or sustain operating profitability in
the future.
1997 vs. 1996
Coal Mining. Revenue from the Company's coal mines declined 5% in 1997
compared to 1996. Alternate source coal revenue declined by $16 million in
1997. The Company's primary coal customer, Commonwealth Edison Company
("Commonwealth Edison"), accelerated its contractual commitments in 1996 for
alternate source coal, thus reducing its obligations in 1997. In addition to
the decline in tonnage shipped, the price of coal sold to Commonwealth Edison
declined 1% in 1997. Revenue attributable to other contracts increased by
approximately $4 million. The actual amount of coal shipped under these other
contracts increased 5% in 1997, but the price at which it was sold was 4%
lower than 1996.
Gross margin, as a percentage of revenue, declined 11% from 1996 to 1997.
Gross margins in 1996 were higher than in recent years due to the additional
high margin alternate source coal sold to Commonwealth Edison in 1996 and the
refund of premiums from a captive insurance company that insured against black
lung disease. The decline in Commonwealth Edison shipments and an overall
decline in average selling price adversely affected the results for 1997. If
current market conditions continue, the Company will experience a significant
decline in coal revenue and earnings over the next several years as delivery
requirements under long-term contracts decline and as long-term contracts
begin to expire.
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Information Services. Revenue increased by 124% to $94 million in 1997 from
$42 million in 1996. Revenue from computer outsourcing services increased 20%
to $49 million in 1997 from $41 million in 1996. The increase was due to new
computer outsourcing contracts signed in 1997. Revenue for systems integration
grew to $45 million in 1997 from less than $1 million in 1996. Strong demand
for Year 2000 renovation services fueled the growth in systems integration
revenues.
Gross margin, as a percentage of revenue, decreased to 28% in 1997 from 41%
in 1996 for the computer outsourcing business. The reduction of the gross
margin was due to up-front costs associated with new contracts and significant
increases in personnel costs due to the tightening supply of computer
professionals. Gross margin for the systems integration business was
approximately 40% in 1997. A comparison to 1996 gross margin is not meaningful
due to the start-up nature of the business.
General and Administrative Expenses. Excluding C-TEC, general and
administrative expenses increased 20% to $114 million in 1997. The increase
was primarily attributable to a $41 million increase in the information
services business' general and administrative expenses. The majority of the
increase is attributable to additional compensation expense that was incurred
due to the conversion of a subsidiary's option and stock-appreciation rights
plans to the Company's Class D Stock Option Plan. The remainder of the
increase relates to the increased expenses for new sales offices established
in 1997 for the systems integration business and the additional personnel
hired in 1997 to implement the Business Plan.
Exclusive of the information services business, general and administrative
expenses decreased 26% to $62 million in 1997. A decrease in professional
services and the mine management fees were partially offset by increased
compensation expense. Due to the favorable resolution of certain environmental
and legal matters, costs that were previously accrued for these issues were
reversed in 1997. Partially offsetting this reduction were legal, tax and
consulting expenses associated with the CalEnergy Transaction and the Split-
Off.
Equity Losses. The losses for the Company's equity investments increased
from $9 million in 1996 to $43 million in 1997. Had the C-TEC entities been
accounted for using the equity method in 1996, the losses would have increased
to $13 million. The expenses associated with the deployment and marketing of
the advanced fiber networks in New York, Boston and Washington D.C., and the
costs incurred in connection with the buyout of a marketing contract with
minority shareholders are primarily responsible for the increase in equity
losses attributable to RCN Telecom Services from $6 million in 1996 to $26
million in 1997. The Company's share of the losses of Cable Michigan, Inc.
decreased to $6 million in 1997 from $8 million in 1996. This improvement is
attributable to the gains recognized on the sale of Cable Michigan, Inc.'s
Florida cable systems. The earnings of Commonwealth Telephone Company were
consistent with that of 1996. The Company recorded equity earnings of $9
million in each year attributable to Commonwealth Telephone Company. The
Company also recorded equity losses attributable to several developing
businesses.
Investment Income. Investment income increased 7% in 1997 after excluding C-
TEC's $14 million of investment income in 1996. Gains recognized on the sale
of marketable securities, primarily within the Kiewit Mutual Fund ("KMF"),
increased from $3 million in 1996 to $9 million in 1997. In 1997, KMF
repositioned the securities within its portfolios to more closely track
overall market performance. Partially offsetting these additional gains was a
decline in interest income due to an overall reduction of yield earned by the
KMF portfolios.
Interest Expense. Interest expense increased significantly in 1997 after
excluding $28 million of interest attributable to C-TEC in 1996. California
Private Transportation Company L.P. ("CPTC"), the owner-operator of a
privatized tollroad in California, incurred interest costs of approximately $9
million and $11 million in 1996 and 1997. In 1996, interest of $5 million was
capitalized due to the construction of the tollroad. Construction was
completed in August 1996, and all interest incurred subsequent to that date
was charged against earnings. Interest associated with the financing of the
Aurora, Colorado property of $1 million, also contributed to the increase in
interest expense.
Other Income. Other income in 1996 includes $2 million of other expenses
attributable to C-TEC. Excluding these losses, other income declined from $8
million in 1996 to $1 million in 1997. The absence of gains on the
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sale of timberland properties and other assets, which accounted for $6 million
of income in 1996, is responsible for the decline.
Income Tax (Provision) Benefit. The effective income tax rate for 1997 is
less than the expected statutory rate of 35% due primarily to prior year tax
adjustments, partially offset by the effect of nondeductible compensation
expense associated with the conversion of the information services option and
stock appreciation rights plans to the Company's Class D Stock Option Plan. In
1996, the effective rate was also lower than the statutory rate due to prior
year tax adjustments. These adjustments were partially offset by nondeductible
costs associated with goodwill amortization and taxes on foreign operations.
In 1997 and 1996, the Company settled a number of disputed issues related to
prior years that have been included in prior year tax adjustments.
Discontinued Operations--Construction and Materials. Construction revenues
increased $414 million during 1997 compared to 1996. The consolidation of ME
Holding Inc. (due to the increase in ownership by the Company from 49% to 80%)
("ME Holding") contributed $261 million, almost two-thirds of the increase. In
addition to ME Holding, several large projects and joint ventures became fully
mobilized during the latter part of the year and were well into the "peak"
construction phase.
Material revenues increased 19% to $290 million in 1997 from $243 million in
1996. The acquisition of additional plant sites accounts for 22% of the
increase in sales. The remaining increase was a result of the strong market
for material products in Arizona. This raised sales volume from existing plant
sites and allowed for slightly higher selling prices. The inclusion of $10
million of revenues from the Oak Mountain facility in Alabama also contributed
to the increase.
Construction margins increased to 13% of revenue in 1997 as compared to 10%
in 1996. The favorable resolution of project uncertainties, several change
order settlements, and cost savings or early completion bonuses received
during the year contributed to this increase.
Material margins decreased from 10% of revenue in 1996 to 4% in 1997. Losses
at the Oak Mountain facility in Alabama were the source of the decrease. The
materials margins from sources other than Oak Mountain remained stable as
higher unit sales and selling prices were offset by increases in raw materials
costs.
General and administrative expenses of the Construction Group increased 11%
in 1997 after deducting $17 million of expenses attributable to ME Holding.
Compensation and profit sharing expenses increased $9 million and $2 million,
respectively, from 1996. The increase in these costs is a direct result of
higher construction earnings.
The effective income tax rates in 1997 and 1996 for the Construction Group
differ from the expected statutory rate of 35% primarily due to state income
taxes and prior year tax adjustments.
Discontinued Operations--Energy. Income from discontinued operations
increased to $29 million in 1997 from $9 million in 1996. The acquisition of
Northern Electric plc ("Northern Electric") in late 1996 and the commencement
of operations at the Mahanagdong geothermal facility in July, 1997 were the
primary factors that resulted in the increase.
In October 1997, CalEnergy sold approximately 19.1 million shares of its
common stock. This sale reduced the Company's ownership in CalEnergy to
approximately 24%. It is the Company's policy to recognize gains or losses on
the sale of stock by its investees. The Company recognized an after-tax gain
of approximately $44 million from transactions in CalEnergy stock in the
fourth quarter of 1997.
On July 2, 1997, the Labour Party in the United Kingdom announced the
details of its proposed "Windfall Tax" to be levied against privatized British
utilities. This one-time tax is 23% of the difference between the value of
Northern Electric at the time of privatization and the utility's current value
based on profits over a period of up to four years. CE Electric UK plc ("CE
Electric") recorded an extraordinary charge of approximately $194
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million when the tax was enacted on July 31, 1997. The total after-tax impact
to the Company, directly through its investment in CE Electric and indirectly
through its interest in CalEnergy, was $63 million.
1996 vs. 1995
Coal Mining. Revenue and net earnings improved primarily due to increased
alternate source tons sold to Commonwealth Edison in 1996 and the liquidation
of a captive insurance company which insured against black lung disease. Upon
liquidation, the Company received a refund of premiums paid plus interest in
excess of reserves established by the Company for this liability. Since 1993,
the amended contract with Commonwealth Edison provided that delivery
commitments would be satisfied with coal produced by unaffiliated mines in the
Powder River Basin in Wyoming. Coal produced at the Company's mines did not
change significantly from 1995 levels.
Information Services. Revenue increased 17% to $42 million in 1996 from $36
million in 1995. The increase was primarily due to new computer outsourcing
contracts signed in 1996. Less than $1 million of revenue was generated by the
operations of the new systems integration business, started in February, 1996.
Gross margin as a percentage of revenue for the outsourcing business
decreased to 41% in 1996 from 45% in 1995. The reduction of the gross margin
was primarily due to up-front costs for new customers which were recognized as
an expense when incurred.
Telecommunications. Revenue for the telecommunications segment increased 13%
to $367 million for fiscal 1996. C-TEC's telephone group's $10 million, or 8%,
increase in sales and C-TEC's cable group's $33 million or 26%, increase in
revenue were the primary contributors to the improved results. The increase in
telephone group revenue is due to higher intrastate access revenue from the
growth in access minutes, an increase of 13,000 access lines, and higher
Internet access and video conferencing sales. Cable group revenue increased
primarily due to higher average subscribers and the effects of rate increases
in April 1995 and February 1996. Subscriber counts increased primarily due to
the acquisition of Pennsylvania Cable Systems ("Pennsylvania Cable"), formerly
Twin County Trans Video, Inc., in September 1995, and the consolidation of
Mercom, Inc. ("Mercom") since August 1995. Pennsylvania Cable and Mercom
account for $23 million of the increase in cable revenue in 1996.
The 1996 operating expenses for the telecommunications business increased
$38 million or 18% compared to 1995. The telephone group experienced a 9%
increase in expenses and the cable group's costs increased 31%. The increase
for the telephone group was primarily attributable to higher payroll expenses
resulting from additional personnel, wage increases and higher overtime. Also
contributing to the increase were fees associated with the Internet access
services and consulting services for a variety of regulatory and operational
matters. The cable group's increase was due to increased depreciation,
amortization and compensation expenses associated with the acquisition of
Pennsylvania Cable and the consolidation of Mercom's operations. Also
contributing to the higher costs were rate increases for existing programming
and the costs for additional programming.
General and Administrative Expenses. General and administrative expenses
declined 5% to $181 million in 1996. Decreases in expenses associated with
legal and environmental matters were partially offset by higher mine
management fees paid to the Construction Group, the costs attributable to C-
TEC and the opening of the SR91 toll road. C-TEC's corporate overhead and
other costs increased approximately 13% in 1996. This increase is attributable
to costs associated with the development of RCN Telecom Services' business in
New York and Boston, the acquisition of Pennsylvania Cable, the consolidation
of Mercom and the investigation of the feasibility of various restructuring
alternatives.
Equity Losses. Losses attributable to the Company's equity investments
increased to $9 million in 1996 from $5 million in 1995. The additional losses
were attributable to an enterprise engaged in the renewable fuels business and
to C-TEC's investment in Megacable, S.A. de C.V., Mexico's second largest
cable television operator.
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Investment Income. Investment income increased 24% in 1996 compared to 1995.
Increased gains on the sale of marketable and equity securities and interest
income were partially offset by a slight decline in dividend income.
Interest Expense. Interest expense in 1996 increased 43% compared to 1995.
The increase was primarily due to interest on the CPTC debt that was
capitalized through July 1996, and C-TEC's redeemable preferred stock, issued
in the Pennsylvania Cable acquisition, that began accruing interest in 1996.
Gain on Subsidiary's Stock Transactions. The issuance of the stock of MFS
for acquisitions by MFS and the exercise of MFS employee stock options
resulted in a $3 million net gain to the Company in 1995.
Other. The decrease of other income in 1996 was primarily attributable to
the receipt in 1995 of settlement proceeds related to certain litigation
regarding the Company's mining operations.
Income Tax Benefit (Provision). The effective income tax rate for 1996
differs from the statutory rate of 35% primarily because of adjustments to
prior year tax provisions, partially offset by state taxes and nondeductible
amounts associated with goodwill amortization. In 1995, the rate is lower than
35% due primarily to $93 million of income tax benefits from the reversal of
certain deferred tax liabilities originally recognized on gains from MFS stock
transactions that are no longer required due to the tax-free spin-off of MFS,
and adjustments to prior year tax provisions.
Discontinued Operations--Construction and Materials. Revenue from
construction decreased 1% to $2,303 million in 1996. This resulted from the
completion of several major projects during the year, while many new contracts
were still in the start-up phase. The Construction Group's share of joint
venture revenue remained at 30% of total revenues in 1996. Revenue from
materials increased by less than 1% in 1996. Increased demand for aggregates
in the Arizona market was offset by a decline in precious metal sales. The
Construction Group sold its gold and silver operations in Nevada to Kinross
Gold Corporation ("Kinross") and essentially liquidated its metals inventory
in 1995.
Opportunities in the construction and materials industry continued to expand
along with the economy. Because of the increased opportunities, the
Construction Group was able to be selective in the construction projects it
pursued. Gross margins for construction increased from 8% in 1995 to 10% in
1996. This resulted from the completion of several large projects and
increased efficiencies in all aspects of the construction process. Gross
margins for materials declined from 13% in 1995 to 10% in 1996. The lack of
higher margin precious metals sales in 1996 combined with slightly lower
construction materials margins produced the reduction in operating margin.
In 1995, the exchange of the Construction Group's gold and silver operations
in Nevada for 4,000,000 shares of common stock of Kinross led to a $21 million
gain for the Construction Group. The gain was the difference between the
Construction Group's book value in the gold and silver operations and the
market value of the Kinross shares at the time of the exchange. Other income
was also primarily comprised of mining management fees from the Diversified
Group, of $37 million and $30 million in 1996 and 1995, and gains on the
disposition of property, plant and equipment and other assets of $17 million
and $12 million in 1996 and 1995.
The effective income tax rate for 1996 differs from the statutory rate of
35% primarily because of adjustments to prior year tax provisions and state
taxes. In 1995, the rate was higher than 35% due primarily to state income
taxes.
Discontinued Operations--Energy. Income from discontinued operations
declined in 1996 by 36% to $9 million. Losses attributable to the Company's
interest in CE Casecnan Water and Energy ("CE Casecnan"), additional
development expenses for international activities, and the costs associated
with the Northern Electric transaction were partially offset by increased
equity earnings from CalEnergy.
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FINANCIAL CONDITION--DECEMBER 27, 1997
The Company's working capital, excluding C-TEC and discontinued operations,
increased $392 million or 106% during 1997. This was due to the $182 million
of cash generated by operations, primarily coal operations, and the
significant financing activities described below.
Investing activities included $452 million used to purchase marketable
securities, $42 million of investments and $26 million of capital
expenditures, including $14 million for the Company's existing information
services business and $6 million for a corporate jet. The $42 million of
investments primarily included the Company's $22 million investment in the
Pavilion Towers office complex, located in Aurora, Colorado, and $15 million
of investments in developing businesses. Funding a portion of these activities
was the sale of marketable securities for $167 million.
Sources of financing include $138 million from the issuance of Class D
Stock, $72 million from the exchange of Class C Stock for Class D Stock and
$16 million from the financing for Pavilion Towers. Uses consist primarily of
$12 million for the payment of dividends and $2 million of payments on long-
term debt.
At December 27, 1997, the Company had $140 million of long-term debt. Of
this long-term debt, $114 million was long term debt of CPTC. Approximately
$14 million of additional long-term debt is included in net investments in
discontinued operations--construction.
LIQUIDITY AND CAPITAL RESOURCES
Since late 1997, the Company has substantially increased the emphasis it
places on and the resources devoted to its communications and information
services business. The Company intends to become a facilities-based provider
(that is, a provider that owns or leases a substantial portion of the plant,
property and equipment necessary to provide its services) of a broad range of
integrated communications services. To reach this goal, the Company plans to
expand substantially the business of PKSIS and to create, through a
combination of construction, purchase and leasing of facilities and other
assets, an international, end-to-end, facilities-based communications network.
The Company is designing its network based on IP technology in order to
leverage the efficiencies of this technology to provide lower cost
communications services.
The development of the Business Plan will require significant capital
expenditures, a substantial portion of which will be incurred before any
significant related revenues from the Business Plan are expected to be
realized. These expenditures, together with the associated early operating
expenses, will result in substantial negative cash flow and substantial net
operating losses for the Company for the foreseeable future. The Company
estimates that its capital expenditures in connection with the Business Plan
will be in excess of $500 million in 1998 and will approximate $2 billion in
1999. The Company's current liquidity in addition to the net proceeds of a
proposed private offering of $1.5 billion of the Company's Senior Notes Due
2008 in a transaction exempt from registration under the Securities Act of
1933, as amended, should be sufficient to fund the currently committed
portions of the Business Plan. There can be no assurance that the Company will
complete this private offering.
The Company currently estimates that the implementation of the Business
Plan, as currently contemplated, will require between $8 and $10 billion over
the next 10 years. The Company's ability to implement the Business Plan and
meet its projected growth is dependent upon its ability to secure substantial
additional financing in the future. The Company expects to meet its additional
capital needs with the proceeds from sales or issuance of equity securities,
credit facilities and other borrowings, or additional debt securities. In
addition, the Company may sell or dispose of existing businesses or
investments to fund portions of the Business Plan. The Company may, as part of
its ordinary course of business, sell or lease capacity, its conduits or
access to its conduits. There can be no assurance that the Company will be
successful in producing sufficient cash flow, raising sufficient debt or
equity capital on terms that it will consider acceptable, or selling or
leasing fiber optic capacity or access to its conduits, or that proceeds of
dispositions of the Company's assets will reflect the assets' intrinsic value.
Further, there can be no assurance that expenses will not exceed the Company's
estimates or that the financing needed will not likewise be higher than
estimated. Failure to generate sufficient funds may require the Company
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to delay or abandon some of its future expansion or expenditures, which could
have a material adverse effect on the implementation of the Business Plan.
There can be no assurance that the Company will be able to obtain such
financing if and when it is needed or that, if available, such financing will
be on terms acceptable to the Company. If the Company is unable to obtain
additional financing when needed, it may be required to scale back
significantly its Business Plan and, depending upon cash flow from its
existing business, reduce the scope of its plans and operations.
In connection with implementing the Business Plan, management will continue
reviewing the existing businesses of the Company to determine how those
businesses will complement the Company's focus on communications and
information services. If it is decided that an existing business is not
compatible with the communications and information services business and if a
suitable buyer can be found, the Company may dispose of that business.
In February 1998, the Company announced that it was moving its corporate
headquarters to Broomfield, Colorado, a northwest suburb of Denver. The campus
facility is expected to encompass over 500,000 square feet of office space at
a construction cost of over $70 million. The Company is leasing space in the
Denver area while the campus is under construction. The first phase of the
complex is scheduled for completion in the summer of 1999.
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2. FORWARD LOOKING STATEMENTS--RISK FACTORS
When used in reports filed with the Securities and Exchange Commission and
in other communications by the Company, the words "believes," "anticipates,"
"expects," "may," "will," "estimates" or "continue" or the negative thereof or
variations thereon or comparable terminology, are expressions intended to
identify in certain circumstances forward looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to a number of risks and uncertainties that could cause
actual results to differ materially from those projected, including the risks
discussed in the "Risk Factors" set forth below. Given these uncertainties,
prospective investors are cautioned not to place undue reliance on such
forward looking statements. The Company also undertakes no obligation to
update any forward looking statement.
DEPENDENCE ON NEW BUSINESS PLAN
The Company's new Business Plan provides for the creation of the Level 3
Network, which will generate substantial operating losses and require
significant amounts of capital. See "--Substantial Operating Losses Expected"
and "--Substantial Capital Requirements." The Business Plan is in an early
stage of implementation, thus making an evaluation of its risks and rewards
extremely difficult and speculative. The Business Plan will depend upon a
shift in providing communications services, including traditional voice, fax
transmission and other services, over IP-based networks instead of the PSTN.
There can be no assurance that the Level 3 Network will be able to compete
successfully with the PSTN or other networks as a provider of these services.
The Business Plan also will depend on, among other things, the Company's
ability to assess markets, raise substantial capital, design fiber optic
network backbone routes, install fiber optic cable and facilities (including
switches/routers), obtain rights-of-way, building access rights and any
required government authorizations, franchises and permits, attract customers
and identify, finance and complete suitable acquisitions and, potentially,
joint ventures, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions. In order to manage its growth, the Company
will be required to create complex operating and administrative systems,
including effective systems relating to ordering, provisioning and billing for
communications and information services, and continually improve and upgrade
such systems. The Company must also continue to attract and retain substantial
numbers of qualified managerial, professional and technical personnel. As a
result, there can be no assurance that the Company will be able to implement
and manage successfully its new Business Plan. Since the Business Plan
represents a significant expansion of the Company's communications and
information services business, the Company does not believe that its
historical financial results will serve as a meaningful indicator of the
Company's future financial condition or results of operations.
SUBSTANTIAL OPERATING LOSSES EXPECTED
The development of the Business Plan will require significant capital
expenditures, a substantial portion of which will be incurred before any
significant related revenues from the Business Plan are expected to be
realized. These expenditures, together with the associated early operating
expenses, will result in substantial negative operating cash flow and
substantial net losses for the Company for the foreseeable future. The Company
may never establish a significant customer base for its communications and
information services business, and even if it does establish such a customer
base, there can be no assurance that the Company will not continue to sustain
substantial negative operating cash flow and substantial net losses. There can
be no assurance that the Company will be able to achieve or sustain
profitability in the future.
SUBSTANTIAL CAPITAL REQUIREMENTS
The Company's ability to implement the Business Plan and meet its projected
growth is dependent upon its ability to secure substantial additional
financing in the future. The Company expects to meet its additional capital
needs with the proceeds from sales or issuance of equity securities, credit
facilities and other borrowings, or additional debt securities. In addition,
the Company may sell or dispose of existing businesses or investments or sell
or lease fiber optic capacity or access to its conduits to fund portions of
the Business Plan. The Company currently estimates that the implementation of
the Business Plan, as currently contemplated, will require between
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$8 and $10 billion over the next 10 years. There can be no assurance that the
Company will be successful in producing sufficient cash flow, raising
sufficient debt or equity capital on terms that it will consider acceptable or
selling or leasing fiber optic capacity or access to its conduits, or that
proceeds of dispositions of the Company's assets will reflect the assets'
intrinsic value. Further, there can be no assurance that costs and expenses
will not exceed the Company's estimates or that the financing needed will not
likewise be higher than estimated. Failure to generate sufficient funds may
require the Company to delay or abandon some of its future expansion or
expenditures, which could have a material adverse effect on the implementation
of the Business Plan. There can be no assurance that the Company will be able
to obtain such financing if and when it is needed or that, if available, such
financing will be on terms acceptable to the Company. If the Company is unable
to obtain additional financing when needed, it may be required to scale back
significantly its Business Plan and, depending upon cash flow from its
existing business, reduce the scope of its plans and operations.
Any additional debt financing, if available, may involve restrictive
covenants that adversely affect the Company's ability to finance its future
operations or capital needs or to engage in other business activities that may
be in the interest of the Company. The Company's financing needs may vary
significantly from its current expectations if it is unable to generate
anticipated cash flows or if the Company requires more funds for capital
expenditures than it currently anticipates, particularly as a result of future
network infrastructure installation requirements. No assurance can be given
that the Company's current expectations regarding its cash needs will prove
accurate, and there can be no assurance that the Company's operations will
produce positive cash flow.
DIFFICULTIES IN CONSTRUCTING, OPERATING AND UPGRADING THE LEVEL 3 NETWORK
The Company's ability to generate positive cash flows from operations will
depend in large part upon the successful, timely and cost-effective
construction of the Level 3 Network, as well as on attracting customers and
achieving substantial traffic volumes on the Level 3 Network. The construction
of the Level 3 Network will be affected by a variety of uncertainties and
contingencies, including whether the installation of the required fiber optic
cable and associated electronics which make up the Level 3 Network will be
completed in a timely manner. The construction, operation and any upgrading of
the Level 3 Network is a significant undertaking, requiring 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 Level 3 Network.
Furthermore, certain technology the Company is developing is largely unproven
and may not be compatible with existing technology. In addition, technical
problems may arise with the Level 3 Network once it is built, including as a
result of increasing traffic volume. Many of these factors and problems are
beyond the Company's control. There can be no assurance that the entire Level
3 Network will be completed as planned for the costs and in the time frame
currently estimated. Although the Company believes that its cost estimates and
the build-out schedule are reasonable, there can be no assurance that the
actual construction costs or time required to complete the Level 3 Network
will not substantially exceed current estimates. In addition, the Company must
generate substantial traffic volume on the Level 3 Network in order to realize
the anticipated cash flow, operating efficiencies and cost benefits of the
Level 3 Network. There can be no assurance that the Company will be able to
achieve such increased traffic volume. See "--Products and Services," "--
Competition; Rapid Technological Changes" and "--Pricing Pressures and
Industry Capacity."
The successful and timely completion of the Level 3 Network will depend,
among other things, upon the Company's ability to manage effectively and cost
efficiently the construction of route segments, obtain additional rights-of-
way, install network connections, interconnections and buildouts and attract
qualified technicians capable of dealing with the Level 3 Network's expected
technologies. Successful construction of the Level 3 Network also will depend
upon the timely performance by suppliers and third-party contractors of their
obligations. There can be no assurance that the Company will successfully
manage construction or acquire the remaining necessary rights-of-way or that
third-party contractors will timely perform their obligations. See "--Need to
Obtain and Maintain Permits and Rights-of-Way" and "--Dependence on
Suppliers."
Any of the foregoing may significantly delay or prevent completion of the
Level 3 Network, which would have a material adverse effect on the Company's
financial condition and results of operations.
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The Company anticipates that even after the completion of the initial stages
of the Level 3 Network, future expansions and adaptations of the network's
infrastructure, including the electronic and software components used therein,
may be necessary in order to respond to growth in the number of customers
served, increased demands to transmit larger amounts of data, changes in its
customers' service requirements and technological advances by competitors. The
expansion and adaptation of the Level 3 Network will require substantial
financial, operational and managerial resources. There can be no assurance
that the Company will be able to expand or adapt the Level 3 Network to meet
the evolving standards, demands and requirements of its customers or advances
of its competitors on a timely basis, at a commercially reasonable cost, if at
all, or that the Company will be able to deploy successfully any expanded and
adapted network infrastructure. Any failure by the Company to expand or adapt
the Level 3 Network to the needs of its customers could have a material
adverse effect on the Company's financial condition and results of operations.
NEED TO DEVELOP VOICE TECHNOLOGY FOR IP NETWORKS
The Company is designing the Level 3 Network to be optimized for IP-based
communications, rather than circuit-switched based communications. While
generally adequate for data transmission needs, existing IP networks usually
are not configured to provide the voice quality, real-time communications
requirements of a traditional telephone call or facsimile. With current
technology, this quality can only be achieved by providing a substantial
cushion of communications capacity. There are also concerns about the
reliability and security of IP-voice networks. Existing voice-over IP services
generally require a combination of substantial capacity and either customized
end-user equipment or the dialing of "access codes" or other special
procedures to initiate a call. Level 3 is in the process of developing
technology to enable it to transmit traffic seamlessly over its own router-
based IP network and the circuit-based PSTN. The Company does not believe that
such technology is currently commercially available. There can be no assurance
that the Company's efforts to develop or acquire (including through licenses)
such technology will be successful, or that if it can develop or acquire such
technology, the Company will be able to do so in a timely manner and at an
acceptable cost. In any event, developing or acquiring such technology may
require significant resources and management attention. Failure by the Company
to develop or acquire such technology in a timely and cost efficient manner
could have a material adverse effect on the Company's business, financial
condition and results of operations, including its ability to pay the interest
on and principal of the Notes. Level 3 believes that the design of its network
should address the other significant issues associated with IP-voice
transmission (latency, reliability and security). If the Company's assessment
of the adequacy of the solutions for these other issues is incorrect, the
Company's ability to offer IP-voice services will be impaired.
The Company recently announced the acquisition of XCOM. XCOM has developed
certain technology which may help the Company develop the technology for an
interface between its IP-based network and the PSTN. There can be no assurance
that this acquisition will serve the purposes contemplated by the Company.
DEVELOPMENT OF EFFECTIVE PROCESSES AND SYSTEMS
The Company and its external vendors are developing processes and systems
for the implementation of customer orders for services, the provisioning,
installation and delivery of such services, monthly billing for those services
and automated internal systems for processing customer orders and
provisioning. As the Business Plan provides for rapid growth in the number and
volume of products and services offered by the Company, such processes and
systems, including the business support system, will need to be developed on a
schedule necessary to support the Company's proposed service offering rollout
dates and will be required to expand with and adapt to the Company's 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 for these service elements
could have a material adverse effect upon the Company's ability to implement
the Business Plan.
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DEPENDENCE ON HIRING AND RETAINING QUALIFIED PERSONNEL; KEY PERSONNEL
The Company believes that its future success will depend in large part on
its ability to attract and retain highly skilled, knowledgeable, sophisticated
and qualified managerial, professional and technical personnel. The Company's
businesses will be 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 whom could have a material adverse effect on the Company. The
Company has experienced significant competition in the attraction and
retention of personnel that possess the skill sets that the Company is
seeking. There can be no assurance that the Company will not experience a
shortage of qualified personnel in the future, especially given the Company's
substantial hiring needs.
PRODUCTS AND SERVICES
The Company's ability to offer, market and sell products and services is
important to the Company's long-term strategic growth objectives, and is
dependent on the Company's ability to obtain the needed capital, additional
favorable regulatory developments, the Company's ability to recruit and retain
an effective sales force, the Company's ability to differentiate its products
and services from existing and future competitors, the Company's ability to
assess and access markets and the acceptance of its products and services by
the Company's customers. No assurance can be given that the Company will be
able to obtain such capital, retain such personnel, differentiate its products
and services or assess and access markets or that such developments or
acceptance will occur.
RAPID EXPANSION PLANS; MANAGEMENT OF GROWTH; STRATEGIC TRANSACTIONS
Part of the Business Plan is to achieve rapid growth by building the Level 3
Network and using the Level 3 Network to exploit opportunities expected to
arise from marketplace, regulatory and technological changes and other
industry developments. The Business Plan also contemplates exploring
opportunities for strategic acquisitions and joint ventures, which could be
material. As a result of its strategy, management expects the Company to
experience rapid expansion for the foreseeable future. This growth will
increase the operating complexity of the Company. The Company's ability to
manage its expansion effectively will depend on, among other things: (i) the
expansion, training and management of its employee base, including attracting
and retaining highly skilled personnel (see "--Dependence on Hiring and
Retaining Qualified Personnel; Key Personnel"); (ii) the development,
introduction and marketing of new products and services; (iii) the successful
integration of acquired operations and joint ventures; (iv) the development of
financial and management controls; and (v) the control of the Company's
expenses related to the Business Plan. Failure of the Company to satisfy any
of these requirements, or otherwise manage its growth effectively, could have
a material adverse effect on the Company's business, financial condition and
results of operations.
To manage growth effectively, the Company must develop its sales force,
external installation and repair capability, customer service teams and
information systems, and must develop relationships with third-party vendors.
The Company's hiring needs are substantial. The construction, operation and
any upgrading of the Level 3 Network is a significant undertaking. See "--
Difficulties in Constructing, Operating and Upgrading the Level 3 Network."
Managing the Company's growth will also be complicated by the significant size
and complexity of the planned Level 3 Network, which may place heavy demands
upon the Company's direct sales force, installation and repair capabilities,
customer care organization, business support systems, third party vendors and
management. If the Company is unable to manage its growth effectively, the
Company's business and results of operations could be materially adversely
affected.
In addition, there can be no assurance that the Company will be able to
identify suitable candidates on acceptable terms (especially given the intense
competition in the telecommunications industry) for strategic investments,
acquisitions or joint ventures or that the Company will be able to obtain the
requisite financing for any such transactions. These investments, acquisitions
and joint ventures, if made, will divert the resources and
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management time of the Company and require successful integration with the
Company's existing networks and services.
LACK OF INTERCONNECTION AND PEERING ARRANGEMENTS
The Company's success will depend upon its ability to develop and expand its
network infrastructure and support services in order to have sufficient
geographic reach, capacity, reliability and security at an acceptable cost.
The development and expansion of the Level 3 Network will require that the
Company enter into agreements, on acceptable terms and conditions, with
various providers of infrastructure capacity, in particular interconnection
agreements with ILECs and peering agreements with ISPs. No assurance can be
given that any or all of the requisite agreements can be obtained on
satisfactory terms and conditions.
The Company is currently negotiating agreements for the interconnection of
the Level 3 Network with the networks of the ILECs covering each market in
which the Company is constructing its network. In the future, the Company may
be required to negotiate new interconnection agreements, or renegotiate
existing interconnection agreements, as Level 3 enters new markets. There can
be no assurance that the Company will successfully negotiate such agreements
for interconnection with ILECs or renewals of existing interconnection
agreements. The failure to negotiate required interconnection agreements could
have a material adverse effect on the Company's ability to become a single
source provider of communications and information services.
Peering agreements between the Company and ISPs will be necessary in order
for the Company to 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. MCI and WorldCom recently
announced a merger of the two entities, which is subject to certain regulatory
and other approvals. If this merger is consummated, the resulting entity would
control a substantial percentage of the U.S. Internet backbone. Recently,
companies that have previously offered peering have cut back or eliminated
peering relationships and are establishing new, more restrictive criteria for
peering. Furthermore, if increasing costs and other requirements associated
with maintaining peering with the major national ISPs develop, the Company may
have to comply with those additional requirements in order to continue to
maintain any peering relationships it negotiates. Failure to establish peering
relationships would cause the Company to incur additional operating
expenditures which would have a material adverse effect on the Company's
business, financial condition and results of operations.
NEED TO OBTAIN AND MAINTAIN PERMITS AND RIGHTS-OF-WAY
In order to acquire and develop the Level 3 Network, the Company must obtain
local franchises and other permits, as well as rights to utilize underground
conduit and aerial pole space and other rights-of-way and fiber capacity from
entities such as ILECs and other utilities, railroads, long distance
companies, state highway authorities, local governments and transit
authorities. On April 2, 1998 the Company entered into an agreement with Union
Pacific granting the Company an easement for the laying of conduit along
certain of Union Pacific's rights-of-way in the western United States. There
can be no assurance that the Company will be able, on acceptable terms, to
maintain its existing franchises, permits and rights or to obtain and maintain
the other franchises, permits and rights needed to implement the Business
Plan. The cancellation or non-renewal of such arrangements could materially
adversely affect the Company's business in the affected metropolitan area. In
addition, the failure to enter into and maintain any such required
arrangements for any portion of the Level 3 Network may affect the Company's
ability to develop the Level 3 Network.
DEPENDENCE ON SUPPLIERS
Lease of Communications Capacity. Until the completion of the Company-owned
portion of the Level 3 Network, the Company will lease substantially all of
its intercity communications capacity in North America. On March 23, 1998, the
Company entered into an agreement with Frontier whereby the Company leased
approximately 8,300 miles of OC-12 network capacity currently under
construction connecting 15 U.S. cities. In addition, the Company intends to
lease a significant amount of capacity from ILECs and CLECs to connect the
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Company's customers with the Company's gateway sites, even after the
completion of the Company-owned portion of the Level 3 Network. Accordingly,
the Company will be dependent upon the services of these lessors. The Company
may experience delays and additional costs if any of these relationships with
lessors is terminated or if any one or all of these facilities experiences a
technical or other similar failure, and the Company is unable to reach
suitable agreements with alternate carriers in a timely manner. These events
could have a material adverse effect on the Company's business, financial
condition, competitive position and results of operations.
In Europe, the Company will initially lease substantially all of its
intercity communications capacity. The supply of such capacity for lease is
significantly more limited than in the United States. While the Company
believes that it will be able to lease the necessary capacity in Europe, there
can be no assurance that it will be able to do so, and that if the Company can
lease such capacity, it will be at a price that will not have a material
adverse effect on the Company's business, financial condition, competitive
position and results of operations.
Equipment and Materials. The Company will be dependent on third-party
suppliers of the fiber, conduit, computers, software, switches/routers and
related components that the Company will assemble and integrate into the
Level 3 Network. Due to the large-scale nature of the Level 3 Network, the
Company will be making large purchases of fiber and conduit, which will
represent a significant portion of the current production of these suppliers.
The Company will also depend on the services of third parties with whom it may
contract in the future for customer site installations, routine maintenance,
on-call repair and certain other services. The Company may experience delays
and additional costs if any of these relationships is terminated and the
Company is unable to reach suitable agreements with alternate vendors or
suppliers in a timely manner. Any such occurrence could have a material
adverse effect on the Company's business, financial condition, competitive
position and results of operations and its ability to pay the interest on and
the principal of the Notes.
The development and expansion of the Level 3 Network will require that it
enter into agreements, on acceptable terms and conditions, with various
providers of infrastructure capacity and equipment and support services. No
assurance can be given that any or all of the requisite agreements can be
obtained on satisfactory terms and conditions.
COMPETITION; RAPID TECHNOLOGICAL CHANGES
The communications and information services industry is highly competitive.
Many of the Company's existing and potential competitors in the communications
and information services industry have financial, personnel, marketing and
other resources significantly greater than those of the Company, as well as
other competitive advantages, including existing customer bases. Increased
consolidation and strategic alliances in the industry resulting from the
Telecom Act, the opening of the U.S. market to foreign carriers and
technological advances could give rise to significant new competitors to the
Company. In addition, further deregulation may give rise to unanticipated
additional competitors.
In the special access and private line services market, the Company's
primary competitors will be IXCs, ILECs and CLECs. In the market for
collocation services, the Company will compete with ILECs and CLECs. Most of
these competitors have a significant base of customers for whom they are
currently providing collocation services. Due to the high costs to a customer
of changing collocation sites, the Company may have a competitive disadvantage
relative to these existing competitors. The market for Web hosting services is
also extremely competitive. In this market, the Company will compete with ISPs
and many others, including IXCs, companies that exclusively provide Web
hosting services and a number of companies in the computer industry.
For virtual private network services and voice services, the Company will
compete primarily with national and regional network providers. The ability of
the Company to compete effectively in this market will depend upon its ability
to maintain high quality services at prices equal to or below those charged by
its competitors.
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There are currently four principal facilities-based long distance fiber
optic networks (AT&T, MCI, Sprint and WorldCom, although a proposed merger
between WorldCom and MCI is pending), as well as numerous ILEC and CLEC
networks. The Company is aware that others, including Qwest Communications
International Inc. ("Qwest"), IXC Communications, Inc. ("IXC") and The
Williams Companies, Inc. ("Williams"), are building additional networks that,
when constructed, could employ advanced technology similar to that of the
Level 3 Network and will 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 long distance market, the Company's primary competitors will include
AT&T, MCI, Sprint and WorldCom, all of whom have extensive experience in the
long distance market. In addition, the Telecom Act will allow RBOCs and others
to enter the long distance market. In local markets the Company will compete
with ILECs and CLECs, many of whom have extensive experience in the local
market. While the Company believes that IP technology will prove to be a
viable technology for the transmission of these voice services, such
technology is not yet in place and at this time the Company would not be able
to provide voice services at an acceptable level of quality using IP
technology. There can be no assurance that the Company will be able to develop
or acquire such technology. See "--Need to Develop Voice Technology for IP
Networks." There can be no assurance that the Company will be able to compete
successfully with existing competitors or new entrants in the virtual private
network services and voice services market as well as the other markets it
plans to serve. Failure by the Company to do so could have a material adverse
effect on the Company's business, financial condition and results of
operations.
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, and the introduction of new products or emergence of new technologies
may reduce the cost or increase the supply of certain services similar to
those which the Company plans on providing. Accordingly, in the future the
Company's most significant competitors may be new entrants to the
communications and information services industry, which are not burdened by an
installed base of outdated equipment. The effect of technological changes, and
the competition that may result from such changes, on the Company's operations
cannot be predicted and could have a material adverse effect on the Company's
business, financial condition and results of operations.
PRICING PRESSURES 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 the Company believes that increasing demand for capacity in the last
several years has resulted in a shortage of network capacity and slowed the
decline in prices, the Company anticipates that prices for communications and
information services will continue to decline over the next several years due
primarily to (i) installation by the Company and its competitors (certain of
whom are expanding capacity and constructing or considering new networks) of
fiber networks that provide substantially more transmission capacity than may
be needed over the short or medium term, (ii) recent technological advances
that permit substantial increases in the transmission capacity of both new and
existing fiber, (iii) strategic alliances or similar arrangements, such as
long distance capacity purchasing alliances among certain RBOCs, that increase
the parties' purchasing power and (iv) increased capacity of satellite,
microwave and radio facilities. These price declines may be particularly
severe if recent trends causing increased demand for capacity, such as
Internet usage, change. Rapid growth in the use of the Internet is a recent
phenomenon, and there can be no assurance that such growth will continue at
the same rate or at all. Such pricing pressure could have a material adverse
effect on the business of the Company and on its financial condition and
results of operations, including its ability to complete the Level 3 Network.
GOVERNMENT REGULATION
Communications services are subject to significant regulation at the
federal, state, local and international levels, affecting both the Company and
its existing and potential competitors. Delays in receiving required
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regulatory approvals or the enactment of new and adverse regulations or
regulatory requirements may have a material adverse effect upon the Company.
In addition, future legislative, judicial, and regulatory agency actions could
alter competitive conditions in the markets in which the Company intends to
operate, in ways not necessarily to the Company's advantage.
The Federal Communications Commission (the "FCC") exercises jurisdiction
over interstate and international telecommunications services, including both
long-distance services and the use of local network facilities to originate
and terminate interstate or international calls ("access service"). Under
current FCC regulations, the Company is not required to obtain advance
authorization to offer domestic interstate long-distance and access services.
It is currently required to file tariffs disclosing the rates, terms, and
conditions of certain of its long distance services, and to comply with
certain other FCC requirements. The Company has obtained FCC authorization to
provide international long distance service, and consequently will be required
to file tariffs and comply with certain reporting requirements for certain of
its services. As a carrier providing FCC-regulated services, the Company will
be required to pay various regulatory fees and assessments, although at this
time it does not expect that such fees will have a material effect on its
profitability.
State regulatory commissions exercise jurisdiction over intrastate
telecommunications services, including both local exchange and in-state long
distance services. The Company will be required to obtain regulatory
authorization and/or file tariffs or price lists at state agencies in most
states before it begins offering services in those states. The Company will
also be required to comply with state regulations governing the pricing and
provision of telecommunications service, which vary considerably from state to
state, and to pay various regulatory fees and taxes assessed by states on
telecommunications services and providers.
A variety of governmental authorities regulate the Company's access to
public rights-of-way, including highways, streets, underground conduits, and
the like. See "--Need to Obtain and Maintain Permits and Rights-of-Way." The
Company's facilities will also be subject to numerous local regulations such
as building codes and licensing. Such regulations vary on a city by city and
county by county basis.
There can be no assurance that the FCC or state commissions will grant
authority requested by the Company and required by it to provide services. If
authority is not obtained or if the 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 these
actions. Such challenges could cause the Company to incur substantial legal
and administrative expenses and potentially delay or prevent the provision of
services.
The Telecom Act provides for a significant deregulation of the domestic
telecommunications industry, including the local exchange, long distance and
cable television industries. The Telecom Act remains subject to judicial
review and additional FCC rulemaking, and thus it is difficult to predict what
effect the legislation will have on the Company and its future operations.
There are currently many regulatory actions underway and being contemplated by
federal and state authorities regarding interconnection pricing and other
issues that could result in significant changes to the business conditions in
the telecommunications industry. There can be no assurance that these changes
will not have a material adverse effect on the Company.
The Telecom Act subjects nondominant telecommunications carriers, such as
the Company, to certain federal regulatory requirements upon their provision
of local exchange service in a market. All ILECs and CLECs must interconnect
with other carriers, provide nondiscriminatory access to rights-of-way, offer
reciprocal compensation for termination of traffic, and provide dialing parity
and telephone number portability. The Telecom Act also requires all
telecommunications carriers to ensure that their services are accessible to
and usable by persons with disabilities.
The FCC has to date treated ISPs as "enhanced service providers," 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 examining the status of ISPs and services provided by ISPs in
several ongoing proceedings. On April 10, 1998, the FCC issued a Report to
Congress on its implementation of the universal
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service provisions of the Telecom Act. In that Report, the FCC stated, among
other things, that the provision of transmission capacity to ISPs constitutes
the provision of telecommunications and is therefore subject to common carrier
regulations. 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 in order to provide an information service. Any such
contribution would be related to the ISP's provision of the underlying
telecommunications services according to the Report, separate and apart from
ISP 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. It noted that the FCC did
not have an adequate record on which to make any definitive pronouncements on
that issue at this time, but that the record the FCC had reviewed suggests
that certain forms of phone-to-phone IP telephony appear to have the same
functionality as non-IP telecommunications services and lack the
characteristics that would render them information services. If the FCC were
to determine that certain services are subject to FCC regulations as
telecommunications services, the FCC noted it may find it reasonable that the
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. The Company
cannot predict the outcome or timing of these proceedings. If the FCC were to
determine that ISPs, or services provided by ISPs, 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 the
Company's business, financial condition, competitive position and results of
operations and the Company's ability to pay the interest on and principal of
the Notes.
Pursuant to the Telecom Act, the FCC has recently adopted significant
changes in its universal service subsidy program. Providers of interstate
telecommunications service, as well as certain other entities, must pay for
these programs. The Company's contribution to the universal service fund will
be based on its telecommunications service end-user revenues. The extent to
which the Company's services are viewed as telecommunications services or as
information services will affect the amount of the Company's contribution, if
any. As indicated in the preceding paragraph, the issue of how the Company's
services will be classified has not been resolved. Currently, the FCC assesses
contributions on the basis of a provider's revenue for the previous year.
Since the Company had no telecommunications service revenues in 1997, it will
not be liable for universal service contributions in any material amount
during 1998. With respect to subsequent years, however, the Company is
currently unable to quantify the amount of contributions that it will be
required to make and the effect that these required payments will have on its
financial condition because of uncertainties concerning the size of the
universal fund and uncertainty concerning the classification of the Company's
services. 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.
While both local and long distance (except facilities-based international)
services are now open to competition in Canada, only "Canadian carriers,"
which must be majority-owned and controlled by Canadians, are permitted to
provide facilities-based services, and the regional telephone companies and
the monopoly provider of international services still have majority control of
many significant market sectors and are likely to begin or have begun facing
decreased regulation as competition matures. Even when the Canadian
international services market is opened to competition in October 1998,
Canadian carrier foreign ownership restrictions will still be applicable to
the provision of facilities-based international services. Because the Company
is not eligible to be a Canadian carrier, and thus cannot control a
facilities-based telecommunications service provider in Canada, it cannot
under current law enter the Canadian market as a provider of facilities-based
domestic services or possibly, when they are opened to competition,
facilities-based international services. The Canadian Radio-Television and
Telecommunications Commission ("CRTC") generally regulates the provision of
telecommunications services in Canada (except, until October 25, 1998, over
intra-provincial services in Saskatchewan), but many significant regulatory
issues addressing important issues affecting local competition and the
implementation of Canada's commitments under the Fourth Protocol to the
General Agreement on Trade in Services (the "WTO Agreement") are the subject
of pending regulatory proceedings and legislation as to whose outcomes there
is substantial uncertainty. While there is essentially regulatory forbearance
for resold services, which are open to both Canadian and non-Canadian
controlled firms, resellers could be subject to additional regulation as a
result of pending proceedings and expected legislation implementing Canada's
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commitments under the WTO Agreement. While resold local services are
theoretically open to competition, there has been concern about the
feasibility of allowing companies that are not Canadian carriers, and
therefore not subject to CRTC jurisdiction, to provide resold local services,
and thus about the implementation of resold local services competition.
Because many critical issues remain the subject of pending proceedings and
legislation whose outcome is uncertain, and because the regional telephone
companies and the current monopoly international carrier (Teleglobe Canada)
continue to retain substantial majorities in many service sectors and are
likely to begin or have begun facing decreased regulation as competition
matures, there can be no assurance that the Company will be able to implement
its planned entry into the Canadian market on economically reasonable or
advantageous terms. See "Business--Regulation--Canadian Regulation."
RISK OF NETWORK FAILURE; LIABILITY FOR TRANSMISSIONS
The Company's operations will be dependent upon its ability to protect the
Level 3 Network against damage from natural disasters, power loss,
communications failures and similar events. Despite the proposed redundancy of
the Level 3 Network, and other precautions the Company expects to take, the
occurrence of a natural disaster or other unanticipated problem could cause
service interruptions on the Level 3 Network. See "--Dependence on Suppliers."
The Level 3 Network will use an assemblage of communications equipment,
software, operating protocols and proprietary applications for high speed
transportation of large quantities of data among multiple locations. Given the
complexity of the proposed Level 3 Network, it may be possible that data will
be lost or distorted. Moreover, much of the Company's customers'
communications needs will be extremely time sensitive, and delays in data
delivery may cause significant losses to a customer using the Company's
information network. The Level 3 Network may contain undetected design faults
and software "bugs" that, despite testing by the Company, may be discovered
only after the Level 3 Network has been installed and is in use by customers.
The failure of any equipment or facility on the Level 3 Network could result
in the interruption of service to the customers serviced by such equipment or
facility until necessary repairs are effected or replacement equipment is
installed. Such failures, faults or errors could cause delays or require
modifications that could have a material adverse effect on the Company's
business, financial condition, competitive position, customer base and results
of operations.
SECURITY RISKS
The Level 3 Network will be vulnerable to unauthorized access, computer
viruses and other disruptive problems which, in addition to customer
interruptions, delays and cessations of service, could result in liability to
the Company and a loss of existing customers or could deter potential
customers from using the Level 3 Network. Eliminating computer viruses and
alleviating other security problems may require interruptions, delays or
cessation of service to the Company's customers which could have a material
adverse effect on the Company's business, financial condition, competitive
position and results of operations. Moreover, the actions necessary to
eliminate these problems could be prohibitively expensive.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The Company's success may depend, in part, on its ability to develop and
maintain proprietary rights in certain technology which will underlie the
Level 3 Network. See "--Need to Develop Voice Technology for IP Networks" and
"--Difficulties in Constructing, Operating and Upgrading the Level 3 Network."
To protect its proprietary rights in the technology which may be utilized in
the Level 3 Network, the Company will rely on a combination of trade secret
and copyright protection as well as patents. The Company also will rely on
trademark protection concerning various names, marks, logos and other devices
which serve to identify the Company as the source for and originator of the
Company's services.
While the Company does not know of any technologies which are patented by
others that it believes are necessary for the Company to provide voice-over IP
services, there can be no assurance that such a necessary
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technology will not be patented by other parties now or in the future. If such
a technology were held under patent by another person, the Company would have
to negotiate a license for the use of such technology. There can be no
assurance that the Company could negotiate such a license, or that such a
license would be at a price that was acceptable to the Company. The existence
of such a patent, or the inability of the Company to negotiate a license for
any such technology on terms beneficial to the Company, could have a material
adverse effect on the Company's business, financial condition, competitive
position and results of operations.
Intellectual property litigation is complex and there can be no assurance of
the outcome of any such litigation. Any future intellectual property
litigation, regardless of outcome, could result in substantial expense to the
Company and significant diversion of the efforts of the Company's technical
and management personnel. An adverse determination in any such proceeding
could subject the Company to significant liabilities to third parties, require
disputed rights to be licensed from such parties, if licenses to such rights
could be obtained, and/or require the Company to cease using such technology.
There can be no assurance that any such license would or could be obtained at
costs reasonable to the Company. If forced to cease using such technology,
there can be no assurance that the Company would be able to develop or obtain
alternate technology. Accordingly, an adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could
prevent the Company from manufacturing, using or selling certain of its
products, which could have a material adverse effect on the Company's
business, financial condition, competitive position and results of operations.
YEAR 2000 ISSUES
The Company is conducting a review of its computer systems, including the
computer systems used in the Company's computer outsourcing business, to
identify systems that could be affected by the "Year 2000" computer issue, and
is 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, thus resulting in the inability of computer programs
to distinguish between the year 1900 and 2000. The Company expects that its
Year 2000 compliance project will be completed before the Year 2000 date
change. During the execution of this project, the Company has 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 GAAP.
The expenses associated with this project, as well as the related potential
effect on the Company's earnings, are not expected to have a material effect
on its future operating results or financial condition. There can be no
assurance, however, that the Year 2000 problem will not have a material
adverse effect on the Company's business, financial condition, competitive
position and results of operations.
The Company has initiated communications with its significant suppliers and
customers, including those of the Company's computer outsourcing business and,
in particular, vendors of the Company's computer outsourcing operating
environments, to determine the extent to which the Company is vulnerable to
the failure by such parties to remediate Year 2000 compliance issues. No
assurance can be given, however, that the systems will be made Year 2000
compliant in a timely manner or that the noncompliance of the systems of any
of these parties would not have a material adverse effect on the Company's
business, financial condition, competitive position and results of operations.
PKS Systems Integration LLC ("PKS Systems"), a subsidiary of PKSIS, provides
a wide variety of information technology services to its customers. In fiscal
year 1997, approximately 80% of the revenue generated by PKS Systems related
to projects involving Year 2000 assessment and renovation services performed
by PKS Systems for its customers. 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 remediate
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.
This exposes PKS Systems 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, there can be no assurance as to the effectiveness of such contractual
limitations.
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. There
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can be no assurance, however, that the Year 2000 problem, and any loss
incurred by any customers of PKSIS as a result of the Year 2000 problem will
not have a material adverse effect on the Company's financial condition and
results of operations.
RISKS OF FOREIGN INVESTMENT
The Company expects to expand its operations into international markets in
Canada, Western Europe and Asia. Risks inherent in foreign operations include
loss of revenue, property and equipment from expropriation, nationalization
and confiscatory taxation. The Company will also be exposed to the risk of
changes to laws and policies that govern foreign investment in countries where
it expects to operate as well as, to a lesser extent, changes in United States
laws and regulations relating to investing in or trading with countries in
which the Company may have investments.
Certain of the countries in which the Company expects to operate may be
subject to a substantially greater degree of social, political and economic
instability than is the case in other countries. Such instability may result
from, among other things, the following: (i) authoritarian governments or
military involvement in political and economic decision making, and changes in
government through coups or other extra-constitutional means; (ii) social
unrest associated with demands for improved economic, social and political
conditions; (iii) internal insurgencies and terrorist activities; and (iv)
hostile relations with neighboring countries. Risks associated with social,
political and economic instability in a particular country could have a
material adverse effect on the results of operations and financial condition
of the Company and could result in the loss of the Company's assets in such
country.
FOREIGN CURRENCY EXCHANGE RATES; REPATRIATION
As the Company expands its operations into countries outside of the United
States, its results of operations and the value of its assets will be affected
by the currency exchange rates between the U.S. dollar and the functional
currencies of countries in which it has operations and assets. In some of
these countries, prices of the Company's products and services will be
denominated in the local functional currency or in a currency other than the
U.S. dollar. As a result, the Company may experience economic losses solely as
a result of foreign currency exchange rate fluctuations, which include foreign
currency devaluations against the dollar. The Company may in the future
acquire interests in companies that operate in countries where the removal or
conversion of currency is restricted. There can be no assurance that countries
that do not have such restrictions at the time the Company establishes
operations in those countries will not subsequently impose them, 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
The Company's operations and properties are subject to a wide variety of
laws and regulations relating to protection of the environment, natural
resources, and human health and safety, including laws and regulations
concerning the use and management of hazardous and non-hazardous substances
and wastes. Although the Company has made and will continue to make
significant expenditures relating to its environmental compliance obligations,
there can be no assurance that the Company will at all times be in compliance
with all such requirements.
In connection with certain historical operations, the Company is a party to,
or otherwise involved in, legal proceedings under state and federal law
involving investigation and remediation activities at approximately 110
contaminated properties. The Company could be held liable, jointly and
severally, and without regard to fault, for such investigation and
remediation. Based on presently available information regarding the nature and
volume of its wastes allegedly disposed or released at these properties, the
number of other financially viable, potentially responsible parties, and the
total estimated clean-up costs, the Company does not believe that the costs
associated with these properties will be material, either individually or in
the aggregate.
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The discovery of additional environmental liabilities related to the
Company's historical operations or changes in existing environmental
requirements could have a material adverse effect on the Company's business,
results of operations, or financial condition.
RISKS RELATED TO THE COMPANY'S COAL OPERATIONS
In 1997, $222 million of the Company's $332 million in net revenues were
attributable to its coal mining operations. The level of cash flows generated
in recent periods by the coal operations will not continue after the year 2000
because the delivery requirements under the Company's current long-term
contracts decline significantly after that date. Moreover, in the absence of
those contracts, the Company's coal mining operations would not be able to
operate profitably by selling its production on the spot markets for coal. A
substantial majority of the Company's coal mining revenues are concentrated
under contracts with three customers.
The Company's coal operations are subject to extensive laws and regulations
that impose stringent operational, maintenance, financial assurance,
environmental compliance, reclamation, restoration and closure requirements,
including requirements governing air and water emissions, waste disposal,
worker health and safety, benefits for current and retired coal miners, and
other general permitting and licensing requirements. The Company may not at all
times be in compliance with all such requirements. Liabilities or claims
associated with such noncompliance could require the Company to incur material
costs or suspend production. Mine reclamation costs that exceed the Company's
reserves for such matters also could require the Company to incur material
costs.
3. ISSUANCE OF PRESS RELEASE
On April 7, 1998, Level 3 issued a press release relating to the proposed
offering of its Senior Notes Due 2008 in a transaction that is exempt from
registration under the Securities Act of 1933 (the "Securities Act"). As
required by Rule 135(c) under the Securities Act, this press release is filed
as Exhibit 99.1 to this Current Report and incorporated herein by reference as
if set forth in full.
On April 28, 1998, Level 3 issued a press release relating to the
consummation of the offering of $2.0 billion aggregate principal amount of its
9 1/8% Senior Notes Due 2008 in a transaction that is exempt from registration
under the Securities Act. As required by Rule 135(c) under the Securities Act,
this press release is filed as Exhibit 99.2 to this Current Report and
incorporated herein by reference as if set forth in full.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial Statements of business acquired
None.
(b) Pro forma financial information
None.
(c) Exhibits
99.1 Press Release, dated April 7, 1998 related to the proposed offering
of Senior Notes Due 2008.
99.2 Press Release, dated April 28, 1998 related to the consummation of
the offering of 9 1/8% Senior Notes Due 2008.
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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 hereunto duly authorized.
/s/ Neil J. Eckstein
-----------------------------
Vice President
April 30, 1998
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EXHIBIT 99.1
NEWS RELEASE
IMMEDIATE RELEASE
Contacts:
News Media: Josh Howell Investors: Julie Stangl
402/943-1309 402/943-1310
Steve Ingish
402/943-1337
LEVEL 3 COMMUNICATIONS ANNOUNCES PROPOSED OFFERING
OF $1.5 BILLION IN SENIOR NOTES
OMAHA, NEBRASKA, April 7, 1998-Level 3 Communications, Inc. (Nasdaq: LVLT) today
announced that it intends to offer $1.5 billion aggregate principal amount of
Senior Notes Due 2008 in a transaction that is exempt from registration under
the Securities Act of 1933, as amended. The Senior Notes will be senior,
unsecured obligations of Level 3, ranking pari passu with all existing and
future senior unsecured indebtedness of Level 3. Interest rate, redemption terms
and additional terms will be determined at the time of the pricing of the
offering. The offering is subject to final approval by Level 3's Board of
Directors.
Level 3 currently intends to use the net proceeds of the offering in connection
with the implementation of its business plan to increase substantially its
information services business and to expand the range of services it offers by
building an advanced, facilities-based communications network in both the United
States and Europe using Internet Protocol (IP) technology.
The securities offered by Level 3 will not be registered under the Securities
Act of 1933, as amended, and may not be offered or sold in the United States
absent registration or an applicable exemption from such Act's registration
requirements.
<PAGE>
Exhibit 99.2
Press Release
Contacts:
News Media: Josh Howell Investors: Julie Stangl
402/943-1309 402/943-1310
Steve Inglish
402/943-1337
LEVEL 3 COMMUNICATIONS ANNOUNCES OFFERING
OF $2.0 BILLION IN SENIOR NOTES
OMAHA, NEBRASKA, April 28, 1998 - Level 3 Communications, Inc. (Nasdaq: LVLT)
today announced that it has sold $2.0 billion aggregate principal amount of
9-1/8% Senior Notes Due 2008 in a transaction that is exempt from registration
under the Securities Act of 1933, as amended. The price to the purchasers of the
Senior Notes was 99.579%. The Senior Notes will mature on May 1, 2008 and are
senior, unsecured obligations of Level 3, ranking pari passu with all existing
and future senior unsecured indebtedness of Level 3. Interest on the Senior
Notes is payable in cash semiannually on May 1 and November 1 of each year,
commencing November 1, 1998.
Level 3 currently intends to use the net proceeds of the offering in connection
with the implementation of its business plan to increase substantially its
information services business and to expand the range of services it offers by
building an advanced, international, facilities-based communications network
based on Internet Protocol (IP) technology.
The securities offered by Level 3 have not been registered under the Securities
Act of 1933, as amended, and may not be offered or sold in the United States
absent registration or an applicable exemption from such Act's registration
requirements.
