FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1998
or
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period__________to__________
Commission file number 0-15658
LEVEL 3 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 47-0210602
(State of Incorporation) (I.R.S. Employer
Identification No.)
3555 Farnam Street, Omaha, Nebraska 68131
(Address of principal executive offices) (Zip Code)
(402)-536-3677
(Registrant's telephone number,
including area code)
Peter Kiewit Sons', Inc.
(Former name if changed since last report)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports(s)), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The number of shares outstanding of each class of the issuer's
common stock, as of May 1, 1998:
Common Stock 149,677,680 shares
Class R Convertible Common Stock 6,538,231 shares
LEVEL 3 COMMUNICATIONS, INC.
Part I - Financial Information
Item 1. Financial Statements:
Consolidated Condensed Statements of Earnings
Consolidated Condensed Balance Sheets
Consolidated Condensed Statements of Cash Flows
Consolidated Statement of Changes in Stockholders' Equity
Notes to Condensed Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Part II - Other Information
Item 2. Changes in Securities
Item 6. Exhibits and Reports on Form 8-K
Signatures
Index to Exhibits
LEVEL 3 COMMUNICATIONS, INC.
Consolidated Condensed Statements of Earnings
(unaudited)
Three Months Ended
March 31,
(dollars in millions, except per share data) 1998 1997
Revenue $ 87 $ 80
Costs and Expenses:
Operating expenses 42 39
Depreciation and amortization 6 5
General and administrative expenses 48 16
------ ------
Total costs and expenses 96 60
------ ------
Earnings (Loss) from Operations (9) 20
Other Income (Expense):
Interest income 26 7
Interest expense (4) (3)
Other, principally equity losses of
unconsolidated entities (22) (3)
----- ------
Total other income - 1
----- ------
Earnings (Loss) Before Income Taxes and
Discontinued Operations (9) 21
Income Tax (Provision) Benefit 3 (5)
----- -----
Earnings (Loss) from Continuing Operations (6) 16
Discontinued Operations:
Gain on separation of construction operations 608 -
Gain on disposition of energy business,
net of income tax expense of $174 324 -
Energy, net of income tax expense of $2 - 4
Construction, net of income tax expense of $10 - 15
----- -----
Earnings from discontinued operations 932 19
----- -----
Net Earnings $ 926 $ 35
===== =====
Earnings (Loss) Per Share:
Continuing Operations:
Basic $(0.04) $0.12
====== =====
Diluted $(0.04) $0.12
====== =====
Discontinued Operations:
Basic $ 6.38 $0.04
====== =====
Diluted $ 6.38 $0.04
====== =====
Net Earnings:
Basic $ 6.34 $0.16
====== =====
Diluted $ 6.34 $0.16
====== =====
Net Earnings excluding gain on split-off
of construction operations:
Basic $ 2.18 $0.16
====== =====
Diluted $ 2.18 $0.16
====== =====
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC.
Consolidated Condensed Balance Sheets
March 31, December 27,
1998 1997
(dollars in millions, except per share data)
(unaudited)
Assets
Current Assets
Cash and cash equivalents $ 806 $ 87
Marketable securities 1,289 678
Restricted securities 24 22
Accounts receivable 54 42
Investment in discontinued operations - energy - 643
Other 24 22
------ -----
Total Current Assets 2,197 1,494
Property, Plant and Equipment, less
accumulated depreciation and amortization
of $224 and $228 192 184
Investments 342 383
Investment in discontinued
operations - construction - 652
Other Assets 63 66
------ -----
$2,794 $2,779
====== ======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC.
Consolidated Condensed Balance Sheets
March 31, December 27,
1998 1997
(dollars in millions, except per share data)
(unaudited)
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 54 $ 31
Current portion of long-term debt 4 3
Accrued reclamation and other mining costs 14 19
Deferred income taxes 14 15
Income taxes payable 198 -
Other 20 21
----- -----
Total Current Liabilities 304 89
Long-Term Debt, less current portion 137 137
Deferred Income Taxes 66 83
Accrued Reclamation Costs 101 100
Other Liabilities 137 140
Stockholders' Equity:
Preferred stock, no par value, authorized 250,000
shares;
no shares outstanding in 1998 and 1997 - -
Common Stock, $.01 par value in 1998:
Common Stock (Class D in 1997), authorized
500,000,000 shares;
147,199,552 shares outstanding in 1998 and
135,517,140 outstanding in 1997 1 8
Class R Common Stock, authorized 8,500,000 shares;
6,538,231 shares outstanding in 1998
and no shares outstanding in 1997 - -
Class B, authorized 8,000,000 shares; no shares
outstanding in 1998 or 1997 - -
Class C, authorized 125,000,000 shares; no shares
outstanding
in 1998 and 10,132,343 outstanding in 1997 - 1
Additional paid-in capital 447 427
Accumulated other comprehensive income (loss) 13 (5)
Retained earnings 1,588 1,799
------ ------
Total Stockholders' Equity 2,049 2,230
------ ------
$2,794 $2,779
====== ======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC.
Consolidated Condensed Statements of Cash Flows
(unaudited)
Three Months Ended
March 31,
(dollars in millions) 1998 1997
Cash flows from continuing operations:
Net cash provided by continuing operations $ 17 $ 108
Cash flows from investing activities:
Proceeds from sales and maturities of
marketable securities 819 25
Purchases of marketable securities (1,422) (14)
Investments (3) (25)
Proceeds from sale of property, plant and
equipment and other investments 20 -
Capital expenditures (18) (7)
Other - (2)
----- -----
Net cash used in investing activities (604) (23)
Cash flows from financing activities:
Payments on long-term debt including
current portion (2) -
Issuances of common stock 17 -
Proceeds from exercise of stock options 10 -
Dividends paid - (12)
Exchange of Class C Stock for Common Stock, net 122 71
Other - 1
------ -----
Net cash provided by financing activities 147 60
Cash flows from discontinued operations:
Proceeds from sale of energy operations 1,159 -
Investments in discontinued energy operations - (13)
------ -----
Net cash provided by (used in) discontinued
operations 1,159 (13)
Cash and cash equivalents of C-TEC at the
beginning of 1997 - (76)
----- -----
Net change in cash and cash equivalents 719 56
Cash and cash equivalents at beginning of year 87 147
------ -----
Cash and cash equivalents at end of period $ 806 $ 203
====== =====
The activities of the Construction & Mining Group have been
removed from the Consolidated Condensed Statements of Cash Flows.
See accompanying notes to consolidated condensed financial
statements.
LEVEL 3 COMMUNICATIONS, INC.
Consolidated Statement of Changes in Stockholders' Equity
For the three months ended March 31, 1998
(unaudited)
Class Common Class
B&C Stock R Additional Other
(dollars Common (Class D Common Paid-in Comprehensive Retained
in millions) Stock in 1997) Stock Capital Income(Loss) Earnings Total
Balance at
December 28,
1997 $ 1 $ 8 $ - $ 427 $ (5) $1,799 $2,230
Common Stock:
Issuance of
Common Stock - - - 17 - - 17
Stock options
exercised - 1 - 9 - - 10
Designation of
par value
to $.01 - (8) - 8 - - -
Stock option
grants - - - 2 - - 2
Income tax
benefit from
exercise of
options - - - 1 - - 1
Issuance of
Class R Stock - - - 92 - (92) -
Class C Stock:
Repurchases - - - (25) - - (25)
Conversion of
debentures - - - 10 - - 10
Net earnings - - - - - 926 926
Other
comprehensive
income - - - - 3 - 3
Split-off of
the Construction
& Mining Group (1) - - (94) 15 (1,045) (1,125)
---- ---- ---- ----- ---- ------- ------
Balance at
March 31,
1998 $ - $ 1 $ - $ 447 $ 13 $ 1,588 $2,049
==== === ==== ===== ==== ======= ======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC.
Notes to Consolidated Condensed Financial Statements
1. Basis of Presentation
The consolidated condensed balance sheet of Level 3
Communications, Inc. and subsidiaries ("Level 3" or "the
Company"), at December 27, 1997 has been condensed from the
Company's audited balance sheet as of that date. All other
financial statements contained herein are unaudited and, in the
opinion of management, contain all adjustments (consisting
only of normal recurring accruals) necessary for a fair
presentation of financial position, results of operations and
cash flows for the periods presented. The Company's accounting
policies and certain other disclosures are set forth in the notes
to the consolidated financial statements contained in the
Company's Annual Report on Form 10-K, as amended, for the year
ended December 27, 1997. These financial statements should be
read in conjunction with the Company's audited consolidated
financial statements and notes thereto. The preparation of the
consolidated condensed financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amount of
assets and liabilities, disclosure of contingent assets and
liabilities and the reported amount of revenue and expenses
during the reported period. Actual results could differ from
these estimates.
In 1997, the Company agreed to sell its energy assets to
CalEnergy Company, Inc. ("CalEnergy") and to separate the
Construction & Mining Group from the Diversified Group. On
January 2, 1998, the Company completed the sale of its energy
assets to CalEnergy. On March 31, 1998 the Company completed the
split-off of the Construction & Mining Group to stockholders that
held Class C Stock. Therefore, the assets and liabilities and
results of operations of both businesses were classified as
discontinued operations on the consolidated condensed balance
sheet, statements of earnings and cash flows for all periods
presented.
The results of operations for the three months ended March 31,
1998 are not necessarily indicative of the results to be expected
for the full year.
On May 1, 1998, the Company's Board of Directors changed Level
3's fiscal year end from the last Saturday in December to a
calendar year end. The additional five days in the 1998 fiscal
year will be reflected in the Company's Form 10-K.
Where appropriate, items within the consolidated condensed
financial statements have been reclassified from the previous
periods to conform to current year presentation.
2. Reorganization - Discontinued Construction Operations
On March 31, 1998 a separation of the Company's Construction &
Mining Group and Diversified Group was completed through the
split-off of the Construction and Mining Group ("the Split-off").
The Company recognized a gain of $608 million equal to the
difference between the carrying value of the Construction &
Mining Group and its fair value in accordance with the Financial
Accounting Standards Board Emerging Issues Tax Force Issue 96-4.
No taxes were provided on this gain due to the tax-free nature of
the Split-off. The Company then reflected the fair value of the
Construction & Mining Group as a distribution to the Class C
stockholders.
In connection with the Split-off, Level 3 and the Construction &
Mining Group entered into various agreements including a
Separation Agreement, a Tax Sharing Agreement and an amended Mine
Management Agreement.
The Separation Agreement, as amended, provides for the allocation
of certain risks and responsibilities between Level 3 and the
Construction & Mining Group and for cross-indemnifications that
are intended to allocate financial responsibility to the
Construction & Mining Group for liabilities arising out of the
construction business and to allocate to Level 3 financial
responsibility for liabilities arising out of the non-
construction businesses. The Separation Agreement also allocates
certain corporate-level risk exposures not readily allocable to
either the construction businesses or the non-construction
businesses.
Under the Tax Sharing Agreement, with respect to periods, or
portions thereof, ending on or before the Split-off, Level 3 and
the Construction & Mining Group generally will be responsible for
paying the taxes relating to such returns, including any
subsequent adjustments resulting from the redetermination of
such tax liabilities by the applicable taxing authorities, that
are allocable to the non-construction businesses and construction
businesses, respectively. The Tax Sharing Agreement also
provides that Level 3 and the Construction & Mining Group will
indemnify the other from certain taxes and expenses that would be
assessed if the Split-off were determined to be taxable, but
solely to the extent that such determination arose out of the
breach by Level 3 or the Construction & Mining Group,
respectively, of certain representations made to the Internal
Revenue Service in connection with the ruling issued with respect
to the Split-off. If the Split-off were determined to be taxable
for any other reason, those taxes would be allocated equally to
Level 3 and the Construction & Mining Group. Finally, under
certain circumstances, Level 3 would make certain liquidated
damage payments to the Construction & Mining Group if the Split-
off was determined to be taxable, in order to indirectly
compensate Class C stockholders for taxes assessed upon them in
that event.
In connection with the Split-off, the Mine Management Agreement,
pursuant to which the Construction & Mining Group provides mine
management and related services to Level 3's coal mining
operations, was amended to provide the Construction & Mining
Group with a right of offer in the event that Level 3 were to
determine to sell any or all of its coal mining properties.
Under the right of offer, Level 3 would be required to offer to
sell those properties to the Construction & Mining Group. If the
Construction & Mining Group were to decline to purchase the
properties at that price, Level 3 would be free to sell them to a
third party for an amount greater than or equal to that price.
If Level 3 were to sell the properties to a third party, thus
terminating the Mine Management Agreement, it would be required
to pay the Construction & Mining Group an amount equal to the
discounted present value of the Mine Management Agreement,
determined, if necessary, by an appraisal process.
Following the Split-off, the Company's Common Stock began trading
on The Nasdaq National Market on April 1, 1998, under the symbol
"LVLT". In connection with the Split-off, the construction
business was renamed "Peter Kiewit Sons', Inc." and the Class D
Stock became the common stock of Level 3 Communications, Inc.
("Common Stock"). Accordingly, the separate financial statements of
Peter Kiewit Sons', Inc. should be obtained to review the financial
position of the Construction & Mining Group as of March 31, 1998
and December 27, 1997, and the results of operations for the three
months ended March 31, 1998 and 1997.
The Company's certificate of incorporation gave stockholders the
right to exchange their Class C Stock for Class D Stock under a
set conversion formula. That right was eliminated as a result of
the Split-off. To replace that conversion right, Class C
stockholders received 6.5 million shares of a new Class R
Convertible Stock ("Class R Stock") in January 1998, which is
convertible into Level 3 Common Stock in accordance with terms
ratified by stockholders in December 1997. The Company reflected
in the equity accounts the exchange of the conversion right and
issuance of the Class R Stock at its fair value of $92 million at
the date of the Split-off.
On May 1, 1998, the Board of Directors of Level 3 Communications,
Inc. determined to force conversion of all shares of the
Company's Class R Stock into common stock of the Company,
effective May 15, 1998. The Class R Stock will be converted into
Level 3 Common Stock in accordance with the formula set forth in
the Certificate of Incorporation of the Company. The formula
provides for a conversion ratio equal to $25, divided by the
average of the midpoints between the high and low sales prices
for Level 3 Common Stock on each of the fifteen trading days
during the period beginning April 9 and ending April 30. That
average for that period was $64.28125. Accordingly, each holder
of Class R Stock will receive .3889 of a share of Level 3 Common
Stock for each share of Class R Stock held. As a result of the
forced conversion, certain adjustments will be made to the cost
sharing and risk allocation provisions of the Separation
Agreement and Tax Sharing Agreement between Level 3 and Peter
Kiewit Sons', Inc. which will reduce the costs and risks
allocated to the Company.
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 PKS Information Services, Inc. subsidiary 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 "Business Plan"). The Company is
designing the network based on IP technology in order to
leverage the efficiencies of this technology to provide lower cost
communications services.
3. Discontinued Energy Operations
On January 2, 1998, the Company completed the sale of its energy
assets to CalEnergy. Level 3 recognized an after-tax gain on the
disposition of $324 million and the after-tax proceeds of
approximately $967 million from the transaction will be used to
fund in part the Business Plan. Results of operations for the
period through January 2, 1998 were not considered significant
and the gain on disposition was calculated using the carrying
amount of the energy assets as of December 27, 1997.
4. Earnings Per Share
Basic earnings per share have been computed using the weighted
average number of shares during each period. Diluted earnings
per share have been computed by including stock options
considered to be dilutive common stock equivalents.
The Company had a loss from continuing operations for the period
ended March 31, 1998, therefore, no potential common shares
related to Company stock options have been included in the
computation of the diluted earnings per share calculations. For
the period ending March 31, 1997, potentially dilutive stock
options are calculated in accordance with the treasury stock
method which assumes that proceeds from exercise of all options
are used to repurchase common stock at the average market value.
The number of shares remaining after the proceeds are exhausted
represent the potentially dilutive effect of the options.
The following details the earnings per share calculations for
Level 3 Common Stock:
Three Months
Ended March 31,
1998 1997
Earnings (loss) from continuing
operations (in millions): $ (6) $ 16
Earnings from discontinued operations 932 4
------- -------
Net earnings $ 926 $ 20
======= =======
Total number of weighted average shares outstanding
used to compute basic earnings per
share (in thousands) 146,163 122,207
Additional dilutive stock options - 271
------- -------
Total number of shares used to compute dilutive
earnings per share 146,163 122,478
======= =======
Continuing operations:
Basic earnings (loss) per share $(0.04) $ 0.12
====== =======
Diluted earnings (loss) per share $(0.04) $ 0.12
====== =======
Discontinued operations:
Basic earnings per share $ 6.38 $ 0.04
====== =======
Diluted earnings per share $ 6.38 $ 0.04
====== =======
Net earnings:
Basic earnings per share $ 6.34 $ 0.16
====== =======
Diluted earnings per share $ 6.34 $ 0.16
====== =======
Net earnings excluding gain on split-off
of construction operations
Basic earnings per share $ 2.18 $ 0.16
====== =======
Diluted earnings per share $ 2.18 $ 0.16
====== =======
The Company has 10,032,111 options outstanding that were not included in the
computation of diluted earnings per share because to do so would have been
anti-dilutive for the three months ended March 31, 1998.
Effective December 26, 1997, the Company issued a dividend of
four shares of Level 3 Common Stock (previously Class D Stock)
for each share of Level 3 Common Stock outstanding. All share
information and per share data have been restated to reflect this
dividend.
5. Investments
On September 5, 1997, C-TEC Corporation ("C-TEC") announced that
its board of directors had approved the planned restructuring of
C-TEC into three publicly traded companies effective September
30, 1997. Under the terms of the restructuring C-TEC
shareholders received stock in the following companies:
Commonwealth Telephone Enterprises, Inc., containing the local
telephone group and related engineering business;
Cable Michigan, Inc. containing the cable television operations
in Michigan; and
RCN Corporation, Inc. which consists of RCN Telecom Services; C-
TEC, existing cable systems in the Boston-Washington D.C.
corridor; and the investment in Megacable S.A. de C.V., a cable
operator in Mexico. RCN Telecom Services is a provider of
packaged local and long distance telephone, video and internet
access services provided over fiber optic networks to residential
customers in Boston, New York City and Washington, D.C.
As a result of the restructuring, Level 3 owns less than 50% of
each of the outstanding shares and voting rights of each entity,
and therefore accounts for each entity using the equity method.
The following is summarized financial information of the three
entities created as a result of the C-TEC restructuring for the
three months ended March 31, 1998 and 1997, and as of March 31,
1998 and December 31, 1997(in millions):
Three Months
Ended March 31,
Operations 1998 1997
Commonwealth Telephone Enterprises:
Revenue $ 53 $ 46
Net income (loss) available to common shareholders 4 (7)
Level 3's share:
Net income (loss) 2 (3)
Goodwill amortization (1) (1)
----- -----
Equity in net income (loss) $ 1 $ (4)
===== =====
Cable Michigan:
Revenue $ 21 $ 20
Net loss available to common shareholders (1) (2)
Level 3's share:
Net loss (1) (1)
Goodwill amortization (1) -
----- ----
Equity in net loss $ (2) $ (1)
===== ====
RCN Corporation:
Revenue $ 40 $ 30
Net loss available to common shareholders (68) (11)
Level 3's share:
Net loss (31) (5)
Goodwill amortization - -
----- -----
Equity in net loss $ (31) $ (5)
===== =====
Commonwealth
Telephone Cable RCN
Enterprises Michigan Corporation
Financial Position 1998 1997 1998 1997 1998 1997
Current assets $ 63 $ 71 $ 16 $ 23 $ 989 $ 703
Other assets 313 303 117 120 589 448
----- ------ ----- ----- ----- -----
Total assets 376 374 133 143 1,578 1,151
Current liabilities 75 76 18 16 107 70
Other liabilities 259 260 156 166 1,086 708
Minority interest - - 14 15 23 16
----- ----- ----- ----- ----- -----
Total liabilities 334 336 188 197 1,216 794
----- ----- ----- ---- ----- -----
Net assets (liabilities) $ 42 $ 38 $ (55) $(54) $ 362 $ 357
===== ===== ===== ==== ===== =====
Level 3's share:
Equity in net assets
(liabilities) $ 20 $ 18 $ (27) $(26) $ 167 $ 173
Goodwill 56 57 71 72 16 41
----- ----- ----- ---- ----- -----
$ 76 $ 75 $ 44 $ 46 $ 183 $ 214
===== ===== ===== ==== ===== =====
The Company recognizes gains and losses from the sale, issuance
and repurchase of stock by its subsidiaries and equity method
investees once any unamortized goodwill associated with the
investment has been reduced to a zero balance. During the first
quarter of 1998, RCN Corporation issued stock in the acquisition
of two Internet service providers. The increase in the Company's
proportionate share of RCN Corporation's net assets as a result
of these acquisitions reduced unamortized goodwill attributable
to the Company's investment in RCN Corporation.
On March 31, 1998 the market value of Level 3's investments in
Commonwealth Telephone, Cable Michigan and RCN was $247 million,
$85 million and $668 million, respectively.
6. Level 3 Stock Plan
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")
when it adopted an outperform stock option program ("OSO").
Under SFAS No. 123, the fair value of an option (as computed in
accordance with accepted option valuation models) on the date of
grant is amortized over the vesting period of the option. 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.
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 Level 3 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 Level 3 Common Stock
outperforms the S&P 500 Index. To the extent that the Level 3
Common Stock outperforms the S&P 500, the value of OSOs to an
option holder may exceed the value of non-qualified stock
options.
The Company believes that the fair value method of accounting
more appropriately reflects the substance of the transaction
between an entity that issues stock options, or other stock-based
instruments, and its employees; that is, an entity has granted
something of value to an employee (the stock option or other
instrument) generally in return for their continued employment
and services. The Company believes that the value of the
instrument granted to employees should be recognized in financial
statements because nonrecognition implies that either the
instruments have no value or that they are free to employees,
neither of which is an accurate reflection of the substance of
the transaction. Although the recognition of the value of the
instruments results in compensation expense in an entity's
financial statements, the expense differs from other compensation
expense in that these charges will not be settled in cash, but
rather, generally, through issuance of common stock.
The Company believes that the adoption of SFAS 123 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 of each option estimated at the time of its grant. The
expense recognized for the three months ended March 31, 1998 was
$2 million. On a pro forma basis, adopting SFAS No. 123 would not
have had a material impact on the results of operaitons in the first
quarter of 1997.
7. Comprehensive Income
In the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." The standard requires the display and reporting of
comprehensive income which includes all changes in stockholders'
equity with the exception of additional investments by
stockholders or distributions to stockholders. Comprehensive
income for the Company includes net earnings, unrealized gains
(losses) on securities and foreign currency translation
adjustments, which are charged or credited to the cumulative
translation account within stockholders' equity.
Comprehensive income for the three months, ended March 31, 1998
and 1997 was as follows (in millions):
Three Months Ended
March 31,
1998 1997
Net earnings $ 926 $ 35
Other comprehensive income before tax:
Foreign currency translation adjustments 1 2
Unrealized holding gains (losses)
arising during period 8 (17)
Less: reclassification adjustment for
gains (losses) included in net earnings (5) -
------ ------
Other comprehensive income (loss),
before tax 4 (15)
Income tax (expense) benefit related to items
of other comprehensive income (1) 6
------ ------
Other comprehensive income, net of taxes 3 (9)
------ ------
Comprehensive income $ 929 $ 26
====== ======
8. New Accounting Pronouncements
On April 3, 1998, the Accounting Standards Executive Committee
issued Statement of Position 98-5 ("SOP 98-5"), Reporting on the
Costs of Start-Up Activities, which provides guidance on the
financial reporting of start-up and organization costs. It
requires costs of start-up activities and organization costs to
be expensed as incurred. SOP 98-5 is effective for financial
statements for fiscal years beginning after December 15, 1998.
The Company is required to reflect the initial application of SOP
98-5 as the cumulative effect of a change in accounting
principle, as described in Accounting Principles Board Opinion
No. 20, Accounting Changes. As a result of the cumulative effect
of a change in accounting treatment, the Company expects to
record a charge to earnings in the first quarter of 1999 for any
unamortized start-up or organization costs as of the beginning of
1999.
9. Other Matters
In January 1998, approximately 2.3 million shares of Class C
Stock, with a redemption value of $122 million were converted
into 10.5 million shares of Level 3 Common Stock (formerly Class
D Stock).
The Company is involved in various lawsuits, claims and
regulatory proceedings incidental to its business. Management
believes that any resulting liability for legal proceedings
beyond that provided should not materially affect the Company's
financial position, future results of operations or future cash
flows.
On March 23, 1998, the Company and Frontier Communications
International, Inc. ("Frontier") entered into an agreement
("Frontier Agreement") enabling the Company to lease
approximately 8,300 miles of OC-12 network capacity on Frontier's
new 13,000 mile SONET fiber optic, IP-capable network currently
under construction for a period of up to five years. The leased
network will initially connect 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. The Company expects to
recognize these costs as the leased network is utilized.
10. Subsequent Events
On April 2, 1998, the Company announced it had reached a
definitive agreement with Union Pacific Railroad Company ("Union
Pacific") granting the Company the use of approximately 7,800
miles of rights-of-way along Union Pacific's rail routes for
construction of the Company's North American intercity network.
The Company expects that the Union Pacific agreement will satisfy
substantially all of its anticipated right-of-way requirements
west of the Mississippi River and approximately 50% of the right-
of-way requirements for its North American intercity network.
The agreement provides for initial fixed payments of up to $8
million to Union Pacific upon execution of the agreement and
throughout the construction period, recurring payments in the
form of cash, communications capacity, and other communications
services based on the number of conduits that are operational and
certain construction obligations of the Company to provide fiber
or conduit connections for Union Pacific at the Company's
incremental cost of construction.
On April 23, 1998, the Company acquired XCOM Techologies, Inc.
("XCOM"), a privately held company that 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 public switched telephone network. The
Company issued approximately 2.6 million shares of Level 3 Common
Stock and 0.4 million options and warrants to purchase Level 3
Common Stock in exchange for all the stock, options and warrants
of XCOM. The value of the transaction will be determined through
an appraisal. The Company expects to account for this
transaction as a purchase and expects to recognize a significant
charge to earnings during the second quarter of 1998 for the
portion of the cost of the purchase attributable to in-process
research and development efforts.
On April 28, 1998, the Company received $1.937 billion of
proceeds from an offering of $2 billion aggregate principal
amount 9.125% Senior Notes Due 2008 ("the Offering"). The Senior
Notes are senior, unsecured obligations of the Company, ranking
pari passu with all existing and future senior unsecured
indebtedness of the Company. The Senior Notes contain certain
covenants, which among others, limit consolidated debt, dividend
payments, and transactions with affiliates. The Company 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 IP technology.
LEVEL 3 COMMUNICATIONS, INC.
Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the
Company's consolidated condensed financial statements (including
the notes thereto), included elsewhere herein.
This document contains forward looking statements and information
that are based on the beliefs of management as well as
assumptions made by and information currently available to the
Company. When used in this document, the words "anticipate",
"believe", "estimate" and "expect" and similar expressions, as
they relate to the Company or its management, are intended to
identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and
are subject to certain risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize,
or should underlying assumptions prove incorrect, actual results
may vary materially from those described in this document.
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 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 (the "Split-off"). 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. Accordingly, the separate financial
statements and management's discussion and analysis of financial
condition and results of operations of Peter Kiewit Sons', Inc.
should be obtained to review the financial position of the
Construction Group as of March 31, 1998 and December 27, 1997,
and the results of operations for the quarters ended March 31,
1998 and 1997.
On March 31, 1998, as a result of the Split-off, the Company
recognized, within discontinued operations, a gain of $608
million equal to the difference between the carrying value of
the Construction Group and its fair value in accordance with
Financial Accounting Standards Board Emerging Issues Task Force
Issue 96-4. No taxes were provided on this gain due to the tax-
free nature of the Split-off. Also on March 31, 1998, the
Company reflected the fair value of the Construction Group as a
distribution to the Class C stockholders.
Listing of Common Stock
Effective April 1, 1998, the Company's Common Stock began trading
on The Nasdaq National Market under the symbol "LVLT."
Conversion of Class R Stock
On May 1, 1998, the Board of the Company determined to force
conversion of all shares of the Company's Class R Stock into
Common Stock of the Company, effective May 15, 1998. The Class R
Stock will be converted into the Company's Common Stock in
accordance with the formula set forth in the Company's
Certificate of Incorporation. The formula provides for a
conversion ratio equal to $25, divided by the average of the
midpoints between the high and low sales prices for the Company's
Common Stock on each of the fifteen trading days during the
period beginning April 9 and ending April 30, 1998. That average
for that period was $64.28125. Accordingly, each holder of Class
R Stock will receive .3889 of a share of Common Stock for each
share of Class R Stock held. In total, the 6.5 million shares of
Class R Stock will convert into 2.5 million shares of Common
Stock on May 15, 1998. As a result of the forced conversion,
certain adjustments will be made to the cost sharing and risk
allocation provisions of the Separation Agreement and Tax Sharing
Agreement between the Company and Peter Kiewit Sons', Inc. which
will reduce the costs of the Split-off and risks allocated to the Company.
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 Level 3 Common
Stock (formerly Class D Stock).
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 recognized an after-
tax gain of $324 million in the first quarter of 1998. The after-
tax proceeds from this transaction of approximately $967 million
will be used to fund in part the Company's planned expansion of
its information services business and the development of an
advanced, international, facilities-based communications network
("Business Plan").
Stock Options
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")
when it adopted an outperform stock option program ("OSO").
Under SFAS No. 123, the fair value of an option (as computed in
accordance with accepted option valuation models) on the date of
grant is amortized over the vesting period of the option. 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.
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 Level 3 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 Level 3 Common Stock
outperforms the S&P 500 Index. To the extent that the Level 3
Common Stock outperforms the S&P 500, the value of OSOs to an
option holder may exceed the value of non-qualified stock
options.
The Company believes that the fair value method of accounting
more appropriately reflects the substance of the transaction
between an entity that issues stock options, or other stock-based
instruments, and its employees; that is, an entity has granted
something of value to an employee (the stock option or other
instrument) generally in return for their continued employment
and services. The Company believes that the value of the
instrument granted to employees should be recognized in financial
statements because nonrecognition implies that either the
instruments have no value or that they are free to employees,
neither of which is an accurate reflection of the substance of
the transaction. Although the recognition of the value of the
instruments results in compensation expense in an entity's
financial statements, the expense differs from other compensation
expense in that these charges will not be settled in cash, but
rather, generally, through issuance of common stock.
The Company believes that the adoption of SFAS No. 123 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 of each option estimated at the time of its
grant. The expense recognized for the three months ended March
31, 1998 was $2 million.
Corporate Headquarters
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.
Frontier Agreement
On March 23, 1998, the Company and Frontier Communications
International, Inc. ("Frontier") entered into an agreement
("Frontier Agreement") enabling the Company to lease
approximately 8,300 miles of OC-12 network capacity on Frontier's
new 13,000 mile SONET fiber optic, IP-capable network currently
under construction for a period of up to five years. The leased
network will initially connect 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. The Company expects to
recognize these costs as the leased network is utilized.
Union Pacific Rights-of-Way
On April 2, 1998, the Company announced it had reached a
definitive agreement with Union Pacific Railroad Company (the
"Union Pacific Agreement") granting the Company the use of
approximately 7,800 miles of rights-of-way along Union Pacific's
rail routes for construction of the Company's North American
intercity network. The Company expects that the Union Pacific
Agreement will satisfy substantially all of its anticipated right-
of-way requirements west of the Mississippi River and
approximately 50% of the right-of-way requirements for its North
American intercity network. The agreement provides for initial
fixed payments of up to $8 million to Union Pacific upon
execution of the agreement and throughout the construction
period, recurring payments in the form of cash, communications
capacity, and other communications services based on the number
of conduits that are operational and certain construction
obligations of the Company to provide fiber or conduit
connections for Union Pacific at the Company's incremental cost
of construction.
XCOM Technologies, Inc. Acquisition
On April 23, 1998, the Company acquired XCOM Techologies, Inc.
("XCOM"), a privately held company that 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 public switched telephone network. The
Company issued approximately 2.6 million shares of Level 3 Common
Stock and 0.4 million options and warrants to purchase Level 3
Common Stock in exchange for all the common and preferred stock
of XCOM. The value of the transaction will be determined through
an appraisal. The Company expects to account for this
transaction as a purchase and expects to recognize a significant
charge to earnings during the second quarter of 1998 for the
portion of the cost of the purchase attributable to in-process
research and development efforts.
Senior Notes
On April 28, 1998, the Company received $1.937 billion of
proceeds from an offering of $2 billion aggregate principal
amount 9.125% Senior Notes Due 2008 ("the Offering"). The Senior
Notes are senior, unsecured obligations of the Company, ranking
pari passu with all existing and future senior unsecured
indebtedness of the Company. The Senior Notes contain certain
covenants, which among others, limit consolidated debt, dividend
payments and transactions with affiliates. The Company 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 IP technology.
Results of Operations
In late 1997, the Company announced a 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. 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 periods 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.
First Quarter 1998 vs. First Quarter 1997
Revenue for the quarters ended March 31, is summarized as follows
(in millions):
1998 1997
Communications and Information Services $ 29 $ 16
Coal Mining 53 61
Other 5 3
----- -----
$ 87 $ 80
===== =====
Communications and Information Services revenue consists of
computer outsourcing revenue of $15 million and systems
integration revenue of $14 million in 1998. The comparable
amounts in 1997 were $11 million and $5 million. Computer
outsourcing revenues increased due to the addition of several new
customers since the first quarter of 1997. The increase in
systems integration revenue in the first quarter of 1998 reflects
the pattern of growth experience throughout 1997 as the Company
expanded its computer network systems integration, consulting,
and Year 2000 and software reengineering activities since this
business commenced operations in 1997.
The Company plans to begin offering IP network services in 15
U.S. cities in the fall of 1998. In preparation for the product
launch, the Company made significant progress during the first
quarter in 1998 in obtaining appropriate licenses, agreements and
technical facilities. The Company has secured approximately
750,000 square feet of space for technical gateway and
collocation sites in these 15 cities, and received Certificates
of Public Convenience and Necessity in eight states. The Company
also obtained collocation agreements in 56 Central Offices and
has begun construction in most of these locations, and is
currently in discussions with all the incumbent local exchange
carriers for Interconnection Agreements.
Coal mining revenues decreased in 1998 due primarily to the
expiration of a long term sales contract at the end of 1997 and
continued lower prices for new customer contracts. Coal mining
revenue for the year ended 1998 is expected to approximate 1997
revenue, due to additional alternative source and brokerage
revenue expected during the remainder of 1998.
Operating Expenses increased to $42 million in 1998 from $39
million in 1997 primarily due to costs associated with increased
systems integration revenue. Margins from the computer
outsourcing and systems integration businesses improved in 1998
primarily due to increased revenues from new customers obtained
since the first quarter of 1997 and from the systems integration
business, which was in a start-up mode in 1997. Coal margins
declined slightly in 1998 due to the expiration of a long term
sales contract at the end of 1997. Coal mining margins for the
year ended 1998 are expected to approximate margins recognized in
1997 due to additional high margin alternative source coal
expected to be sold throughout the remainder of 1998. 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.
Depreciation and Amortization increased slightly in 1998 to $6
million from $5 million in 1997 primarily due to increased
depreciation on PKS Information Services equipment purchased for
new computer outsourcing customers. The Company expects to incur
additional amortization expense beginning in the second quarter
of 1998 due to the acquisition of XCOM. Additional depreciation
is expected beginning in the third quarter of 1998 when the
Company commences operations on its IP network.
General and Administrative Expenses increased significantly in
1998 to $48 million from $16 million in 1997 primarily due to the
cost of activities associated with preparing for the expected
launch of the IP network in the third quarter of 1998. In
addition, the Company incurred approximately $7 million of
professional service costs associated with the initial
development of a substantial, scaleable business support system
infrastructure, specifically designed to enable the Company to
offer services efficiently to its targeted customers. In
addition to these costs, the Company incurred incremental
compensation and relocation costs for the substantial number of
new employees that have been hired to begin implementation of the
Business Plan, legal costs associated with obtaining licenses,
agreements and technical facilities and other development costs
associated with the Company's plans to begin offering services in
15 U.S. cities in the fall of 1998. Other than costs associated
with the business support system, which the Company will begin to
capitalize in the second quarter of 1998, general and
administrative costs are expected to increase significantly in
future periods as the Company implements the Business Plan.
EBITDA which consists of earnings (losses) before interest,
income taxes, depreciation, amortization, non cash stock-based
compensation and other non-operating income or expenses was $(3)
million in 1998 and $25 million in 1997. The primary reason for
the decrease between periods is the significant increase in
general and administrative expenses, described above, incurred in
connection with the implementation of the Company's Business
Plan. EBITDA is commonly used in the communications industry to
analyze companies on the basis of operating performance. EBITDA
is not intended to represent cash flow for the periods. See
Consolidated Condensed Statements of Cash Flows.
Interest Income increased significantly in 1998 to $26 million
from $7 million in 1997 as the Company's average cash, cash
equivalents and marketable securities balance approximated $2
billion in the first quarter of 1998. Proceeds on the sale of
the Company's energy assets to CalEnergy of $1.16 billion were
received on January 2, 1998. The Company's average cash, cash
equivalents and marketable securities balance approximated $550
million in 1997. Pending utilization of the cash equivalents and
marketable securities in implementing the Business Plan, the
Company intends to invest the funds primarily in government and
governmental agency securities. This investment strategy will
provide for less yield on the funds, but is expected to reduce
the risk to principal prior to using the funds in implementing
the Business Plan.
Interest Expense increased slightly in 1998 to $4 million from $3
million in 1997 due primarily to interest incurred on a $15
million mortgage with Metropolitan Life established in June 1997
with the Company's Pavilion Towers office building in Aurora,
Colorado serving as collateral. The majority of the interest
expense relates to bank and institutional notes with recourse
only to the SR91 toll road project. Interest expense will
increase substantially in future periods due to the completion of
the offering of $2 billion aggregate principle amount of 9.125%
Senior Notes Due 2008 issued on April 28, 1998. Amortization of
debt issuance costs associated with its offering will also
increase interest expense in future periods. A significant
portion of the interest will be capitalized as the Company
develops the IP network.
Other Expense, net increased substantially in 1998 to $(22)
million from $(3) million in 1997 due primarily to increased
losses recognized by the Company's equity method investee, RCN
Corporation, Inc. ("RCN"), a full service provider of local, long
distance, internet and cable television services primarily to
residential users in densely populated areas in the Northeast
United States. The Company's share of these losses approximated
$31 million. RCN is incurring significant costs in developing its
business plan and during the first quarter of 1998 it acquired
Ultranet Communications, Inc. and Erols Internet, Inc., two
Internet service providers with operations in the Boston to
Washington, D.C. corridor. RCN recognized a charge to earnings
of approximately $45 million (Company's share $21 million) with
respect to certain costs of the acquisitions associated with in-
process research and development activities.
Also included in Other Income (Expense) are equity earnings in
Commonwealth Telephone Enterprises, Inc., a Pennsylvania public
utility providing telephone service, equity in losses of Cable
Michigan, Inc., a cable television operator in the State of
Michigan, and realized gains and losses on the sale of marketable
securities, investments and other assets each not individually
significant to the Company's results of operations.
Income Tax Benefit approximates the statutory rate in 1998. The
income tax provision in 1997 is slightly below the statutory rate
due primarily to depletion allowances and other individually
insignificant deductions for tax purposes in excess of that
recognized for financial reporting purposes.
Discontinued Operations includes the one-time gain of $608
million recognized upon the distribution of the Construction
Group to former Class C stockholder on March 31, 1998. Also
included in discontinued operations is the gain, net of tax, of
$324 million from the Company's sale of its energy assets to
CalEnergy on January 2, 1998.
Financial Condition-March 31, 1998
The Company's working capital increased substantially during the
first quarter of 1998 due primarily to the sale of the Company's
energy assets to CalEnergy for $1.16 billion on January 2, 1998.
The Company's working capital was $1.9 billion on March 31, 1998
and $1.4 billion on December 27, 1997. The Company's operations
provided $17 million of cash during the first quarter of 1998,
primarily from coal mining operations partially offset by costs
in implementing the Business Plan.
The Company made capital expenditures of $18 million during the
first quarter of 1998, primarily related to the development of
the infrastructure associated with the IP network and the
purchase of equipment used by the computer outsourcing business.
The Company also had net purchases of marketable securities of
$603 million, primarily attributable to the investment of the
CalEnergy transaction proceeds. The Company also made several
small investments in development stage businesses during the
first quarter of 1998.
Financing activities in the first quarter of 1998 consisted
primarily of cash received upon the conversion of 2.3 million
shares of Class C Stock, with a redemption value of $122 million,
into 10.5 million shares of Level 3 Common Stock (formerly Class
D Stock) during January 1998 , proceeds from sales of Level 3
Common Stock of $17 million and the exercise of the Company's
stock options for $10 million. The Company reflected in the
equity accounts the exchange of the conversion right and the
issuance of the Class R Stock at its fair value of $92 million on
the date of the Split-off. The Company will recognize a similar
adjustment to the equity accounts of approximately $70 million
during the second quarter of 1998 due to the forced conversion of
the Class R Stock effective May 15, 1998.
On April 28, 1998, the Company received $1.937 billion of
proceeds from an offering of $2 billion aggregate principal
amount 9.125% Senior Notes Due 2008 ("the Offering"). The Senior
Notes are senior, unsecured obligations of the Company, ranking
pari passu with all existing and future senior unsecured
indebtedness of the Company. The Senior Notes contain certain
covenants, which among others, limit consolidated debt, dividend
payments and transactions with affiliates. The Company 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 IP technology.
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
its subsidiary, PKS Information Services, Inc., 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 operating 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 the Offering should be sufficient to fund the
currently committed portions of the Business Plan.
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. The Offering was issued under an
indenture which permits the Company and its subsidiaries to
incur substantial amounts of debt. 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 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
businesses, 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.
New Accounting Pronouncement
On April 3, 1998, the Accounting Standards Executive Committee
issued Statement of Position 98-5, ("SOP 98-5") Reporting on the
Costs of Start-Up Activities, which provides guidance on the
financial reporting of start-up costs and organization costs. It
requires costs of start-up activities and organization costs to
be expensed as incurred. SOP 98-5 is effective for financial
statements for fiscal years beginning after December 15, 1998.
The Company is required to reflect the initial application of SOP
98-5 as the cumulative effect of a change in accounting
principle, as described in Accounting Principles Board Opinion
No. 20, Accounting Changes. As a result of the cumulative effect
of a change in accounting treatment, the Company expects to
record a charge to earnings in the first quarter of 1999 for any
unamortized start-up or organization costs as of the beginning of
1999.
LEVEL 3 COMMUNICATIONS, INC.
PART II - OTHER INFORMATION
Item 2. Changes in Securities
Pursuant to an agreement dated March 2, 1998, the Company sold
200,000 shares of Common Stock, par value $.01 per share to Mr.
James Goodwin, in connection with financial advisory services to
be provided to the Company at an aggregate purchase price of
$8,000,000. The sale to Mr. Goodwin was made pursuant to the
exemption from registration contained in Section 4(2) under the
Securities Act of 1933, as amended.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed as part of this report are listed below.
Exhibit
Number
3.1 Articles of Incorporation. (Incorporated by reference to
Exhibit No. 1 to Amendment No. 1 to the Company's
Registration Statement on Form 8-A File No. 0-15658).
3.4 By-laws. (Incorporated by reference to Exhibit No. 2 to
Amendment No. 1 to the Company's Registration Statement
on Form 8-A File No. 0-15658).
18 Letter re change in accounting principles.
27 Financial Data Schedule.
(b) The Company filed a Form 8-K on January 15, 1998 reporting
the disposition of its energy assets to CalEnergy Company,
Inc. which closed on January 2, 1998.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act
of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
LEVEL 3 COMMUNICATIONS, INC.
Dated: May 15, 1998 \s\Eric J. Mortensen
Eric J. Mortensen
Controller
Chief Accounting Officer
LEVEL 3 COMMUNICATIONS, INC.
INDEX TO EXHIBITS
Exhibit
No.
3.1 Articles of Incorporation. (Incorporated by reference to
Exhibit No. 1 to Amendment No. 1 to the Company's
Registration Statement on Form 8-A File No. 0-15658).
3.4 By-laws. (Incorporated by reference to Exhibit No. 2 to
Amendment No. 1 to the Company's Registration Statement on
Form 8-A File No. 0-15658).
18 Letter re change in accounting principles.
27 Financial Data Schedule.
Exhibit 18
Level 3 Communications, Inc.
3555 Farnam Street
Omaha, NE 68131
We are providing this letter to Level 3 Communications, Inc. (the
"Company") for inclusion as an exhibit to your Form 10-Q filing
pursuant to Item 601 of Regulation S-K.
We have read management's disclosure for the change in accounting
from the intrinsic value based method for measuring stock
compensation cost to the fair value based method contained in the
Company's Form 10-Q for the quarter ended March 31, 1998.
Because the fair value based method is designated as the
preferred method by Statement of Financial Accounting Standards
(SFAS) No. 123, we concur that the newly adopted accounting
principle described above is preferable in the Company's
circumstances to the method previously applied.
We have not audited any financial statements of the Company as of
any date or for any period subsequent to December 27, 1997, nor
have we audited the application of the change in accounting
principle disclosed in Form 10-Q of the Company for the three
months ended March 31, 1998; accordingly, our comments are
subject to revision on completion of an audit of the financial
statements that include the accounting change.
Coopers & Lybrand L.L.P.
May 15, 1998
Omaha, Nebraska
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Form
10-Q for the period ending March 31, 1998 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 806
<SECURITIES> 1,313
<RECEIVABLES> 54
<ALLOWANCES> 0
<INVENTORY> 4
<CURRENT-ASSETS> 2,197
<PP&E> 416
<DEPRECIATION> 224
<TOTAL-ASSETS> 2,794
<CURRENT-LIABILITIES> 304
<BONDS> 137
0
0
<COMMON> 1
<OTHER-SE> 2,048
<TOTAL-LIABILITY-AND-EQUITY> 2,197
<SALES> 53
<TOTAL-REVENUES> 87
<CGS> 26
<TOTAL-COSTS> 45
<OTHER-EXPENSES> 51
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> (9)
<INCOME-TAX> (3)
<INCOME-CONTINUING> (6)
<DISCONTINUED> 932
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 926
<EPS-PRIMARY> $2.18<F1>
<EPS-DILUTED> $2.18<F1>
<FN>
<F1>$2.18 excludes the gain on the split-off of the construction operations.
</FN>
</TABLE>
