<PAGE>
RULE NO. 424(b)(5)
REGISTRATION NO. 333-91899
REGISTRATION NO. 333-68887
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus supplement is not complete and may be +
+changed. We will deliver a final prospectus supplement and prospectus to +
+purchasers of these securities. This prospectus supplement and the +
+accompanying prospectus are not an offer to sell these securities nor are +
+they seeking an offer to buy these securities in any jurisdictions where the +
+offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED FEBRUARY 2, 2000
U.S. PROSPECTUS SUPPLEMENT
(To Prospectus Dated December 10, 1999)
[LOGO OF LEVEL(3)]
15,000,000 Shares
Level 3 Communications, Inc.
Common Stock
--------
We are selling 15,000,000 shares of our common stock. This prospectus
supplement relates to an offering of 12,000,000 shares in the United States. In
addition, 3,000,000 shares are being offered outside the United States in an
international offering. The U.S. and the international underwriters may, under
certain circumstances, purchase up to an additional 2,250,000 shares at the
initial price to the public less the underwriting discount.
Our common stock is quoted on the Nasdaq National Market under the symbol
"LVLT." The last reported sale price of our common stock on the Nasdaq National
Market on February 2, 2000 was $111.13 per share.
--------
Investing in our common stock involves certain risks. See "Risk Factors"
beginning on page S-8.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus supplement or the related prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
--------
<TABLE>
<CAPTION>
Per
Share Total
----- -----
<S> <C> <C>
Public Offering Price $ $
Underwriting Discount $ $
Proceeds to Level 3 (before expenses) $ $
</TABLE>
The underwriters are offering the shares subject to various conditions. The
underwriters expect to deliver the shares to purchasers on or about , 2000.
--------
Global Coordinator & Sole Book-Running Manager
Salomon Smith Barney
--------
Salomon Smith Barney Goldman, Sachs & Co.
J.P. Morgan & Co.
Morgan Stanley Dean Witter
Chase H&Q
Credit Suisse First Boston
Merrill Lynch & Co.
, 2000
<PAGE>
[ARTWORK APPEARING ON INSIDE FRONT COVER OF PROSPECTUS SUPPLEMENT]
<TABLE>
<CAPTION>
LEVEL 3 COMMUNICATIONS
- ----------------------------------------------------- -------------------------------------------------------------
OUR PROGRESS OUR SERVICES
- ----------------------------------------------------- -------------------------------------------------------------
<S> <C>
- - 27 U.S. markets served and London, Paris, - Transport Services
Amsterdam and Frankfurt
- Colocation
- - Launched initial services to customers
over a leased network - Internet Access
- - Completed facilities based local metropolitan - Managed Modem
networks in 22 U.S. markets and 3
European markets - (3)Voice(/SM*/)
- - Completed construction of 9,334 miles of North
American intercity network and 2,139 miles of
European intercity network
- - Secured approximately 3.4 million square feet of
space for Gateway facilities (/*/)Long distance only
- ----------------------------------------------------- -------------------------------------------------------------
</TABLE>
[LOGO OF LEVEL 3]
<TABLE>
<CAPTION>
- ----------------------------------------------------- -------------------------------------------------------------
OUR NETWORK* OUR STRATEGY
- ----------------------------------------------------- -------------------------------------------------------------
<S> <C>
- - An intercity network covering nearly - Become the low cost provider of communications
16,000 miles in North America services
- - Leased or owned local networks in 56 North - Combine latest generations of fiber
American markets and electronics
- - An intercity network covering approximately - Offer comprehensive range of communications
4,750 miles across Europe services
- - Leased or owned local networks in 21 - Provide significant colocation facilities
European and Pacific Rim markets
- Provide seamless interconnection to PSTN
- - Approximately 6.5 million square feet of
Gateway facilities in North America, Europe - Accelerate market roll-out
and the Pacific Rim
- Target web centric customers
- - Undersea capacity, including a 1.28 Tbps
transatlantic cable system and a 2.56 Tbps - Develop advanced business support systems
Northern Asia cable system initally
connecting Hong Kong to Tokyo - Leverage existing information services
capabilities
- Attract and motivate high quality
employees
(/*/) At completion
- ----------------------------------------------------- -------------------------------------------------------------
</TABLE>
<PAGE>
[ARTWORK APPEARING ON INSIDE FRONT COVER OF PROSPECTUS SUPPLEMENT]
LEVEL 3 GATEWAYS
We created the term Gateway site to describe the major communications hubs of
our network. Our gateways are advanced technical facilities which provide
colocation space for customers' equipment and facilities, link our networks to
other communications networks, and house our own network equipment. Each of our
Gateway facilities is served by redundant, fault tolerant connections to our
network.
<TABLE>
<CAPTION>
REPRESENTATIVE COLOCATION GATEWAY FACILITY
<S> <C>
Los Angeles [PICTURE OF TECHNICAL SPACE IN
Modem equipment is used for our Managed Modem LOS ANGELES GATEWAY FACILITY]
service. This equipment will also be used for
voice service.
London [PICTURE OF COLOCATION SPACE IN
Level 3's facilities have been designed to anticipate LONDON GATEWAY FACILITY]
and embrace the rapid pace of technological advances.
We have constructed our Gateway facilities to be
more readily upgradeable and capable of evolving as
technology changes and to meet customer demand.
Denver [PICTURE OF BACKUP POWER AND BATTERY
Level 3 Gateways provide climate-controlled SPACE IN DENVER GATEWAY FACILITY]
environments and managed power with UPS
battery and generator backup.
</TABLE>
<PAGE>
[ARTWORK APPEARING ON INSIDE FRONT COVER OF PROSPECTUS SUPPLEMENT]
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
MARKETS SERVED IN 2000
- -----------------------------------------------------------------------------------------------------
United States Europe Pacific Rim
- ----------------------------------------------------------------------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Atlanta El Paso* Manchester Orlando San Francisco Amsterdam Hong Kong*
Austin* Fort Worth* Memphis* Philadelphia San Jose Brussels* Tokyo*
Baltimore Houston Miami Phoenix* San Luis Obispo* Dusseldorf*
Boston Indianapolis* Nashville* Princeton* Seattle Frankfurt
Charlotte* Jacksonville* New Orleans* Providence St. Louis London
Chicago Jersey City New York City Raleigh* Stamford Munich*
Cincinnati Kansas City* Newark Richmond* Tampa Paris
Dallas Long Island Oakland* Sacramento* Washington, D.C.
Denver Los Angeles Omaha* San Antonio* Wilmington*
Detroit Louisville* Orange County* San Diego
</TABLE>
* Not in service; final market selection subject to change
[PICTURE OF TECHNICAL SPACE IN CHICAGO GATEWAY FACILITY]
Chicago
Level 3 Gateway facilities house
sophisticated optical and electronic
equipment, bringing together all of
Level 3's technology.
[DIAGRAM OF LAYOUT
OF TYPICAL
GATEWAY FACILITY
(NOT TO SCALE.)]
[PICTURE OF TECHNICAL SPACE IN WASHINGTON, D.C.
GATEWAY FACILITY]
Washington, D.C.
Network surveillance equipment in our
Gateways is used by our Network
Operations Center in Denver to monitor
the network 24 hours a day, 7 days a week.
[PICTURE OF COLOCATION SPACE IN NEW YORK
GATEWAY FACILITY]
New York
Level 3's Colocation facilities are among
the largest and most modern in the
industry, housing a state-of-the-art
network of telephone and web hosting
equipment. Colocation services from
Level 3 provide customers a quick,
cost-efficient way to launch their services.
<PAGE>
You should rely only on the information contained in or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We
have not authorized anyone to provide you with different information. We are
not making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information contained in or
incorporated by reference in this prospectus supplement or the accompanying
prospectus is accurate as of any date other than the date on the front of this
prospectus supplement.
------------
TABLE OF CONTENTS
Prospectus Supplement
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Supplement Summary............................................ S-1
Risk Factors............................................................. S-8
Information Regarding Forward-Looking Statements......................... S-16
Use of Proceeds.......................................................... S-17
Capitalization........................................................... S-17
Common Stock Price Range and Dividends................................... S-18
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... S-19
Industry Overview........................................................ S-35
Business................................................................. S-41
Management............................................................... S-62
Security Ownership of Certain Beneficial Owners and Management........... S-66
Certain Transactions and Relationships................................... S-68
Certain United States Federal Tax Consequences to Non-United States
Holders................................................................. S-71
Underwriting............................................................. S-73
Legal Matters............................................................ S-77
Experts.................................................................. S-77
Glossary of Terms........................................................ S-78
Index to Financial Statements............................................ F-1
Prospectus
About This Prospectus.................................................... 1
Where You Can Find More Information...................................... 1
Risk Factors............................................................. 1
The Company.............................................................. 2
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends......... 2
Application of Proceeds.................................................. 2
Description of Debt Securities........................................... 3
Description of Preferred Stock........................................... 12
Description of Depositary Shares......................................... 17
Description of Common Stock.............................................. 20
Description of Outstanding Capital Stock................................. 20
Plan of Distribution..................................................... 21
Legal Matters............................................................ 23
Experts.................................................................. 23
</TABLE>
(i)
<PAGE>
PROSPECTUS SUPPLEMENT SUMMARY
This summary contains a general summary of the information contained in this
prospectus supplement. It may not include all the information that is important
to you. You should read the entire prospectus supplement, our prospectus dated
December 10, 1999, and the documents incorporated by reference before making an
investment decision.
Level 3 Communications, Inc. was known as "Peter Kiewit Sons', Inc." prior
to the March 31, 1998 split-off of its construction and mining management
business from its other businesses. See "Business--History." See "Risk Factors"
for factors that you should consider before investing in shares of our common
stock and "Information Regarding Forward-Looking Statements" for information
relating to statements contained in this prospectus supplement that are not
historical facts. Capitalized terms used but not defined in this prospectus
supplement have the meaning given to them in "Glossary of Terms."
Level 3
We engage in the communications, information services and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, we announced a business plan to
increase substantially our communications and information services business and
to expand the range of services we offer. This plan is referred to in this
prospectus supplement as the "Business Plan." We are implementing the Business
Plan by building an advanced, international, facilities based communications
network based on Internet Protocol technology.
As our Business Plan is implemented, our network will combine both local and
long distance networks and connect customers end-to-end across North America
and in Europe and the Pacific Rim. Over the next two to three years, our
network is expected to encompass:
. an intercity network covering nearly 16,000 miles in North America;
. leased or owned local networks in 56 North American markets;
. an intercity network covering approximately 4,750 miles across Europe;
. leased or owned local networks in 21 European and Pacific Rim markets;
. approximately 6.5 million square feet of gateway facilities in North
America, Europe and the Pacific Rim; and
. undersea capacity, including a 1.28 Tbps transatlantic cable system and
a 2.56 Tbps Northern Asia cable system initially connecting Hong Kong to
Tokyo.
We expect to substantially complete the North American intercity portion of
our network by the end of the year 2000. In the interim, we have leased a
national network over which we began to offer services in the third quarter of
1998. We also expect to substantially complete the first two rings of our three
ring European intercity network by the end of the year 2000. In the interim, we
have also leased a European intercity network over which we began to offer
services in early 1999. As of December 31, 1999, we had secured 100% of the
rights-of-way required for our planned North American intercity network, had
completed construction of 9,334 route miles of this network and had
approximately 6,200 route miles under construction. Also, as of December 31,
1999, we had secured substantially all of the rights-of-way required for the
first two rings of our planned European intercity network, completed
construction of 2,139 route miles of this network and had approximately 3,400
route miles under construction.
In December 1999, we began carrying customer traffic between Dallas and
Houston on the first completed and lit segment of our North American intercity
network. We have operational facilities based local metropolitan networks in 22
U.S. markets and 3 European markets. We have secured approximately 3.4 million
S-1
<PAGE>
square feet of space for our gateway facilities, which vary in size and the
nature of services currently offered. We have completed the buildout of
approximately 1.3 million square feet of this space. Our gateways are advanced
technical facilities which provide colocation space for our customers'
equipment and facilities, link our networks to other communications networks
and house our own network equipment. We have gateway facilities in 25 U.S.
markets and in London, Paris, Amsterdam and Frankfurt. We have announced the
development and construction of a 1.28 Tbps transatlantic undersea cable
system, as well as the development and construction of a 2.56 Tbps Northern
Asia undersea cable system initially connecting Hong Kong to Tokyo.
We believe that, as technology advances, a comprehensive range of both
consumer and business communications services will be provided over networks,
such as ours, utilizing Internet Protocol technology. These services will
include traditional voice services, as well as other data services such as
Internet access. We believe this shift has begun, and over time should
accelerate, since Internet Protocol networks offer:
. more efficient use of network capacity than the traditional public
switched telephone networks;
. an open protocol which allows for market driven development of new uses
and applications;
. the prospect of technological advances that will address problems
currently associated with Internet Protocol based applications that use
the public Internet; and
. an open architecture that enables new competition among suppliers and
should ultimately lead to lower network costs.
Level 3's Strategy
Key elements of our strategy include:
. Become the Low Cost Provider of Communications Services. Our network is
designed to provide high quality communications services at a lower cost
by taking advantage of efficiencies in new technologies such as packet-
switching, using open, non-proprietary interfaces in the network design
and by having an upgradable network that can more readily incorporate
future technological improvements.
. Combine Latest Generations of Fiber and Electronics. In order to achieve
unit cost reductions for transmission capacity, we have designed our
network with multiple conduits to deploy successive generations of fiber
to exploit improvements in transmission electronics. Optimizing
transmission electronics to exploit specific generations of fiber optic
technology currently provides transmission capacity on the new fiber
more cost effectively than deploying new electronics on previous
generations of fiber.
. Offer a Comprehensive Range of Communications Services. We provide a
comprehensive range of communications services over our network,
including private line, (3)VoiceSM long distance services, colocation,
Internet access and managed modem. We expect to begin commercial testing
of some features associated with local voice services during the first
quarter of 2000. We are also offering dark fiber and conduits along our
local metropolitan networks and intercity networks on a long-term lease
basis.
. Provide Significant Colocation Facilities. We have been experiencing
higher demand for our colocation services from our web centric customers
than we anticipated in preparing our Business Plan. We believe that
providing colocation services on our network attracts web centric
customers by allowing us to offer those customers reduced bandwidth
costs, rapid provisioning of additional bandwidth, interconnection with
other third-party networks and improved network performance. Therefore,
we believe that controlling significant colocation facilities in our
gateways provides us with a competitive advantage. In addition, having
significant colocation facilities in a gateway allows the intra-facility
exchange of traffic amongst a large number of customers to occur at a
substantially lower cost than would be the case for traffic transported
to other locations.
S-2
<PAGE>
As of December 31, 1999, we had secured approximately 3.4 million square
feet of space for our gateway facilities and had completed the buildout of
approximately 1.3 million square feet of this space. We believe we
currently have more colocation space than any of our competitors. In
January 2000, we announced an expansion of our Business Plan to increase
significantly the aggregate amount of our global gateway facilities to 6.5
million square feet over the next two to three years.
. Provide Seamless Interconnection to the Public Switched Telephone Network.
In December 1999 we began to offer (3)Voice long distance service to allow
the seamless interconnection of Internet Protocol networks with the public
switched telephone network for long distance voice transmissions. Seamless
interconnection allows customers to use our Internet Protocol based
services without modifying existing telephone equipment or dialing
procedures (that is, without the need to dial access codes or follow other
similar special procedures). Our managed modem service uses similar
softswitch technology to seamlessly interconnect to the public switched
telephone network.
. Accelerate Market Roll-out. To support the launch of our services and
develop a customer base in advance of completing our network build, we
offer services over a combination of leased local and intercity
facilities. Over time, these leased networks will be displaced by the
networks that we are constructing.
. Target Web Centric Customers. To increase revenue-producing traffic on
our network more rapidly, we are using a direct sales force focused on
communications intensive and web centric businesses. These businesses
include ISPs, application service providers, content providers, systems
integrators, next generation carriers, web-hosting companies, streaming
media companies and Internet Protocol based storage providers. Providing
continually declining bandwidth costs to these companies is at the core
of our market enabling strategy because bandwidth generally represents a
substantial portion of web centric businesses' costs.
. Develop Advanced Business Support Systems. We are developing a
substantial, scalable and web-enabled business support system
infrastructure specifically designed to enable us to offer services
efficiently to targeted customers. We believe that this system will
reduce our operating costs, give our customers direct control over some
of the services they buy from us and allow us to grow rapidly without
redesigning the architecture of the business support system.
. Leverage Existing Information Services Capabilities. We are expanding
our 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 Internet Protocol networks and web browser access.
. Attract and Motivate High Quality Employees. We have developed programs
designed to attract and retain employees with the technical skills
necessary to implement the Business Plan. The programs include our
Shareworks stock purchase plan and our Outperform Stock Option program.
Competitive Advantages
We believe that we have the following competitive advantages that, together
with our strategy, will assist us in implementing the Business Plan:
. Experienced Management Team. We have assembled a management team that we
believe is well suited to implement the Business Plan. Most of our
senior management has been involved in leading the development and
marketing of telecommunications products and in designing, constructing
and managing intercity, metropolitan and international networks.
. A More Readily Upgradable Network Infrastructure. Our network design
strategy takes advantage of recent innovations, incorporating many
features that are not present in older communications networks, and
provides us flexibility to take advantage of future developments and
innovations. We have designed the transmission network to optimize all
aspects of fiber and electronics simultaneously
S-3
<PAGE>
as a system to deliver the lowest unit cost to our customers. As fiber
and transmission electronic technology changes, we expect to realize new
unit cost improvements by deploying the latest fiber and transmission
electronics technology in available empty or spare conduit in our
multiple conduit network. We believe that the spare conduit design of
our network will enable us to effect this deployment more quickly and at
lower cost than other carriers.
. Integrated End-to-End Network Platform with Significant Colocation
Facilities. We believe that the integration of our local and intercity
networks with our colocation facilities will expand the scope and reach
of our on-net customer coverage and facilitate the uniform deployment of
technological innovations as we manage our future upgrade paths.
. Systems Integration Capabilities. We believe that our ability to offer
computer outsourcing and systems integration services, particularly
services relating to allowing a customer's legacy systems to be accessed
with web browsers, will provide additional opportunities for selling our
products and services.
Our principal executive offices are located at 1025 Eldorado Boulevard,
Broomfield, Colorado 80021 and our telephone number is (720) 888-1000.
S-4
<PAGE>
The Offering
The following information assumes no exercise of the underwriters' over-
allotment option. See "Underwriting." The number of shares outstanding excludes
an aggregate of 70,000,000 shares of common stock reserved for issuance under
our Outperform Stock Option program which includes our Shareworks stock
purchase plan. The number of shares outstanding also excludes an aggregate of
12,620,455 shares of common stock currently issuable upon conversion of our 6%
convertible subordinated notes due 2009 and an aggregate of shares of
common stock that would be issuable upon conversion of the convertible
subordinated notes that we are concurrently offering.
Common Stock:
U.S. offering.................. 12,000,000 shares
International offering......... 3,000,000 shares
Total....................... 15,000,000 shares
Common stock to be outstanding
after this offering............
356,772,589 shares
Use of proceeds................. Our net proceeds (estimated to be $ ) will
be used for working capital, capital
expenditures, acquisitions and other general
corporate purposes in connection with the
implementation of our Business Plan.
Nasdaq National Market symbol... "LVLT"
Risk factors.................... Investing in shares of our common stock
involves a high degree of risk. See "Risk
Factors" beginning on page S-8 of this
prospectus supplement for a discussion of
certain matters that you should consider
before investing in shares of the common
stock.
Other Offerings
We are also offering senior notes and senior discount notes, which will
generate aggregate gross proceeds of $1,000,000,000, (Euro)400,000,000
(approximately $391,000,000) of senior notes and $500,000,000 of convertible
subordinated notes, each in a separate offering pursuant to a separate
prospectus supplement or offering memorandum. No offering is conditioned on the
closing of any other. We may not complete any of the other offerings. In
addition, the size of each of our other offerings is subject to change. This
prospectus supplement relates only to the offering of common stock and not to
the other offerings. The senior notes and senior discount notes and the euro-
denominated senior notes will not be registered under the Securities Act of
1933 and may not be offered or sold in the United States absent registration or
an applicable exemption from registration requirements.
S-5
<PAGE>
Summary Financial Data
The summary financial data presented below as of and for the fiscal years
ended the last Saturday in December of 1995, 1996, 1997 and December 31, 1998
have been derived from Level 3's audited consolidated financial statements and
the notes related to those financial statements. The selected financial data
presented below as of and for the fiscal year ended December 31, 1999 have been
derived from Level 3's unaudited financial statements. In the opinion of
management, the unaudited financial statements have been prepared on the same
basis as the audited financial statements and include all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation
of the financial position and results of operations as of such dates and for
such periods. The following information should be read in conjunction with
Level 3's audited consolidated financial statements and the notes related to
those financial statements, which are included in this prospectus supplement.
Since the Business Plan represents a significant expansion of Level 3's
communications and information services business, Level 3 does not believe that
the following information serves as a meaningful indicator of Level 3's future
financial condition or results of operations. Level 3 expects to incur
substantial net operating losses for the foreseeable future, and Level 3 may
not be able to achieve or sustain operating profitability in the future.
<TABLE>
<CAPTION>
Fiscal Year Ended (1)
-----------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
( in millions)
<S> <C> <C> <C> <C> <C>
Results of Operations:
Revenue.......................... $ 515 $ 392 $ 332 $ 652 $ 580
Income (loss) from continuing
operations(2)................... (487) (128) 83 104 126
Net earnings (loss)(3)........... (487) 804 248 221 244
Financial Position:
Total assets..................... 8,904 5,525 2,779 3,066 2,945
Current portion of long-term
debt............................ 6 5 3 57 40
Long-term debt, less current
portion(4)...................... 3,989 2,641 137 320 361
Stockholders' equity(5).......... 3,405 2,165 2,230 1,819 1,607
</TABLE>
- --------
(1) In October 1993, Level 3 acquired 35% of the outstanding shares of C-TEC
Corporation, which shares entitled Level 3 to 57% of the available voting
rights of C-TEC Corporation. C-TEC Corporation is sometimes referred to in
this prospectus supplement as "C-TEC." At December 28, 1996, Level 3 owned
48% of the outstanding shares and 62% of the voting rights of C-TEC.
As a result of the restructuring of C-TEC in 1997, Level 3 owned less than
50% of the outstanding shares and voting rights of each of the three
entities into which C-TEC was divided, and therefore accounted for each
entity using the equity method beginning in 1997. Level 3 consolidated C-
TEC in its financial statements from 1995 to 1996.
The financial position and results of operations of the construction and
mining management businesses of Level 3 have been classified as
discontinued operations due to the March 31, 1998 split-off of Level 3's
construction and mining management businesses from its other businesses.
Level 3's construction and mining management businesses are referred to in
this prospectus supplement as the "Construction Group."
In 1995, Level 3 dividended its investment in its former subsidiary, MFS
Communications Company, Inc. to the holders of the Class D Stock. MFS
Communications Company, Inc. is sometimes referred to in this prospectus
supplement as "MFS." MFS' results of operations have been classified as a
single line item on the statement of operations for 1995.
Level 3 sold its energy segment to MidAmerican Energy Holdings Company
(formerly known as CalEnergy Company, Inc.) in 1998 and classified it as
discontinued operations within the financial statements. MidAmerican
Energy Holdings Company is sometimes referred to in this prospectus
supplement as "MidAmerican."
S-6
<PAGE>
(2) Level 3 incurred significant expenses in conjunction with the expansion of
its communications and information services businesses in 1998 and 1999.
During 1999, RCN Corporation, sometimes referred to in this prospectus
supplement as "RCN," issued stock in a public offering and for certain
transactions that diluted Level 3's ownership of RCN from 41% at December
31, 1998 to 35% at December 31, 1999. The increase in Level 3's
proportionate share of RCN's net assets as a result of these transactions
resulted in a pre-tax gain of $117 million for Level 3 in 1999. Level 3
recognized gains of $62 million in 1998 for RCN stock activity and $3
million in 1995 for MFS stock activity.
In 1998, Level 3 acquired XCOM Technologies, Inc. and its developing
telephone-to-Internet Protocol network bridge technology. XCOM
Technologies, Inc. is sometimes referred to in this prospectus supplement
as "XCOM." Level 3 recorded a $30 million nondeductible charge against
earnings for the write-off of in-process research and development acquired
in the transaction.
In 1998, Cable Michigan, Inc. was acquired by Avalon Cable of Michigan,
Inc. Level 3 received approximately $129 million for its shares of Cable
Michigan, Inc. in the acquisition and recognized a pre-tax gain of
approximately $90 million in 1998.
(3) In 1998, Level 3 recognized a gain of $608 million equal to the difference
between the carrying value of the Construction Group and its fair value.
No taxes were provided on this gain due to the tax-free nature of the
split-off.
Level 3 also recognized in 1998 an after-tax gain of $324 million on the
sale of its energy segment to MidAmerican.
(4) In 1998, Level 3 issued $2 billion of 9 1/8% senior notes due 2008 and
$834 million principal amount at maturity of 10 1/2% senior discount notes
due 2008. The issue price of the 10 1/2% senior discount notes was
approximately 60% of the principal amount at maturity. In 1999, Level 3
issued $823 million of 6% convertible subordinated notes due 2009 and
entered into a $1.375 billion senior secured credit facility of which $475
million was outstanding as of December 31, 1999.
(5) In March 1999, Level 3 received approximately $1.5 billion of net proceeds
from the sale of 28.75 million shares of its common stock.
S-7
<PAGE>
RISK FACTORS
Before you invest in shares of our common stock, you should carefully
consider the following risks.
We are dependent on our new Business Plan that relies on Internet Protocol
technology
The current status of our Business Plan makes evaluation of its risks and
rewards extremely difficult and speculative. The Business Plan depends upon a
shift in providing communications services over Internet Protocol based
networks instead of the traditional public-switched networks. Our strategy
assumes that the technology that we and others have developed solves the
problems currently associated with Internet Protocol based applications and
will scale for full deployment, and that others will continue to develop new
uses and applications for Internet Protocol based networks. The success of our
Business Plan depends on other assumptions as well, such as our ability to use
open, non-proprietary interfaces in our network software and hardware that
allow us to buy equipment in the future from multiple vendors. We must generate
substantial traffic volume at acceptable prices on our network in order to
realize the anticipated operating efficiencies and cost benefits of the
network.
Substantial operating losses are expected for the foreseeable future
The development of our Business Plan requires significant capital
expenditures. We expect to incur a large portion of these capital expenditures
before we receive any significant related revenues from our Business Plan.
Because of these capital expenditures and the related early operating expenses,
we expect substantial negative operating cash flow and net losses for the
foreseeable future. For 1999, we incurred a loss from continuing operations of
$487 million. We expect our operating losses for the foreseeable future to be
substantially higher. We may never establish a significant customer base for
our communications and information services business, and even if we do, we may
continue to sustain substantial negative operating cash flow and net losses as
a result of low prices or higher costs. In addition, we will incur
substantially higher selling, general and administrative expenses as we develop
our Business Plan.
Since our Business Plan is a significant expansion of our communications and
information services business, we believe that our historical financial results
will not provide investors with a meaningful indicator of our future financial
condition or results of operations.
A failure to finance our substantial capital requirements could adversely
affect our Business Plan
The implementation of our Business Plan and our ability to meet our
projected growth depends on our ability to secure substantial additional
financing. We estimate that the implementation of our Business Plan, as
currently contemplated, requires between $13 and $14 billion over the 10-year
period of the plan. However, the amount of additional financing we need could
be higher than we currently estimate. The implementation of our Business Plan
and our future financial results could be adversely affected if we are
unsuccessful in obtaining required financing through:
. raising debt or equity capital at the times we need on terms that we
consider acceptable;
. generating cash flow from our operations; and
. offering others fiber optic capacity on our network or access to our
conduits.
If we fail to obtain the required financing, we may be required to delay or
abandon some of our future expansion or spending plans. Our existing level of
debt and its terms may limit our ability to raise additional capital and
otherwise restrict our activities. Additional equity issuances would dilute
your ownership interest. In addition, if our operations do not produce positive
cash flow in sufficient amounts to pay our financing obligations, our future
financial results and our ability to implement our Business Plan will be
materially and adversely affected.
S-8
<PAGE>
Difficulties in constructing our network could increase its estimated cost and
delay its scheduled completion
The construction, operation and any upgrading of our network is a
significant undertaking. Administrative, technical, operational and other
problems that could arise may be more difficult to address and solve due to the
significant size and complexity of the planned network. We are also dependent
on timely performance by third-party suppliers and contractors. In addition,
important aspects of our network, such as voice capability, will rely on
technology that is in the development stage or that is largely commercially
unproven. This new technology also may not be compatible with existing
technology. Many of these factors and problems are beyond our control. As a
result, the entire network may not be completed as planned for the cost and in
the time frame that we currently estimate. We may be materially adversely
affected as a result of any significant increase in the estimated cost of the
network or any significant delay in its anticipated completion.
After its initial completion, future expansions and adaptations of our
network's electronic and software components may be necessary in order to
respond to:
. a growing number of customers;
. increased demands by our customers to transmit larger amounts of data;
. changes in our customers' service requirements; and
. technological advances by our competitors.
Any expansion or adaptation of our network will require substantial
additional financial, operational and managerial resources. If we are unable to
expand or adapt our network to respond to these developments on a timely basis
and at a commercially reasonable cost, then our business will be materially
adversely affected.
Our business could be materially affected by problems arising from the
commercial deployment of our voice technology for Internet Protocol networks
We and others have developed technology that we believe will avoid the need
for customers on a private Internet Protocol based network to dial access codes
or follow other special procedures to initiate a voice call. We began to
commercially deploy this technology for long distance voice service in December
1999 and problems with it may be discovered as it continues to be deployed. Our
efforts to commercially deploy this technology in a timely manner and at an
acceptable cost may not be successful, and such a failure could have a material
adverse effect on us. We are currently testing some features associated with
local voice service such as caller ID, voicemail and call forwarding. To date,
Internet Protocol voice telephony using the public Internet has had significant
problems with quality, latency, reliability and security. Until we more fully
commercially deploy our voice telephony services, we cannot predict whether our
plans for solving these problems will work.
The commercial deployment of our voice telephony services also requires that
we develop related business support systems. Our failure to develop these
business support systems could have an adverse effect on the commercial
deployment of these services.
Our Business Plan requires the development of effective business support
systems to implement customer orders and to provide and bill for services
Our Business Plan depends on our ability to develop effective business
support systems. This is a complicated undertaking requiring significant
resources and expertise and support from third-party vendors. Business support
systems are needed for:
. implementing customer orders for services;
. provisioning, installing and delivering these services; and
. monthly billing for these services.
S-9
<PAGE>
Since our Business Plan provides for rapid growth in the number and volume
of products and services we offer, we need to develop these business support
systems on a schedule sufficient to meet our proposed service rollout dates. In
addition, we will require these business support systems to expand and adapt
with our rapid growth. The failure to develop effective business support
systems could have a material adverse effect on our ability to implement our
Business Plan.
We may be unable to hire and retain sufficient qualified personnel; the loss of
any of our key executive officers could adversely affect us
We believe that our future success will depend in large part on our ability
to attract and retain highly skilled, knowledgeable, sophisticated and
qualified managerial, professional and technical personnel. To implement our
Business Plan, we need to have a substantial number of additional employees. We
have experienced significant competition in attracting and retaining personnel
who possess the skills that we are seeking. As a result of this significant
competition, we may experience a shortage of qualified personnel. Our
businesses are managed by a small number of key executive officers,
particularly James Q. Crowe, Chief Executive Officer, R. Douglas Bradbury,
Chief Financial Officer, Kevin J. O'Hara, Chief Operating Officer and Colin
V.K. Williams, Executive Vice President. The loss of any of these key executive
officers could have a material adverse effect on us.
Inability to manage effectively our planned rapid expansion could adversely
affect our operations
Our Business Plan contemplates rapid expansion of our business for the
foreseeable future. This growth will increase our operating complexity and
require that we, among other things, rapidly:
. expand our employee base with highly skilled personnel;
. develop, introduce and market new products and services;
. integrate any acquired operations and joint ventures;
. secure space suitable for colocation facilities;
. develop financial and management controls and systems; and
. control expenses related to our Business Plan.
The significant size and complexity of our planned network and planned rate
of expansion will make it more difficult to satisfy these requirements. Our
failure to satisfy any of these requirements, or otherwise manage our growth
effectively, could have a material adverse effect on us.
If we were to make strategic investments, acquisitions or joint ventures,
our resources and management time could be diverted and we may be unable to
integrate them successfully with our existing network and services.
We must obtain and maintain permits and rights-of-way to develop our network
The operation of our networks requires that we obtain many local franchises
and other permits. We also must obtain rights to use underground conduit and
aerial pole space and other rights-of-way and fiber capacity. The process of
obtaining these franchises, permits and rights is time consuming and
burdensome. If we are unable, on acceptable terms and on a timely basis, to
obtain and maintain the franchises, permits and rights needed to implement our
Business Plan, the buildout of our network could be materially adversely
affected. In addition, the cancellation or non-renewal of the franchises,
permits or rights we do obtain, or the loss of the rights-of-way we have
obtained, could materially adversely affect us.
Termination of relationships with key suppliers could cause delay and costs
Until we complete the company-owned portion of our network, we will lease
substantially all of our intercity communications capacity in North America,
Europe and possibly elsewhere. As a result, we will be dependent on the
providers of this capacity. In addition, we intend to lease a significant
amount of capacity
S-10
<PAGE>
from local exchange carriers to connect our customers to our gateway sites. We
are also dependent on third-party suppliers for substantial amounts of fiber,
conduit, computers, software, switches/routers and related components that we
will assemble and integrate into our network. If any of these relationships are
terminated or a supplier fails to provide reliable services or equipment and we
are unable to reach suitable alternative arrangements quickly, we may
experience significant delays and additional costs. If that happens, we could
be materially adversely affected.
Our industry is highly competitive with participants that have greater
resources and existing customers
The communications and information services industry is highly competitive.
Many of our existing and potential competitors have financial, personnel,
marketing and other resources significantly greater than ours. Many of these
competitors have the added competitive advantage of an existing customer base.
In addition, significant new competitors could arise as a result of:
. increased consolidation and strategic alliances in the industry
resulting from recent Congressional and FCC actions;
. allowing foreign carriers to compete in the U.S. market;
. further technological advances; and
. further deregulation and other regulatory initiatives.
If we are unable to compete successfully, our business could be materially
adversely affected.
Rapid technological changes can lead to further competition
The communications and information services industry is subject to rapid and
significant changes in technology. In addition, the introduction of new
products or technologies may reduce the cost or increase the supply of certain
services similar to those that we plan to provide. As a result, our most
significant competitors in the future may be new entrants to the communications
and information services industry. These new entrants may not be burdened by an
installed base of outdated equipment. Technological changes and the resulting
competition on our operations could have a material adverse effect on us.
Increased industry capacity and other factors could lead to lower prices for
our products and services
AT&T, MCI WorldCom, Sprint and Qwest currently own nationwide long distance
fiber optic networks. MCI WorldCom has entered into an agreement to acquire
Sprint. In Europe, GTS, MCI WorldCom and Viatel currently own intercity
networks. Qwest's network, as well as the intercity networks being deployed by
others, including Broadwing and Williams Communications in the United States
and KPNQwest, i-21 and Global Crossing in Europe, use advanced technology
similar to that of our network. In addition, there are numerous local and
regional networks. Increased capacity may cause significant decreases in the
prices for services. Prices may also decline due to capacity increases
resulting from technological advances and strategic alliances, such as long
distance capacity purchasing alliances among regional Bell operating companies.
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 may not continue at the
same rate. Increased competition has already led to a decline in rates charged
for various telecommunications services.
We are subject to significant regulation that could change in an adverse manner
Communications services are subject to significant regulation at the
federal, state, local and international levels. These regulations affect us and
our existing and potential competitors. Delays in receiving required regulatory
approvals, completing interconnection agreements with incumbent local exchange
carriers or the enactment of new and adverse regulations or regulatory
requirements may have a material adverse effect on us. In addition, future
legislative, judicial, and regulatory agency actions could have a material
adverse effect on us.
S-11
<PAGE>
Recent federal legislation provides for a significant deregulation of the
U.S. telecommunications industry, including the local exchange, long distance
and cable television industries. This legislation remains subject to judicial
review and additional FCC rulemaking. As a result, we can not predict the
legislation's effect on our future operations. Many regulatory actions are
under way or are being contemplated by federal and state authorities regarding
important items. These actions could have a material adverse effect on us.
Canadian law currently does not permit us to offer services in Canada
Ownership of facilities that originate or terminate traffic in Canada is
currently limited to Canadian carriers. This restriction will block our entry
into the Canadian market unless appropriate arrangements can be made to address
it.
Potential regulation of Internet service providers could adversely affect our
operations
The FCC has to date treated Internet service providers as enhanced service
providers. Enhanced service providers are currently exempt from federal and
state regulations governing common carriers, including the obligation to pay
access charges and contribute to the universal service fund. The FCC is
currently examining the status of Internet service providers and the services
they provide. If the FCC were to determine that Internet service providers, or
the services they provide, are subject to FCC regulation, including the payment
of access charges and contribution to the universal service funds, it could
have a material adverse effect on us.
The FCC has also been considering whether local carriers are obligated to
pay compensation to each other for the transport and termination of calls to
Internet service providers when a local call is placed from an end user of one
carrier to an Internet service provider served by a competing local exchange
carrier. Recently, the FCC determined that it had no rule addressing inter-
carrier compensation for these calls. In the absence of a federal rule, state
commissions may elect not to require payment of reciprocal compensation for
these calls. The FCC also released for comment alternative federal rules to
govern compensation for these calls in the future. If state commissions, the
FCC or the courts determine that inter-carrier compensation does not apply,
carriers, including us, may be unable to recover their costs or will be
compensated at a significantly lower rate and may be required to refund
compensation previously paid.
Network failure or delays and errors in transmissions expose us to potential
liability
Our network will use a collection of communications equipment, software,
operating protocols and proprietary applications for the high speed
transportation of large quantities of data among multiple locations. Given the
complexity of our proposed network, it may be possible that data will be lost
or distorted. Delays in data delivery may cause significant losses to a
customer using our network. Our network may also contain undetected design
faults and software bugs that, despite our testing, may be discovered only
after the network has been installed and is in use. The failure of any
equipment or facility on the network could result in the interruption of
customer service until we effect necessary repairs or install replacement
equipment. Network failures, delays and errors could also result from natural
disasters, power losses, security breaches and computer viruses. These
failures, faults or errors could cause delays, service interruptions, expose us
to customer liability or require expensive modifications that could have a
material adverse effect on our business.
Intellectual property and proprietary rights of others could prevent us from
using necessary technology to provide Internet Protocol voice services
While we do not know of any technologies that are patented by others that we
believe are necessary for us to provide Internet Protocol voice services, this
necessary technology may in fact be patented by other parties either now or in
the future. If this technology were held under patent by another person, we
would have to negotiate a license for the use of that technology. We may not be
able to negotiate such a license at a price that is acceptable to us. The
existence of such a patent, or our inability to negotiate a license for any
such technology on acceptable terms, could force us to cease using the
technology and offering products and services incorporating the technology.
S-12
<PAGE>
PKS Systems Integration LLC may have liability from its Year 2000 customer
projects
PKS Information Services, Inc. derived a substantial portion of its revenue
from projects that its subsidiary, PKS Systems Integration LLC, or PKSSI,
conducted involving Year 2000 assessment and renovation services. These
activities of PKSSI expose us to potential risks that may include problems with
services provided by PKSSI to its customers and the potential for claims
arising under PKSSI's customer contracts. PKSSI's attempts to contractually
limit its exposure to liability for Year 2000 compliance issues may not be
effective. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000--December 31, 1999."
Foreign currency exchange rate fluctuations or repatriation could result in
losses
Our international expansion will cause our results of operations and the
value of our assets to be affected by the exchange rates between the U.S.
dollar and the currencies of the additional countries in which we have
operations and assets. In some of these countries, prices of our products and
services will be denominated in a currency other than the U.S. dollar. As a
result, we may experience economic losses solely as a result of foreign
currency exchange rate fluctuations, including a foreign currency's devaluation
against the U.S. dollar. We may also in the future acquire interests in
companies that operate in countries where the removal or conversion of currency
is restricted. In addition, similar restrictions could be imposed in countries
where we conduct business after we begin our operations.
Environmental liabilities from our historical operations could be material
Our operations and properties are subject to a wide variety of laws and
regulations relating to environmental protection, human health and safety.
These laws and regulations include those concerning the use and management of
hazardous and non-hazardous substances and wastes. We have made and will
continue to have to make significant expenditures relating to our environmental
compliance obligations. We may not at all times be in compliance with all these
requirements.
In connection with certain historical operations, we are a party to, or
otherwise involved in, legal proceedings under state and federal law involving
investigation and remediation activities at approximately 110 contaminated
properties. We could be held liable, jointly and severally, and without regard
to our own fault, for such investigation and remediation. The discovery of
additional environmental liabilities related to our historical operations or
changes in existing environmental requirements could have a material adverse
effect on us.
Significant future declines in cash flow from coal operations
Approximately 40% of our net revenues for 1999 were attributable to our coal
mining operations. The level of cash flows generated in recent periods by our
coal operations will not continue after the year 2000. These cash flow levels
will decrease because the delivery requirements under our current long-term
contracts decline significantly after that date. Moreover, without those
contracts, our coal mining operations would not be able to operate profitably
by selling their production on the spot markets. A substantial majority of our
coal mining revenues are provided by three customer contracts.
Potential liabilities and claims arising from our coal operations could be
significant
Our coal operations are subject to extensive laws and regulations that
impose stringent operational, maintenance, financial assurance, environmental
compliance, reclamation, restoration and closure requirements. These
requirements include those 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. We may not at all times be
in compliance with all of these requirements. Liabilities or claims associated
with this non-compliance could require us to incur material costs or suspend
production. Mine reclamation costs that exceed our reserves for these matters
also could require us to incur material costs.
S-13
<PAGE>
Anti-takeover provisions could limit our share price and delay a change of
management
Our certificate of incorporation and by-laws contain provisions that could
make it more difficult or even prevent a third party from acquiring our company
without the approval of our incumbent board of directors. These provisions,
among other things:
. divide our board of directors into three classes, with members of each
class to be elected in staggered three-year terms;
. prohibit stockholder action by written consent in place of a meeting;
. limit the right of stockholders to call special meetings of
stockholders;
. limit the right of stockholders to present proposals or nominate
directors for election at annual meetings of stockholders; and
. authorize our board of directors to issue preferred stock in one or more
series without any action on the part of stockholders.
If there is a change of control of Level 3, we may be required under the
provisions of our indentures and senior secured credit facility to repurchase
or repay the debt outstanding under those agreements.
These provisions could limit the price that investors might be willing to
pay in the future for shares of our common stock and significantly impede the
ability of the holders of our common stock to change management. In addition,
we have adopted a poison pill rights plan, which has anti-takeover effects. Our
rights plan, if triggered, will cause substantial dilution to a person or group
that attempts to acquire our company on terms not approved by our board of
directors. Provisions and agreements that inhibit or discourage takeover
attempts could reduce the market value of our common stock.
Sales of a large number of shares by Level 3 or by stockholders could depress
our stock price
The market price of our common stock could drop as a result of sales of a
large number of our shares in the public market after the offering. The
perception that sales may occur could have the same results. We will be subject
to a 90-day black-out period following the date of this prospectus supplement.
During this black-out period, we are not allowed to issue additional common
stock or securities convertible into common stock except in certain
circumstances or unless Salomon Smith Barney consents. One exception allows us
to issue additional stock in connection with acquisitions. A second exception
applies if we are included in a major market index.
Our officers and directors will not be subject to any lock-up provision.
Additional shares are issuable under our benefit program depending on the
extent to which, if any, our stock outperforms the S&P 500 by either rising at
a higher rate or falling at a lower rate. The number of such shares that would
be issued is based on a multiplier related to how much our stock outperforms
the S&P 500.
The trading value of our common stock may fluctuate significantly
Since our common stock has been publicly traded, its market price has
fluctuated significantly and may continue to do so in the future. Significant
fluctuations in the market price of our common stock may occur in response to
various factors and events, including, among other things:
. the depth and liquidity of the trading market for our common stock;
. quarterly variations in actual or anticipated operating results;
. changes in estimates by securities analysts;
. market conditions in the communications and information services
industry;
S-14
<PAGE>
. announcements and performance by competitors;
. regulatory actions; and
. general economic conditions.
The terms of our debt agreements restrict us from making payments with respect
to our common stock
We intend to retain future earnings for use in our business, and we do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. In addition, our indentures and senior secured credit facility contain
limitations on our ability to declare and pay cash dividends.
Certain foreign holders may be subject to adverse U.S. federal income tax
consequences
We may be or may become a "United States real property holding corporation,"
or a USRPHC, for U.S. federal income tax purposes. Generally, if we have been,
are or become a USRPHC and our common stock is considered to be "regularly
traded" under applicable U.S. Treasury Regulations, then a Non-U.S. Holder (as
defined in "Certain United States Federal Tax Consequences to Non-United States
Holders") that owns or has owned, actually or constructively, at any time
during the shorter of the holder's holding period and the five year period
ending on the date of disposition, more than 5% of the total fair market value
of the common stock outstanding during that period may be subject to adverse
U.S. federal income tax consequences upon the disposition of the common stock.
See "Certain United States Federal Tax Consequences to Non-United States
Holders--Sale of Common Stock."
S-15
<PAGE>
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus supplement contains or incorporates by reference forward-
looking statements. These forward-looking statements include, among others,
statements concerning:
. the Business Plan, its advantages and our strategy for implementing the
Business Plan;
. anticipated growth of the communications and information services
industry;
. plans to devote significant management time and capital resources to our
business;
. expectations as to our future revenues, margins, expenses and capital
requirements;
. anticipated dates on which we will begin providing certain services or
reach specific milestones in the Business Plan; and
. other statements of expectations, beliefs, future plans and strategies,
anticipated developments and other matters that are not historical
facts.
You should be aware that these forward-looking statements are subject to
risks and uncertainties, including financial, regulatory, environmental,
industry growth and trend projections, that could cause actual events or
results to differ materially from those expressed or implied by the statements.
The most important factors that could prevent us from achieving our stated
goals include, but are not limited to, our failure to:
. achieve and sustain profitability based on the creation and
implementation of our advanced, international, facilities based
communications network based on Internet Protocol technology;
. overcome significant early operating losses;
. produce sufficient capital to fund the Business Plan;
. develop financial and management controls, as well as additional
controls of operating expenses as well as other costs;
. attract and retain qualified management and other personnel;
. install on a timely basis the switches/routers, fiber optic cable and
associated electronics required for successful implementation of the
Business Plan;
. successfully complete commercial testing of our softswitch technology
for voice transmission services;
. negotiate new and maintain existing peering agreements; and
. develop and implement effective business support systems for processing
customer orders and provisioning.
For a discussion of certain of these factors, see "Risk Factors."
S-16
<PAGE>
USE OF PROCEEDS
Our net proceeds from this offering are estimated to be $ , or $ if the
underwriters' over-allotment option is exercised in full. Our net proceeds
from this offering and the other offerings will be used for working capital,
capital expenditures, acquisitions and other general corporate purposes in
connection with the implementation of our Business Plan. Although we evaluate
potential acquisitions from time to time, we currently have no agreement or
understanding with any person to effect any material acquisition.
Pending this utilization, we intend to invest the net proceeds of this
offering in short-term investments.
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of December 31, 1999 and that capitalization as adjusted to give
effect to the net proceeds from this offering, assuming no exercise of the
underwriters' over-allotment option and as further adjusted to give effect to
the net proceeds from the other offerings. These further adjustments assume
that all the other offerings are completed for the amounts indicated below.
The table also assumes the conversion of the euro-denominated senior notes at
an exchange rate of euros per dollar, the spot trading rate of the euro at
the end of the London business day on , 2000.
<TABLE>
<CAPTION>
December 31, 1999
-----------------------------
As
Further
Adjusted
As Adjusted for the
for this Other
Actual Offering Offerings
------ ----------- ---------
(dollars in millions)
<S> <C> <C> <C>
Cash and marketable securities................... $3,446 $ $
====== === ===
Current portion of long-term debt................ $ 6 $ $
====== === ===
Long-term debt, less current portion............. $3,989 $ $
Senior Notes and Senior Discount Notes........... -- --
Euro-denominated Senior Notes.................... -- --
Convertible Subordinated Notes................... -- --
------ --- ---
Total long-term debt, less current portion..... 3,989
Stockholders' equity
Preferred Stock, $.01 par value; authorized
10,000,000 shares; no shares outstanding,
actual, as adjusted and as further adjusted... -- -- --
Common Stock, $.01 par value; authorized
1,500,000,000 shares; 341,396,727 shares
outstanding, actual and shares
outstanding as adjusted and as further
adjusted...................................... 3
Additional paid-in capital..................... 2,501
Accumulated other comprehensive loss........... (5)
Retained earnings.............................. 906
------ --- ---
Total stockholders' equity................... 3,405
------ --- ---
Total capitalization............................. $7,394 $ $
====== === ===
</TABLE>
We are also offering senior notes and senior discount notes which will
generate aggregate gross proceeds of $1,000,000,000, (Euro)400,000,000
(approximately $391,000,000) of senior notes and $500,000,000 of convertible
subordinated notes, each in a separate offering pursuant to a separate
prospectus supplement or offering memorandum. No offering is conditioned on
the closing of any other. We may not complete any of the other offerings. In
addition, the size of each of our other offerings is subject to change. This
prospectus supplement relates only to the offering of common stock and not to
the other offerings. The senior notes and senior discount notes and the euro-
denominated senior notes will not be registered under the Securities Act of
1933 and may not be offered or sold in the United States absent registration
or an applicable exemption from registration requirements.
S-17
<PAGE>
COMMON STOCK PRICE RANGE AND DIVIDENDS
Our common stock is quoted on the Nasdaq National Market under the symbol
"LVLT." It began trading on the Nasdaq National Market on April 1, 1998, the
day following the split-off of the Construction Group from our other
businesses. The table below sets forth, for the calendar quarters indicated,
the high and low per share closing sale prices of our common stock as reported
by the Nasdaq National Market. The prices set forth in the table have been
adjusted to reflect the two-for-one split of our common stock effected as a
stock dividend in August 1998.
<TABLE>
<CAPTION>
High Low
Year Ended December 31, 1998 ------ ------
<S> <C> <C>
Second Quarter (from April 1, 1998)......................... $37.13 $24.00
Third Quarter............................................... 42.13 29.78
Fourth Quarter.............................................. 43.13 24.00
Year Ended December 31, 1999
First Quarter............................................... 72.81 39.75
Second Quarter.............................................. 93.06 60.06
Third Quarter .............................................. 65.50 46.88
Fourth Quarter.............................................. 84.56 51.19
Year Ended December 31, 2000
First Quarter (through February 2, 2000).................... 119.56 73.81
</TABLE>
On February 2, 2000, the closing price per share of our common stock was
$111.13. We urge you to obtain current market quotations of our common stock
before making any decision with respect to an investment in our common stock.
We intend to retain future earnings for use in our business, and we do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. In addition, our indentures and senior secured credit facility contain
limits on our ability to declare and pay cash dividends.
S-18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. For a
more detailed description of these risks, please see "Risk Factors" and
"Information Regarding Forward-Looking Statements."
Recent Developments
BusinessNet Ltd. Acquisition
On January 5, 1999, Level 3 acquired BusinessNet Ltd., a leading London-
based Internet service provider in a largely stock-for-stock transaction valued
at $12 million and accounted for as a purchase. After completion of certain
adjustments, the Company agreed to issue approximately 400,000 shares of common
stock and paid $1 million in cash in exchange for all of the issued and
outstanding shares of BusinessNet's capital stock. Of the approximately 400,000
shares Level 3 agreed to issue in connection with the acquisition,
approximately 150,000 shares of its common stock have been pledged to Level 3
to secure certain indemnification obligations of the former BusinessNet
stockholders. In October 1999, Level 3 released approximately 42,000 shares of
the pledged shares. The pledge of the remaining shares will terminate in July
2000 unless otherwise extended pursuant to the terms of the acquisition
agreement. Liabilities exceeded assets acquired, and goodwill of $16 million
was recognized from the transaction which is being amortized over five years.
Common Stock Offering
On March 9, 1999, the Company closed the offering of 28,750,000 shares of
its common stock through a public offering. The net proceeds from the offering
of approximately $1.5 billion, after underwriting discounts and offering
expenses, are being used for working capital, capital expenditures,
acquisitions and other general corporate purposes in connection with the
implementation of the Business Plan.
Increase in Authorized Shares Outstanding
On February 25, 1999, the Company's Board of Directors approved an increase
in the number of authorized shares of common stock from 500 million to 1
billion. On April 12, 1999, the Board of Directors approved a further increase
in the number of authorized shares of common stock by 500 million to 1.5
billion. The Company's stockholders approved the increase in authorized shares
at its 1999 Annual Meeting held on May 27, 1999.
Transatlantic Undersea Cable System
On April 23, 1999, Level 3 announced that it had contracted with Tyco
Submarine Systems Ltd. to design and build a transatlantic 1.28 Tbps undersea
cable system from Long Island, New York to North Cornwall, UK. The cable system
is expected to be in service by September 2000 and is expected to cost between
$600 to $800 million. The total cost will depend on how the cable is upgraded
over time. Level 3 has prefunded the purchase of significant amounts of
undersea capacity as part of the Business Plan, but may require additional
funding depending on the cable's ultimate structure, pre-construction sales and
ownership.
S-19
<PAGE>
European Network
Level 3 announced on April 29, 1999 that it had finalized contracts relating
to construction of Ring 1 of its European network in France, Belgium, the
Netherlands, Germany and the United Kingdom. Ring 1, which is approximately
1,800 miles, will connect Paris, Frankfurt, Amsterdam, Brussels and London. The
network is expected to be ready for service by September 2000. Ring 1 is part
of the approximately 4,750 mile intercity network. This European network will
be linked to the Level 3 North American intercity network by the Level 3
transatlantic 1.28 Tbps cable system currently under development, also expected
to be ready for service by September 2000.
On July 26, 1999, the Company announced two important developments of its
European network build with agreements with Eurotunnel and Alcatel. Eurotunnel
will install and supply Level 3 with multiple cross-Channel cables between the
United Kingdom and France through the high-security service tunnel. The first
of these cables will be completed by the end of the first quarter of 2000.
Subsequent cables will be installed to upgrade and expand the network as and
when required or when new fiber technology becomes available. Alcatel will
design, develop and install an undersea cable to link the Level 3 network
between the United Kingdom and Belgium. The cable system is already under
development and will be completed by the end of the first half of 2000.
COLT Cost Sharing Agreement
On May 4, 1999, Level 3 and COLT Telecom Group plc announced an agreement to
share costs for the construction of European networks. The agreement calls for
Level 3 to share construction costs of COLT's planned 1,600 mile intercity
German network linking Berlin, Cologne, Dusseldorf, Frankfurt, Hamburg, Munich
and Stuttgart. In return, COLT will share construction costs of Ring 1 of Level
3's planned European network.
Lucent Agreement
On June 23, 1999, the Company announced a minimum four year, $250 million
strategic agreement with Lucent Technologies to purchase Lucent systems,
including new software switches or "softswitches." The minimum purchase
commitment is subject to certain conditions and has the potential to grow to $1
billion over five years.
Under this nonexclusive agreement, Lucent will provide Level 3 its Lucent
Technologies Softswitch, a software switch for Internet Protocol networks that
is intended to combine the reliability and features that customers expect from
the public switched telephone network with the cost effectiveness and
flexibility of Internet Protocol technology. With the Lucent Softswitch, Level
3 expects to provide a full range of Internet Protocol based communications
services similar in quality and ease of use to services on traditional circuit
voice networks. In addition, the companies also agreed to collaborate on future
enhancements of softswitches and gateway products to support next-generation
broadband services for business and consumers that will combine high-quality
voice and video communications with Internet-style web data services.
6% Convertible Subordinated Notes
In September 1999, the Company closed the offering of $823 million aggregate
principal amount of its 6% convertible subordinated notes due 2009. The net
proceeds from the offering of approximately $798 million, after underwriting
discounts and offering expenses, are being used for working capital, capital
expenditures, acquisitions and other general corporate purposes in connection
with the implementation of the Business Plan.
Senior Secured Credit Facility
On September 30, 1999, the Company entered into a senior secured credit
facility in the aggregate principal amount of $1.375 billion. The facility is
comprised of a senior secured revolving credit facility in the
S-20
<PAGE>
amount of $650 million and a two-tranche senior secured term loan facility
aggregating $725 million. At December 31, 1999 the Company had $475 million in
outstanding aggregate borrowings under the two-tranche secured term loan
facility. The facility is sometimes referred to in this prospectus supplement
as the senior secured credit facility.
(3)Voice/SM/
During December 1999, Level 3 commercially launched (3)Voice, its Internet
Protocol long distance service, which utilizes softswitch technology. This long
distance service is currently available in 10 markets. The Company expects to
begin commercial testing of some features associated with local service, such
as caller ID, voice mail and call forwarding, during the first quarter of 2000.
Customers access the (3)Voice long distance service by using existing telephone
equipment and dialing procedures.
Northern Asia Undersea Cable System
On January 24, 2000, Level 3 announced its intention to develop and
construct a 2.56 Tbps Northern Asia undersea cable system initially connecting
Hong Kong and Tokyo. This connection is expected to be in service by the end of
the second quarter of 2001.
Expansion of Business Plan
On January 24, 2000, the Company announced the expansion of its business
plan to increase the amount of gateway space it intends to secure to
approximately 6.5 million square feet. Level 3 currently has secured
approximately 3.4 million square feet of gateway space. We have completed the
buildout of approximately 1.3 million square feet of this space.
Recent Accounting Developments
Effective July 1, 1999, the Financial Accounting Standards Board, or the
FASB, issued Interpretation No. 43, "Real Estate Sales, an interpretation of
FASB Statement No. 66." Certain sale and long-term right-to-use agreements of
dark fiber and capacity entered into after June 30, 1999 are required to be
accounted for in the same manner as sales of real estate with property
improvements or integral equipment. Failure to satisfy the requirements of the
Interpretation will result in the deferral of revenue recognition for these
contracts. The adoption of this Interpretation does not have a current effect
on the Company's cash flows. Accounting practice and guidance with respect to
the accounting treatment of these transactions is evolving. Any changes in the
accounting treatment could affect the way the Company accounts for revenue and
expenses associated with these agreements in the future.
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 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 it may not be able to achieve or sustain operating
profitability in the future.
Fourth Quarter Financial Highlights
Communications and Information Services Revenue. Communications and
information services revenue for the three months ended December 31, 1999 was
$121 million, a 188 percent increase over the $42 million of revenue for the
three months ended December 31, 1998. The year-over-year increase was a result
of
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<PAGE>
significant growth in the communications business. As of December 31, 1999, the
Company was offering communications services in 27 U.S. markets and four
European markets.
On October 21, 1999, Level 3 announced that it had reached an agreement with
Bell Atlantic Corporation that established new reciprocal compensation rates
between the two local carriers. Included in communications revenue for the
quarter was $16 million attributable to reciprocal compensation. This includes
revenue of $11 million from the settlement of all outstanding reciprocal
compensation billing issues through September 1999 together with payments for
billed minutes during the quarter.
Also included in communications revenue for the quarter was $26 million of
revenue from both intercity and local dark fiber contracts. Approximately 800
miles of intercity dark fiber were delivered to customers during the quarter,
along with portions of several metropolitan networks.
Other Revenue. Other revenue of $52 million for the fourth quarter included
$49 million from coal mining, a slight decrease from fourth quarter 1998 coal
mining revenue of $50 million. As previously disclosed, 1999 coal revenue was
approximately 10 percent less than 1998 coal annual revenue due to reduced
shipments under long-term coal contracts in 1999. Full year 1999 coal revenue
was $207 million versus $228 million in 1998.
Cost of Revenue. The cost of revenue for the fourth quarter 1999 was $117
million. This represents a 92 percent increase over the fourth quarter 1998
cost of revenue of $61 million. This increase was primarily due to the
continued expansion and acceleration of the Business Plan for the
communications business.
Depreciation and Amortization. Depreciation and amortization expenses for
the fourth quarter were $73 million, a 109 percent increase over the fourth
quarter 1998 depreciation and amortization expenses of $35 million. These
charges reflect the significant increase in capital spending for growth of the
communications business.
Selling, General and Administrative Expenses. Selling, general and
administrative (SG&A) expenses for the quarter were $168 million. This
represents a 44 percent increase over the fourth quarter 1998 SG&A expenses of
$117 million. The Company added over 300 employees to the communications
business during the quarter. The total number of all Level 3 employees at the
end of the quarter was approximately 3,850.
The Company recognized $40 million in stock based compensation expense
during the quarter. The majority of this expense is due to Level 3's Outperform
Stock Option program (OSO). Under this plan, OSOs are issued to all employees
quarterly, with the exercise price indexed to the performance of the Standard &
Poors (S&P) 500 Index. This program directly aligns management's and
stockholders' interests by basing stock option value on the Company's ability
to outperform the S&P 500. This is a non-cash expense, accounted for in
accordance with SFAS No. 123, "Accounting For Stock-Based Compensation."
Capital Expenditures. Capital expenditures for property, plant and equipment
were $1.3 billion for the quarter. The majority of the spending was for
construction of the U.S. and European intercity networks, certain local
networks in the U.S. and Europe, and the transatlantic cable network. Capital
expenditures for 1999 were $3.4 billion. This acceleration in spending is a
result of faster than expected completion of network construction.
Third Quarter 1999 vs. Third Quarter 1998
The following discussion should be read in conjunction with the Company's
consolidated condensed financial statements (including the notes thereto)
included elsewhere herein.
S-22
<PAGE>
Revenue. Revenue for the quarters ended September 30, is summarized as
follows (in millions):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Communications and Information Services......................... $ 69 $ 37
Coal Mining .................................................... 60 63
Other........................................................... 5 6
---- ----
$134 $106
==== ====
</TABLE>
Communications and information services revenue for the three months ended
September 30, 1999 increased 86% compared to the same period in 1998. New
products which the Company began offering in late 1998 and early 1999,
including private line, colocation and managed modem services, provided $36
million of revenue for the communications segment in 1999. In 1998,
communications revenue of $8 million was directly attributable to XCOM which
was acquired in April 1998. A significant portion of XCOM's revenue is
attributable to reciprocal compensation agreements with Bell Atlantic. These
agreements require the company originating a call to compensate the company
terminating the call. The Federal Communication Commission, the FCC, has been
considering whether local carriers are obligated to pay compensation to each
other for the transport and termination of calls to Internet service providers
when a local call is placed from an end-user of one carrier to an Internet
service provider served by the competing local exchange carrier. In 1999, the
FCC determined that it had no rule addressing inter-carrier compensation for
these calls. The FCC also released for comment alternative federal rules to
govern compensation for these calls in the future. If state commissions, the
FCC or the courts determine that inter-carrier compensation does not apply,
carriers, including the Company, may be unable to recover their costs or will
be compensated at a significantly lower rate and may be required to refund
amounts previously received. In May 1999, the Massachusetts Department of
Public Utilities ruled that Bell Atlantic was no longer required to pay the
established reciprocal compensation rates for certain services. As a result,
Level 3 elected, effective at the beginning of the second quarter of 1999, not
to recognize this revenue source until these uncertainties were resolved. Bell
Atlantic also notified the Company that it would escrow all amounts due the
Company under the reciprocal compensation agreements until the issue was
resolved. The Company reached a tentative agreement with Bell Atlantic in
October 1999. The agreement establishes new inter-carrier or reciprocal
compensation rates between the two carriers and assures that the Company will
be paid for the traffic it terminates from Bell Atlantic. As part of the
agreement, the Company and Bell Atlantic have also settled past disputes over
reciprocal compensation billing issues. The implementation of the new rate
structure and the reciprocal compensation billing settlements are contingent
upon certain conditions including approval by relevant regulatory authorities.
Revenue attributable to the Bell Atlantic settlement agreement will not be
recognized until the uncertainties related to the regulatory approvals have
been resolved.
Revenue for the computer outsourcing and systems integration businesses
increased 6% and 23% to $17 million and $16 million, respectively. The growth
for the computer outsourcing business is attributable to additional services
provided to existing customers while the increase in system integration revenue
is due to application outsourcing work performed for new clients.
Coal mining revenue decreased $3 million, or 5% in the third quarter of 1999
compared to the same period in 1998. This decrease is primarily due to the
expiration of a long-term coal contract in 1998. The expiration of these
contracts are expected to result in a 10% decline in coal revenues in 1999.
Partially offsetting this decline was an increase in shipments taken by
Commonwealth Edison Company. Commonwealth is obligated to purchase annually,
minimum amounts of coal; however, it is Commonwealth's option as to when the
coal will be purchased.
If current market conditions continue, the Company will experience a
significant decline in coal revenue and earnings beginning in 2001 as delivery
requirements under long-term contracts decline as additional long-term
contracts begin to expire.
Other revenue is primarily attributable to a privately owned toll road in
Southern California.
S-23
<PAGE>
Cost of Revenue. Cost of revenue increased 113% in 1999 to $100 million from
$47 million in 1998. This increase was primarily due to the continued expansion
of the communications and information services businesses. Cost of revenue for
the communications business is expected to increase substantially in the future
as the Company continues to increase the number of markets in which it offers
services and the products available in each of those markets. The cost of
revenue for the information services business was consistent with the
corresponding increase in revenue. The cost of revenue for the coal business,
as a percentage of revenue, increased approximately 2% due to the expiration of
the higher margin long-term contract in 1998.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased to $63 million in 1999 from $15 million in 1998. The commencement of
operations in 26 U.S. and 4 European markets and the completion of the initial
installation of 17 local networks in the second half of 1998 and 1999 resulted
in the higher depreciation expense in 1999. In addition, the amortization of
goodwill attributable to the acquisitions of GeoNet, BusinessNet and others
contributed to the higher depreciation and amortization expense in 1999.
Selling, General, and Administrative Expenses. Selling, general and
administrative expenses increased significantly in 1999 to $178 million from
$96 million in 1998 primarily due to the cost of activities associated with the
expanding communications business. The Company incurred incremental
compensation and travel costs for the substantial number of new employees that
have been hired to implement the Business Plan. The total number of employees
of the Company increased to approximately 3,600 at September 30, 1999.
Professional fees and other development costs associated with the Company's
plans to expand services offered in the U.S., Europe and Asia, consulting fees
to develop and implement the Company's business support systems, and
advertising, marketing and other selling costs for the Company's new Internet
Protocol products and services also increased selling, general and
administrative expenses. In addition to the costs to expand the communications
and information services businesses, the Company recorded $39 million of non-
cash compensation expense in the third quarter of 1999 under SFAS No. 123
related to grants of stock options and warrants. General and administrative
costs are expected to increase significantly in future periods as the Company
continues to implement the Business Plan.
EBITDA. EBITDA, as defined by the Company, consists of earnings (losses)
before interest, income taxes, depreciation, amortization, non-cash operating
expenses (including stock-based compensation and in-process research and
development charges) and other non-operating income or expenses. EBITDA was
$(25) million in 1998 and $(105) million in 1999. The primary reason for the
decrease between periods is the significant increase in cost of revenue and
selling, 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, however, should not be considered an
alternative to operating or net income as an indicator of the performance of
the Company's businesses, or as an alternative to cash flows from operating
activities as a measure of liquidity, in each case determined in accordance
with generally accepted accounting principles. See "Consolidated Condensed
Statements of Cash Flows."
Interest Income. Interest income decreased 4% in 1999 to $51 million from
$53 million in 1998. The Company's average cash, cash equivalents and
marketable securities balance increased slightly from approximately $3.7
billion during the third quarter of 1998 to approximately $3.9 billion during
the third quarter of 1999. However, the weighted average yield for the
Company's portfolio decreased by approximately 50 basis points in 1999
primarily due to the funds being invested in shorter term treasury securities.
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 lower yields on the funds, but is expected to reduce the
risk to principal in the short term prior to using the funds in implementing
the Business Plan.
Interest Expense, Net. Interest expense, net decreased from $46 million in
1998 to $34 million in 1999. This decrease is a direct result of capitalized
interest for network construction and business support systems increasing from
$5 million for the three months ended September 30, 1998 to $35 million for the
corresponding
S-24
<PAGE>
period in 1999. Interest costs on the Company's outstanding debt increased due
to the issuance in December 1998 of $834 million aggregate principal amount at
maturity of 10.5% senior discount notes due 2008 and the $823 million of 6%
subordinated convertible notes due 2009 issued in September 1999. The
amortization of debt issuance costs associated with the senior discount notes
and 6% convertible subordinated notes also increased interest expense in 1999.
Interest costs will continue to increase due to the senior secured credit
facility entered into by the Company on September 30, 1999.
Gain on Equity Investee Stock Transactions. Gain on equity investee stock
transactions was $5 million in 1999. In the third quarters of 1998 and 1999 RCN
issued stock for certain acquisitions which diluted the Company's ownership of
RCN but increased its proportionate share of RCN's net assets. The increase in
the Company's proportionate share of RCN's net assets resulted in a pre-tax
gain of $5 million for the Company in the third quarter of 1999. In 1998, the
Company recognized a $4 million gain in the third quarter related to RCN stock
activity.
Other Expense, Net. Other expense, net increased in 1999 to $35 million from
$31 million. Other expense consists primarily of the Company's share of losses
incurred by the Company's equity method investees, principally RCN. RCN is
incurring significant costs in developing its business plan including the
acquisitions of several Internet service providers. The Company recorded $37
million of equity losses attributable to RCN in the third quarter of 1999, as
compared to $22 million in the third quarter of 1998. In 1998, the Company
elected to discontinue its funding of Gateway Opportunity Fund, LP, or Gateway,
which provided venture capital to developing businesses. The Company recorded
losses of $11 million in the third quarter of 1998 to reflect Level 3's equity
in losses of the underlying businesses of Gateway. Also included in other
expense are equity earnings in Commonwealth Telephone Enterprises, Inc., and
realized gains and losses on the sale of other assets each not individually
significant to the Company's results of operations.
Income Tax (Provision) Benefit. Income tax benefit in 1998 and 1999 differs
from the statutory rate of 35% primarily due to losses incurred by the
Company's international subsidiaries which cannot be included in the
consolidated U.S. federal return, non-deductible goodwill amortization expense
and state income taxes.
Nine Months 1999 vs. Nine Months 1998
Revenue. Revenue for the nine months ended September 30, is summarized as
follows (in millions):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Communications and Information Services......................... $168 $102
Coal Mining..................................................... 158 178
Other........................................................... 16 16
---- ----
$342 $296
==== ====
</TABLE>
Communications and information services revenue increased from $102 million
for the nine months ended September 30, 1998 to $168 million for the nine
months ended September 30, 1999. In May 1999 the Massachusetts Department of
Public Utilities ruled that Bell Atlantic was no longer required to pay the
established reciprocal compensation rates for certain services. As a result,
Level 3 elected not to recognize additional revenue, beginning in the second
quarter, from these agreements until the uncertainties are resolved. The
Company reached a tentative agreement with Bell Atlantic in October 1999. The
agreement establishes new inter-carrier or reciprocal compensation rates
between the two carriers and assures that the Company will be paid for the
traffic it terminates from Bell Atlantic. As part of the agreement, the Company
and Bell Atlantic have also settled past disputes over reciprocal compensation
billing issues. The implementation of the new rate structure and reciprocal
compensation billing settlement are contingent upon certain conditions
including approval by relevant regulatory authorities. Revenue attributable to
the Bell Atlantic settlement agreement will not be recognized until the
uncertainties related to the regulatory approvals have been resolved.
Systems integration revenue increased 14% to $48 million in 1999. Revenue
for the computer outsourcing business increased 11% to $51 million in 1999.
Revenue attributable to new customers and additional services for existing
customers led to the increase in computer outsourcing and systems integration
revenue.
S-25
<PAGE>
Mining revenue in 1999 decreased to $158 million from $178 million in 1998
due to timing of shipments taken by Commonwealth. The purchase agreement with
Commonwealth requires that minimum amounts of coal must be purchased; however,
it does not stipulate when the coal must be purchased. In addition, the
expiration of a long-term contract in late 1998 will result in an approximate
10% decline in 1999 coal sales from 1998 levels.
Other revenue was consistent with 1998, and is primarily attributable to a
privately owned toll road in Southern California.
Cost of Revenue. Cost of revenue increased $105 million or 76% to $243
million in 1999 as a result of the expanding communications business. In 1999
network expenses were $107 million as compared to $4 million in the prior year.
The increase in costs is primarily attributable to the XCOM and GeoNet
acquisitions, the costs associated with our leased intercity networks leases
and costs attributable to the development and introduction of products the
Company began offering in late 1998 and 1999. The cost of revenue, as a
percentage of revenue, for the information services business increased slightly
for the nine months ended September 30, 1999 compared to the same period in
1998. The increase is primarily due to the costs incurred by the systems
integration segment to transition from Year 2000 services to systems and
software reengineering for Internet Protocol related applications. The cost of
revenue for the coal business as a percentage of revenue, increased due to the
expiration of the high margin long-term contract in 1998.
Depreciation and Amortization Expense. Depreciation expense increased from
$31 million in 1998 to $155 million in 1999. The significant increase in the
amount of assets placed in service during the last half of 1998 and first nine
months of 1999 for the communications business resulted in the increase in
depreciation expense. The acquisitions of XCOM, GeoNet and BusinessNet in 1998
and 1999 resulted in goodwill amortization increasing to $26 million in 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased significantly to $460 million in 1999 from
$199 million in 1998 primarily due to the cost of activities associated with
the expanding communications business. Compensation, travel and facilities
costs increased substantially due to the additional employees that have been
hired to implement the Business Plan. The total number of employees of the
Company increased to approximately 3,600 at September 30, 1999. Professional
fees, including legal costs associated with obtaining licenses, agreements and
technical facilities and other development costs associated with the Company's
plans to expand services offered in U.S., European and Asian markets,
consulting fees incurred to develop and implement the Company's business
support systems, and advertising, marketing and other selling costs contributed
to higher selling, general and administrative expenses. In addition, the
Company recorded $86 million of non-cash compensation in the first nine months
of 1999 for expenses recognized under SFAS No. 123 related to grants of stock
options and warrants, up from $23 million in 1998. As the Company continues to
implement the Business Plan, general and administrative costs are expected to
continue to increase significantly.
Write-off of In-Process Research and Development. Write-off of in-process
research and development of $30 million in 1998 was the portion of the purchase
price allocated to the telephone network-to-Internet Protocol network bridge
technology acquired by the Company in the XCOM transaction and was estimated
through formal valuation. In accordance with generally accepted accounting
principles, the $30 million was taken as a nondeductible charge against
earnings in the second quarter of 1998.
EBITDA. EBITDA decreased from $(18) million in 1998 to $(275) million in
1999. The primary reason for the decrease between periods is the significant
increase in cost of revenue and selling, general and administrative expenses,
described above, incurred in connection with the implementation of the Business
Plan.
Interest Income. Interest income increased substantially from $124 million
in 1998 to $158 million in 1999 primarily as a function of the Company's
increasing average cash, cash equivalents and marketable securities balances.
The average cash balance increased from approximately $2.9 billion during the
first nine months of 1998 to approximately $4 billion during the first nine
months of 1999. Yields on the portfolio, however, have
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<PAGE>
declined slightly from 1998. The accelerating Business Plan has required the
Company to shorten the average term of treasury securities in which it invests
in 1999. 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 lower yields on the funds, but is expected to reduce the
risk to principal in the short term prior to using the funds in implementing
the Business Plan.
Interest Expense, Net. Interest expense, net increased $46 million to $132
million in 1999 due to the completion of the offering of $2 billion aggregate
principal amount of 9.125% senior notes due 2008 in April 1998, $834 million
aggregate principal amount at maturity of 10.5% senior discount notes due 2008
offered in the fourth quarter of 1998 and the 6% convertible subordinated notes
due 2009 issued in September 1999. The amortization of the related debt
issuance costs also contributed to the increased interest expense in 1999. The
Company capitalized $65 million and $6 million of interest expense on network
construction and business support systems in the first nine months of 1999 and
1998, respectively.
Gain on Equity Investee Stock Transactions. Gain on equity investee stock
transactions increased to $116 million during the first nine months of 1999.
RCN issued stock in a public offering and for certain transactions which
diluted the Company's ownership of RCN from 41% at December 31, 1998 to 35% at
September 30, 1999. The increase in the Company's proportionate share of RCN's
net assets as a result of these transactions resulted in a pre-tax gain of $116
million from subsidiary stock sales for the Company in the first nine months of
1999. The Company recognized $25 million of gains for similar stock
transactions of RCN in 1998.
Other Expense, Net. Other expense, net decreased to $65 million in 1999 from
$78 million in 1998. Other expense consists of the Company's share of losses
incurred by the Company's equity method investees, primarily RCN. RCN is
incurring significant costs in developing its business plan including the
acquisitions of several Internet service providers. The Company recorded $90
million of equity losses attributable to RCN in the first nine months of 1999,
as compared to $75 million in the first nine months of 1998. The Company also
sold 1.2 million shares of Burlington Resources common stock, resulting in a
pre-tax gain of $17 million for the Company in 1999. In 1998, the Company
elected to discontinue its funding of Gateway, which provided venture capital
to developing businesses. The Company recorded losses of $18 million in 1998 to
reflect Level 3's equity in losses of the underlying businesses of Gateway.
Equity earnings of Commonwealth Telephone Enterprises, Inc. and gains on the
disposition of other assets were not individually significant in the first nine
months of 1999 or 1998.
Income Tax (Provision) Benefit. Income tax benefit in 1998 and 1999 differs
from the statutory rate of 35% primarily due to losses incurred by the
Company's international subsidiaries which cannot be included in the
consolidated U.S. federal return, non-deductible goodwill amortization expense
and state income taxes. The income tax benefit in 1998 also differs from the
statutory rate due to the $30 million non-deductible write-off of the research
and development costs acquired in the XCOM acquisition.
Discontinued Operations. Discontinued operations includes the one-time gain
of $608 million recognized upon the distribution of the Construction Group to
former Class C stockholders 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 MidAmerican on January 2, 1998.
1998 vs. 1997
In 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 are reflected in the period ended December 31,
1998. There were 52 weeks in fiscal years 1997 and 1996.
S-27
<PAGE>
Revenue. Revenue for the years ended December 31, 1998 and December 27, 1997
is summarized as follows (in millions):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Communications and Information Services....................... $144 $ 95
Coal Mining................................................... 228 222
Other......................................................... 20 15
---- ----
$392 $332
==== ====
</TABLE>
Communications and Information Services revenue increased 52% in 1998. The
Internet Protocol business generated revenues of approximately $24 million in
1998, of which $22 million is attributable to the acquisition of XCOM.
Approximately 87% of XCOM's revenue is attributable to reciprocal compensation
agreements with Bell Atlantic. These agreements require the company originating
a call to compensate the company terminating the call. The FCC has been
considering whether local carriers are obligated to pay compensation to each
other for the transport and termination of calls to Internet service providers
when a local call is placed from an end user of one carrier to an Internet
service provider served by the competing local exchange carrier. Recently, the
FCC determined that it had no rule addressing inter-carrier compensation for
these calls. In the absence of a federal rule, the FCC determined that it would
not be unreasonable for a state commission, in some circumstances, to require
payment of compensation for these calls. The FCC also released for comment
alternative federal rules to govern compensation for these calls in the future.
If state commissions, the FCC or the courts determine that inter-carrier
compensation does not apply, carriers, including us, may be unable to recover
their costs or will be compensated at a significantly lower rate and may be
required to refund amounts previously received. Bell Atlantic has notified the
Company that it will be escrowing all amounts due the Company under the
reciprocal compensation agreements until the issue is resolved. An unfavorable
resolution of this matter may have a material adverse effect on the Company's
communications revenues.
The computer outsourcing business experienced significant revenue growth in
1998. The inclusion of a full year of revenue from customers which began
service in 1997 and an increase in revenue from the existing customer base,
resulted in a 26% increase in outsourcing revenue. The systems integration
business experienced a 27% increase in revenue in 1998. This increase is
primarily attributable to new acquisitions and a strong demand for Year 2000
renovation during the first six months of 1998 and other systems reengineering
services.
Revenue from coal mines increased slightly in 1998. An increase in alternate
source coal sales to Commonwealth was partially offset by the expiration of a
long-term contract also with Commonwealth. In 1998 the Company and Commonwealth
amended their contract to allow Commonwealth to accelerate delivery of coal.
The amended contract requires Commonwealth to take delivery of its year 2001
coal commitments in 1998, 1999 and 2000. Of the 2001 commitments, 50% was taken
in 1998 and 25% will be taken in both 1999 and 2000. The expiration of the
long-term contract was partially offset by contracts with new customers in
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 as these long-term
contracts begin to expire.
Other revenue is primarily attributable to CPTC, the owner operator of the
SR91 toll road in southern California. Revenues increased in 1998 primarily due
to higher traffic counts and increases in toll rates.
Cost of Revenue. Operating expenses increased 22% from $163 million in 1997
to $199 million in 1998 primarily due to expenses incurred in connection with
the Business Plan to expand the communications and information services
businesses. Operating expenses related to communications and information
services revenue in 1998 were $98 million up from $62 million in 1997. Costs
attributable to the XCOM and GeoNet acquisitions as well as costs associated
with the Frontier lease are responsible for an $11 million increase in
operating expenses. Operating expenses for the computer outsourcing and systems
integration business increased $5 million and $20 million in 1998,
respectively. The increase in the computer outsourcing operating
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expenses is primarily attributable to the startup expenses associated with the
second data center in Tempe, Arizona. Higher than expected costs for Year 2000
work resulted in the significant increase in systems integration operating
expenses in 1998. The Company also incurred expenses to refocus its efforts
away from Year 2000 services to systems and software reengineering for Internet
Protocol related applications. Operating expenses related to coal mining were
consistent with the prior year.
Depreciation and Amortization Expense. Depreciation and amortization expense
has increased $46 million from $20 million in 1997. The primary reason for this
increase is the $910 million of capital expenditures in 1998, of which
approximately $481 million was placed in service in 1998. The majority of
the assets placed in service are associated with 15 gateway sites constructed
for the expansion of the communications business. Also contributing to the
increase was the depreciation and amortization on equipment purchased for
computer outsourcing contracts, assets acquired through business acquisitions
in 1998 and the amortization of goodwill related to these acquisitions.
Depreciation and amortization will continue to increase in 1999 as additional
facilities are placed in service.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $226 million to $332 million in 1998. This
increase of 213% from 1997 is primarily attributable to the implementation of
the Business Plan, including additional communications and information services
personnel. The total number of communications and information services
employees at December 31, 1998 was approximately 2,200 as compared to
approximately 1,000 at December 27, 1997. Cash compensation included in expense
increased from $14 million in 1997 to $51 million in 1998. In addition, $39
million of non-cash stock based compensation expense was recorded in 1998, of
which $24 million was related to the Company's Outperform Stock Option program
introduced in the second quarter of 1998. These costs are accounted for in
accordance with SFAS No. 123. Professional fees increased $74 million in 1998
primarily for legal costs associated with obtaining licenses, agreements and
technical facilities and other development costs associated with starting to
offer services in U.S. cities. Also included in professional fees is third
party software and associated development costs incurred in developing
integrated business support systems. These expenses were recorded in accordance
with the AICPA Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use", which specifically
identifies those costs that should be expensed or capitalized for internally
developed software. Selling, general and administrative expenses are expected
to increase significantly in future periods as the Company continues to
implement the Business Plan.
Write-off of In-process Research and Development. Write-off of in process
research and development was $30 million in 1998. On April 23, 1998 the Company
completed the acquisition of XCOM, a privately held company that developed
certain components necessary for the Company to develop an interface between
its Internet Protocol based network and the existing public switched telephone
network.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated to
acquired in-process research and development, and was taken as a nondeductible
charge to earnings in the second quarter of 1998. In October 1998, the SEC
issued new guidelines for valuing acquired research and development which are
applied retroactively. Consequently, the Company has reduced the charge by $85
million, which also increases goodwill by a corresponding amount. Goodwill
associated with the XCOM transaction is being amortized over a 5 year period.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guideline and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
EBITDA. EBITDA, as defined by the Company, consists of earnings (losses)
before interest, income taxes, depreciation, amortization, non-cash operating
expenses (including stock-based compensation and in process research and
development charges) and other non-operating income or expenses. The Company
excludes non-cash compensation due to its adoption of the expense recognition
provisions of SFAS No. 123. EBITDA decreased from $84 million in 1997 to $(100)
million in 1998 primarily due to the significant increase
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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 Statements of Cash Flows."
Interest Income. Interest income increased significantly in 1998 to $173
million from $33 million in 1997 as the Company's cash, cash equivalents and
marketable securities balances increased to $3.7 billion at December 31, 1998
from $765 million at December 27, 1997 as a result of the two debt offerings
and the proceeds from the sale of its energy business. Pending utilization of
the cash equivalents and marketable securities in implementing the Business
Plan, the Company intends to continue investing the funds primarily in
government and governmental agency securities. This investment strategy will
provide lower yields on the funds, but is expected to reduce the risk to
principal in the short term prior to using the funds in implementing the
Business Plan.
Interest Expense, Net. Interest expense, net increased significantly from
$15 million in 1997 to $132 million in 1998 due to the completion of the
offering of $2 billion aggregate principal amount of 9 1/8% senior notes due
2008 issued on April 28, 1998 and $834 million aggregate principal amount at
maturity of 10 1/2% senior discount notes due 2008 issued on December 2, 1998.
The amortization of a portion of the $79 million of debt issuance costs
associated with the senior notes and senior discount notes also increased
interest expense in 1998. The Company capitalized $15 million of interest
expense on network construction and business support systems development
projects in 1998.
Equity Losses in Unconsolidated Subsidiaries. Equity losses in
unconsolidated subsidiaries increased to $132 million in 1998 primarily due to
the equity losses attributable to RCN. RCN is the largest single source,
facilities based provider of communications services to the residential markets
primarily in the Northeast and the largest regional Internet service provider
in the Northeast. RCN is also incurring significant costs in developing its
business plan including the acquisitions of several Internet service providers.
RCN's losses increased from $52 million in 1997 to $205 million in 1998. The
Company's proportionate share of these losses, including goodwill amortization,
was $92 million and $26 million in 1998 and 1997, respectively. In 1998, the
Company elected to discontinue its funding of Gateway, which provided venture
capital to developing businesses. The Company recorded losses of $28 million
and $15 million in 1998 and 1997, respectively, to reflect Level 3's equity in
losses of the underlying businesses of Gateway. Also included in equity losses
are equity earnings of Commonwealth, a Pennsylvania public utility providing
telephone services, and equity losses of Cable Michigan prior to its sale in
1998, a cable television operator in the State of Michigan.
Gain on Equity Investee Stock Transactions. Gain on equity investee stock
transactions was $62 million in 1998. During 1998, RCN issued stock in a public
offering and for certain acquisitions. These transactions decreased the
Company's ownership in RCN from 48% in 1997 to 41% in 1998, but increased its
proportionate share of RCN's net assets. The Company recorded a pre-tax gain of
approximately $62 million to reflect this increase in value.
Gains on Sale of Assets. Gains on sale of assets increased significantly in
1998 due to the sale of Cable Michigan to Avalon Cable of Michigan, Inc. in
November 1998. The Company recognized a gain of approximately $90 million from
the cash for stock transaction. Also included in gains on the disposal of
assets are $8 million and $1 million of gains on the disposal of property,
plant and equipment in 1998 and 1997 respectively, and $9 million of gains on
the sale of marketable securities in both periods.
Income Tax (Provision) Benefit. Income tax (provision) benefit differs from
the expected statutory rate of 35% primarily due to the nondeductible write-off
of the in process research and development costs allocated in the XCOM
transaction, losses incurred by the Company's international subsidiaries which
cannot be included in the consolidated U.S. federal income tax return and state
income taxes. In 1997 the effective rate was less than the expected statutory
rate primarily due to prior year tax adjustments, partially offset by the
effect of nondeductible compensation expense associated with the conversion of
the information services option and SAR plans to the Level 3 Stock Plan.
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Discontinued Operations. Discontinued operations includes the one-time gain
of $608 million recognized upon the distribution of the Construction Group to
former Class C stockholders 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 MidAmerican on January 2, 1998.
Financial Condition--December 31, 1999
The Company's working capital decreased approximately $0.7 billion during
1999 from $3.5 billion at December 31, 1998 to $2.8 billion at December 31,
1999. The decrease was primarily due to the capital expenditures and operating
expenses incurred to implement the Business Plan. Partially offsetting these
expenditures were the proceeds from the $1.5 billion equity offering completed
in March 1999, the $823 million offering of 6% convertible subordinated notes
and the $475 million proceeds from the $1.375 billion senior secured credit
facility. Both the 6% convertible subordinated note offering and the senior
secured credit facility were completed in September 1999.
Cash provided by continuing operations increased from approximately $170
million in 1998 to approximately $450 million in 1999 primarily due to the
changes in components of working capital and an increase in interest income.
Interest income increased in 1999 as a result of the proceeds received from the
9 1/8% senior notes, 10 1/2% senior discount notes, 6% convertible subordinated
notes, senior secured credit facility and the March 1999 equity offering. The
increase in cash provided by interest income was partially offset by the semi-
annual payment of interest on the 9 1/8% senior notes. The initial interest
payment on the 6% convertible subordinated notes is due in 2000. Interest
payments on amounts outstanding under the senior secured credit facility are
due periodically based on the Company's selection of alternative base rate and
LIBOR loans. A commitment fee on the unused portions of the senior secured
credit facility is payable on the last business day of each calendar quarter.
Interest payments on the 10 1/2% senior discount notes are deferred until 2004.
An increase in the costs paid to implement the Business Plan also reduced cash
provided by continuing operations.
Investing activities include the purchase and sale of approximately $4.6
billion and $5.2 billion, respectively, of marketable securities. The Company
also incurred costs of $3.4 billion for capital expenditures, primarily for the
expanding communications business.
Financing sources in 1999 consisted primarily of the net proceeds of $451
million from the senior secured credit facility, net proceeds of $798 million
from the offering of $823 million aggregate principal amount of 6% convertible
subordinated notes due 2009, net proceeds of $1.5 billion from the issuance of
28.75 million shares of common stock and the exercise of Company stock options
for $22 million. The Company also repaid long-term debt of approximately $6
million during 1999.
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 has commenced the implementation of a plan to
become a facilities based provider (that is, a provider that owns or leases a
substantial portion of the property, plant and equipment necessary to provide
its services) of a broad range of integrated communications services. To reach
this goal, the Company is expanding substantially the business of its
subsidiary, PKS Information Services, Inc. to create, through a combination of
construction, purchase and leasing of facilities and other assets, an advanced,
international, facilities based communications network. The Company is
designing its network based on Internet Protocol 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, may result in substantial negative operating cash flow and
substantial net operating losses for the Company for the foreseeable future.
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Although the Company believes that its cost estimates and build-out schedule
are reasonable, the actual construction costs or the timing of the expenditures
may deviate from current estimates. The Company's capital expenditures in
connection with the Business Plan were approximately $3.4 billion in 1999. The
Company estimates that its capital expenditures in connection with the Business
Plan will approximate $3.5 billion in 2000. The Company's current liquidity and
the agreement with INTERNEXT 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 $13 and $14 billion over
the 10-year period of the Business Plan. 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 credit facilities and
other borrowings, including the senior secured credit facility entered into on
September 30, 1999, and sales or issuance of additional equity securities or
additional debt securities, including this offering and the other offerings.
The 9 1/8% senior notes and the 10 1/2% senior discount notes were issued under
indentures which permit the Company and its subsidiaries to incur substantial
amounts of debt. The senior secured credit facility also permits the Company to
incur substantial amounts of unsecured debt.
In addition, the Company may sell or dispose of existing businesses or
investments to fund portions of the Business Plan. The Company may sell or
lease fiber optic capacity, or access to its conduits. The Company may not 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. In addition, proceeds from
dispositions of the Company's assets may not reflect the assets' intrinsic
value. Further, expenses may exceed the Company's estimates and the financing
needed may 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.
The Company may not be able to obtain such financing if and when it is
needed and, if available, such financing may not 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.
Year 2000--December 31, 1999
Level 3 Communications, LLC. Level 3's wholly owned subsidiary, Level 3
Communications, LLC, is a new company that is implementing new technologies to
provide Internal Protocol technology-based communications services to its
customers. The expenses associated with Level 3 Communications, LLC's Year 2000
remediation program did not have a material effect on the operating results or
financial condition of Level 3 Communications, LLC through December 31, 1999.
There can be no assurance, however, that the Year 2000 problem, and any loss
incurred by any customers of Level 3 as a result of the Year 2000 problem, will
not have a material adverse effect on Level 3 Communications, LLC's financial
condition or results of operations in the future.
PKSIS. PKS Information Services, Inc., or PKSIS, provides a wide variety of
information technology services. PKSIS has two main lines of business: computer
outsourcing and systems integration. The computer outsourcing business is
managed by PKS Computer Services LLC, or PKSCS. The systems integration is
managed by PKS Systems Integration LLC, or PKSSI.
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PKSIS derived a substantial portion of its revenues in 1999 from projects
that its subsidiary, PKSSI, conducted involving Year 2000 assessment and
renovation services. This exposes PKSSI to potential risks that may include
problems with services provided by PKSSI to its customers and the potential
claims arising under PKSSI's customer contracts. PKSSI attempts to
contractually limit its exposure to liability for Year 2000 compliance issues.
However, these contractual limitations may not be effective.
The expenses associated with PKSIS' Year 2000 efforts, did not, and the
related potential effect on PKSIS' earnings are not expected to, have a
material effect on the future operating results or financial condition of Level
3. There 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 Level 3's financial condition or results
of operations in the future.
Costs of Year 2000 Issues. Level 3 incurred approximately $2 million of
costs in 1999. These costs primarily arise from direct costs of Level 3
employees verifying equipment and software as Year 2000 ready. However, Level 3
does not separately track the internal employee costs incurred for its Year
2000 projects. Level 3 does track all material costs incurred for its Year 2000
projects as well as all costs incurred by the Year 2000 program office. Level 3
estimated the time and effort expended by its employees on Year 2000 projects
based on an analysis of Year 2000 project plans.
PKSIS incurred approximately $4 million of costs to implement its Year 2000
program through 1998, and incurred an additional approximately $4 million of
costs in 1999. These costs primarily arise from direct costs of PKSCS employees
working on upgrades per vendor specifications of operating system software for
PKSCS outsourcing customers and the cost of vendor supplied operating systems
software upgrades and the cost of additional hardware. However, PKSIS does not
separately track the internal costs incurred for its Year 2000 projects and
does not track the cost and time its employees spend on Year 2000 projects.
PKSCS has estimated the time and effort expended by its employees on Year 2000
projects based on an analysis of Year 2000 project plans. Labor costs for
PKSCS' Year 2000 projects were estimated to be $2 million for 1998 and $1
million in 1999. Costs for software upgrades, additional equipment costs and a
test system for PKSCS' Year 2000 projects were estimated to be $2 million for
1998 and $3 million in 1999. Such costs are not available for PKSSI but are not
believed to be material. Year 2000 costs for PKSSI are believed to be
substantially less than PKSCS and focus primarily on the cost of evaluating
and, if necessary, upgrading network and desktop hardware and software. The
costs incurred by PKSSI for performing Year 2000 services for its customers are
included within PKSSI's pricing for such services.
Market Risk--December 31, 1999
Level 3 is subject to market risks arising from changes in interest rates,
equity prices and foreign exchange rates. The Company's exposure to interest
rate risk increased due to the $1.375 billion senior secured credit facility
entered into by the Company in September 1999. As of December 31, 1999, the
Company had borrowed $475 million under the senior secured credit facility.
Amounts drawn on the term loan and revolving credit facilities bear interest at
the alternate base rate or LIBOR rate plus applicable margins. As the alternate
base rate and LIBOR rate fluctuate, so too will the interest expense on amounts
borrowed under the facilities. The Company continues to evaluate alternatives
to limit interest rate risk.
Level 3 continues to hold positions in certain publicly traded entities,
primarily Commonwealth Telephone and RCN. The Company accounts for these two
investments using the equity method. The market value of these investments is
approximately $1.866 billion as of December 31, 1999, which is significantly
higher than their carrying value of $292 million. The Company does not
currently have plans to dispose of these investments; however, if any such
transaction occurred, the value received for the investments would be affected
by the market value of the underlying stock at the time of any such
transaction. A 20% decrease in the price of Commonwealth Telephone and RCN
stock would result in approximately a $373 million decrease in fair market
value of these investments. The Company does not currently utilize financial
instruments to minimize its exposure to price fluctuations in equity
securities.
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The Company's Business Plan includes developing and constructing networks in
Europe and Asia. As of December 31, 1999, the Company had invested significant
amounts of capital in Europe and will continue to expand its presence in Europe
and Asia in 2000. As of December 31, 1999, the Company had not utilized
financial instruments to minimize its exposure to foreign currency
fluctuations. The Company will continue to analyze risk management strategies
to reduce foreign currency exchange risk in the future.
The change in equity security prices is based on hypothetical movements and
is not necessarily indicative of the actual results that may occur. Future
earnings and losses will be affected by actual fluctuations in interest rates,
equity prices and foreign currency rates.
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INDUSTRY OVERVIEW
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,"
that long distance carriers were required to pay to the ILECs to access the
ILECs' networks.
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.
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
Telecommunications Act of 1996 (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 and NYNEX merged in August 1997, Pacific Telesis Group and
SBC Communications merged in April 1997, SBC Communications and Ameritech
merged in October 1999, GTE and Bell Atlantic have proposed a merger and MCI
WorldCom has agreed to acquire Sprint. 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 of Tele-Communications, Inc.,
WorldCom's mergers with MFS and Brooks Fiber Properties and Qwest's proposed
acquisition of US West. They have also sought to otherwise improve their
competitive positions, through transactions such as WorldCom's 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. 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.
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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 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
Internet Protocol, 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 content 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
ILECs, CLECs and ISPs using Internet Protocol 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.
Internet Protocol 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.
On June 23, 1999, Level 3 announced a minimum four year, $250 million
strategic agreement with Lucent Technologies to purchase Lucent systems,
including software switches or "softswitches." The minimum purchase commitment
is subject to certain conditions and has the potential to grow to $1 billion
over five years.
Under this nonexclusive agreement, Lucent will provide Level 3 its Lucent
Technologies Softswitch, a software switch for Internet Protocol networks that
is intended to combine the reliability and features that customers expect from
the public switched telephone network with the cost effectiveness and
flexibility of Internet Protocol technology. With the Lucent Softswitch, Level
3 expects to provide a full range of Internet Protocol based communications
services similar in quality and ease of use to services on traditional circuit
voice networks. In addition, the companies also agreed to collaborate on future
enhancements of softswitches and gateway products to support next-generation
broadband services for business and consumers that will combine high-quality
voice and video communications with Internet-style web data services.
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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. It has been estimated that in
1998 local exchange services accounted for revenues of $96.8 billion, long
distance services generated revenues of $110.5 billion and Internet access
revenues totaled $8.3 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 an ILEC or CLEC 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 an ILEC or CLEC
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.
The following diagram is a simplified illustration of a typical long
distance call:
[GRAPHIC OF TYPICAL LONG DISTANCE CALL]
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.
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The following diagram is a simplified illustration of a typical local call:
[GRAPHIC OF TYPICAL LOCAL CALL]
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 Internet
Protocol 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.
The following diagram is a simplified illustration of a typical Internet
access service:
[GRAPHIC OF TYPICAL INTERNET ACCESS SERVICE]
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. It has been estimated that in 1998 local exchange
services accounted for revenues of $124.6 billion, long distance services
generated revenues of $199.6 billion and Internet access revenues totaled $7.1
billion.
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Internet Protocol Network and Interconnection. The Company designed the
Level 3 network to be optimized for Internet Protocol based communications,
rather than circuit-switch based communications such as that utilized by the
PSTN. The network was designed with the goal of providing 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 Internet Protocol 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. In
addition, existing voice-over Internet Protocol services generally require
either customized end-user equipment or the dialing of "access codes" or the
following of other similar special procedures to initiate a call. There are
also concerns about the reliability and security of existing Internet Protocol
voice networks.
The Company has developed its Internet Protocol voice services so that
customers will not be required to dial access codes or follow other special
procedures to initiate a call. The Company and other technology providers have
developed, and we are commercially testing, softswitch technology to enable the
transmission of traffic seamlessly between a router-based Internet Protocol
network and the circuit-based PSTN. When commercially deployed, this technology
will provide the Level 3 network with the same ubiquity of the PSTN.
Specifically, this technology will provide Level 3 with (1) the ability to
originate PSTN telephone traffic from an ILEC's switch (when the origination
point is not on the Level 3 network), (2) route the traffic over the Level 3
network and (3) 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). 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 codes, for routing the call to the Level 3 network. Level 3
believes that by building its own network with significant excess capacity,
expandability 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 Internet
Protocol voice transmission (quality, latency, reliability and security) will
have been satisfactorily addressed. The Company commercially launched its
Internet Protocol long distance voice transmission services in December 1999.
The Company expects to begin commercial testing of some features associated
with local service, such as caller ID, voice mail and call forwarding, during
the first quarter of 2000. See "Risk Factors--Our business could be materially
affected by problems arising from the commercial deployment of our voice
technology for Internet Protocol networks."
On November 16, 1998, Level 3 and Bell Communications Research Inc.
announced the merger of their respective specifications for a new protocol
designed to bridge between the current circuit-based PSTN and emerging Internet
Protocol based networks. The merged specification, called the Media Gateway
Control Protocol, or MGCP, represents a combination of the Internet Protocol
Device Control, or lPDC, specification developed by a consortium formed by
Level 3 and made up of leading communications hardware and software companies,
and the Simple Gateway Control protocol, developed by Bell Communications
Research and Cisco Systems. The MGCP specification is available without a fee
to service providers and hardware and software vendors interested in
implementing it in their networks and equipment.
The significance of MGCP is that when implemented it will provide customers
with a seamless interconnection between traditional PSTN and the newer Internet
Protocol technology networks. Level 3 believes that this integration will
enable customers to benefit from the lower cost of Internet Protocol network
services, including voice and fax, without modifying existing telephone and fax
equipment or dialing access codes. Level 3 plans to use MGCP in the development
of its own network.
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On May 13, 1999, a group of leading telecommunications companies announced
the formation of the International Softswitch Consortium, or the "Consortium."
Level 3 was one of the founding members of this Consortium. The Consortium
currently has approximately 100 members. The purpose of the organization is to
promote open standards and protocols and new application development for the
distributed set of hardware and software platforms that are referred to as
softswitches and can seamlessly interconnect the PSTN with information and
applications currently available only over the Internet. The Consortium is the
first group to focus exclusively on interconnection between Internet Protocol
networks and the PSTN, and is promoting worldwide compatibility and
interoperability of these networks. The Consortium's charter also calls for it
to act as a catalyst in stimulating independent software vendors to develop
value-added services for service providers and network users of Internet
Protocol networks.
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BUSINESS
Level 3 engages in the communications, information services and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, the Company announced 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 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 and, more recently, an investment in C-TEC Corporation and
its successors RCN, Commonwealth Telephone and Cable Michigan, Inc.) in 1988,
the information services business in 1990 and the alternative energy business,
through an investment in MidAmerican, in 1991. Level 3 also has made
investments in several development-stage ventures.
In 1995, the Company distributed to the holders of Class D Stock 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 in
a transaction valued at $14.3 billion.
In December 1997, the Company's stockholders ratified the decision of the
Board to effect the split-off separating the Construction Group. 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. In conjunction with the split-off,
the Company changed its name to "Level 3 Communications, Inc.," and the
Construction Group changed its name to "Peter Kiewit Sons', Inc."
In January 1998, the Company completed the sale to MidAmerican of its energy
investments, consisting primarily of a 24% equity interest in MidAmerican. The
Company received proceeds of approximately $1.16 billion from this sale, and as
a result recognized an after-tax gain of approximately $324 million in 1998.
In November 1998, Avalon Cable of Michigan, Inc. acquired all the
outstanding stock of Cable Michigan. Level 3 received approximately $129
million in cash for its interest in Cable Michigan and recognized a pre-tax
gain of approximately $90 million.
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. Since that time, the Company has 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. The Company has expanded
substantially the business of its subsidiary PKSIS and is creating, through a
combination of construction, purchase and leasing of facilities and other
assets, an advanced, international, facilities based communications network.
The Company designed the Level 3 network based on Internet Protocol 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 Internet
Protocol technology. These services will include traditional voice services, 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, Internet Protocol
technology generally uses network capacity more efficiently than the
traditional circuit-switched PSTN. This is because capacity in a packet
switched network is shared between end points only when they are
communicating at any given time, whereas in circuit switched networks,
capacity is reserved between communicating end points even when no
information is actually being transmitted. Therefore, services including
voice, e-mail and file transfer can be provided for lower cost over a
network using Internet Protocol technology.
. Open Protocol. Internet Protocol technology is an open protocol (a non-
proprietary standard) which allows for market driven development of new
services and applications for Internet Protocol 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 and slower to accept
change.
. Improving Technologies. The Company and other technology companies have
developed solutions to address problems associated with certain Internet
Protocol based applications that use the public Internet. For example,
typical voice over Internet Protocol solutions are characterized by
cumbersome two-stage dialing requirements, latency (delay through the
network which can negatively affect timing sensitive communications such
as voice), quality and concerns about adequate security and reliability.
During December 1999, Level 3 commercially launched (3)Voice long
distance service in 10 markets, the first voice service to utilize
softswitch technology. Level 3 expects to begin commercial testing of
some features associated with local service, such as caller ID, voice
mail and call forwarding, during the first quarter of 2000. Level 3's
Internet Protocol voice technology provides a seamless interconnection
with the PSTN using softswitch architecture.
. Open Architecture. The open architecture of Level 3's distributed
network enables new competition among suppliers for the individual
components of the Internet Protocol voice switching system. The Company
believes that this competition amongst vendors will enable more rapid
improvement in the price/performance ratio of individual network
components and thereby lower network cost.
Level 3's Strategy. The Company is seeking to capitalize on the benefits of
Internet Protocol technology by pursuing the Business Plan. Key elements of the
Company's strategy include:
. Become the Low Cost Provider of Communications Services. Our network is
designed to provide high quality communications services at a lower
cost. For example, the Level 3 network is being constructed using
multiple conduits to allow the Company to cost-effectively deploy future
generations of optical networking components and thereby expand capacity
and reduce unit costs. In addition, the Company's strategy is to
maximize the use of open, non-proprietary interfaces in the design of
its network software and hardware. This approach is intended to provide
Level 3 with the ability to purchase the most cost-effective network
equipment from multiple vendors. New technologies such as packet-
switching will also enhance the efficiencies of our network.
. Combine Latest Generations of Fiber and Electronics. In order to achieve
unit cost reductions for transmission capacity, Level 3 has designed its
network with multiple conduits to deploy successive generations of fiber
to exploit improvements in transmission electronics. Optimizing
transmission electronics to exploit specific generations of fiber optic
technology currently provides transmission capacity on the new fiber
more cost effectively than deploying new electronics on previous
generations of fiber.
. Offer a Comprehensive Range of Communications Services. The Company
provides a comprehensive range of communications services over the Level
3 network, including private line, (3)Voice long distance services,
colocation, Internet access and managed modem.
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Level 3 expects to begin commercial testing of some features associated
with local service, such as caller ID, voice mail and call forwarding,
during the first quarter of 2000. Level 3 is also offering dark fiber
and conduits along its local and intercity networks on a long-term lease
basis.
. Provide Significant Colocation Facilities. Level 3 has been experiencing
higher demand for its colocation services from its web centric customers
than was anticipated in preparing the Business Plan. Level 3 believes
that providing colocation services on its network attracts web centric
customers by allowing Level 3 to offer those customers reduced bandwidth
costs, rapid provisioning of additional bandwidth, interconnection with
other third-party networks and improved network performance. Therefore,
Level 3 believes that controlling significant colocation facilities in
its gateways provides it with a competitive advantage. In addition,
significant colocation facilities in a gateway allow Level 3 to price
the exchange of traffic between its customers that are colocated in the
same facility at significantly lower cost than the exchange of traffic
between a customer located outside the facility and a customer located
within the facility.
As of December 31, 1999, Level 3 had secured approximately 3.4 million
square feet of space for its gateway facilities and had completed the
buildout of approximately 1.3 million square feet of this space. Level 3
believes it currently has more colocation space than any of its
competitors. In January 2000, Level 3 announced an expansion of its
Business Plan to increase significantly the aggregate amount of its
global gateway facilities to 6.5 million square feet over the next two
to three years.
. Provide Seamless Interconnection to the PSTN. During December 1999, the
Company launched its (3)Voice long distance service that allows the
seamless interconnection of the Level 3 network with the PSTN for long
distance voice transmissions. Seamless interconnection allows customers
to use Level 3's Internet Protocol based services without modifying
existing telephone equipment or dialing procedures (that is, without the
need to dial access codes or follow other similar special procedures).
The Company's managed modem service uses similar softswitch technology
to seamlessly interconnect to the PSTN.
. Accelerate Market Roll-out. To support the launch of its services and
develop a customer base in advance of completing the construction of its
network, Level 3 offers services over a combination of leased local and
intercity facilities. Over time, these leased networks will be displaced
by the networks that the Company is constructing.
. Target Web Centric Customers. The Company's distribution strategy is to
utilize a direct sales force focused on communications intensive and web
centric businesses. These businesses include ISPs, application service
providers, content providers, systems integrators, next generation
carriers, web-hosting companies, streaming media companies and Internet
Protocol based storage providers. Providing continually declining
bandwidth costs to these companies is at the core of the Company's
market enabling strategy because bandwidth generally represents a
substantial portion of web centric businesses' costs.
. Develop Advanced Business Support Systems. The Company is developing a
substantial, scalable and web-enabled business support system
infrastructure specifically designed to enable the Company to offer
services efficiently to its targeted customers. The Company believes
that this system will reduce its operating costs, give its customers
direct control over some of the services they buy from the Company and
allow the Company to grow rapidly without redesigning the architecture
of its business support system.
. Leverage Existing Information Services Capabilities. The Company is
expanding 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 Internet Protocol networks and web
browser access.
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. Attract and Motivate High Quality Employees. The Company has developed
programs designed to attract and retain employees with the technical
skills necessary to implement the Business Plan. The programs include
the Company's Shareworks stock purchase plan and its Outperform Stock
Option program.
Competitive Advantages. The Company believes that it has the following
competitive advantages that, together with its strategy, 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 was involved in leading the development and
marketing of telecommunications products and in designing, constructing
and managing intercity, metropolitan and international networks.
. A More Readily Upgradable Network Infrastructure. Level 3's network
design takes advantage of recent innovations, incorporating many of the
features that are not present in older communication networks, and
provides Level 3 flexibility to take advantage of future developments
and innovations. Level 3 has designed the transmission network to
optimize all aspects of fiber and electronics simultaneously as a system
to deliver the lowest unit cost to its customers. As fiber and
transmission electronic technology changes, Level 3 expects to realize
new unit cost improvements by deploying the latest fiber and
transmission electronics technology in available empty or spare conduit
in the multiple conduit Level 3 network. The Company believes that the
spare conduit design of the Level 3 network will enable Level 3 to
effect this deployment more quickly and at lower cost than other
carriers.
. 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 Company believes that the integration of its local and
intercity networks with its colocation facilities will expand the scope
and reach of its on-net customer coverage, and facilitate the uniform
deployment of technological innovations as the Company manages its
future upgrade paths.
. Systems Integration Capabilities. The Company believes that its ability
to offer computer outsourcing and systems integration services,
particularly services relating to allowing a customer's legacy systems
to be accessed with web browsers, will provide additional opportunities
for selling the Company's products and services.
The Level 3 Network
An important element of the Business Plan is the development of the Level 3
network, an advanced, international, facilities based communications network
optimized for Internet Protocol technology. Today, the Company is primarily
offering its communications services using local and intercity facilities that
are leased from third parties. This enables the Company to offer services
during 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 two to three years, the
Company's network is expected to encompass:
. an intercity network covering nearly 16,000 miles in North America;
. leased or owned local networks in 56 North American markets;
. an intercity network covering approximately 4,750 miles across Europe;
. leased or owned local networks in 21 European and Pacific Rim markets;
. approximately 6.5 million square feet of gateway facilities in North
America, Europe and the Pacific Rim; and
. undersea capacity, including a 1.28 Tbps transatlantic cable system and
a 2.56 Tbps Northern Asia cable system initially connecting Hong Kong to
Tokyo.
See "Risk Factors--Difficulties in constructing our network could increase its
estimated cost and delay its scheduled completion."
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Intercity Networks. The Company's nearly 16,000 mile fiber optic intercity
network in North America will consist of the following:
. Rights-of-way ("ROW") from a number of third parties including
railroads, highway commissions and utilities. The Company has procured
these rights from sources that maximize the security and quality of the
Company's installed network. The Company has secured 100% of the ROW
required for the planned North American intercity network. It has
obtained these rights pursuant to agreements with railroads, state and
local departments of transportation, utilities, pipeline companies and
others.
. Multiple conduits connecting local networks in approximately 200 North
American cities. In general, Level 3 will install groups of 10 to 12
conduits in its intercity network. The Company believes that the
availability of spare conduit will allow it to deploy future
technological innovations in optical networking components as well as
providing Level 3 with the flexibility to offer conduit to other
entities.
. 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. In addition, the Company believes that
the installation of newer optical fibers will allow a combination of
greater wavelengths of light per strand, higher digital transmission
speeds and greater spacing of network electronics. The Company also
believes that each new generation of optical fiber will allow increases
in the performance of these aspects of the fiber and will result in
lower unit costs.
. 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.
In December 1999, Level 3 began carrying customer traffic between Dallas and
Houston on the first completed and lit segment of its North American intercity
network.
To support the launch of its services in the third quarter of 1998, the
Company leased intercity capacity from two providers. This leased capacity will
be displaced over time by Level 3's North American intercity network.
On July 20, 1998, Level 3 entered into a network construction cost-sharing
agreement with INTERNEXT, LLC, a subsidiary of NEXTLINK Communications, Inc.
The agreement, which is valued at $700 million, calls for INTERNEXT to acquire
the right to use 24 fibers and certain associated facilities installed along
the entire route of Level 3's North American intercity network in the United
States. INTERNEXT will pay Level 3 as segments of the intercity network are
completed which will reduce the overall cost of the network to the Company. The
network as provided to INTERNEXT will not include the necessary electronics
that allow the fiber to carry communications transmissions. Also, under the
terms of the agreement, INTERNEXT has the right to an additional conduit for
its exclusive use and to share costs and capacity in certain future fiber cable
installations in Level 3 conduits.
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The following diagram depicts the currently planned North American intercity
network when fully constructed:
[GRAPHIC OF CURRENTLY PLANNED NORTH AMERICAN INTERCITY NETWORK]
The Company expects to substantially complete its North American intercity
network by the end of the year 2000. 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.
As of December 31, 1999, the Company had completed 9,334 route miles of the
intercity network and had approximately 6,200 route miles under construction.
In Europe, the Company is deploying an approximately 4,750 mile fiber optic
intercity network with characteristics similar to those of the North American
intercity network. As in North America, the Company will provide initial
service in Europe over a leased network that will be displaced over time by the
intercity network owned by the Company.
On April 29, 1999, Level 3 announced that it had finalized contracts
relating to construction of Ring 1 of its European network in France, Belgium,
the Netherlands, Germany and the United Kingdom. Ring 1, which is approximately
1,800 miles, will connect Paris, Frankfurt, Amsterdam, Brussels and London. The
network is expected to be ready for service by September 2000. Ring 1 is part
of the approximately 4,750 mile intercity network. This European network will
be linked to the Level 3 North American intercity network by the Level 3
transatlantic 1.28 Tbps cable system currently under development, also expected
to be ready for service by September 2000.
On July 26, 1999, the Company announced two important developments of its
European network build with agreements with Eurotunnel and Alcatel. Eurotunnel
will install and supply Level 3 with multiple cross-Channel cables between the
United Kingdom and France through the high-security service tunnel. The first
of these cables will be completed by the end of the first quarter of 2000.
Subsequent cables will be installed to upgrade and expand the network as and
when required or when new fiber technology becomes available. Alcatel will
design, develop and install an undersea cable to link the Level 3 network
between the United Kingdom and Belgium. The cable system is already under
development and will be completed by the end of the first half of 2000.
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In addition, on May 4, 1999, Level 3 and COLT Telecom Group plc announced an
agreement to share costs for the construction of European networks. The
agreement calls for Level 3 to share construction costs of COLT's planned 1,600
mile intercity German network linking Berlin, Cologne, Dusseldorf, Frankfurt,
Hamburg, Munich and Stuttgart. In return, COLT will share construction costs of
Ring 1 of Level 3's planned European network.
The Company has entered into transoceanic capacity agreements that will link
Level 3's North American, European and Pacific Rim intercity networks. One
agreement provides for Level 3's participation in the construction of an
undersea cable system that will connect Japan and the United States by the end
of the year 2000. The remaining agreements relate to the Company's
transatlantic capacity. These agreements are in addition to the agreement
relating to the Company's 1.28 Tbps transatlantic undersea cable system.
In the Pacific Rim, the Company currently intends to provide service over a
leased line intercity network and long-term leases of submarine cable capacity.
In 1999, Level 3 opened its Asia Pacific headquarters in Hong Kong. On January
24, 2000, Level 3 announced two important developments of its Asian network
with the planned construction of a 2.56 Tbps undersea cable initially
connecting Hong Kong to Tokyo and gateway facilities in each city. This
connection between Hong Kong and Tokyo is intended to be the first stage in the
construction by Level 3 of an undersea network in the region and is scheduled
for completion in the second quarter of 2001.
Local Market Infrastructure. The Company's local facilities include fiber
optic networks, in a SONET ring configuration, connecting Level 3's intercity
network gateway sites to ILEC and CLEC central offices, long distance carrier
POPs, buildings housing communication-intensive end users and Internet peering
and transit facilities.
The Company had secured approximately 3.4 million square feet of space for
its gateway facilities as of December 31, 1999 and had completed the buildout
of approximately 1.3 million square feet of this space. The Company's gateway
facilities are being designed to house local sales staff, operational staff,
the Company's transmission and Internet Protocol routing/switching facilities
and technical space to accommodate colocation 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 through dual, fault tolerant connections.
The Company is offering private line, (3)Voice, colocation services, Internet
access and managed modem at its gateway sites. The availability of these
services varies by location.
As of December 31, 1999, the Company had operational facilities based local
metropolitan networks in 22 U.S. markets and 3 European markets. Also, as of
December 31, 1999, the Company had entered into interconnection agreements with
RBOCs covering 49 markets.
The Company has negotiated master leases with several 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.
The launches of services in London and Frankfurt followed the Company's
acquisitions of BusinessNet Limited, a leading UK ISP, in January 1999 and
miknet Internet Based Services GmbH, a leading German ISP, in September 1998.
In addition, in June 1999, the Company completed the construction of its
metropolitan network in the City of London. The Company launched its
international gateway in London in January 1999 and Paris, Amsterdam and
Frankfurt in June 1999. The 75,000 square foot office and operations facility
in London is the hub of European operations and houses the operational center
and network equipment, along with additional space for expansion and colocation
services. In addition, in July 1999, Level 3 acquired a building with an
additional approximately 263,000 square feet of space to serve as colocation
technical space in London. The Company is currently offering services in and
among London, Paris, Amsterdam and Frankfurt.
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Communications 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 is building 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.
As the Business Plan is being implemented, the Company is offering a
comprehensive range of communications services, including the following:
. Transport Services. The Company's transport services consist of private
line and special access services and long-term leases of dark fiber and
conduits.
[_] Private Line and Special Access. Private line and special access
services are established as a permanent physical connection between
locations for the exclusive use of the customer. The Company is
offering the following types of private line and special access
services:
. Private Line. This type of link is a dedicated line connecting
two end-user locations for voice and data applications, including
ISPs.
. 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.
The Company is currently offering its special access and private
line services with available transmission speeds from T1 to OC3 and
OC48.
[_] Dark Fiber and Conduits. The Company is offering dark fiber and conduit
along its local and intercity networks on a long-term lease basis.
Customers can lease dark fiber and conduit in any combination of three
ways: (1) segment by segment, (2) full ring or (3) the entire Level 3
network. Level 3 offers colocation space in its gateway and intercity
retransmission facilities to these customers for their transmission
electronics. Although Level 3 will not be responsible for the management
of the transmission electronics, Level 3 is contemplating providing
installation and maintenance services for this equipment on a fee for
service basis.
. Colocation. The Company is offering 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 colocation 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 operational colocation sites, the Company is
offering customers AC/DC power, optional UPS power, emergency back-up
generator power, HVAC, fire protection and security. Level 3 is also
offering high-speed, reliable connectivity to the Level 3 leased network
and other networks, including both local and wide area networks, the
PSTN and Internet. These sites are being monitored and maintained 24
hours a day, seven days a week.
Level 3 is offering customers, including ISPs, the opportunity to
colocate their web-server computers at the Company's larger gateway
sites, enabling them to take advantage of the marketing, customer
service, internal company information networks ("intranets") and other
benefits offered by such web presence. By colocating its web-server in a
Level 3 facility, a customer has 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 is responsible for maintaining the
content and performance of its server, the Company's technicians will be
available to monitor basic server operation. The Company will also offer
redundant infrastructure consisting of multiple routers and connections
to Internet backbones.
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. Internet Access. The Company is offering Internet access to business
customers, other carriers and ISPs. These services include high-capacity
Internet connections ranging from 45 Mbps to 1,000 Mbps.
. Managed Modem. The Company is offering to its customers an outsourced,
turn-key infrastructure solution for the management of dial up access to
either the public Internet or a corporate data network that may include
access to the public Internet ("Managed Modem"). This service was the
first offered by the Company that used softswitch technology to
seamlessly interconnect to the PSTN. While ISPs are provided a fully
managed dial-up network infrastructure for access to the public
Internet, corporate customers that purchase Managed Modem services
receive connectivity for remote users to support data applications such
as telecommuting, e-mail retrieval, and client/server applications. For
Managed Modem customers, Level 3 arranges for the provision of local
network coverage, dedicated local telephone numbers (which the Managed
Modem customer distributes to its customers in the case of an ISP or to
its employees in the case of a corporate customer), racks and modems as
well as dedicated connectivity from the customer's location to the Level
3 gateway facility. Level 3 also provides monitoring of this
infrastructure 24 hours a day, seven days a week. By providing a turn-
key infrastructure modem solution, Level 3 believes that this product
allows its customers to save both capital and operating costs.
. Voice. During December 1999, Level 3 commercially launched (3)Voice, its
Internet Protocol based long distance service, which uses softswitch
technology. This long distance service is currently available in 10
markets. The Company expects to begin commercial testing of some
features associated with local service, such as caller ID, voice mail
and call forwarding, during the first quarter of 2000. Customers access
(3)Voice long distance service by using existing telephone equipment and
dialing procedures. The Company believes that (3)Voice long distance
service is offered at a quality level equal to that of the PSTN.
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 Company's systems integration services
help customers define, develop and implement cost-effective information
services. 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. PKSIS believes that it is able to utilize its expertise
and 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.
PKSIS 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 Internet Protocol networks. PKSIS 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.
Distribution Strategy
Level 3's distribution strategy is to utilize a direct sales force focused
on communications intensive and web centric businesses. These businesses
include ISPs, application service providers, content providers, systems
integrators, next generation carriers, web-hosting companies, streaming media
companies and Internet Protocol
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based storage providers. Level 3 believes that these companies are the most
significant drivers of bandwidth demand. The past distinctions between retail
and wholesale have been blurred as these communications intensive and web
centric businesses purchase Level 3 services, add value to our services and
then remarket the services to end-users. Bandwidth constitutes a significant
portion of these companies' cost structure and their needs for bandwidth in
many cases are growing at an exponential rate. Providing continually declining
bandwidth costs to these companies is at the core of Level 3's market enabling
strategy.
Level 3 expects that approximately 85% of its sales will be to web centric
customers that package communications services into value added services and
directly sell into the residential and business markets. The remaining
approximately 15% of Level 3's sales will be to other customers that are
communications intensive and have high growth in communications and information
services consumption. Level 3 has segmented its sales organization into four
channels to implement this distribution strategy. These include a
Regional/Account Sales Group, a Carrier Sales Group and a Dark Fiber Sales
Group.
Business Support System
In order to pursue its sales and 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, scalable
business support system, 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 has developed a business support system architecture intended to
maximize both reliability and scalability. See "Risk Factors--Our Business Plan
requires the development of effective business support systems to implement
customer orders and to provide and bill for services."
Key design aspects of the business support system development program are:
. integrated modular applications to allow the Company to upgrade specific
applications as new products are available;
. a scalable architecture that allows 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 Level 3's enterprise resource planning suites.
The first four releases of the business support system have been delivered
and contain functionality necessary to support the set of services presently
offered. See "--Communications and Information Services."
Interconnection and Peering
As a result of 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."
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As of December 31, 1999, the Company had entered into interconnection
agreements covering 49 markets. The Company may be required to negotiate new or
renegotiate existing interconnection agreements as Level 3 expands its
operations in current and additional markets in the future and as existing
agreements expire or are terminated.
Peering agreements between the Company and ISPs are necessary in order for
the Company to exchange traffic with those ISPs without having to pay transit
costs. The Company has peering arrangements with approximately 90 domestic ISPs
and approximately 50 international ISPs and is currently purchasing transit
from one major ISP. 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. In order to
maintain certain of its peering relationships, Level 3 will have to meet these
more restrictive criteria.
Employee Recruiting and Retention
As of December 31, 1999, Level 3 had 3,175 employees in the communications
portion of its business and PKSIS had approximately 681 employees, for a total
of 3,856 employees. The Company believes that its ability to implement the
Business Plan will depend in large part on its ability to attract and retain
substantial numbers of additional qualified employees. 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 relocation to new
facilities 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 the cash 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--We may be
unable to hire and retain sufficient qualified personnel; the loss of any of
our key executive officers could adversely affect us."
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 employees. 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 its common stock. The Shareworks
program also provides that, subject to satisfactory Company performance, the
Company's employees will be eligible annually for grants by the Company of its
restricted common stock of up to 3% of the employees' compensation, which
shares will vest three years from the employee's initial grant date.
The Company has adopted the OSO program, which differs from LTI programs
generally adopted by the Company's competitors that make employees eligible for
conventional non-qualified stock options ("NQSOs"). While widely adopted, the
Company believes such NQSO programs reward 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 employees a success-based reward balancing the associated risk.
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The OSO program was designed by the Company so that its stockholders receive
a market related return on their investment before OSO holders receive any
return on their options. The Company believes that the OSO program aligns
directly employees' and stockholders' interests by basing stock option value on
the Company's ability to outperform the market in general, as measured by 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 our common stock outperforms
the S&P 500 Index. Participants in the OSO program do not realize any value
from options unless our common stock price outperforms the S&P 500 Index. To
the extent that our 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 of the Construction Group from its other
businesses, the Company adopted the recognition provisions of 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. The adoption of SFAS No. 123 resulted
in non-cash charges to operations of $126 million in 1999 and $39 million in
1998 and will continue to result in non-cash charges to operations for future
periods that the Company believes will also be material. 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 are IXCs, ILECs and CLECs. Most of these competitors have a
significant base of customers for whom they are currently providing colocation
services. Due to the high costs to CLECs of switching colocation sites, the
Company may have a competitive disadvantage relative to these competitors. The
market for the colocation of web-servers is extremely competitive. In this
market, the Company competes with ISPs and many others, including Exodus,
GlobalCenter and Qwest.
For voice services, the Company will compete primarily with national and
regional network providers. AT&T, Sprint, MCI WorldCom and Qwest currently own
nationwide long distance fiber optic networks. Significant new competitors
could arise as a result of increased consolidation and strategic alliances in
the industry resulting from recent Congressional and FCC actions. MCI WorldCom
has entered into an agreement to acquire Sprint. In Europe, GTS, MCI WorldCom
and Viatel currently own intercity networks. Qwest's network as well as the
intercity networks being deployed by others, including Broadwing and Williams
Communications in the United States and KPNQwest, i-21 and Global Crossing in
Europe, use advanced technology similar to that of the Level 3 network and
offer significantly more capacity to the marketplace. Increased capacity 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. Interexchange Carriers and certain CLECs with excess fiber optic
strands may be competitors in the dark fiber business. In the long distance
market, the Company's primary competitors will include AT&T, MCI WorldCom,
Sprint and Qwest, 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. Bell Atlantic was recently authorized to conduct in-
region long distance service in New York. SBC has filed an application to
conduct such service in Texas. These providers are also competitors in the
provision of internet access. In local markets the Company will compete with
ILECs and CLECs, many of whom have extensive experience in the local market.
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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 and information 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
recently obtained FCC approval to land its transatlantic cable in the U.S. The
Company has obtained FCC authorization to provide international services on a
facilities and resale basis. The Company has filed tariffs for its interstate
and international long distance services with the FCC.
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.
. 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 and at prices based on cost (which
may include a reasonable profit). At the option of the carrier seeking
interconnection, colocation of the requesting carrier's equipment in an
ILEC's premises must be offered, except where the ILEC can demonstrate
space limitations or other technical impediments to colocation.
. Unbundled Access. Requires all ILECs to provide nondiscriminatory access
to specified unbundled network elements (including certain network
facilities, equipment, features, functions, and capabilities) at any
technically feasible point within their networks, on nondiscriminatory
terms and at prices based on cost (which may include a reasonable
profit).
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. Number Portability. Requires all ILECs and CLECs to permit, to the
extent technically feasible, 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. Even
when an agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunications 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. The United States Court of Appeals for the Eighth Circuit (the
"Eighth Circuit") vacated certain portions of the Interconnection Decision. On
January 25, 1999, the Supreme Court reversed the Eighth Circuit with respect to
the FCC's jurisdiction to issue regulations governing local interconnection
pricing (including regulations governing reciprocal compensation). The Supreme
Court also found that the FCC had authority to promulgate a "pick and choose"
rule and upheld most of the FCC's rules governing access to unbundled network
elements. The Supreme Court, however, remanded to the FCC the standard by which
the FCC identified the network elements that must be made available on an
unbundled basis.
On November 5, 1999, the FCC released an order largely retaining its list of
unbundled network elements but eliminating the requirement that ILECs provide
unbundled access to local switching for customers with four or more lines in
the densest portion of the top 50 Metropolitan Statistical Areas, and the
requirement to unbundle operator services and directory assistance.
The Eighth Circuit decisions and their recent reversal by the Supreme Court
continue to cause uncertainty about the rules governing the pricing, terms and
conditions of interconnection agreements. The Supreme Court's action in
particular may require or trigger the renegotiation of existing agreements.
Although state public utilities commissions have continued to conduct
arbitrations, and to implement and enforce interconnection agreements during
the pendency of the Eighth Circuit proceedings, the Supreme Court's recent
ruling and further proceedings on remand (either at the Eighth Circuit or the
FCC) may affect the scope of state commissions' authority to conduct such
proceedings or to implement or enforce interconnection agreements. They could
also result in new or additional rules being promulgated by the FCC. Given the
general uncertainty surrounding the effect of the Eighth Circuit decisions and
the recent decision of the Supreme Court reversing them, the Company may not be
able to continue to obtain or enforce interconnection terms that are acceptable
to it or that are consistent with its business plans.
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.
Recently, the FCC approved Bell Atlantic's
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petition to offer long distance service in New York. SBC has filed an
application to conduct such service in Texas. The Telecom Act permitted the
RBOCs to enter the out-of-region long distance market immediately upon its
enactment.
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. The FCC has made
major changes in the interstate access charge structure. In a December 24, 1996
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. On August 5, 1999 the FCC
adopted an order granting price cap LECs additional pricing flexibility,
implementing certain access charge reforms and seeking comments on others. The
order provides certain immediate regulatory relief to price cap carriers and
sets a framework of "triggers" to provide those companies with greater pricing
flexibility to set interstate access rates as competition increases. The order
also initiated a rulemaking to determine whether the FCC should regulate the
access charges of CLECs. 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. A May 16, 1997 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. Several
parties appealed the May 16th order. On August 19, 1998, the Eighth Circuit
upheld the FCC's access charge reform rules.
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 for the transport and termination of such calls. To
date, thirty-six state commissions have ruled on this issue in the context of
state commission arbitration proceedings or enforcement proceedings. In thirty-
three states, to date, the state commission has determined that reciprocal
compensation is owed for such calls. Several of these cases are presently on
appeal. Reviewing courts have upheld the state commissions in eight decisions
rendered to date on appeal. Appeals from these decisions are pending in the
Fourth and Fifth U.S. Circuit Courts of Appeal. The Seventh Circuit upheld the
Illinois Commerce Commission decision on June 18, 1999. On February 25, 1999,
the FCC issued a Declaratory Ruling on the issue of inter-carrier compensation
for calls bound to ISPs. The FCC ruled that the calls are largely
jurisdictionally interstate calls, not local calls. The FCC, however,
determined that this issue was not dispositive of whether inter-carrier
compensation is owed. The FCC noted a number of factors which would allow the
state commissions to leave their decisions requiring the payment of
compensation undisturbed. The Company cannot predict the effect of the FCC's
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ruling on existing state decisions, or the outcome of pending appeals or of
additional pending cases. The Ninth Circuit dismissed an appeal of a Washington
decision on the ground that it constituted a collateral attack on the FCC's
ruling. The FCC also issued proposed rules to address inter-carrier
compensation in the future.
The Company recently entered into an agreement with Bell Atlantic which
establishes rates for transmission of local and Internet bound traffic.
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 Internet Protocol 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 Internet Protocol telephony appear to have similar
functionality to non-Internet Protocol telecommunications services and lack the
characteristics that would render them information services. If the FCC were to
determine that certain Internet Protocol 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-Internet Protocol based telecommunications service
providers. The FCC also noted that other forms of Internet Protocol 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, 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 and recently
doubled the size of the high cost fund for non-rural LECs. 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. The
Company is currently unable to quantify the amount of subsidy payments 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 uncertainties concerning the classification of its services.
The
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Fifth Circuit Court of Appeals recently upheld the FCC in most respects, but
rejected the FCC's effort to base contributions on intrastate revenues. 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.
The FCC recently adopted new rules designed to make it easier and less
expensive for CLECs to obtain colocation at ILEC central offices by, among
other things, restricting the ILEC's ability to prevent certain types of
equipment from being colocated and requiring ILECs to offer alternative
colocation arrangements which will be less costly.
On November 18, 1999, the FCC adopted a new order requiring ILECs to provide
line sharing, which will allow CLECs to offer data services over the same line
the consumer uses for voice services without the CLECs being required to offer
the voice services. State commissions have been authorized to establish the
prices to the CLECs for such services. The decision has been appealed.
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 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. 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 currently is authorized to
provide telecommunications services in all fifty states and the District of
Columbia, other than Alaska.
The Company has a pending application for authority to provide
telecommunications services in Alaska. In addition, the Company has filed an
application with the California Public Utilities Commission to expand the
Company's network within that state. While approval of the application is
expected by mid-2000, the Company cannot predict how quickly the Commission
will act and whether any such delays will affect its ability to complete the
network.
States also often require prior approvals or notifications for certain
transfers of assets, customers or ownership of certificated carriers and for
issuances by certified carriers of equity or debt.
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 privately and
publicly owned land. Rights-of-way that are not already secured may not be
available to the Company on economically reasonable or advantageous terms.
Canadian Regulation
The Canadian Radio-television and Telecommunications Commission (the "CRTC")
generally regulates long distance telecommunications services in Canada.
Regulatory developments over the past several years
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have terminated the historic monopolies of the regional telephone companies,
bringing significant competition to this industry for both domestic and
international long distance services, 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 former 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 or from a third country, the CRTC recently lifted this restriction. The
Teleglobe monopoly on international services and submarine cable landing rights
terminated as of October 1, 1998, although the provision of Canadian
international transmission facilities-based services remains restricted to
"Canadian carriers" with majority ownership by Canadians. Ownership of non-
international transmission facilities are limited to Canadian carriers but the
Company can own international submarine cables landing in Canada. The Company
cannot, under current or foreseen law, enter the Canadian market as a provider
of transmission facilities-based domestic services. Recent CRTC rulings address
issues such as the framework for international contribution charges payable to
the local exchange carriers to offset some of the capital and operating costs
of the provision of switched local access services of the incumbent regional
telephone companies, in their capacity as ILECs, and the new entrant CLECs.
While competition is permitted in virtually all 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 of the regional
telephone companies except SaskTel (although Saskatchewan has subsequently
allowed local service competition in that province). As a result, networks
operated by CLECs may now be interconnected with the networks of the ILECs.
Transmission facilities-based CLECs are subject to the same majority Canadian
ownership "Canadian carrier" requirements as transmission 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 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, notably unbundled local loops in large, urban areas. ILECs,
which, unlike CLECs, remained fully regulated, will be subject to price cap
regulation in respect of their utility services for an initial four-year period
beginning May 1, 1997, and these services must not be priced below cost.
Interexchange 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 colocate equipment in ILEC central
offices pursuant to terms and conditions of tariffs and intercarrier
agreements. Certain local competition issues are still to be resolved. The CRTC
has ruled that resellers cannot be classified as CLECs, and thus are not
entitled to CLEC interconnection terms and conditions.
The Company's Other Businesses
The Company's other businesses include its investment in the C-TEC Companies
(as defined), coal mining, the SR91 Tollroad (as defined) and certain other
assets. In 1998, the Company completed the sale of its interests in United
Infrastructure Company, MidAmerican and Kiewit Investment Management Corp.
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C-TEC Companies
On September 30, 1997, C-TEC completed a tax-free restructuring, which
divided C-TEC into three public companies (the "C-TEC Companies"): C-TEC, which
changed its name to Commonwealth Telephone, RCN and 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 Holding Company with a
liquidation value of approximately $499 million as of December 31, 1999. 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 291,000 main access lines. Commonwealth Telephone also provides
network access and long distance services to IXCs. Commonwealth Telephone's
business customer base is diverse in size as well as industry, with very little
concentration. A subsidiary, 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
December 31, 1999, the C-TEC Holding Company owned approximately 47.9% of the
outstanding common stock of Commonwealth Telephone.
On October 23, 1998, Commonwealth Telephone completed a rights offering of
3.7 million shares of its common stock. In the offering, Level 3 exercised all
rights it received and purchased approximately 1.8 million additional shares of
Commonwealth Telephone common stock for an aggregate subscription price of
$37.7 million.
RCN. RCN is a full service provider of local, long distance, Internet 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. and San Francisco to San Diego corridors. 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 December 31, 1999, the C-TEC Holding Company owned approximately 34.5% of
the outstanding common stock of RCN.
Cable Michigan. Cable Michigan was 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. On June
4, 1998, Cable Michigan announced that it had agreed to be acquired by Avalon
Cable. Level 3 received approximately $129 million in cash when the transaction
closed on November 6, 1998.
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 Peter Kiewit Sons', Inc. ("New PKS"). Decker
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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--Environmental liabilities from our historical operations could be
material," "--Significant future declines in cash flow from coal operations"
and "--Potential liabilities and claims arising from our coal operations could
be significant."
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 95% of sales are made under long-term contracts, and the
remainder are made on the spot market. Approximately 75%, 77% and 79% of KCP's
revenues in 1999, 1998 and 1997 respectively, were derived from long-term
contracts with Commonwealth Edison Company (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 for 1999
was $33 million.
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 1997, KCP's production
represented 1.4% 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 Company 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 for the year ended December 31, 1999 was approximately $7
million. KCP's share of accrued estimated reclamation costs was $100 million at
December 31, 1999. The Company did not make significant capital expenditures
for environmental compliance
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with respect to the coal business in 1999. 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, and financial condition.
SR91 Tollroad
The Company has invested $12.9 million for a 65% equity interest and lent
$6.4 million to California Private Transportation Company L.P. ("CPTC"), which
developed, financed, and currently operates the 91 Express Lanes, a ten mile,
four-lane tollroad in Orange County, California (the "SR91 Tollroad"). 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 defaults by Level 3 on its outstanding debt and
certain judgments 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 SR91 Tollroad opened in
December 1995 and achieved operating break-even in 1996. Approximately 93,900
customers have registered to use the tollroad as of December 31, 1999, and
weekday volumes typically exceed 21,600 vehicles per day during December 1999.
Legal Proceedings
In August 1999, the Company was named as a defendant in Schweizer vs. Level
3 Communications, Inc., et al., a purported national class action, filed in the
District Court, County of Boulder, State of Colorado which involves the
Company's right to install its fiber optic cable network in easements and
right-of-ways crossing the plaintiffs' land. In general, the Company obtained
the rights to construct its network from railroads, utilities, and others, and
is installing its network along the rights-of-way so granted. Plaintiffs in the
purported class action assert that they are the owners of lands over which the
Company's fiber optic cable network passes, and that the railroads, utilities,
and others who granted the Company the right to construct and maintain its
network did not have the legal ability to do so. The action purports to be on
behalf of a national class of owners of land over which the Company's network
passes or will pass. The complaint seeks damages on theories of trespass,
unjust enrichment and slander of title and property, as well as punitive
damages. Although the Company is not aware of any additional similar claims,
the Company may in the future receive claims and demands related to rights-of-
way issues similar to the issues in the Schweizer litigation that may be based
on similar or different legal theories. Although it is too early for the
Company to reach a conclusion as to the ultimate outcome of this litigation,
management believes that the Company has substantial defenses to the claims
asserted in the Schweizer action (and any similar claims which may be named in
the future), and intends to defend them vigorously.
The Company and its subsidiaries are parties to many other legal
proceedings. Management believes that any resulting liabilities for these legal
proceedings, beyond amounts reserved, will not materially affect the Company's
financial condition, future results of operations, or future cash flows.
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MANAGEMENT
Directors and Executive Officers
Set forth below is information as of February 1, 2000 about each director
and each executive officer of the Company. The executive officers of the
Company have been determined in accordance with the rules of the SEC.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Walter Scott, Jr........ 68 Chairman of the Board
James Q. Crowe.......... 50 President, Chief Executive Officer and Director
R. Douglas Bradbury..... 49 Executive Vice President, Chief Financial Officer and Director
Kevin J. O'Hara......... 39 Executive Vice President and Chief Operating Officer
Colin V.K. Williams..... 60 Executive Vice President
Stephen C. Liddell...... 38 Group Vice President
Kathleen A. Perone...... 46 Group Vice President
Gail P. Smith........... 40 Group Vice President
Philip B. Fletcher...... 66 Director
William L. Grewcock..... 74 Director
Richard R. Jaros........ 47 Director
Robert E. Julian........ 60 Director
David C. McCourt........ 43 Director
Kenneth E. Stinson...... 57 Director
Michael B. Yanney....... 66 Director
</TABLE>
Other Management
Set forth below is information as of February 1, 2000, about the following
members of senior management of the Company.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Jimmy D. Byrd........... 39 President and Chief Executive Officer of PKSIS
Linda J. Adams.......... 43 Group Vice President
Daniel P. Caruso........ 36 Group Vice President
Sureel A. Choksi........ 27 Group Vice President and Treasurer
Donald H. Gips.......... 40 Group Vice President
Joseph M. Howell, III... 53 Group Vice President
Michael D. Jones........ 42 Group Vice President
Thomas C. Stortz........ 48 Group Vice President, General Counsel and Secretary
Ronald J. Vidal......... 39 Group Vice President
John F. Waters, Jr...... 34 Group Vice President
</TABLE>
Walter Scott, Jr. has been the Chairman of the Board of the Company since
September 1979, and a director of the Company since April 1964. Mr. Scott has
been Chairman Emeritus of New PKS since the split-off. Mr. Scott is also a
director of New PKS, Berkshire Hathaway Inc., Burlington Resources Inc.,
MidAmerican, ConAgra, Inc., Commonwealth Telephone, RCN, U.S. Bancorp and
Valmont Industries, Inc.
James Q. Crowe has been the President and Chief Executive Officer of the
Company since August 1997, and a director of the Company since June 1993. Mr.
Crowe was President and Chief Executive Officer of MFS from June 1993 to June
1997. Mr. Crowe also served as Chairman of the Board of WorldCom from January
1997 until July 1997, and as Chairman of the Board of MFS from 1992 through
1996. Mr. Crowe is presently a director of New PKS, Commonwealth Telephone, RCN
and InaCom Communications, Inc.
R. Douglas Bradbury has been Executive Vice President and Chief Financial
Officer of the Company since August 1997, and a director of the Company since
March 1998. Mr. Bradbury served as Chief Financial Officer of MFS from 1992 to
1996, Senior Vice President of MFS from 1992 to 1995, and Executive Vice
President of MFS from 1995 to 1996.
Kevin J. O'Hara has been Executive Vice President of the Company since
August 1997, and Chief Operating Officer of the Company since March 1998. Prior
to that, Mr. O'Hara served as President and Chief
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Executive Officer of MFS Global Network Services, Inc. from 1995 to 1997, and
as Senior Vice President of MFS and President of MFS Development, Inc. from
October 1992 to August 1995. From 1990 to 1992, he was a Vice President of MFS
Telecom, Inc. ("MFS Telecom").
Colin V.K. Williams has been Executive Vice President of the Company since
July 1998 and President of Level 3 International, Inc. since July 1998. Prior
to joining the company, Mr. Williams was Chairman of WorldCom International,
Inc., where he was responsible for the international communications business
and the development and operation of WorldCom's fiber networks overseas. In
1993 Mr. Williams initiated and built the international operations of MFS.
Prior to joining MFS, Mr. Williams was Corporate Director, Business Development
at British Telecom from 1988 until 1992.
Stephen C. Liddell has been the Group Vice President of the Company since
February 1, 2000. Mr Liddell is responsible for the Company's Asian operations.
Prior to that, Mr. Liddell was Senior Vice President of the Company from May
1999 to February 1, 2000. Prior to that, Mr. Liddell was President, Asia-
Pacific Region at MCI-WorldCom from January 1996 to April 1999 and was Vice
President and General Manager, International Networks at MFS Communications
from July 1994 to January 1996. Mr. Liddell was Commercial Director and
Director of Planning and Business Development at Syncordia (British Telecom)
from November 1991 to July 1994 and Business Development Executive at British
Telecom from April 1989 to November 1991.
Kathleen A. Perone has been Group Vice President of the Company since
February 1, 2000. Ms. Perone is responsible for the Company's North American
operations. Prior to that, Ms. Perone was Vice President, Sales of the Company
from 1998 to February 1, 2000. Prior to that, Ms. Perone was President, Global
Services and Telecom East, of MFS/WorldCom, from 1990 to 1998 and Vice
President, National Accounts at Cable & Wireless from 1989 to 1990.
Gail P. Smith has been Group Vice President of the Company since February 1,
2000. Prior to that, Ms. Smith served as Senior Vice President, International
Sales and Marketing of the Company from December 1998 to February 1, 2000.
Prior to that, Ms. Smith was Vice President and General Manager of WorldCom
International Networks from November 1994 to July 1997 and European Marketing
Director during the start-up phase of MFS International.
Philip B. Fletcher has been a director of the Company since February 1999.
Mr. Fletcher was Chairman of the Board of ConAgra, Inc. from May 1993 until
September 1998. Mr. Fletcher was Chief Executive Officer of ConAgra, Inc. from
September 1992 to September 1997. Mr. Fletcher is a director of ConAgra, Inc.
and chairman of its executive committee.
William L. Grewcock has been a director of the Company since January 1968.
Prior to the split-off, Mr. Grewcock was Vice Chairman of the Company for more
than five years. He is presently a director of New PKS.
Richard R. Jaros has been a director of the Company since June 1993 and
served as President of the Company from 1996 to 1997. Mr. Jaros served as
Executive Vice President of the Company from 1993 to 1996 and Chief Financial
Officer of the Company from 1995 to 1996. He also served as President and Chief
Operating Officer of CalEnergy from 1992 to 1993, and is presently a director
of MidAmerican, Commonwealth Telephone and RCN.
Robert E. Julian has been a director of the Company since March 31, 1998.
Mr. Julian has also been Chairman of the Board of PKSIS since 1995. From 1992
to 1995 Mr. Julian served as Executive Vice President and Chief Financial
Officer of the Company.
David C. McCourt has been a director of the Company since March 31, 1998.
Mr. McCourt has also served as Chairman and Chief Executive Officer of
Commonwealth Telephone and RCN since October 1997. From 1993 to 1997 Mr.
McCourt served as Chairman of the Board and Chief Executive Officer of C-TEC.
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Kenneth E. Stinson has been a director of the Company since January 1987.
Mr. Stinson has been Chairman of the Board and Chief Executive Officer of New
PKS since the Split-Off. Prior to the Split-Off, Mr. Stinson was Executive Vice
President of the Company for more than the last five years. Mr. Stinson is also
a director of ConAgra, Inc. and Valmont Industries, Inc.
Michael B. Yanney has been a director of the Company since March 31, 1998.
He has served as Chairman of the Board, President and Chief Executive Officer
of America First Companies L.L.C. for more than the last five years. Mr. Yanney
is also a director of Burlington Northern Santa Fe Corporation, RCN, Forest Oil
Corporation and Mid-America Apartment Communities, Inc.
Jimmy D. Byrd has been the President and Chief Executive Officer of PKSIS
since March 1999. Mr. Byrd was President and General Manager of the New South
Wales Office of Corporate Express, Inc. and Chief Information Officer of
Corporate Express, Inc. Australia/New Zealand from 1997 to 1999. From 1993 to
1997 he was Vice President and CIO for Temple-Inland, Inc., was a National
Sales Manager for Visual Information Technologies from 1990 to 1993 and was an
Advisory Marketing Representative for IBM from 1982 to 1990.
Linda J. Adams has been Group Vice President Human Resources of the Company
since February 1, 2000. Prior to that, Ms. Adams was Vice President Human
Resources of the Company from November 1998 to February 1, 2000. Prior to that,
Ms. Adams was initially Vice President of Human Resources Rent-A-Center, a
subsidiary of Thorn Americas, Inc., and then Senior Vice President of Human
Resources for Thorn Americas, Inc. from August 1995 until August 1998. Prior to
that, Ms. Adams was Vice President of Worldwide Compensation & Benefits for
PepsiCo, Inc. from August 1994 to August 1995.
Daniel P. Caruso has been Group Vice President Global Customer Operations of
the Company since February 1, 2000. Prior to that, Mr. Caruso served as Senior
Vice President, Network Services of the Company from October 1997 to February
1, 2000. Prior to that, Mr. Caruso was Senior Vice President, Local Service
Delivery of WorldCom from December 1992 to September 1997 and was a member of
the senior management of Ameritech from June 1986 to November 1992.
Sureel A. Choksi has been Group Vice President Corporate Development and
Treasurer of the Company since February 1, 2000. Prior to that, Mr. Choksi
served as Vice President and Treasurer of the Company from January 1999 to
February 1, 2000. Prior to that, Mr. Choksi was a Director of Finance at the
Company from 1997 to 1998, an Associate at TeleSoft Management, LLC in 1997 and
an Analyst at Gleacher Natwest from 1995 to 1997.
Donald H. Gips has been Group Vice President Sales and Marketing of the
Company since February 1, 2000. Prior to that, Mr. Gips served as Senior Vice
President, Corporate Development of the Company from November 1998 to February
1, 2000. Prior to that, Mr. Gips served in the White House as Chief Domestic
Policy Advisor to Vice President Gore from April 1997 to April 1998. Before
working at the White House, Mr. Gips was at the Federal Communications
Commission as the International Bureau Chief and Director of Strategic Policy
from January 1994 to April 1997. Prior to his government service, Mr. Gips was
a management consultant at McKinsey and Company.
Joseph M. Howell, III has been Group Vice President Corporate Marketing of
the Company since February 1, 2000. Prior to that, Mr. Howell served as Senior
Vice President, Corporate Marketing of the Company from October 1997 to
February 1, 2000. Prior to that, Mr. Howell was Senior Vice President of
MFS/WorldCom from 1993 to 1997.
Michael D. Jones has served as Group Vice President and Chief Information
Officer of the Company since February 1, 2000. Prior to that, Mr. Jones served
as Senior Vice President and Chief Information Officer of the Company from
December 1998 to February 1, 2000. Prior to that, Mr. Jones was Vice President
and Chief Information Officer of Corporate Express, Inc. from May 1994 to May
1998.
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Thomas C. Stortz has been Group Vice President, General Counsel and
Secretary of the Company since February 1, 2000. Prior to that, Mr. Stortz
served as Senior Vice President, General Counsel and Secretary of the Company
from September 1998 to February 1, 2000. Prior to that, he served as Vice
President and General Counsel of Peter Kiewit Sons', Inc. and Kiewit
Construction Group, Inc. from April 1991 to September 1998. He has served as a
director of Peter Kiewit Sons', Inc., RCN, C-TEC, Kiewit Diversified Group Inc.
and CCL Industries, Inc.
Ronald J. Vidal has been Group Vice President New Ventures and Investor
Relations of the Company since February 1, 2000. Prior to that, Mr. Vidal
served as Senior Vice President, New Ventures of the Company from October 1997
to February 1, 2000. Prior to that, Mr. Vidal was a Vice President of
MFS/WorldCom from September 1992 to October 1997. Mr. Vidal joined the Company
in construction project management in July 1983.
John F. Waters, Jr. has been Group Vice President and Chief Technology
Officer of the Company since February 1, 2000. Prior to that, Mr. Waters was
Vice President, Engineering of the Company from November 1997 until February 1,
2000. Prior to that, Mr. Waters was an executive staff member of MCI
Communications from 1994 to November 1997.
The Board is divided into three classes, designated Class I, Class II and
Class III, each class consisting, as nearly as may be possible, of one-third of
the total number of directors constituting the Board. The Class I Directors
consist of Walter Scott, Jr., James Q. Crowe and Philip B. Fletcher; the Class
II Directors consist of William L. Grewcock, Richard R. Jaros, Robert E. Julian
and David C. McCourt; and the Class III Directors consist of R. Douglas
Bradbury, Kenneth E. Stinson and Michael B. Yanney. There is one vacancy among
the Class I Directors. The term of the Class I Directors will terminate on the
date of the 2001 annual meeting of stockholders; the term of the Class II
Directors will terminate on the date of the 2002 annual meeting of
stockholders; and the term of the Class III Directors will terminate on the
date of the 2000 annual meeting of stockholders. At each annual meeting of
stockholders, successors to the class of directors whose term expires at that
annual meeting will be elected for three-year terms. The Company's officers are
elected annually to serve until each successor is elected and qualified or
until his death, resignation or removal.
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<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
beneficial ownership of our common stock, as of February 1, 2000 and as
adjusted to reflect the sale of shares in this offering (without giving effect
to the underwriters' overallotment option), by the Company's directors,
executive officers, and directors and executive officers as a group, and the
only person known by the Company to beneficially own more than 5% of the
outstanding common stock.
<TABLE>
<CAPTION>
Percent of common stock
beneficially owned
-----------------------
Number of shares of Before this After this
Name common stock+ offering is offering is
- ---- ------------------- ----------- -----------
<S> <C> <C> <C>
Walter Scott, Jr.(1).............. 33,333,958 9.8% 9.3%
James Q. Crowe(2)................. 11,006,382 3.2 3.1
R. Douglas Bradbury(3)............ 3,276,055 * *
Kevin J. O'Hara(4)................ 1,975,793 * *
Colin V.K. Williams............... 409,344 * *
Michael D. Jones (5).............. 259,311 * *
Philip B. Fletcher................ 5,000 * *
William L. Grewcock(6)............ 11,530,166 3.4 3.2
Richard R. Jaros(7)............... 3,502,236 1.0 1.0
Robert E. Julian(8)............... 3,998,434 1.2 1.1
David C. McCourt(9)............... 119,738 * *
Kenneth E. Stinson(10)............ 729,231 * *
Michael B. Yanney(11)............. 114,599 * *
Directors and Executive Officers
as a Group (16 persons)(12)...... 70,732,152 20.6 19.9
Donald L. Sturm(13)............... 18,373,750 5.4 5.1
</TABLE>
- --------
* Less than 1%.
+ Included in this table are the number of shares of common stock issuable
upon exercise of Outperform Stock Options, which are exercisable within 60
days. The value of the Outperform Stock Options is dependent upon the extent
to which the Company's common stock has outperformed the results of the S&P
500. The number of shares of common stock issuable upon exercise of an
Outperform Stock Option has been calculated based upon the closing price of
the Company's common stock on February 1, 2000. The number of shares
issuable upon exercise of an Outperform Stock Option is therefore subject to
changes in the extent to which the Company's common stock has outperformed
the results of the S&P 500 and the Company's common stock closing price.
(1) Includes 99,700 shares of common stock held by the Suzanne Scott
Irrevocable Trust as to which Mr. Scott shares voting and investment powers
and 383,502 shares of common stock issuable upon conversion of $25 million
in principal amount of our 6% convertible subordinated notes that Mr. Scott
holds.
(2) In May 1999, Mr. Crowe announced that he had contributed 1,000,000 shares
of common stock to a trust of which he is the sole beneficiary and that,
beginning on May 10, 1999, the trust would sell 4,000 shares each trading
day until all the shares held by the trust were sold. The information in
the above table includes the remaining 292,000 shares of common stock held
by that trust. Includes 386,768 shares of common stock subject to vested
Outperform Stock Options.
(3) Includes 500,000 shares of common stock subject to vested non-qualified
stock options and 120,865 shares of common stock subject to vested
Outperform Stock Options.
(4) Includes 46,000 shares of common stock held by Kevin J. O'Hara Family LTD
Partnership. Includes 250,000 shares of common stock subject to vested non-
qualified stock options and 120,865 shares of common stock subject to
vested Outperform Stock Options.
(5) Includes 170,000 shares of common stock subject to vested non-qualified
stock options and 84,606 shares of common stock subject to vested Outperform
Stock Options.
S-66
<PAGE>
(6) Includes 1,154,640 shares of common stock held by Grewcock Family Limited
Partnership. Includes 351,230 shares of common stock held by the Bill &
Berniece Grewcock Foundation as to which Mr. Grewcock shares voting and
investment powers. Includes 4,738 shares of common stock subject to vested
Outperform Stock Options.
(7) Includes 370,000 shares of common stock held by the Jaros Family Limited
Partnership. Includes 4,738 shares of common stock subject to vested
Outperform Stock Options. Includes 1,269,500 shares of common stock held by
Mr. Jaros and 730,000 shares of common stock subject to options held by a
grantor trust, of which Mr. Jaros is the residual beneficiary. See "Certain
Transactions and Relationships."
(8) Includes 4,854 shares of common stock subject to vested Outperform Stock
Options.
(9) Includes 4,738 shares of common stock subject to vested Outperform Stock
Options.
(10) Includes 4,738 shares of common stock subject to vested Outperform Stock
Options.
(11) Includes 4,854 shares of common stock subject to vested Outperform Stock
Options.
(12) Includes 771,971 shares of common stock subject to vested non-qualified
stock options and 661,100 shares of common stock subject to vested
Outperform Stock Options.
(13) Mr. Sturm's business address is 3033 East First Avenue, Denver, Colorado
80206. Based solely on Mr. Sturm's Schedule 13D dated May 5, 1998,
adjusted for a subsequent stock dividend, Mr. Sturm owns 15,610,310 shares
of common stock, and has voting and investment power with respect to
2,613,440 shares held by trusts and partnerships established for family
members and beneficially owns 150,000 shares as a member of the board of
directors of the University of Denver.
S-67
<PAGE>
CERTAIN TRANSACTIONS AND RELATIONSHIPS
Certain Relationships and Related Transactions
All share information has been adjusted to reflect the Company's 2-for-1
stock split, effected as a stock dividend in August 1998.
In connection with his retention as Chief Executive Officer of the Company,
Mr. Crowe entered into an engagement agreement (the "Engagement Agreement")
with the Company. Under the Engagement Agreement, the Company acquired from Mr.
Crowe, Mr. Bradbury and an additional individual, Broadband Capital Group,
L.L.C., a company formed to develop investment opportunities, for a purchase
price of $68,523, the owners' cash investment in that company. Pursuant to the
Engagement Agreement, the Company sold 10,000,000 shares of the Company's
former Class D Diversified Group Convertible Exchangeable Common Stock, par
value $.0625 per share (the "Class D Stock") to Mr. Crowe and 2,500,000 shares
of Class D Stock to Mr. Bradbury, in each case at $5.425 per share. The
Engagement Agreement also provided that the Company would make available for
sale, from time to time prior to the consummation of the Split-off, to certain
employees of the Company designated by Mr. Crowe in connection with the
implementation of the Business Plan, up to an aggregate of 10,500,000 shares of
Class D Stock.
During 1999, Mr. Crowe entered into an agreement for the period October 1999
to October 2000 to purchase personal use of the Company's aircraft. Mr. Crowe
has agreed that the Company will charge him the cost to operate the aircraft as
allowed by Part 91 of the U.S. Federal Aviation Administration regulations for
personal use of corporate aircraft. The Company expects that the amount to be
paid by Mr. Crowe for the one-year period will be approximately $100,000.
In October 1999, Mr. Crowe paid the Company an aggregate of $74,905 for
personal use of the Company's aircraft during the preceding 12 months. This
payment was calculated based upon the U.S. Federal Aviation Administration
regulations for this type of use as adjusted pursuant to Internal Revenue
Service regulations.
In January 1999, the Company repurchased a portion of the stock of the C-TEC
Holding Company held by David C. McCourt, a director of the Company, for a
total purchase price of approximately $5.6 million. Concurrently with this
repurchase, a portion of the Company's interest in the C-TEC Holding Company
was redeemed so that Mr. McCourt's percentage ownership of the outstanding C-
TEC Holding Company common stock remains at 10%. The C-TEC Holding Company is
Level 3's subsidiary, which holds Level 3's interests in both RCN and
Commonwealth Telephone.
On September 30, 1999, a subsidiary of the Company entered into an agreement
to purchase a 15% interest in a Falcon 900 aircraft from Elk Mountain Ventures,
Inc., a company owned by Walter Scott, Jr., the Company's Chairman. The
purchase price paid for the interest in the aircraft was $2.7 million.
On July 1, 1998, the Company issued 187,706 shares of its common stock to
Mr. Colin V.K. Williams, an Executive Vice President of the Company, in
connection with the Company's acquisition of UltraLine (Bermuda) Limited, a
company owned by Mr. Williams. The value of the transaction, based upon the
trading price of its common stock on that date, was approximately $5 million.
On June 18, 1998, Level 3 entered into a contract with Peter Kiewit Sons',
Inc. for the construction of Level 3's nearly 16,000 mile North American
intercity network. Construction of the North American intercity network is
currently expected to cost an estimated $3 billion and be completed by the end
of the year 2000. Level 3 has also entered into various other agreements with
PKS including for construction activities relating to its local networks,
gateway facilities and headquarters facility in Broomfield, Colorado. For the
year ended December 31, 1999, the Company incurred the following expenses under
these agreements to PKS: $918 million relating to construction of intercity and
local networks as well as gateway construction; $102 million for construction
of the Company's headquarters facility; and $4 million for miscellaneous
construction projects. PKS has the opportunity to earn a significant award fee
with respect to the construction of the intercity network, the amount of which
will be based on cost and speed of construction, quality, safety and program
S-68
<PAGE>
management. The award fee will be determined by Level 3's assessment of PKS'
performance in each of these areas. In 1999, the Company accrued approximately
$35 million toward the award fee, which is included in the $918 million
indicated above.
In connection with the Split-off, Level 3 and PKS entered into various
agreements intended to implement the Split-off, including a separation
agreement and a tax-sharing agreement.
Separation Agreement. Level 3 and PKS entered into a separation agreement
(the "Separation Agreement") relating to the allocation of certain risks and
responsibilities between PKS and Level 3 after the Split-off and certain other
matters. The Separation Agreement provides that each of PKS and Level 3 will
indemnify the other with respect to the activities of its subsidiary business
groups, except as specifically provided under other agreements between the
companies. The cross-indemnities are intended to allocate financial
responsibility to PKS for liabilities arising out of the construction
businesses formerly conducted by Level 3, and to allocate to Level 3 financial
responsibility for liabilities arising out of the non-construction businesses
conducted by Level 3. The Separation Agreement also allocates between PKS and
Level 3 certain corporate-level risk exposures not readily allocable to either
the construction businesses or the non-construction businesses.
The Separation Agreement provides that each of Level 3 and PKS will be
granted access to certain records and information in the possession of the
other company, and requires that each of Level 3 and PKS retain all such
information in its possession for a period of ten years following the Split-
off. Under the Separation Agreement, each company is required to give the other
company prior notice of any intention to dispose of any such information.
The Separation Agreement provides that, except as otherwise set forth
therein or in any related agreement, costs and expenses in connection with the
Split-off will be paid 82.5% by Level 3 and 17.5% by PKS. On March 18, 1998,
Level 3 and PKS entered into an amendment to the Separation Agreement that
provides that PKS will bear substantially all of those expenses if the Level 3
Board determined to force conversion of all outstanding Class R Stock of Level
3 on or before July 15, 1998 (a "Forced Conversion Determination").
The Level 3 Board made such a determination and, accordingly, substantially
all of those expenses will be borne by PKS.
Tax Sharing Agreement. Level 3 and PKS have entered into a tax sharing
agreement (the "Tax Sharing Agreement") that defines each company's rights and
obligations with respect to deficiencies and refunds of federal, state and
other taxes relating to operations for tax years (or portions thereof) ending
prior to the Split-off and with respect to certain tax attributes of Level 3
and PKS after the Split-off. Under the Tax Sharing Agreement, with respect to
periods (or portions thereof) ending on or before the Split-off, Level 3 and
PKS 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 business and the construction business, respectively.
The Tax Sharing Agreement also provides that Level 3 and PKS will indemnify
the other from certain taxes and expenses that would be assessed on PKS and
Level 3, respectively, 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 PKS, respectively, of certain representations made to the Internal Revenue
Service in connection with the private letter ruling issued with respect to the
Split-off. Under the Tax Sharing Agreement, if the Split-off were determined to
be taxable for any other reason, those taxes and certain other taxes associated
with the Split-off (together, "Split-off Taxes") would be allocated 82.5% to
Level 3 and 17.5% to PKS. The Tax Sharing Agreement, however, provides that
Split-off Taxes will be allocated one-half to each of Level 3 and PKS if a
Forced Conversion Determination is made. As a result of the Forced Conversion
Determination, the Split-off Taxes would be so allocated. Finally, the Tax
Sharing Agreement provides, under certain circumstances, for certain liquidated
damage payments from Level 3 to PKS if the Split-off were determined to be
taxable, which are intended to compensate stockholders of PKS indirectly for
taxes assessed upon them in that event. Those liquidated damage payments,
however, are reduced because of the Forced Conversion Determination.
S-69
<PAGE>
Mine Management Agreement. In 1992, PKS and Level 3 entered into a mine
management agreement (the "Mine Management Agreement") pursuant to which a
subsidiary of PKS, Kiewit Mining Group Inc. ("KMG"), provides mine management
and related services for Level 3's coal mining properties. In consideration of
the provision of such services, KMG receives a fee equal to thirty percent of
the adjusted operating income of the coal mining properties. The term of the
Mine Management Agreement expires on January 1, 2016.
In connection with the Split-off, the Mine Management Agreement was amended
to provide KMG 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 KMG at
the price that Level 3 would seek to sell the properties to a third party. If
KMG 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 KMG an
amount equal to the discounted present value to KMG of the Mine Management
Agreement, determined, if necessary, by an appraisal process.
S-70
<PAGE>
CERTAIN UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS
A general discussion of certain United States federal income and estate tax
consequences of the acquisition, ownership and disposition of common stock
applicable to Non-U.S. Holders (as defined) of common stock is set forth below.
In general, a "Non-U.S. Holder" is a person other than: (i) a citizen or
resident (as defined for United States federal income or estate tax purposes,
as the case may be) of the United States; (ii) a corporation or other entity
taxable as a corporation organized in or under the laws of the United States or
a political subdivision thereof; (iii) an estate the income of which is subject
to United States federal income taxation regardless of its source, or (iv) a
trust if and only if (A) a court within the United States is able to exercise
primary supervision over the administration of the trust and (B) one or more
United States trustees have the authority to control all substantial decisions
of the trust. The discussion is based on current law and is provided for
general information only. The discussion does not address aspects of United
States federal taxation other than income and estate taxation and does not
address all aspects of federal income and estate taxation. The discussion does
not consider any specific facts or circumstances that may apply to a particular
Non-U.S. Holder and does not address all aspects of United States federal
income and estate tax laws that may be relevant to Non-U.S. Holders that may be
subject to a special treatment under such laws (for example, insurance
companies, tax-exempt organizations, financial institutions or broker-dealers).
This discussion is based on the Internal Revenue Code of 1986, as amended,
Treasury Regulations promulgated thereunder and administrative and judicial
interpretations thereof, all of which are subject to change, possibly with
retroactive effect. ACCORDINGLY, PROSPECTIVE INVESTORS ARE URGED TO CONSULT
THEIR TAX ADVISORS REGARDING THE UNITED STATES FEDERAL, STATE, LOCAL AND
FOREIGN INCOME AND OTHER TAX CONSEQUENCES OF ACQUIRING, HOLDING AND DISPOSING
OF COMMON STOCK.
Dividends
In general, the gross amount of dividends paid to a Non-U.S. Holder will be
subject to United States withholding tax at a 30% rate (or any lower rate
prescribed by an applicable tax treaty) unless the dividends are (i)
effectively connected with a trade or business carried on by the Non-U.S.
Holder within the United States and a Form 4224 is filed with the withholding
agent or (ii) if a tax treaty applies, are attributable to a United States
permanent establishment of the Non-U.S. Holder. If either exception applies,
the dividend will be taxed at ordinary U.S. federal income tax rates. A Non-
U.S. Holder may be required to satisfy certain certification requirements in
order to claim the benefit of an applicable treaty rate or otherwise claim a
reduction of, or exemption from, the withholding obligation pursuant to the
above described rules. In the case of a Non-U.S. Holder that is a corporation,
effectively connected income may also be subject to the branch profits tax,
except to the extent that an applicable tax treaty provides otherwise.
Sale of Common Stock
Generally, a Non-U.S. Holder will not be subject to United States federal
income tax on any gain realized upon the disposition of such Non-U.S. Holder's
common stock unless: (i) the Company has been, is, or becomes a "U.S. real
property holding corporation" for federal income tax purposes, such Non-U.S.
Holder owned more than 5% of the common stock sold during a specified period,
and certain other requirements are met; (ii) the gain is effectively connected
with a trade or business carried on by the Non-U.S. Holder within the United
States; (iii) the common stock is disposed of by an individual Non-U.S. Holder
who holds the common stock as a capital asset and is present in the United
States for 183 days or more in the taxable year of the disposition; or (iv) the
Non-U.S. Holder is an individual who lost his U.S. citizenship within the last
10 years and such loss had, as one of its principal purposes, the avoidance of
taxes, and the gains are considered derived from sources within the United
States. The Company may be or may become a United States real property holding
corporation. Non-U.S. Holders should consult applicable treaties, which may
exempt from United States taxation gains realized upon the disposition of
common stock in certain cases.
S-71
<PAGE>
Estate Tax
Common stock owned or treated as owned by an individual Non-U.S. Holder at
the time of his or her death will be includible in the individual's gross
estate for United States federal estate tax purposes, unless an applicable
treaty provides otherwise, and may be subject to United States federal estate
tax.
Backup Withholding and Information Reporting Requirements
On October 14, 1997, the IRS issued final regulations relating to
withholding, information reporting and backup withholding that unify current
certification procedures and forms and clarify reliance standards (the "Final
Regulations"). The Final Regulations were intended to be effective with respect
to payments made after December 31, 1998. Pursuant to an IRS notice, however,
such Final Regulations will not be effective until January 1, 2001.
Except as provided below, this section describes rules applicable to
payments made before the Final Regulations take effect. Backup withholding
(which generally is a withholding tax imposed at the rate of 31% on certain
payments to persons that fail to furnish the information required under the
United States information reporting and backup withholding rules) generally
will not apply to (i) dividends paid to Non-U.S. Holders that are subject to
the 30% withholding discussed above (or that are not so subject because a tax
treaty applies that reduces or eliminates such 30% withholding) or (ii)
dividends paid on the common stock to a Non-U.S. Holder at an address outside
the United States. The Company will be required to report annually to the IRS
and to each Non-U.S. Holder the amount of dividends paid to, and the tax
withheld with respect to, such holder, regardless of whether any tax was
actually withheld. This information may also be made available to the tax
authorities in the Non-U.S. Holder's country of residence.
In the case of a Non-U.S. Holder that sells common stock to or through a
United States office of a broker, the broker must backup withhold at a rate of
31% and report the sale to the IRS, unless the holder certifies its non-U.S.
status under penalties of perjury or otherwise establishes an exemption. In the
case of a Non-U.S. Holder that sells common stock to or through the foreign
office of a United States broker, or a foreign broker with certain types of
relationships to the United States, the broker must report the sale to the IRS
(but not backup withhold) unless the broker has documentary evidence in its
files that the seller is a Non-U.S. Holder or certain other conditions are met,
or the holder otherwise establishes an exemption. A Non-U.S. Holder will
generally not be subject to information reporting or backup withholding if such
Non-U.S. Holder sells the common stock to or through a foreign office of a non-
United States broker.
Any amount withheld under the backup withholding rules from a payment to a
Non-U.S. Holder is allowable as a credit against the holder's U.S. federal
income tax, which may entitle the Non-U.S. Holder to a refund, provided that
the holder furnishes the required information to the IRS. In addition, certain
penalties may be imposed by the IRS on a Non-U.S. Holder who is required to
supply information but does not do so in the proper manner.
Among other things, the Final Regulations eliminate the general current law
presumption that dividends paid to an address in a foreign country are paid to
a resident of that country. In addition, the Final Regulations impose certain
certification and documentation requirements on Non-U.S. Holders claiming the
benefit of a reduced withholding rate with respect to dividends under a tax
treaty.
Prospective purchasers of common stock are urged to consult their tax
advisors as to the application of the current rules regarding backup
withholding and information reporting and as to the effect, if any, of the
Final Regulations on their acquisition, ownership and disposition of the common
stock.
S-72
<PAGE>
UNDERWRITING
Subject to the terms and conditions stated in the underwriting agreement
between Level 3 and the U.S. underwriters, each of the U.S. underwriters named
below, for whom Salomon Smith Barney Inc. is acting as the global coordinator
and sole book-running manager and, together with Goldman, Sachs & Co., J.P.
Morgan Securities Inc., Morgan Stanley & Co. Incorporated, Chase Securities
Inc., Credit Suisse First Boston Corporation and Merrill Lynch, Pierce, Fenner
& Smith Incorporated, as the U.S. representatives, has severally agreed to
purchase, and Level 3 has agreed to sell to each such U.S. underwriter, the
number of shares set forth opposite the name of such U.S. underwriter.
<TABLE>
<CAPTION>
Number
Name of shares
---- ----------
<S> <C>
Salomon Smith Barney Inc.......................................
Goldman, Sachs & Co............................................
J.P. Morgan Securities Inc.....................................
Morgan Stanley & Co. Incorporated..............................
Chase Securities Inc. .........................................
Credit Suisse First Boston Corporation.........................
Merrill Lynch, Pierce, Fenner & Smith Incorporated.............
----------
Total........................................................ 12,000,000
==========
</TABLE>
Subject to the terms and conditions stated in the underwriting agreement
between Level 3 and the international underwriters, each of the international
underwriters named below, for whom Salomon Brothers International Limited is
acting as the global coordinator and sole book-running manager and, together
with Goldman Sachs International, J.P. Morgan Securities Ltd., Morgan Stanley &
Co. International Limited, Credit Suisse First Boston (Europe) Limited, Merrill
Lynch International, Chase Securities Inc., Credit Lyonnais Securities,
Kleinwort Benson Limited and Societe Generale, as the international
representatives, has severally agreed to purchase, and Level 3 has agreed to
sell to each such international underwriter, the number of shares set forth
opposite the name of such international underwriter.
<TABLE>
<CAPTION>
Number
Name of shares
---- ----------
<S> <C>
Salomon Brothers International Limited.........................
Goldman Sachs International....................................
J.P. Morgan Securities Ltd.....................................
Morgan Stanley & Co. International Limited.....................
Credit Suisse First Boston (Europe) Limited....................
Merrill Lynch International....................................
Chase Securities Inc. .........................................
Credit Lyonnais Securities.....................................
Kleinwort Benson Limited.......................................
Societe Generale...............................................
----------
Total........................................................ 3,000,000
==========
</TABLE>
S-73
<PAGE>
The underwriting agreements provide that the obligations of the several
underwriters to purchase the shares offered hereby are subject to approval of
certain legal matters by counsel and to certain other conditions. The
underwriting agreements provide that the obligations of the underwriters are
such that if any of the shares are purchased by the underwriters pursuant to
the underwriting agreements, all the shares agreed to be purchased by the
underwriters (other than those covered by the over-allotment option described
below) must be so purchased. The price to public and underwriting discount per
share for the offerings will be identical. The closing of the international
offering is a condition to the closing of the U.S. offering, and the closing of
the U.S. offering is a condition to the closing of the international offering.
The underwriters propose to offer part of the shares to the public at the
public offering price set forth on the cover page of this prospectus supplement
and part of the shares to certain dealers at a price less a concession not in
excess of $ per share under the public offering price. The underwriters may
allow, and such dealers may re-allow, a concession not in excess of $ per
share to certain other dealers. After the initial offering of the shares to the
public, the public offering price and such concessions may be changed by the
representatives.
Level 3 has granted to the underwriters an option, exercisable for 30 days
from the date of this prospectus supplement, to purchase up to 2,250,000
additional shares from Level 3 at the price to public less the underwriting
discount. The underwriters may exercise such option solely for the purpose of
over-allotments, if any, incurred in connection with the offering of the shares
offered hereby. To the extent that the U.S. underwriters and the international
underwriters exercise such option, each of the U.S. underwriters and the
international underwriters, as the case may be, will become obligated, subject
to certain conditions, to purchase an additional number of option shares
proportionate to such U.S. underwriter's or international underwriter's initial
commitment.
Each U.S. underwriter has severally agreed that, as part of the distribution
of the 12,000,000 shares offered by the U.S. underwriters, (i) it is not
purchasing any of the U.S. securities for the account of anyone other than a
United States Person and (ii) it has not offered or sold, and will not offer or
sell, directly or indirectly, any of the U.S. securities or distribute any U.S.
prospectus supplement to any person outside the United States or to anyone
other than a United States Person. Each international underwriter has severally
agreed that, as part of the distribution of the 3,000,000 shares offered by the
international underwriters, (x) it is not purchasing any of the international
securities for the account of any United States Person and (y) it has not
offered or sold, and will not offer or sell, directly or indirectly, any of the
international securities or distribute any international prospectus supplement
to any person in the United States or to any United States Person.
The foregoing limitations do not apply to stabilization transactions or to
certain other transactions specified in the U.S. underwriting agreement, the
international underwriting agreement and the agreement between U.S.
underwriters and international underwriters, including: (1) certain purchases
and sales between the U.S. underwriters and the international underwriters; (2)
certain offers, sales, resales, deliveries or distributions to or through
investment advisors or other persons exercising investment discretion; (3)
purchases, offers or sales by a U.S. underwriter who is also acting as an
international underwriter or by an international underwriter who is also acting
as a U.S. underwriter; and (4) other transactions specifically approved by the
representatives. "United States Person" shall mean any person who is a national
or resident of the United States, any corporation, partnership or other entity
created or organized in or under the laws of the United States or of any
political subdivision thereof, and any estate or trust the income of which is
subject to United States Federal income taxation, regardless of its source
(other than any non-United States branch of any United States Person), and
shall include any United States branch of a person other than a United States
Person.
Pursuant to the agreement between U.S. underwriters and international
underwriters, sales may be made between the U.S. underwriters and the
international underwriters of such number of shares as may be mutually agreed.
The price of any shares so sold shall be the public offering price, less an
amount not greater than the concession to securities dealers. To the extent that
there are sales between the U.S. underwriters and the international underwriters
pursuant to the agreement between U.S. underwriters and international
underwriters, the number of shares initially available for sale by the U.S.
underwriters or by the international underwriters may be more or less than the
amount specified on the cover page of this prospectus supplement.
S-74
<PAGE>
Each international underwriter has severally represented and agreed that (1)
it has not offered or sold, and, prior to the expiration of six months from the
closing date, will not offer or sell in the United Kingdom any international
securities other than to persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (whether as principal
or agent) for the purpose of their business or in circumstances which
constitute an offer to the public in the United Kingdom for the purposes of the
Public Offers of Securities Regulations 1995, (2) has complied and will comply
with all applicable provisions of the Financial Services Act 1986 with respect
to anything done by it in relation to the international securities in, from or
otherwise involving the United Kingdom and (3) it has only issued or passed on
and will only issue or pass on to any person in the United Kingdom any document
received by it in connection with the issue of the international securities if
that person is of a kind described in Article 11(3) of the Financial Services
Act 1986 (Investment Advertisements) (Exemptions) Order 1996 (as amended) or is
a person to whom the document may otherwise lawfully be issued or passed on.
No action has been or will be taken in any jurisdiction by Level 3 or the
underwriters that would permit any offering to the general public of the shares
offered hereby in any jurisdiction other than the United States.
Purchasers of the shares offered hereby may be required to pay stamp taxes
and other charges in accordance with the laws and practices of the country of
purchase in addition to the offering price set forth on the cover page hereof.
Level 3 has agreed that, for a period of 90 days from the date of this
prospectus supplement, it will not, without the prior written consent of
Salomon Smith Barney, offer, sell, contract to sell, issue, announce the
offering or issuance of, register, cause to be registered or announce the
registration or intended registration of, in any case for its own account, any
shares of common stock of Level 3, including any such shares beneficially or
indirectly owned or controlled by Level 3, or any securities convertible into
or exchangeable for common stock, except for: (1) up to 3,000,000 shares of
common stock issued in connection with acquisitions, provided that this limit
may be exceeded if the purchaser of such shares agrees to be bound for any
remaining portion of the 90-day "black-out" period, (2) common stock issued
pursuant to any employee benefit plan, stock ownership or stock option plan or
dividend reinvestment plan in effect on the date hereof, or options granted
pursuant to any such plan in effect on the date hereof provided that such
options cannot be exercised for any remaining portion of the 90-day "black-out"
period, (3) common stock issued in connection with the inclusion of Level 3's
common stock in any Major Market Index (as defined in the underwriting
agreement), (4) maintaining the effectiveness of any registration statement in
place on the date hereof or otherwise permitted to be filed under this
paragraph, (5) common stock issued in connection with the exercise of any
warrants outstanding on the date hereof, (6) common stock issued to prospective
employees in connection with such employees being hired by Level 3, (7) common
stock issued in this offering, the convertible notes being concurrently
offered, and the common stock issuable upon conversion of such convertible
notes and upon conversion of Level 3's existing 6% convertible notes due 2009
and (8) the filing, announcing or amending of a shelf registration for up to $5
billion of securities, provided that this clause (8) shall not permit the
actual offering ("take-down") of any such securities during this "black-out"
period. Salomon Smith Barney, in its sole discretion, may release any of the
securities subject to these "black-out" agreements at any time without notice.
The common stock is quoted on the Nasdaq National Market under the symbol
"LVLT."
The U.S. underwriting agreement and the international underwriting agreement
provide that Level 3 will indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute
to payments the underwriters may be required to make in respect thereof.
In connection with the offering, Salomon Smith Barney, on behalf of the
underwriters, may over-allot, or engage in syndicate covering transactions,
stabilizing transactions and penalty bids. Over-allotment involves syndicate
sales of common stock in excess of the number of shares to be purchased by the
underwriters in the offering, which creates a syndicate short position.
Syndicate covering transactions involve purchases of the common stock in the
open market after the distribution has been completed in order to cover
syndicate short
S-75
<PAGE>
positions. Stabilizing transactions consist of certain bids or purchases of
common stock made for the purpose of preventing or retarding a decline in the
market price of the common stock while the offering is in progress. Penalty
bids permit the underwriters to reclaim a selling concession from a syndicate
member when Salomon Smith Barney Inc., in covering syndicate short positions or
making stabilizing purchases, repurchases shares originally sold by that
syndicate member. These activities may cause the price of the common stock to
be higher than the price that otherwise would exist in the open market in the
absence of such transactions. These transactions may be effected on the Nasdaq
National Market or in the over-the-counter market, or otherwise and, if
commenced, may be discontinued at any time.
In addition, in connection with this offering, certain of the underwriters
(and selling group members) may engage in passive market making transactions in
Level 3's common stock on the Nasdaq National Market, prior to the pricing and
completion of the offering. Passive market making consists of displaying bids
on the Nasdaq National Market no higher than the bid prices of independent
market makers and making purchases at prices no higher than those independent
bids and effective in response to order flow. Net purchases by a passive market
maker on each day are limited to a specified percentage of the passive market
maker's average daily trading volume in the common stock during a specified
period and must be discontinued when such limit is reached. Passive market
making may cause the price of Level 3's common stock to be higher than the
price that otherwise would exist in the open market in the absence of such
transactions. If passive market making is commenced, it may be discontinued at
any time.
The following table shows the underwriting discounts and commissions that we
will pay to the underwriters in connection with this offering. These amounts
are shown assuming both no exercise and full exercise of the underwriters'
option to purchase additional shares of common stock.
<TABLE>
<CAPTION>
No Full
Exercise Exercise
-------- --------
<S> <C> <C>
Per share.................................................. $ $
Total...................................................... $ $
</TABLE>
Level 3 estimates that its total expenses of this offering will be $1.1
million.
The representatives and the other underwriters have been retained to perform
certain investment banking and advisory services for Level 3 from time to time
for which they have received customary fees and expenses. The underwriters may,
from time to time, engage in transactions with and perform services for Level 3
in the ordinary course of their business. Some of the underwriters are acting
as lead underwriters for, and initial purchasers in, the other Level 3
offerings and are lenders under Level 3's credit facility.
S-76
<PAGE>
LEGAL MATTERS
The validity of the common stock offered by this prospectus supplement will
be passed upon for the Company by Willkie Farr & Gallagher, New York, New York.
Certain legal matters relating to this offering will be passed upon for the
underwriters by Cravath, Swaine & Moore, New York, New York.
EXPERTS
The consolidated financial statements of Level 3 Communications, Inc. as of
December 31, 1998 and for the year then ended, included in this prospectus
supplement have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in
giving said report.
The consolidated balance sheet of Level 3 Communications, Inc. as of
December 27, 1997, and the related statements of earnings, cash flows,
comprehensive income, and changes in stockholders' equity for each of the two
years in the period ended December 27, 1997 included in this prospectus
supplement, as well as the consolidated balance sheets of RCN Corporation and
Subsidiaries as of December 31, 1997 and 1998 and the related statements of
operations, cash flows, comprehensive income, and changes in stockholders'
equity, for each of the three years in the period ended December 31, 1998,
incorporated by reference in this prospectus supplement, have been included or
incorporated herein in reliance on the reports of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of that firm as experts in
accounting and auditing.
S-77
<PAGE>
GLOSSARY OF TERMS
<TABLE>
<C> <S>
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.
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.
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.
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.
dark fiber.................. Fiber optic strands that are not connected to
transmission equipment.
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.
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.
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.
</TABLE>
S-78
<PAGE>
<TABLE>
<S> <C>
Gbps........................ Gigabits per second. A transmission rate. One gigabit
equals 1.024 billion bits of information.
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
colocation 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.
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.
Kbps........................ Kilobits per second. A transmission rate. One kilobit
equals 1,024 bits of information.
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 ILECs and CLECs.
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
(interexchange carriers)... Long distance carriers provide services between 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 million bits of information.
</TABLE>
S-79
<PAGE>
<TABLE>
<S> <C>
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.
OC3......................... A data communications circuit consisting of three DS3s
capable of transmitting data at 155 Mbps.
OC48........................ A data communications circuit consisting of forty-eight
DS3s capable of transmitting data at approximately 2.45
Gbps.
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 a
communications provider 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.
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 four local telephone companies as a
result of the mergers of Bell Atlantic with NYNEX and SBC
with Pacific Telesis and Ameritech.
reciprocal compensation..... The compensation of a CLEC for termination of a local
call by the ILEC on the CLEC's network, which is the same
as the compensation that the CLEC pays the ILEC for
termination of local calls on the ILEC's 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.
</TABLE>
S-80
<PAGE>
<TABLE>
<S> <C>
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.
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.
Tbps........................ Terabits per second. A transmission rate. One terabit
equals 1.024 trillion bits of information.
T1.......................... A data communications circuit capable of transmitting
data at 1.544 Mbps.
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.
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 new 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 to 8 Mbps
("ADSL").
</TABLE>
S-81
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
(formerly, Peter Kiewit Sons', Inc.)
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Financial Statements as of September 30, 1999 and for the three months
and nine months ended September 30, 1999 and September 30, 1998
(unaudited):
Consolidated Condensed Statements of Operations........................ F-2
Consolidated Condensed Balance Sheets.................................. F-3
Consolidated Condensed Statements of Cash Flows........................ F-5
Consolidated Statement of Changes in Stockholders' Equity.............. F-6
Consolidated Statements of Comprehensive Income (Loss)................. F-7
Notes to Consolidated Condensed Financial Statements................... F-8
Financial Statements as of December 31, 1998 and December 27, 1997 and
for the three years ended December 31, 1998:
Reports of Independent Public Accountants.............................. F-22
Consolidated Statements of Earnings.................................... F-24
Consolidated Balance Sheets............................................ F-25
Consolidated Statements of Cash Flows.................................. F-26
Consolidated Statements of Changes in Stockholders' Equity............. F-28
Consolidated Statements of Comprehensive Income........................ F-29
Notes to Consolidated Financial Statements............................. F-30
</TABLE>
Schedules not indicated above have been omitted because of the absence of
the conditions under which they are required or because the information called
for is shown in the consolidated financial statements or in the notes thereto.
F-1
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
-------------- --------------
1999 1998 1999 1998
------ ------ ------ ------
(dollars in millions,
except share data)
<S> <C> <C> <C> <C>
Revenue........................................ $ 134 $ 106 $ 342 $ 296
Costs and Expenses:
Cost of revenue.............................. 100 47 243 138
Depreciation and amortization................ 63 15 155 31
Selling, general and administrative
expenses.................................... 178 96 460 199
Write-off of in-process research &
development................................. -- -- -- 30
------ ------ ------ ------
Total costs and expenses................... 341 158 858 398
------ ------ ------ ------
Loss from Operations........................... (207) (52) (516) (102)
Other Income (Expense):
Interest income.............................. 51 53 158 124
Interest expense, net........................ (34) (46) (132) (86)
Gain on equity investee stock transactions... 5 4 116 25
Other, net................................... (35) (31) (65) (78)
------ ------ ------ ------
Total other income (expense)............... (13) (20) 77 (15)
------ ------ ------ ------
Loss Before Income Taxes and Discontinued
Operations ................................... (220) (72) (439) (117)
Income Tax Benefit............................. 73 23 143 28
------ ------ ------ ------
Loss from Continuing Operations................ (147) (49) (296) (89)
Discontinued Operations:
Gain on split-off of Construction Group...... -- -- -- 608
Gain on disposition of energy business, net
of income tax expense of $175............... -- -- -- 324
------ ------ ------ ------
Earnings from discontinued operations........ -- -- -- 932
------ ------ ------ ------
Net Earnings (Loss)........................ $ (147) $ (49) $ (296) $ 843
====== ====== ====== ======
Earnings (Loss) Per Share (Basic and Diluted):
Continuing operations........................ $ (.43) $ (.16) $ (.89) $ (.30)
====== ====== ====== ======
Discontinued operations...................... $ -- $ -- $ -- $ 3.11
====== ====== ====== ======
Net earnings (loss).......................... $ (.43) $ (.16) $ (.89) $ 2.81
====== ====== ====== ======
Net earnings (loss), excluding gain on split-
off of Construction Group................... $ (.43) $ (.16) $ (.89) $ .78
====== ====== ====== ======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
F-2
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(dollars in millions)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents.......................... $1,486 $ 842
Marketable securities.............................. 2,732 2,863
Restricted cash and securities..................... 528 32
Accounts receivable, net........................... 118 57
Income taxes receivable............................ 163 54
Other.............................................. 43 29
------ ------
Total Current Assets................................. 5,070 3,877
Property, Plant and Equipment, net................... 3,072 1,061
Investments.......................................... 363 323
Other Assets, net.................................... 330 261
------ ------
$8,835 $5,522
====== ======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
F-3
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(dollars in millions,
except share data)
<S> <C> <C>
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable.................................. $ 653 $ 276
Current portion of long-term debt................. 6 5
Accrued payroll and employee benefits............. 62 16
Accrued interest.................................. 81 33
Deferred revenue.................................. 84 1
Other............................................. 53 39
------ ------
Total Current Liabilities........................... 939 370
Long-Term Debt, less current portion................ 3,977 2,641
Deferred Income Taxes............................... 40 86
Accrued Reclamation Costs........................... 97 96
Other Liabilities................................... 251 164
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, authorized
10,000,000 shares;
no shares outstanding in 1999 and 1998............ -- --
Common Stock:
Common Stock, $.01 par value, authorized
1,500,000,000 shares;
340,689,116 shares outstanding in 1999
and 307,874,706 outstanding in 1998.............. 3 3
Class R, $.01 par value, authorized
8,500,000 shares; no shares outstanding in 1999
and 1998......................................... -- --
Additional paid-in capital.......................... 2,435 765
Accumulated other comprehensive (loss) income....... (4) 4
Retained earnings................................... 1,097 1,393
------ ------
Total Stockholders' Equity.......................... 3,531 2,165
------ ------
$8,835 $5,522
====== ======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
F-4
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended
September 30,
----------------
1999 1998
------- -------
(dollars in
millions)
<S> <C> <C>
Cash flows from continuing operations:
Net cash provided by continuing operations................. $ 408 $ 128
Cash flows from investing activities:
Proceeds from sales and maturities of marketable
securities................................................ 4,369 2,882
Purchases of marketable securities......................... (4,254) (5,132)
Capital expenditures....................................... (2,154) (409)
Investments................................................ (3) (24)
Proceeds from sale of property, plant and equipment and
other investments......................................... 11 26
Other...................................................... 1 --
------- -------
Net cash used in investing activities...................... (2,030) (2,657)
Cash flows from financing activities:
Issuance of long-term debt, net of issuance costs.......... 1,250 1,937
Payments on long-term debt including current portion....... (5) (7)
Increase in cash and restricted securities................. (495) --
Issuances of common stock.................................. 1,498 21
Proceeds from exercise of stock options.................... 18 7
Exchange of Class C Stock for Common Stock, net............ -- 122
------- -------
Net cash provided by financing activities.................. 2,266 2,080
Cash flows from discontinued operations:
Proceeds from sale of energy operations, net of income tax
payments of $144 million.................................. -- 1,015
------- -------
Net cash provided by discontinued operations............... -- 1,015
------- -------
Net change in cash and cash equivalents...................... 644 566
Cash and cash equivalents at beginning of year............... 842 87
------- -------
Cash and cash equivalents at end of period................... $ 1,486 $ 653
======= =======
</TABLE>
The activities of the Construction & Mining Group have been removed from the
consolidated condensed statements of cash flows in 1998. The Construction Group
had cash flows of ($62) million for the three months ended March 31, 1998.
See accompanying notes to consolidated condensed financial statements.
F-5
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the nine months ended September 30, 1999
(unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-in Comprehensive Retained
Stock Capital Income (Loss) Earnings Total
------ ---------- ------------- -------- ------
(dollars in millions)
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1998.. $ 3 $ 765 $ 4 $1,393 $2,165
Common Stock:
Issuances, net.............. -- 1,504 -- -- 1,504
Stock options exercised..... -- 18 -- -- 18
Stock option grants......... -- 88 -- -- 88
Income tax benefit from
exercise of options........ -- 60 -- -- 60
Net Loss...................... -- -- -- (296) (296)
Other Comprehensive Loss...... -- -- (8) -- (8)
---- ------ ----- ------ ------
Balance at September 30,
1999......................... $ 3 $2,435 $ (4) $1,097 $3,531
==== ====== ===== ====== ======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
F-6
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
--------------- ---------------
1999 1998 1999 1998
------- ------ ------- ------
(dollars in millions)
<S> <C> <C> <C> <C>
Net (Loss) Earnings......................... $ (147) $ (49) $ (296) $ 843
Other Comprehensive Income (Loss) Before
Tax:
Foreign currency translation adjustments.. 9 -- 1 1
Unrealized holding loss arising during
period................................... -- (4) (2) (1)
Reclassification adjustment for gains
included in net (loss) earnings.......... -- -- (12) (8)
------- ------ ------- ------
Other Comprehensive Income (Loss) Before
Tax........................................ 9 (4) (13) (8)
Income Tax (Expense) Benefit Related to
Items of Other Comprehensive Income
(Loss)..................................... (3) 1 5 3
------- ------ ------- ------
Other Comprehensive Income (Loss) Net of
Taxes...................................... 6 (3) (8) (5)
------- ------ ------- ------
Comprehensive (Loss) Income................. $ (141) $ (52) $ (304) $ 838
======= ====== ======= ======
</TABLE>
See accompanying notes to consolidated condensed financial statements.
F-7
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Unaudited)
1. Basis of Presentation
The consolidated condensed balance sheet of Level 3 Communications, Inc. and
subsidiaries ("Level 3" or the "Company"), at December 31, 1998 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 elsewhere herein. 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.
The Company has embarked on a plan to become a facilities-based provider
(that is, a provider that owns or leases a substantial portion of the property,
plant and equipment necessary to provide its services) of a broad range of
integrated communications services in the United States, Europe and Asia. To
reach this goal, the Company is expanding substantially the business of its PKS
Information Services, Inc. subsidiary and creating, 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 building the network based on Internet
Protocol technology in order to leverage the efficiencies of this technology to
provide lower cost communications services.
In 1997, the Company agreed to sell its energy assets to MidAmerican Energy
Holding Company, Inc. (f/k/a CalEnergy Company, Inc.) ("MidAmerican") and to
separate the construction operations ("Construction Group") from the Company.
On January 2, 1998, the Company completed the sale of its energy assets to
MidAmerican. On March 31, 1998, the Company completed the split-off of the
Construction Group to stockholders that held Class C Stock. Therefore, the
results of operations of both businesses have been classified as discontinued
operations on the consolidated condensed statements of operations for 1998.
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 four days for the period ending September 30, 1998, were not
material to the overall results of operations and cash flows.
The results of operations for the nine months ended September 30, 1999, are
not necessarily indicative of the results expected for the full year.
Where appropriate, items within the consolidated condensed financial
statements have been reclassified from the previous periods to conform to
current period presentation.
2. Reorganization--Discontinued Construction Operations
Prior to March 31, 1998, the Company had a two-class capital structure. The
Company's Class C Stock reflected the performance of the Construction Group and
the Class D Stock reflected the performance of the other businesses, including
communications, information services and coal mining. In 1997 the Board of
Directors of Level 3 approved a proposal for the separation of the Construction
Group from the other operations of the Company through a split-off of the
Construction Group (the "Split-off"). In December 1997, the Company's
stockholders approved the Split-off and in March 1998, the Company received a
ruling from the Internal Revenue Service that stated the Split-off would be
tax-free to U.S. stockholders. The Split-off was
F-8
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
effected on March 31, 1998. As a result of the Split-off, the Company no longer
owns any interest in 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 results of operations of the Construction Group for the
three months ended March 31, 1998.
On March 31, 1998, the Company reflected the fair value of the Construction
Group as a distribution to the Class C stockholders because the distribution
was considered non-pro rata as compared to the Company's previous two-class
capital stock structure. The Company recognized a gain of $608 million within
discontinued operations, 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, "Accounting
for Reorganizations Involving a Non-Pro Rata Split-off of Certain Nonmonetary
Assets to Owners". No taxes were provided on this gain due to the tax-free
nature of the Split-off.
In connection with the Split-off, the Class D Stock became the common stock
of Level 3 Communications, Inc. ("Common Stock"), and shortly thereafter, began
trading on the Nasdaq National Market under the symbol "LVLT".
3. Discontinued Energy Operations
On January 2, 1998, the Company completed the sale of its energy assets to
MidAmerican. These assets included approximately 20.2 million shares of
MidAmerican common stock (assuming the exercise of 1 million options held by
Level 3), Level 3's 30% interest in CE Electric and Level 3's investments in
international power projects in Indonesia and the Philippines. 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 are being used
in part to fund 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 (Loss) Per Share
Basic earnings (loss) per share have been computed using the weighted
average number of shares during each period. The Company had a loss from
continuing operations for the three and nine month periods ended September 30,
1999 and 1998. Therefore, the dilutive impact of the Convertible Subordinated
Notes and the 21,534,433 options and warrants outstanding at September 30, 1999
and 19,690,144 options and warrants outstanding at September 30, 1998 have not
been included in the computation of diluted earnings (loss) per share because
the resulting computation would have been anti-dilutive.
Effective August 10, 1998, the Company issued a dividend of one share of
Level 3 Common Stock for each share of Level 3 Common Stock outstanding. All
share information and per share data have been restated to reflect the stock
dividend.
F-9
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
The following details the earnings (loss) per share calculations for Level 3
Common Stock:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
---------------- ----------------
1999 1998 1999 1998
------- ------- ------- -------
(in millions)
<S> <C> <C> <C> <C>
Loss From Continuing Operations........ $ (147) $ (49) $ (296) $ (89)
Discontinued Operations:
Gain on Split-off of Construction
Group............................... -- -- -- 608
Earnings from Discontinued Energy
Operations.......................... -- -- -- 324
------- ------- ------- -------
Earnings from Discontinued
Operations........................ -- -- -- 932
------- ------- ------- -------
Net Earnings (Loss).................... $ (147) $ (49) $ (296) $ 843
======= ======= ======= =======
Total Number of Weighted Average Shares
Outstanding Used to Compute Basic and
Diluted Earnings per Share (in
thousands)............................ 340,298 306,515 332,039 300,151
======= ======= ======= =======
Earnings (Loss) per Share (Basic and
Diluted):
Continuing operations................ $ (.43) $ (.16) $ (.89) $ (.30)
======= ======= ======= =======
Discontinued operations.............. $ -- $ -- $ -- $ 3.11
======= ======= ======= =======
Net earnings (loss).................. $ (.43) $ (.16) $ (.89) $ 2.81
======= ======= ======= =======
Net earnings (loss), excluding gain
on Split-off of Construction Group.. $ (.43) $ (.16) $ (.89) $ .78
======= ======= ======= =======
</TABLE>
5. Acquisitions
On January 5, 1999, Level 3 acquired BusinessNet Ltd. ("BusinessNet"), a
leading London-based Internet service provider in a largely stock-for-stock
transaction valued at $12 million and accounted for as a purchase. After
completion of certain adjustments, the Company agreed to issue approximately
400,000 shares of Common Stock and paid $1 million in cash in exchange for all
of the issued and outstanding shares of BusinessNet's capital stock. Of the
approximately 400,000 shares Level 3 agreed to issue in connection with the
acquisition, approximately 150,000 shares of Level 3 Common Stock have been
pledged to Level 3 to secure certain indemnification obligations of the former
BusinessNet stockholders. In October 1999, Level 3 released approximately
42,000 shares pursuant to the acquisition agreement. The pledge of the
remaining shares will terminate approximately 18 months from the acquisition
date, unless otherwise extended pursuant to the terms of the acquisition
agreement. Liabilities exceeded assets acquired, and goodwill of $16 million
was recognized from the transaction which is being amortized over five years.
On April 23, 1998, the Company acquired XCOM Technologies, Inc. ("XCOM"), a
privately held company that has developed technology which provides certain key
components necessary for the Company to develop an interface between its
Internet Protocol-based network and the existing public switched telephone
network. The Company issued approximately 5.3 million shares of Level 3 Common
Stock and 0.7 million options and warrants to purchase Level 3 Common Stock in
exchange for all the stock, options and warrants of XCOM.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated to
in-process research and development and was taken as a non-deductible charge to
earnings in the second quarter of 1998. The purchase price exceeded the fair
value of the net assets acquired by $30 million which was recognized as
goodwill.
F-10
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
In October 1998, the Securities and Exchange Commission ("SEC") issued new
guidelines for valuing acquired research and development which are applied
retroactively. The Company believes its accounting for the acquisition was made
in accordance with generally accepted accounting principles and established
appraisal practices at the time of the acquisition. However, due to the
significance of the charge relative to the total value of the acquisition, the
Company reviewed the facts with the SEC. Consequently, using the revised
guidelines and assumptions, the Company reduced the charge for in-process
research and development from $115 million to $30 million, and increased the
related goodwill by $85 million. The goodwill associated with the XCOM
transaction is being amortized over a five year period. The results for the
three and nine months ended September 30, 1998 have been restated to reflect
the reduced charge for in-process research and development and increased
amortization expense.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guidelines and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
The cumulative operating results of BusinessNet, XCOM and other 1998
acquisitions were not significant relative to the Company's 1999 and 1998
results.
For the Company's acquisitions, the excess purchase price over the fair
market value of the underlying assets was allocated to goodwill and other
intangible assets and property based upon preliminary estimates of fair value.
The final purchase price allocation for XCOM did not vary significantly from
preliminary estimates. The Company does not believe that the final purchase
price allocation will vary significantly from the preliminary estimates for the
entities acquired after September 30, 1998.
6. Property, Plant and Equipment, net
Construction in Progress
The Company is currently constructing its communications network. Costs
associated directly with the uncompleted network and interest expense incurred
during construction are capitalized based on the weighted average accumulated
construction expenditures and the interest rates related to borrowings
associated with the construction. Certain gateway facilities, local networks
and operating equipment have been placed in service during 1999. These assets
are being depreciated over their useful lives, primarily ranging from 3-25
years. As other segments of the network are placed in service, the assets will
be depreciated over their useful lives.
The Company is currently developing business support systems required for
its Business Plan. The external direct costs of software, materials and
services, payroll and payroll related expenses for employees directly
associated with the project and interest costs incurred when developing the
business support systems are capitalized. Upon completion of the projects, the
total costs of the business support systems are amortized over their useful
lives of 3 years.
For the nine months ended September 30, 1999, the Company invested $2,021
million in its communications business, including $825 million on the U.S.
intercity network, $464 million on international networks, $144 million on
transoceanic networks and $419 million on gateway facilities and local
networks.
F-11
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
Capitalized business support systems and network construction costs that
have not been placed in service have been classified as construction-in-
progress within Property, Plant and Equipment below.
<TABLE>
<CAPTION>
Accumulated Book
Cost Depreciation Value
------ ------------ ------
(dollars in millions)
<S> <C> <C> <C>
September 30, 1999
Land and Mineral Properties......................... $ 41 $ (16) $ 25
Facility and Leasehold Improvements:
Communications..................................... 162 (4) 158
Information Services............................... 26 (3) 23
Coal Mining........................................ 73 (63) 10
CPTC............................................... 91 (8) 83
Operating Equipment:
Communications..................................... 369 (64) 305
Information Services............................... 59 (36) 23
Coal Mining........................................ 115 (104) 11
CPTC............................................... 17 (6) 11
Network Construction Equipment...................... 91 (7) 84
Furniture and Office Equipment...................... 103 (33) 70
Other............................................... 126 (31) 95
Construction-in-Progress............................ 2,174 -- 2,174
------ ----- ------
$3,447 $(375) $3,072
====== ===== ======
December 31, 1998
Land and Mineral Properties $ 37 $ (16) $ 21
Facility and Leasehold Improvements:
Communications..................................... 80 (1) 79
Information Services............................... 24 (2) 22
Coal Mining........................................ 74 (61) 13
CPTC............................................... 91 (5) 86
Operating Equipment:
Communications..................................... 245 (18) 227
Information Services............................... 53 (30) 23
Coal Mining........................................ 119 (104) 15
CPTC............................................... 17 (4) 13
Network Construction Equipment...................... 46 (1) 45
Furniture and Office Equipment...................... 67 (10) 57
Other............................................... 72 (2) 70
Construction-in-Progress............................ 390 -- 390
------ ----- ------
$1,315 $(254) $1,061
====== ===== ======
</TABLE>
7. Investments
The Company holds significant equity positions in two publicly traded
companies; RCN Corporation ("RCN") and Commonwealth Telephone Enterprises, Inc.
("Commonwealth Telephone"). RCN is a facilities-based provider of
communications services to the residential market primarily in the northeastern
United States and California. RCN provides local and long distance phone, cable
television and Internet services in several markets; including Boston, New
York, Washington, D.C., and California's San Francisco to San Diego corridor.
Commonwealth Telephone holds Commonwealth Telephone Company, an incumbent
local exchange carrier operating in various rural Pennsylvania markets, and
CTSI, Inc., a competitive local exchange carrier which commenced operations in
1997.
On September 30, 1999, Level 3 owned approximately 35% and 48% of the
outstanding shares of RCN and Commonwealth Telephone, respectively, and
accounts for each entity using the equity method. The market value of the
Company's investment in the two entities was $1,092 million and $468 million,
respectively, on September 30, 1999.
F-12
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
The Company recognizes gains from the sale, issuance and repurchase of stock
by its subsidiaries and equity method investees in its statement of operations.
During 1999, RCN issued stock in a public offering and for certain transactions
which diluted the Company's ownership of RCN from 41% at December 31, 1998 to
35% at September 30, 1999. The increase in the Company's proportionate share of
RCN's net assets as a result of these transactions resulted in a pre-tax gain
of $5 million and $116 million for the Company for the three and nine months
ended September 30, 1999. The Company also recognized a gain of $4 million and
$25 million for the three and nine months ended September 30, 1998 related to
stock transactions of RCN.
In October 1999, RCN announced that Vulcan Ventures, Inc. had agreed to
invest $1.65 billion in RCN. This transaction, expected to close during the
first quarter of 2000, is in the form of preferred stock convertible to 26.6
million shares of RCN common stock. The preferred shares must be converted to
common shares within a three to seven year period at $62 per share. Level 3,
based on current market conditions, expects to recognize a significant gain
when Vulcan Ventures, Inc. converts its RCN preferred stock to RCN common
stock.
F-13
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
The following is summarized financial information of RCN and Commonwealth
Telephone for the three and nine months ended September 30, 1999 and 1998, and
as of September 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
-------------- --------------
1999 1998 1999 1998
------ ------ ------ ------
Operations
- ---------- (in millions)
<S> <C> <C> <C> <C>
RCN Corporation:
Revenue....................................... $ 70 $ 58 $ 204 $ 148
Net loss available to common shareholders..... (96) (53) (232) (170)
Level 3's share:
Net loss..................................... (37) (22) (89) (75)
Goodwill amortization........................ -- -- (1) --
------ ------ ------ ------
Equity in net loss.......................... $ (37) $ (22) $ (90) $ (75)
====== ====== ====== ======
Commonwealth Telephone Enterprises:
Revenue....................................... $ 68 $ 58 $ 192 $ 167
Net income available to common shareholders... 6 3 17 12
Level 3's share:
Net income................................... 3 2 8 6
Goodwill amortization........................ -- -- (1) (1)
------ ------ ------ ------
Equity in net income........................ $ 3 $ 2 $ 7 $ 5
====== ====== ====== ======
<CAPTION>
Commonwealth
RCN Telephone
Corporation Enterprises
-------------- --------------
1999 1998 1999 1998
------ ------ ------ ------
Financial Position
- ------------------
<S> <C> <C> <C> <C>
Current assets.................................. $1,704 $1,093 $ 85 $ 79
Other assets.................................... 1,150 815 403 354
------ ------ ------ ------
Total assets.................................. 2,854 1,908 488 433
Current liabilities............................. 192 178 84 85
Other liabilities............................... 1,766 1,282 262 223
Minority interest............................... 129 77 -- --
Preferred stock................................. 249 -- -- --
------ ------ ------ ------
Total liabilities and preferred stock......... 2,336 1,537 346 308
------ ------ ------ ------
Common Equity............................... $ 518 $ 371 $ 142 $ 125
====== ====== ====== ======
Level 3's share:
Equity in net assets.......................... $ 184 $ 150 $ 68 $ 60
Goodwill...................................... 26 34 54 56
------ ------ ------ ------
$ 210 $ 184 $ 122 $ 116
====== ====== ====== ======
</TABLE>
Investments at September 30, 1999 and December 31, 1998 also include $23
million for the Company's investment in the Pavilion Towers office buildings in
Aurora, Colorado.
F-14
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
8. Other Assets, net
At September 30, 1999 and December 31, 1998 other assets consisted of the
following:
<TABLE>
<CAPTION>
1999 1998
---- ----
(in
millions)
<S> <C> <C>
Goodwill:
XCOM, net of accumulated amortization of $32 and $15............... $ 80 $100
GeoNet, net of accumulated amortization of $3 and $1............... 18 20
BusinessNet, net of accumulated amortization of $3 and $--......... 13 --
Other, net of accumulated amortization of $5 and $1................ 15 19
Prepaid Network Assets............................................... 51 --
Debt Issuance Costs.................................................. 106 67
Deferred Development and Financing Costs............................. 15 15
Unrecovered Mine Development Costs................................... 14 15
Leases............................................................... 6 9
Timberlands.......................................................... 3 3
Other................................................................ 9 13
---- ----
Total other assets............................................... $330 $261
==== ====
</TABLE>
9. Long-Term Debt
6% Convertible Subordinated Notes
On September 14, 1999, the Company received $798 million of proceeds, after
transaction costs, from an offering of $823 million aggregate principal amount
of its 6% Convertible Subordinated Notes Due 2009 ("Subordinated Notes"). The
Subordinated Notes are unsecured and subordinated to all existing and future
senior indebtedness of the Company. Interest on the notes accrues at 6% per
year and is payable each year in cash on March 15 and September 15. The
principal amount of the notes will be due on September 15, 2009. The
Subordinated Notes may be converted into shares of common stock of the Company
at any time prior to maturity, unless the Company has caused the conversion
rights to expire. The conversion rate is 15.3401 shares per each $1,000
principal amount of Subordinated Notes, subject to adjustment in certain
circumstances. On or after September 15, 2002, Level 3, at its option, may
cause the conversion rights to expire. Level 3 may exercise this option only if
the current market price exceeds approximately $91.27 (which represents 140% of
the conversion price) for 20 trading days within any period of 30 consecutive
trading days including the last day of that period.
Debt issuance costs of $25 million were capitalized and are being amortized
as interest expense over the term of the Subordinated Notes.
Senior Secured Credit Facilities
On September 30, 1999, certain Level 3 subsidiaries entered into $1.375
billion of secured credit facilities ("Senior Secured Credit Facilities"). The
facilities are comprised of a senior secured revolving credit facility in the
amount of $650 million and a two-tranche senior secured term loan facility
aggregating $725 million. The secured term loan facility consists of a $450
million tranche A and a $275 million tranche B term loan facility.
On September 30, 1999, Level 3 borrowed $475 million under the secured term
loan facility. The $475 million and prepaid interest have been placed in an
interest bearing escrow account until the Company receives the remaining state
regulatory approvals necessary to close this financing. The Company expects to
receive all the necessary regulatory approvals during the fourth quarter of
1999.
F-15
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
The obligations under the revolving credit facility are secured by
substantially all the assets of Level 3 and, subject to certain exceptions, its
wholly owned domestic subsidiaries (other than the borrower under the term loan
facilities). Such assets will also secure a portion of the term loan
facilities. Additionally, all obligations under the term loan facilities will
be secured by the equipment that is purchased with the proceeds of the term
loan facilities.
Amounts drawn under the secured credit facility will bear interest, at the
option of the Company, at the alternate base rate or reserve-adjusted LIBOR
plus applicable margins. The applicable margins for the revolving credit
facility and tranche A term loan facility range from 50 to 175 basis points
over the alternate base rate and from 150 to 275 basis points over LIBOR and
are fixed for the tranche B term loan facility at 2.5% over the alternate base
rate and 3.5% over LIBOR. Interest and commitment fees on the revolving credit
facility and the term loan facilities are payable quarterly with specific rates
determined by actual borrowings under each facility.
The revolving credit facility provides for automatic and permanent quarterly
reductions of the amount available for borrowing under that facility,
commencing at $17.25 million on March 31, 2004, and increasing to approximately
$61 million per quarter. The tranche A term loan facility amortizes in
consecutive quarterly payments beginning on March 31, 2004, commencing at $9
million per quarter and increasing to $58.5 million per quarter. The revolving
credit facility and tranche A term loan facility mature on September 30, 2007.
The tranche B term loan facility amortizes with substantially all of the
scheduled payments due in equal amounts from March 31, 2007 to January 15,
2008.
The Senior Secured Credit Facilities contain certain covenants, which among
other things, limit additional indebtedness, dividend payments, certain
investments and transactions with affiliates. Level 3 and the borrowers must
also comply with specific financial and operational tests and maintain certain
financial ratios.
Debt Issuance costs of $23 million were capitalized and will be amortized as
interest expense over the terms of the Senior Secured Credit Facilities.
Level 3 currently intends to use the proceeds from the Senior Secured Credit
Facilities and Subordinated Notes for working capital, capital expenditures and
other general corporate purposes in connection with the implementation of its
business plan, including the acquisition of telecommunications assets.
9.125% Senior Notes
On April 28, 1998, the Company received $1.94 billion of net proceeds from
an offering of $2 billion aggregate principal amount 9.125% Senior Notes Due
2008 ("Senior Notes"). Interest on the notes accrues at 9.125% per year and is
payable on May 1 and November 1 each year in cash.
Debt issuance costs of $65 million were capitalized and are being amortized
as interest expense over the term of the Senior Notes.
10.5% Senior Discount Notes
On December 2, 1998, the Company sold $834 million aggregate principal
amount at maturity of 10.5% Senior Discount Notes Due 2008 ("Senior Discount
Notes"). The sales proceeds of $500 million, excluding debt issuance costs,
were recorded as long term debt. Interest on Senior Discount Notes accretes at
a rate of 10.5% per annum, compounded semiannually, to an aggregate principal
amount of $834 million by December 1, 2003. Cash interest will not accrue on
the Senior Discount Notes prior to December 1, 2003; however, the Company may
elect to commence the accrual of cash interest on all outstanding Senior
Discount Notes on or after December 1, 2001. Accrued interest expense for the
nine months ended September 30, 1999 on the Senior Discount Notes of $40
million was added to long-term debt.
F-16
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
Debt issuance costs of $14 million have been capitalized and are being
amortized as interest expense over the term of the Senior Discount Notes.
The Company capitalized $35 and $65 million of interest expense and
amortized debt issuance costs related to network construction and business
systems development projects for the three and nine months ended September 30,
1999 and $5 million and $6 million for the three and nine months ended
September 30, 1998.
10. Employee Benefit Plans
The Company adopted the recognition provisions of SFAS No. 123, "Accounting
for Stock Based Compensation" ("SFAS No. 123") in 1998. 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 periods of
the options. The recognition provisions of SFAS No. 123 are applied
prospectively upon adoption. As a result, the recognition provisions 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. Although the recognition
of the value of the stock awards results in compensation or professional
expenses in an entity's financial statements, the expense differs from other
compensation and professional expenses 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 1999 and thereafter. The amount of
the non-cash charges will be dependent upon a number of factors, including the
number of grants and the fair value of each grant estimated at the time of its
award.
Non-Qualified Stock Options and Warrants
The Company granted 55,100 nonqualified stock options with a fair value of
$1 million ("NQSO") to employees during the nine months ended September 30,
1999. The expense recognized for the three and nine months ended September 30,
1999 for NQSOs and warrants outstanding at September 30, 1999 in accordance
with SFAS No. 123 was $1 million and $5 million, respectively. In addition to
the expense recognized, the Company capitalized less than $1 million and $1
million of non-cash compensation costs for the three and nine months ended
September 30, 1999, respectively, related to NQSOs and warrants for employees
directly involved in the construction of the Internet Protocol network and the
development of the business support systems. As of September 30, 1999, the
Company had not recognized $7 million of compensation costs for NQSOs and
warrants granted in 1998 and 1999. The Company recognized $3 million and $9
million of expense for the three and nine months ended September 30, 1998 for
NQSOs and warrants granted during the nine months ended September 30, 1998. In
addition to the expense recognized, the Company capitalized $1 million of non-
cash compensation costs for the three and nine months ended September 30, 1998.
Outperform Stock Option Plan
In April 1998, the Company adopted an outperform stock option ("OSO")
program that was designed so that the Company's stockholders would 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 outperfom 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 awards unless the Common Stock price outperforms the S&P
500 Index. When the stock price gain is greater that the corresponding gain on
the S&P 500 Index, the value received for awards under the OSO plan is based on
a formula involving a multiplier related to the level by which the Common
F-17
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
Stock outperforms the S&P 500 Index. To the extent that the Common Stock
outperforms the S&P 500, the value of OSOs to a holder may exceed the value of
non-qualified stock options.
OSO grants are made quarterly to participants employed on the date of the
grant. Each award vests in equal quarterly installments over two years and has
a four-year life. Each award typically has a two-year moratorium on exercising
from the date of grant. As a result, once a participant is 100% vested in the
grant, the two year moratorium expires. Therefore, each grant has an exercise
window of two years.
The fair value recognized under SFAS No. 123 for the 2,309,247 OSOs granted
to employees for services performed for the nine months ended September 30,
1999 was $139 million. The Company recognized $35 million and $74 million of
compensation expense for the three and nine months ended September 30, 1999 for
OSOs granted in 1999 and 1998. In addition to the expense recognized, $2
million and $5 million of non-cash compensation was capitalized for the three
and nine months ended September 30, 1999 for employees directly involved in the
construction of the Internet Protocol network and development of business
support systems. As of September 30, 1999, the Company had not recognized $99
million of compensation costs for OSOs granted in 1998 and 1999. The Company
recognized $9 million and $14 million of expense for the three and nine months
ended September 30, 1998 for OSOs outstanding at September 30, 1998. In
addition to the expense recognized the Company capitalized $1 million of non-
cash compensation for the three and nine months ended September 30, 1998.
Shareworks and Restricted Stock
The Company recorded $3 million and $7 million of non-cash compensation
expense for the three and nine months ended September 30, 1999 related to the
Shareworks and restricted stock programs adopted in the third quarter of 1998.
As of September 30, 1999, the Company had not recognized $9 million of
compensation costs for Shareworks and restricted stock granted in 1998 and
1999. The non-cash compensation expense for the Shareworks and restricted stock
programs was less than $1 million for the three and nine months ended September
30, 1998.
11. Stockholders' Equity
On March 9, 1999 the Company closed the offering of 28.75 million shares of
its Common Stock through an underwritten public offering. The net proceeds from
the offering of approximately $1.5 billion after underwriting discounts and
offering expenses will be used for working capital, capital expenditures,
acquisitions and other general corporate purposes in connection with the
implementation of the Company's Business Plan.
12. Industry Data
In 1998, the Company adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information". SFAS No. 131 establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports issued to stockholders. Operating segments are components of an
enterprise for which separate financial information is available and which is
evaluated regularly by the Company's chief operating decision maker, or
decision making group, in deciding how to allocate resources and assess
performance. Operating segments are managed separately and represent strategic
business units that offer different products and serve different markets.
The Company's reportable segments include: communications and information
services (including communications, computer outsourcing and systems
integration segments), and coal mining. Other primarily
F-18
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
includes California Private Transportation Company L.P. ("CPTC"), a privately
owned tollroad in southern California, equity investments and other corporate
assets and overhead not attributable to a specific segment.
Industry data for the Company's discontinued construction and energy
operations are not included.
EBITDA, as defined by the Company, consists of earnings (loss) before
interest, income taxes, depreciation, amortization, non-cash operating expenses
(including stock-based compensation and in-process research and development
charges) and other non-operating income or expense. The Company excludes
noncash compensation due to its adoption of the expense recognition provisions
of SFAS No. 123. 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.
The information presented in the table below includes information for the
three and nine month periods ended September 30, 1999 and 1998 for all income
statement and cash flow information presented and as of September 30, 1999 and
December 31, 1998 for all balance sheet information presented.
<TABLE>
<CAPTION>
Communications & Information Services
-------------------------------------
Computer Systems Coal
Communications Outsourcing Integration Mining Other Total
-------------- ----------- ----------- ------ ------ ------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
1999
Three Months Ended
September 30, 1999
Revenue................. $ 36 $17 $16 $ 60 $ 5 $ 134
EBITDA.................. (105) 4 (4) 25 (25) (105)
Capital Expenditures.... 903 2 -- 1 33 939
Depreciation and
Amortization........... 51 3 1 2 6 63
Nine Months Ended
September 30, 1999
Revenue................. $ 69 $51 $48 $158 $ 16 $ 342
EBITDA.................. (272) 11 (7) 64 (71) (275)
Capital Expenditures.... 2,021 7 1 1 124 2,154
Depreciation and
Amortization........... 111 7 4 4 29 155
1998
Three Months Ended
September 30, 1998
Revenue................. $ 8 $16 $13 $ 63 $ 6 $ 106
EBITDA.................. (39) 3 (4) 27 (12) (25)
Capital Expenditures.... 243 1 -- -- 21 265
Depreciation and
Amortization........... 9 2 -- 1 3 15
Nine Months Ended
September 30, 1998
Revenue................. $ 14 $46 $42 $178 $ 16 $ 296
EBITDA.................. (68) 11 (7) 73 (27) (18)
Capital Expenditures.... 350 10 3 1 45 409
Depreciation and
Amortization........... 14 6 1 4 6 31
Identifiable Assets.....
September 30, 1999..... $3,119 $63 $51 $347 $5,255 $8,835
December 31, 1998...... 1,072 59 42 362 3,987 5,522
</TABLE>
F-19
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
The following information provides a reconciliation of EBITDA to loss from
continuing operations for the three and nine months ended September 30, 1999
and 1998:
<TABLE>
<CAPTION>
Three Nine
Months Months
Ended Ended
September September
30, 30,
----------- -----------
1999 1998 1999 1998
----- ---- ----- ----
(in millions)
<S> <C> <C> <C> <C>
EBITDA $(105) $(25) $(275) $(18)
Depreciation and Amortization Expense (63) (15) (155) (31)
Non-Cash Compensation Expense (39) (12) (86) (23)
Write-off of In-Process Research and Development -- -- -- (30)
----- ---- ----- ----
Loss from Operations (207) (52) (516) (102)
Other (Expense) Income (13) (20) 77 (15)
Income Tax Benefit 73 23 143 28
----- ---- ----- ----
Loss from Continuing Operations $(147) $(49) $(296) $(89)
===== ==== ===== ====
</TABLE>
13. Related Party Transactions
Peter Kiewit Sons', Inc. ("Kiewit") acted as the general contractor on
several significant projects for the Company in 1999 and 1998. These projects
include the intercity network, local loops and gateway sites, the Company's new
corporate headquarters in Colorado and a new data center in Tempe, Arizona.
Kiewit provided approximately $592 million and $37 million of construction
services related to these projects in the first nine months of 1999 and 1998,
respectively.
Level 3 also receives certain mine management services from Kiewit. The
expense for these services was $9 million and $23 million for the three and
nine months ended September 30, 1999, respectively, and $10 million and $27
million for the three and nine months ended September 30, 1998, respectively,
and is recorded in selling, general and administrative expenses.
14. Other Matters
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 21 million shares
of Class D Stock (now known as Common Stock).
In August 1999 the Company was named as a defendant in Schweizer vs. Level 3
Communications, Inc. et. al., a purported national class action, filed in the
District Court, County of Boulder, State of Colorado which involves the
Company's right to install its fiber optic cable network in easements and
right-of-ways crossing the plaintiffs' land. In general, the Company obtained
the rights to construct its network from railroads, utilities, and others, and
is installing its network along the rights-of-way so granted. Plaintiffs in the
purported class action assert that they are the owners of lands over which the
Company's fiber optic cable network passes, and that the railroads, utilities,
and others who granted the Company the right to construct and maintain its
network did not have the legal ability to do so. The action purports to be on
behalf of a national class of owners of land over which the Company's network
passes or will pass. The complaint seeks damages on theories of trespass,
unjust enrichment and slander of title and property, as well as punitive
damages. Although the Company is not aware of any additional similar claims,
the Company may in the future receive claims and demands related to the rights-
of-way issues similar to the issues in the Schweizer litigation that may be
based on similar or different legal theories. Although it is too early for the
Company to reach a conclusion as to
F-20
<PAGE>
the ultimate outcome of this litigation, management believes that the Company
has substantial defenses to the claims asserted in the Schweizer action (and
any similar claims which may be named in the future), and intends to defend
them vigorously.
The Company is involved in various other 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.
Level 3 filed with the Securities and Exchange Commission a "universal"
shelf registration statement covering up to $3.5 billion of common stock,
preferred stock, debt securities and depositary shares that became effective
February 17, 1999. On March 9, 1999 the Company received approximately $1.5
billion from the sale of 28.75 million shares of Common Stock and on September
14, 1999 the Company sold $823 million aggregate principal amount of its 6%
Convertible Subordinated Notes under the "universal" shelf registration
statement.
F-21
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Level 3 Communications, Inc.:
We have audited the consolidated balance sheet of Level 3 Communications, Inc.
and subsidiaries (a Delaware corporation) as of December 31, 1998 and the
related consolidated statements of earnings, cash flows, changes in
stockholders' equity and comprehensive income for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Level 3
Communications, Inc. and subsidiaries as of December 31, 1998 and the
consolidated results of their operations and their cash flows for the year then
ended in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Denver, Colorado
March 29, 1999
F-22
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Level 3 Communications, Inc. and Subsidiaries
(formerly, Peter Kiewit Sons', Inc.)
We have audited the consolidated balance sheet of Level 3 Communications, Inc.
and Subsidiaries (formerly, Peter Kiewit Sons', Inc.) as of December 27, 1997
and the related consolidated statements of earnings, cash flows, changes in
stockholders' equity and comprehensive income for each of the two years in the
period ended December 27, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Level 3
Communications, Inc. and Subsidiaries as of December 27, 1997 and the
consolidated results of their operations and their cash flows for each of the
two years in the period ended December 27, 1997 in conformity with generally
accepted accounting principles.
Coopers & Lybrand L.L.P.
Omaha, Nebraska
March 30, 1998
F-23
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the three years ended December 31, 1998
<TABLE>
<CAPTION>
1998 1997 1996
------ ----- -----
(dollars in
millions, except
per share data)
<S> <C> <C> <C>
Revenue.................................................. $ 392 $ 332 $ 652
Cost and Expenses:
Operating expenses..................................... (199) (163) (268)
Depreciation and amortization.......................... (66) (20) (124)
General and administrative expenses.................... (332) (106) (173)
Write-off of in process research and development....... (30) -- --
------ ----- -----
Total costs and expenses............................. (627) (289) (565)
------ ----- -----
Earnings (Loss) from Operations.......................... (235) 43 87
Other Income (Expense):
Interest income........................................ 173 33 50
Interest expense, net.................................. (132) (15) (33)
Equity losses in unconsolidated subsidiaries........... (132) (43) (9)
Gain on equity investee stock transactions............. 62 -- --
Gain on sale of assets................................. 107 10 10
Other, net............................................. 4 7 2
------ ----- -----
Total other income (expense)......................... 82 (8) 20
------ ----- -----
Earnings (Loss) Before Income Taxes and Discontinued
Operations.............................................. (153) 35 107
Income Tax Benefit (Provision)........................... 25 48 (3)
------ ----- -----
Income (Loss) from Continuing Operations................. (128) 83 104
Discontinued Operations:
Gain on Split-off of Construction Group................ 608 -- --
Construction operations net of income tax expense of
($107) and ($72)...................................... -- 155 108
Gain on disposition of energy business net of income
tax expense of ($175)................................. 324 -- --
Energy, net of income tax benefit (expense) of $1 and
($9).................................................. -- 10 9
------ ----- -----
Income from discontinued operations.................... 932 165 117
------ ----- -----
Net Earnings............................................. $ 804 $ 248 $ 221
====== ===== =====
Earnings (Loss) Per Share of Level 3 Common Stock
(Basic and Diluted):
Continuing operations.................................. $ (.43) $ .33 $ .45
====== ===== =====
Discontinued operations excluding construction
operations............................................ $ 3.09 $ .04 $ .03
====== ===== =====
Net earnings excluding construction operations......... $ 2.66 $ .37 $ .48
====== ===== =====
Net earnings excluding gain on Split-off of
Construction Group.................................... $ .64 $ .37 $ .48
====== ===== =====
</TABLE>
See accompanying notes to consolidated financial statements.
F-24
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and December 27, 1997
<TABLE>
<CAPTION>
1998 1997
------ ------
(dollars in
millions)
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents..................................... $ 848 $ 87
Marketable securities......................................... 2,863 678
Restricted securities......................................... 26 22
Receivables, net.............................................. 57 42
Investment in discontinued operations--energy................. -- 643
Income taxes receivable....................................... 54 2
Other......................................................... 29 20
------ ------
Total Current Assets............................................ 3,877 1,494
Net Property, Plant and Equipment............................... 1,061 184
Investments..................................................... 323 383
Investments in Discontinued Operations--Construction............ -- 652
Other Assets, net............................................... 264 66
------ ------
$5,525 $2,779
====== ======
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable.............................................. $ 276 $ 31
Current portion of long-term debt............................. 5 3
Accrued reclamation and other mining costs.................... 16 19
Accrued interest.............................................. 33 2
Deferred income taxes......................................... 2 15
Other......................................................... 38 19
------ ------
Total Current Liabilities....................................... 370 89
Long-Term Debt, less current portion............................ 2,641 137
Deferred Income Taxes........................................... 86 83
Accrued Reclamation Costs....................................... 96 100
Other Liabilities............................................... 167 140
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, authorized 10,000,000 shares
in 1998, 250,000 shares in 1997: no shares outstanding in 1998
and 1997...................................................... -- --
Common stock:
Common stock, $.01 par value in 1998 and $.0625 par value in
1997, authorized 500,000,000 shares: 307,874,706 outstanding
in 1998 and 271,034,280 outstanding in 1997................. 3 8
Class B, no shares outstanding in 1997....................... -- --
Class C, 10,132,343 shares outstanding in 1997............... -- 1
Class R, $.01 par value, authorized 8,500,000 shares: no
shares outstanding in 1998 and 1997......................... -- --
Additional paid-in capital..................................... 765 427
Accumulated other comprehensive income (loss).................. 4 (5)
Retained earnings.............................................. 1,393 1,799
------ ------
Total Stockholders' Equity...................................... 2,165 2,230
------ ------
$5,525 $2,779
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
F-25
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three years ended December 31, 1998
<TABLE>
<CAPTION>
1998 1997 1996
------- ----- -----
(dollars in
millions)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings.......................................... $ 804 $ 248 $ 221
Less: Income from Discontinued Operations............. (932) (165) (117)
------- ----- -----
Income (loss) from continuing operations.............. (128) 83 104
Adjustments to reconcile income (loss) from
continuing operations to net cash provided by
continuing operations:
Write-off in process research and development..... 30 -- --
Equity losses, net................................ 132 43 9
Depreciation and amortization..................... 66 20 124
Amortization of discounts on marketable
securities....................................... (24) -- --
Amortization of debt issuances costs.............. 3 -- --
Gain on sale of property, plant and equipment and
other assets..................................... (17) (10) (10)
Gain on equity investee's stock transactions...... (62) -- --
Gain on sale of Cable Michigan.................... (90) -- --
Compensation expense attributable to stock
awards........................................... 39 21 --
Federal income tax refunds........................ 46 146 --
Deferred income taxes............................. (50) (103) (68)
Accrued interest on marketable securities......... (39) -- --
Change in working capital items:
Receivables..................................... (1) (9) (1)
Other current assets............................ (10) (1) 6
Payables........................................ 239 (3) 9
Other liabilities............................... 39 (5) 13
Other............................................. (3) -- 3
------- ----- -----
Net Cash Provided by Continuing Operations.............. 170 182 189
Cash Flows from Investing Activities:
Proceeds from sales and maturities of marketable
securities........................................... 3,214 167 378
Purchases of marketable securities.................... (5,334) (452) (311)
Purchases of restricted securities.................... (2) (2) (2)
Capital expenditures.................................. (910) (26) (117)
Investments and acquisitions, net of cash acquired.... (67) (42) (59)
Proceeds from sale of property, plant and equipment,
and other investments................................ 27 1 14
Proceeds from sale of Cable Michigan.................. 129 -- --
Other................................................. -- 3 (8)
------- ----- -----
Net Cash Used in Investing Activities................... $(2,943) $(351) $(105)
</TABLE>
See accompanying notes to consolidated financial statements.
F-26
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
For the three years ended December 31, 1998
<TABLE>
<CAPTION>
1998 1997 1996
------ ----- -----
(dollars in
millions)
<S> <C> <C> <C>
Cash Flows from Financing Activities:
Long-term debt borrowings, net of issuance costs....... $2,426 $ 17 $ 38
Payments on long-term debt, including current portion.. (12) (2) (60)
Issuances of common stock.............................. 21 117 --
Exchange of Class C Stock for Class D Stock, net....... 122 72 20
Stock options exercised................................ 11 21 --
Issuances of subsidiaries' stock....................... -- -- 1
Repurchases of common stock............................ (1) -- (11)
Dividends paid......................................... -- (12) (11)
------ ----- -----
Net Cash Provided by (Used in) Financing Activities...... 2,567 213 (23)
Cash Flows from Discontinued Operations:
Proceeds from sale of discontinued energy operations,
net of income tax payments of $192 million............ 967 -- --
Discontinued energy operations......................... -- 3 5
Investments in discontinued energy operations.......... -- (31) (282)
------ ----- -----
Net Cash Provided by (Used in) Discontinued Operations... 967 (28) (277)
Cash and Cash Equivalents of C-TEC at the Beginning of
1997.................................................... -- (76) --
------ ----- -----
Net Change in Cash and Cash Equivalents.................. 761 (60) (216)
Cash and Cash Equivalents at Beginning of Year........... 87 147 363
------ ----- -----
Cash and Cash Equivalents at End of Year................. $ 848 $ 87 $ 147
====== ===== =====
Supplemental Disclosure of Cash Flow Information:
Income taxes paid...................................... $ 246 $ 62 $ 55
Interest paid.......................................... 104 13 38
Noncash Investing and Financing Activities:
Issuances of stock for acquisitions:
XCOM Technologies, Inc. ............................. $ 154 $ -- $ --
GeoNet Communications, Inc. ......................... 19 -- --
Others............................................... 10 -- --
Conversion of MidAmerican convertible debentures to
common stock.......................................... $ -- $ -- $ 66
</TABLE>
The activities of the Construction Group have been removed from the
consolidated statements of cash flows. The Construction Group had cash flows of
($62) million, $59 million and $79 million for the three months ended March 31,
1998 (the date of the Split-off) and fiscal 1997 and 1996, respectively.
See accompanying notes to consolidated financial statements.
F-27
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the three years ended December 31, 1998
<TABLE>
<CAPTION>
Accumulated
Class B&C Additional Other
Common Common Paid-in Comprehensive Retained
Stock Stock Capital Income (Loss) Earnings Total
--------- ------ ---------- ------------- -------- -------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 30,
1995................... $ 1 $ 1 $210 $ 11 $ 1,384 $ 1,607
Common Stock:
Issuances.............. -- -- -- -- -- --
Repurchases............ -- -- (1) -- (10) (11)
Dividends (a).......... -- -- -- -- (12) (12)
Class C Stock:
Issuances.............. -- -- 27 -- -- 27
Repurchases............ -- -- (1) -- (4) (5)
Dividends (a).......... -- -- -- -- (13) (13)
Net Earnings............ -- -- -- -- 221 221
Other Comprehensive
Income................. -- -- -- 5 -- 5
----- ---- ---- ---- ------- -------
Balance at December 28,
1996................... 1 1 235 16 1,566 1,819
Common Stock:
Issuances.............. -- -- 117 -- -- 117
Stock options
exercised............. -- -- 21 -- -- 21
Stock dividend......... -- 7 (7) -- -- --
Stock option grants.... -- -- 27 -- -- 27
Class C Stock:
Issuances.............. -- -- 33 -- -- 33
Repurchases............ -- -- -- -- (2) (2)
Dividends (b).......... -- -- -- -- (13) (13)
Conversion of
debentures............ -- -- 1 -- -- 1
Net Earnings............ -- -- -- -- 248 248
Other Comprehensive
Loss................... -- -- -- (21) -- (21)
----- ---- ---- ---- ------- -------
Balance at December 27,
1997................... 1 8 427 (5) 1,799 2,230
Common Stock:
Issuances.............. -- 1 203 -- -- 204
Stock options
exercised............. -- 1 10 -- (1) 10
Designation of par
value to $.01......... -- (8) 8 -- -- --
Stock dividend......... -- 1 (1) -- -- --
Stock plan grants...... -- -- 44 -- -- 44
Income tax benefit from
exercise of options... -- -- 19 -- -- 19
Class R Stock:
Issuance and forced
conversion............ -- -- 164 -- (164) --
Class C Stock:
Repurchases............ -- -- (25) -- -- (25)
Conversion of
debentures............ -- -- 10 -- -- 10
Net Earnings............ -- -- -- -- 804 804
Other Comprehensive
Loss................... -- -- -- (6) -- (6)
Split-off of the
Construction & Mining
Group.................. (1) -- (94) 15 (1,045) (1,125)
----- ---- ---- ---- ------- -------
Balance at December 31,
1998................... $ -- $ 3 $765 $ 4 $ 1,393 $ 2,165
===== ==== ==== ==== ======= =======
</TABLE>
- --------
(a) Includes $.70 and $.05 per share for dividends on Class C and Common Stock,
respectively, declared in 1996 but paid in January 1997.
(b) Includes $.80 per share for dividends on Class C declared in 1997 but paid
in January 1998.
See accompanying notes to consolidated financial statements.
F-28
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three years ended December 31, 1998
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(dollars in
millions)
<S> <C> <C> <C>
Net Earnings................................................ $804 $248 $221
Other Comprehensive Income Before Tax:
Foreign currency translation adjustments.................. 1 -- (1)
Unrealized holding gains (losses) arising during period... (2) (23) 12
Reclassification adjustment for gains included in net
earnings................................................. (9) (9) (3)
---- ---- ----
Other Comprehensive Income (Loss), Before Tax............... (10) (32) 8
Income Tax Benefit (Expense) Related to Unrealized Holding
Gains (Losses)............................................. 4 11 (3)
---- ---- ----
Other Comprehensive Income (Loss) Net of Taxes.............. (6) (21) 5
---- ---- ----
Comprehensive Income........................................ $798 $227 $226
==== ==== ====
</TABLE>
See accompanying notes to consolidated financial statements.
F-29
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Reorganization--Discontinued Construction Operations
In October 1996, the Board of Directors (the "Board") of Level 3
Communications, Inc. ("Level 3" or the "Company"), 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 operations
("Construction Group") from the other businesses of the Company (the
"Diversified Group"), thereby forming two independent companies. At the time,
the performance of the Diversified Group was reflected by the Class D Stock.
The performance of the Construction Group was reflected by the Company's Class
C Construction & Mining Group Restricted Redeemable Convertible Exchangeable
Common Stock, par value $.0625 per share (the "Class C Stock"). At the regular
meeting of the Board on July 23, 1997, management submitted to the Board for
consideration a proposal for the 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 and the Class D Stock,
and the receipt by the 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 private letter ruling from the Internal Revenue Service. The Split-
off was effected 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 to replace certain conversion features in the Class C Stock which
would terminate upon the Split-off (ii) New PKS was renamed "Peter Kiewit
Sons', Inc." (iii) the Company was renamed "Level 3 Communications, Inc.", and
(iv) the Class D Stock was designated as common stock, par value $.01 per share
(the "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
December 27, 1997, and the results of operations for the two years ended
December 27, 1997.
On March 31, 1998, the Company reflected the fair value of the Construction
Group as a distribution to the Class C stockholders because the distribution
was considered non-pro rata as compared to the Company's previous two-class
capital stock structure. The Company recognized, a gain of $608 million within
discontinued operations, 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, "Accounting
for Reorganizations Involving a Non-Pro Rata Split-off of Certain Nonmonetary
Assets to Owners". No taxes were provided on this gain due to the tax-free
nature of the Split-off.
In connection with the Split-off, Level 3 and the Construction 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 Group and for
cross-indemnifications that are intended to allocate financial responsibility
to the Construction 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
F-30
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Separation Agreement also allocates certain corporate-level risk exposures not
readily allocable to either the construction business 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 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 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 Group,
respectively, of certain representations made to the Internal Revenue Service
in connection with the private letter ruling issued with respect to the Split-
off. If the Split-off was determined to be taxable for any other reason, those
taxes would be allocated equally to Level 3 and the Construction Group.
Finally, under certain circumstances, Level 3 would make certain liquidated
damage payments to the Construction 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 Group provides mine management and related services to
Level 3's coal mining operations, was amended to provide the Construction 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 Group. If the
Construction 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 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"). Summarized financial information for the Construction
Group is presented below; however, the separate financial statements of Peter
Kiewit Sons', Inc. should be obtained to review the financial position of the
Construction Group as of December 27, 1997 and the results of operations for
each of the two years ended December 27, 1997.
F-31
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is summarized financial information of the Construction Group:
Operations
<TABLE>
<CAPTION>
1997 1996
------ ------
(in millions)
<S> <C> <C>
Revenue........................................................... $2,764 $2,303
Net Earnings...................................................... 155 108
</TABLE>
Financial Position
<TABLE>
<CAPTION>
1997
-------------
(in millions)
<S> <C>
Current Assets.................................................... $1,057
Other Assets...................................................... 284
------
Total assets.................................................... 1,341
Current Liabilities............................................... 579
Other Liabilities................................................. 99
Minority Interest................................................. 11
------
Total liabilities............................................... 689
------
Net Assets........................................................ $ 652
======
</TABLE>
The following details the earnings per share calculations for Class C Stock:
<TABLE>
<CAPTION>
Class C Stock 1997 1996
- ------------- ------- -------
<S> <C> <C>
Net Income Available to Common Shareholders (in millions).... $ 155 $ 108
Add: Interest Expense, Net of Tax Effect Associated with
Convertible Debentures...................................... 1 -- *
------- -------
Net Income for Diluted Shares................................ $ 156 $ 108
======= =======
Total Number of Weighted Average Shares Outstanding Used to
Compute Basic Earnings per Share (in thousands)............. 9,728 10,656
Additional Dilutive Shares Assuming Conversion of Convertible
Debentures.................................................. 441 437
------- -------
Total Number of Shares Used to Compute Diluted Earnings Per
Share....................................................... 10,169 11,093
======= =======
Net Income
Basic earnings per share................................... $ 15.99 $ 10.13
======= =======
Diluted earnings per share................................. $ 15.35 $ 9.76
======= =======
</TABLE>
- --------
* Interest expense attributable to convertible debentures was less than $1
million in 1996.
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 Stock in January 1998, which was convertible into 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 shares of Common Stock, effective May 15, 1998. The Class R Stock was
converted into Common Stock in accordance with the formula set forth in the
certificate of incorporation of the Company. The formula provided for a
conversion ratio equal to $25, divided by the average of the midpoints between
the high and low sales prices for Common Stock on each of the fifteen trading
days during the period beginning April 9, 1998 and ending April 30, 1998. The
average for that period was $32.14, adjusted for the stock dividend issued
August 10, 1998.
F-32
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accordingly, each holder of Class R Stock received .7778 of a share of
Common Stock for each share of Class R Stock held. In total 6.5 million shares
of Class R Stock were converted into 5.1 million shares of Common Stock. The
value of the Class R Stock at the time of the forced conversion was $25 times
the 6.5 million shares outstanding, or $164 million. The Company recognized the
additional $72 million of value upon conversion of the Class R Stock to Common
Stock in the equity accounts. As a result of the forced conversion, certain
adjustments were 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. that were executed in connection with the Split-off. The
effect of these adjustments was to reduce certain Split-off costs and risks
allocated to the Company.
The Company has embarked on a plan 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 in the United States, Europe and Asia. 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 Internet
Protocol technology in order to leverage the efficiencies of this technology to
provide lower cost communications services.
(2) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Level 3
Communications, Inc. and subsidiaries in which it has control, which are
engaged in enterprises primarily related to communications and information
services, and coal mining. Fifty-percent-owned mining joint ventures are
consolidated on a pro rata basis. Investments in other companies in which the
Company exercises significant influence over operating and financial policies
are accounted for by the equity method. All significant intercompany accounts
and transactions have been eliminated.
In 1997, the Company agreed to sell its energy assets to MidAmerican Energy
Holding Company (f/k/a CalEnergy Company, Inc.) ("MidAmerican") and to split-
off the Construction Group. Therefore, the assets and liabilities, and results
of operations, of these businesses have been classified as discontinued
operations on the consolidated balance sheet, statements of earnings and cash
flows. (See notes 1 and 3)
In 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. The transaction was effective September 30, 1997. As a result of the
restructuring plan, the Company owned less than 50% of the outstanding shares
and voting rights of each entity, and therefore has accounted for each entity
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 financial statements.
Communications and Information Services Revenue
Information services revenue is primarily derived from the computer
outsourcing business and the systems integration business. Level 3 provides
outsourcing service, typically through contracts ranging from 3-5 years, to
firms that desire to focus their resources on their core businesses. Under
these contracts, Level 3 recognizes revenue in the month the service is
provided. The systems integration business helps customers define, develop and
implement cost-effective information systems. Revenue from these services is
recognized on a time and materials basis or percentage of completion basis
depending on the extent of the services provided.
Revenue from communications services is recognized monthly as the services
are provided. Amounts billed in advance of the service month are recorded as
deferred revenue, however that amount is not material.
F-33
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentration of credit risk with respect to accounts receivable are limited
due to the dispersion of customer base among geographic areas and remedies
provided by terms of contracts and statutes.
As noted previously, the investments in the three former C-TEC companies
have been accounted for using the equity method in 1998 and 1997.
Coal Sales Contracts
Level 3's coal is sold primarily under long-term contracts with electric
utilities, which burn coal in order to generate steam to produce electricity. A
substantial portion of Level 3's coal sales were made under long-term contracts
during 1998, 1997 and 1996. The remainder of Level 3's sales are made on the
spot market where prices are substantially lower than those in the long-term
contracts. As the long-term contracts expire, a higher proportion of Level 3's
sales will occur on the spot market.
The coal industry is highly competitive. Level 3 competes not only with
other domestic and foreign coal suppliers, some of whom are larger and have
greater capital resources than Level 3, but also with alternative methods of
generating electricity and alternative energy sources. Many of Level 3's
competitors are served by two railroads and, due to the competition, often
benefit from lower transportation costs than Level 3 which is served by a
single railroad. Additionally, many competitors have more favorable geological
conditions than Level 3, often resulting in lower comparative costs of
production.
Level 3 is also required to comply with various federal, state and local
laws concerning protection of the environment. Level 3 believes its compliance
with environmental protection and land restoration laws will not affect its
competitive position since its competitors are similarly affected by such laws.
Level 3 and its mining ventures have entered into various agreements with
its customers which stipulate delivery and payment terms on the sale of coal.
Prior to 1993, one of the primary customers deferred receipt of certain
commitments by purchasing undivided fractional interest in coal reserves of
Level 3 and the mining ventures. Under the agreements, revenue was recognized
when cash was received. The agreements with this customer were renegotiated in
1992. In accordance with the renegotiated agreements, there were no sales of
interest in coal reserves subsequent to January 1, 1993. Level 3 has delivered
and has the obligation to deliver the coal reserves to the customer in the
future if the customer exercises its option to take delivery of the coal. If
the option is exercised, Level 3 presently intends to deliver coal from
unaffiliated mines. In the opinion of the management, Level 3 has sufficient
coal reserves to cover the above sales commitments.
Level 3's coal sales contracts are with several electric utility and
industrial companies. In the event that these customers do not fulfill
contractual responsibilities, Level 3 would pursue the available legal
remedies.
Depreciation and Amortization
Property, plant and equipment are recorded at cost. Depreciation and
amortization for the majority of the Company's property, plant and equipment
are computed on accelerated and straight-line methods based on the following
useful lives:
<TABLE>
<S> <C>
Facility and Leasehold Improvements......................... 35 - 40 years
Operating Equipment......................................... 3 - 7 years
Network Construction Equipment.............................. 5 - 7 years
Furniture and Office Equipment.............................. 3 - 7 years
Other....................................................... 2 - 10 years
</TABLE>
F-34
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Depletion of mineral properties is provided primarily on an units-of-
extraction basis determined in relation to coal committed under sales
contracts.
Software Development Costs
On March 4, 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). The
effective date of this pronouncement is for fiscal years beginning after
December 15, 1998, however, the Company has elected to account for internal
software development costs incurred in developing its integrated business
support systems in accordance with SOP 98-1 in 1998. The Company recognized
$27 million of expense for the development of operating support systems in 1998
that would have previously been capitalized prior to adoption of SOP 98-1.
Start-Up Costs
On April 3, 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-Up Activities", ("SOP 98-5"), which provides guidance on the
financial reporting for 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, however, the Company elected to adopt SOP 98-5 in 1998. The adoption
of SOP 98-5 did not result in a significant charge to earnings in 1998.
Subsidiary and Investee Stock Activity
The Company recognizes gains and losses from the sale, issuance and
repurchase of stock by its subsidiaries and equity method investees in the
statements of earnings.
Earnings Per Share
Basic earnings per share have been computed using the weighted average
number of shares during each period. Diluted earnings per share is computed by
including stock options and other securities considered to be dilutive.
Intangible Assets
Intangible assets primarily include amounts allocated upon acquisitions of
businesses, franchises and subscriber lists. These assets are amortized on a
straight-line basis over the expected period of benefit.
For intangibles originating from Internet Protocol or other information
services related acquisitions, the Company is amortizing these assets over a
five year period. Intangibles attributable to other acquisitions and
investments are amortized over periods which do not exceed 40 years.
Long Lived Assets
The Company reviews the carrying amount of long lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. Measurement of any impairment would include a
comparison of estimated future operating cash flows anticipated to be generated
during the remaining life of the asset to the net carrying value of the asset.
Reserves for Reclamation
The Company follows the policy of providing an accrual for reclamation of
mined properties, based on the estimated total cost of restoration of such
properties to meet compliance with laws governing strip mining, by applying
per-ton reclamation rates to coal mined. These reclamation rates are determined
using the remaining
F-35
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
estimated reclamation costs and tons of coal committed under sales contracts.
The Company reviews its reclamation cost estimates annually and revises the
reclamation rates on a prospective basis, as necessary.
Income Taxes
Deferred income taxes are provided for the temporary differences between the
financial reporting and tax bases of the Company's assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income", which requires that changes in comprehensive income be
shown in a financial statement that is displayed with the same prominence as
other financial statements. The Company has adopted this statement in 1998 as
the Company has unrealized gains and losses on marketable securities classified
as available for sale and has operations in foreign countries and restated 1997
and 1996 to present information on a comparable basis.
Foreign Currencies
Generally, local currencies of foreign subsidiaries are the functional
currencies for financial reporting purposes. Assets and liabilities are
translated into U.S. dollars at year-end exchange rates. Revenue and expenses
are translated using average exchange rates prevailing during the year. Gains
or losses resulting from currency translation are recorded as a component of
accumulated other comprehensive income (loss) in stockholders' equity and in
the statements of comprehensive income.
Stock Dividend
Effective August 10, 1998 and December 26, 1997, the Company issued
dividends of one and four shares, respectively, of 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 these stock
dividends.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Segment Disclosures
In 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"), which changes the way
public companies report information about segments. SFAS No. 131, which is
based on the management approach to segment reporting, includes requirements to
report selected segment information quarterly, and entity wide disclosures
about products and services, major customers, and geographic data. The Company
has provided the information required by SFAS No. 131 in Note 14.
Recently Issued Accounting Pronouncements
On June 15, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 is effective
for fiscal years beginning after June 15, 1999
F-36
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(January 1, 2000 for the Company). SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at the fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part
of a hedge transaction and, if it is, the type of hedge transaction. The
Company currently makes minimal use of derivative instruments as defined by
SFAS No. 133. If the Company does not increase the utilization of these
derivative instruments by the effective date of SFAS No. 133, the adoption of
this standard is not expected to have a significant effect on the Company's
results of operations or its financial position.
Fiscal 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 results
of operations for the additional five days in the 1998 fiscal year are
reflected in the Company's Form 10-K for the period ended December 31, 1998 and
were not material to the overall results of operations and cash flows. There
were 52 weeks in fiscal years 1997 and 1996.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(3) Discontinued Energy Operations
On January 2, 1998, the Company completed the sale of its energy assets to
MidAmerican. These assets included approximately 20.2 million shares of
MidAmerican common stock (assuming the exercise of 1 million options held by
Level 3), Level 3's 30% interest in CE Electric and Level 3's investments in
international power projects in Indonesia and the Philippines ("Energy
Projects"). 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 are being used in part to fund 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.
F-37
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is summarized financial information for discontinued energy
operations for the fiscal years ended December 27, 1997 and December 28, 1996
and as of December 27, 1997:
Income from Discontinued Operations
<TABLE>
<CAPTION>
1997 1996
------ ------
(in millions)
<S> <C> <C>
Operations
Equity in:
MidAmerican earnings, net..................................... $ 16 $ 20
CE Electric earnings, net..................................... 17 (2)
International energy projects earnings, net................... 5 (5)
Investment Income from MidAmerican.............................. -- 5
Income Tax Expense.............................................. (9) (9)
------ ------
Income from operations........................................ 29 9
MidAmerican Stock Transactions
Gain on Investee Stock Activity................................. 68 --
Income Tax Expense.............................................. (24) --
------ ------
Gain on MidAmerican stock activity............................ 44 --
Extraordinary Loss--Windfall Tax
Level 3's Share from MidAmerican................................ (39) --
Level 3's Share from CE Electric................................ (58) --
Income Tax Benefit.............................................. 34 --
------ ------
Extraordinary loss............................................ (63) --
------ ------
Income from Discontinued Energy Operations...................... $ 10 $ 9
====== ======
</TABLE>
In order to fund the purchase of Level 3's energy assets, MidAmerican sold,
in 1997 approximately 19.1 million shares of its common stock at a price of
$37.875 per share. This sale reduced Level 3's ownership in MidAmerican to
approximately 24% but increased its proportionate share of MidAmerican's
equity. Level 3 recognized an after-tax gain of approximately $44 million from
MidAmerican transactions in 1997.
In 1997 the Labour Party in the United Kingdom implemented a "Windfall Tax"
against privatized British utilities. This one-time tax was 23% of the
difference between the value of Northern Electric, plc at the time of
privatization and the utility's current value based on profits over a period of
up to four years. CE Electric recorded an extraordinary charge of approximately
$194 million when the tax was enacted in 1997. The total impact to Level 3
directly through its investment in CE Electric and indirectly through its
interest in MidAmerican, was $63 million.
Investments in Discontinued Operations
<TABLE>
<CAPTION>
1997
-------------
(in millions)
<S> <C>
Investment in MidAmerican......................................... $ 337
Investment in CE Electric......................................... 135
Investment in International Energy Projects....................... 186
Restricted Securities............................................. 2
Deferred Income Tax Liability..................................... (17)
-----
Total........................................................... $ 643
=====
</TABLE>
F-38
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is summarized financial information of MidAmerican, CE
Electric, and the Energy Projects.
Operations
<TABLE>
<CAPTION>
1997 1996
------- -----
(in millions)
<S> <C> <C>
Revenue
MidAmerican................................................... $ 2,271 $ 576
CE Electric................................................... 1,564 37
Net Earnings (Loss)
MidAmerican................................................... $ (84) $ 92
CE Electric................................................... (136) --
Energy Projects............................................... 2 (12)
</TABLE>
Financial Position at December 27, 1997
<TABLE>
<CAPTION>
Energy
MidAmerican CE Electric Projects
----------- ------------- --------
(in millions)
<S> <C> <C> <C>
Current Assets............................... $ 2,053 $ 419 $ 530
Other Assets................................. 5,435 2,519 811
------- ------ ------
Total assets............................... 7,488 2,938 1,341
Current Liabilities.......................... 1,440 1,166 172
Other Liabilities............................ 4,494 1,265 737
Minority Interest............................ 134 56 --
------- ------ ------
Total liabilities.......................... 6,068 2,487 909
------- ------ ------
Net Assets................................... $ 1,420 $ 451 $ 432
======= ====== ======
</TABLE>
(4) Earnings Per Share
The Company had a loss from continuing operations for the year ended
December 31, 1998, therefore, no potential common shares related to Company
stock options and other dilutive securities have been included in the
computation of the diluted earnings per share because the resulting
computation would be anti-dilutive. For the two years ending December 27,
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 Company had 23,147,051 potentially dilutive securities outstanding that
were not included in the computation of diluted earnings per share because to
do so would have been anti-dilutive for the year ended December 31, 1998.
F-39
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following details the earnings (loss) per share calculations for Level 3
Common Stock. A calculation of the earnings per share for the Class C Stock in
1996 and 1997 can be found in Note 1 to the consolidated financial statements.
<TABLE>
<CAPTION>
Year Ended
---------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Earnings (Loss) from Continuing Operations (in
millions)........................................ $ (128) $ 83 $ 104
Earnings from Discontinued Energy Operations...... 324 10 9
Gain on Separation of Construction Operations..... 608 -- --
-------- -------- --------
Net Earnings Excluding Discontinued Construction
Operations....................................... $ 804 $ 93 $ 113
======== ======== ========
Total Number of Weighted Average Shares
Outstanding used to Compute Basic Earnings Per
Share (in thousands)............................. 301,976 249,293 232,012
Additional Dilutive Stock Options................. -- 1,079 622
-------- -------- --------
Total Number of Shares used to Compute Dilutive
Earnings Per Share............................... 301,976 250,372 232,634
======== ======== ========
Earnings (Loss) Per Share (Basic and Diluted):
Continuing operations........................... $ (.43) $ .33 $ .45
======== ======== ========
Discontinued energy operations.................. $ 1.07 $ .04 $ .03
======== ======== ========
Gain on split-off of discontinued construction
operations..................................... $ 2.02 $ -- $ --
======== ======== ========
Net earnings excluding discontinued construction
operations..................................... $ 2.66 $ .37 $ .48
======== ======== ========
Net earnings excluding gain on split-off of
construction operations........................ $ .64 $ .37 $ .48
======== ======== ========
</TABLE>
(5) Acquisitions
On April 23, 1998, the Company acquired XCOM Technologies, 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 Internet Protocol based network and the existing public
switched telephone network. The Company issued approximately 5.3 million shares
of Level 3 Common Stock and 0.7 million options and warrants to purchase Level
3 Common Stock in exchange for all the stock, options and warrants of XCOM.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated to
in-process research and development and was taken as a nondeductible charge to
earnings in the second quarter of 1998. The purchase price exceeded the fair
value of the net assets acquired by $30 million which was recognized as
goodwill.
In October 1998, the Securities and Exchange Commission ("SEC") issued new
guidelines for valuing acquired research and development which are applied
retroactively. The Company believes its accounting for the acquisition was made
in accordance with generally accepted accounting principles and established
appraisal practices at the time of the acquisition. However, due to the
significance of the charge relative to the total value of the acquisition, the
Company reviewed the facts and assumptions with the SEC. Consequently, using
the revised guidelines and assumptions, the Company reduced the charge for in-
process research and development from $115 to $30 million, and increased the
related goodwill by $85 million. The goodwill associated with the XCOM
transaction is being amortized over a five year period.
F-40
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
XCOM's in-process research and development value is comprised primarily of
one project to develop an interface between an Internet Protocol based network
and the existing public switched telecommunications network. Remaining
development efforts for this project include various phases of design,
development and testing. The anticipated completion date for the project in
progress is expected to be over the next 12 months, at which time the Company
expects to begin generating the full economic benefits from the technology.
Funding for this project is expected to be obtained from internally generated
sources.
The value of the in-process research and development represents the
estimated fair value based on risk-adjusted cash flows related to the
incomplete project. At the date of acquisition, the development of this project
had not yet reached technological feasibility and the research and development
("R&D") in progress had no alternative future uses. Accordingly, these costs
were expensed as of the acquisition date.
The Company used independent third-party appraisers to assess and allocate
the value to the in-process research and development. The value assigned to the
asset was determined, using the income approach, by identifying significant
research projects for which technological feasibility had not been established.
The nature of the efforts to develop the acquired in-process technology into
commercially viable products and services principally relate to the completion
of all planning, designing, prototyping, high-volume verification, and testing
activities that are necessary to establish that the proposed technologies meet
their design specifications including functional, technical, and economic
performance requirements.
The value assigned to purchased in-process technology was determined by
estimating the contribution of the purchased in-process technology to
developing a commercially viable product, estimating the resulting net cash
flows from the expected product sales over a 15 year period, discounting the
net cash flows to their present value using a risk-adjusted discount rate of
30%, and adjusting it for the estimated stage of completion.
The Company believes that the foregoing assumptions used in the forecasts
were reasonable at the time of the acquisition. No assurance can be given,
however, that the underlying assumptions used to estimate expected project
sales, development costs or profitability, or the events associated with such
projects, will transpire as estimated. For these reasons, actual results may
vary from the projected results.
Management expects to continue their support of this effort and believes the
Company has a reasonable chance of successfully completing the R&D project.
However, there is risk associated with the completion of the project and there
is no assurance that it will meet with either technological or commercial
success. If the XCOM project is not successful, the Company would not realize
its investment in XCOM and would be required to modify its business plan to
utilize alternative technologies which may increase the cost of its network.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guidelines and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
On September 30, 1998, Level 3 acquired GeoNet Communications, Inc.
("GeoNet"), a regional Internet service provider located in Northern
California. The Company issued approximately 0.6 million shares and options in
exchange for GeoNet's capital stock, which valued the transaction at
approximately $19 million. Acquired liabilities exceeded assets, and goodwill
of $21 million was recognized from this transaction which is being amortized
over five years.
XCOM's and GeoNet's 1997 and 1998 operating results prior to the
acquisitions were not significant relative to the Company's results.
F-41
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Company's acquisitions, the excess purchase price over the fair
market value of the underlying assets was allocated to goodwill and other
intangible assets and property based upon preliminary estimates of fair value.
The Company does not believe that the final purchase price allocation will vary
significantly from the preliminary estimates.
(6) Disclosures about Fair Value of Financial Instruments
The following methods and assumptions were used to determine classification
and fair values of financial instruments:
Cash and Cash Equivalents
Cash equivalents generally consist of funds invested in highly liquid
instruments purchased with an original maturity of three months or less. The
securities are stated at cost, which approximates fair value.
Marketable and Restricted Securities
Level 3 has classified all marketable and restricted securities as
available-for-sale. Restricted securities primarily include investments in
mutual funds that are restricted to fund certain reclamation liabilities of its
coal mining ventures. The amortized cost of the securities used in computing
unrealized and realized gains and losses is determined by specific
identification. Fair values are estimated based on quoted market prices for the
securities on hand or for similar investments. Net unrealized holding gains and
losses are included in accumulated other comprehensive income within
stockholders' equity, net of tax.
F-42
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, 1998 and December 27, 1997 the amortized cost, unrealized
holding gains and losses, and estimated fair values of marketable and
restricted securities were as follows:
<TABLE>
<CAPTION>
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
(dollars in millions)
<S> <C> <C> <C> <C>
1998
Marketable Securities:
U.S. Treasury securities......... $ 2,147 $ 8 $ -- $ 2,155
U.S. Government Agency
securities...................... 639 1 -- 640
Equity securities................ 54 -- (3) 51
Other securities................. 20 -- (3) 17
------- ----- ----- -------
$ 2,860 $ 9 $ (6) $ 2,863
======= ===== ===== =======
Restricted Securities:
Wilmington Trust:
Intermediate term bond fund.... $ 13 $-- $-- $ 13
Equity fund.................... 10 3 -- 13
------- ----- ----- -------
$ 23 $ 3 $ -- $ 26
======= ===== ===== =======
1997
Marketable Securities:
Kiewit Mutual Fund:
Short-term government.......... $ 234 $-- $-- $ 234
Intermediate term bond......... 195 3 -- 198
Tax exempt..................... 154 3 -- 157
Equity......................... 7 4 -- 11
Equity securities................ 48 9 -- 57
Other securities................. 20 1 -- 21
------- ----- ----- -------
$ 658 $ 20 $ -- $ 678
======= ===== ===== =======
Restricted Securities:
Kiewit Mutual Fund:
Intermediate term bond......... $ 10 $-- $-- $ 10
Equity......................... 12 -- -- 12
------- ----- ----- -------
$ 22 $ -- $ -- $ 22
======= ===== ===== =======
</TABLE>
For debt securities, amortized costs do not vary significantly from
principal amounts. Realized gains and losses on sales of marketable and equity
securities were $10 million and $1 million in 1998, $9 million and $-million in
1997, and $3 million and $- million in 1996, respectively.
F-43
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, 1998, the contractual maturities of the debt securities are
as follows:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
--------- -------
(dollars in
millions)
<S> <C> <C>
U.S. Treasury Securities:
Less than 1 year........................................ $ 2,147 $ 2,155
======= =======
U.S. Government Agency Securities:
Less than 1 year........................................ $ 639 $ 640
======= =======
Other Securities:
10+ years............................................... $ 20 $ 17
======= =======
</TABLE>
Maturities for the equity and restricted securities have not been presented
as they do not have a single maturity date.
Long-Term Debt
The fair value of long-term debt was estimated using the Company's
incremental borrowing rates for debt of similar maturities.
The carrying amount and estimated fair values of Level 3's financial
instruments are as follows:
<TABLE>
<CAPTION>
1998 1997
--------------- --------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- -----
(dollars in millions)
<S> <C> <C> <C> <C>
Cash and Cash Equivalents (Note 6).......... $ 848 $ 848 $ 87 $ 87
Marketable Securities (Note 6).............. 2,863 2,863 678 678
Restricted Securities (Note 6).............. 26 26 22 22
Investment in C-TEC Entities (Note 8)....... 300 818 335 776
Investments in Discontinued Energy
Operations (Note 3)........................ -- -- 643 854
Long-term Debt (Note 10).................... 2,646 2,613 140 140
</TABLE>
(7) Property, Plant and Equipment
Construction in Progress
The Company is currently constructing its communications network. Costs
associated directly with the uncompleted network and interest expense incurred
during construction are capitalized based on the weighted average accumulated
construction expenditures and the interest rates related to borrowings
associated with the construction. These costs are not yet being depreciated, as
the assets have not yet been placed in service. As segments of the network
become operational, the assets will be depreciated over their useful lives.
The Company is currently developing business support systems required for
its Business Plan. The external direct costs of software, materials and
services, payroll and payroll related expenses for employees directly
associated with the project and interest costs incurred when developing the
business support systems are capitalized. Upon completion of the projects, the
total cost of the business support systems will be amortized over its useful
life of 3 years.
F-44
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Capitalized business support systems and network construction costs that
have not been placed in service have been classified as construction-in-
progress within Property, Plant & Equipment below.
<TABLE>
<CAPTION>
Accumulated Book
Cost Depreciation Value
------ ------------ ------
(dollars in millions)
<S> <C> <C> <C>
1998
Land and Mineral Properties......................... $ 32 $ (11) $ 21
Facility and Leasehold Improvements
Communications.................................... 80 (1) 79
Information Services.............................. 24 (2) 22
Coal Mining....................................... 18 (15) 3
CPTC.............................................. 91 (5) 86
Operating Equipment
Communications.................................... 245 (18) 227
Information Services.............................. 53 (30) 23
Coal Mining....................................... 180 (155) 25
CPTC.............................................. 17 (4) 13
Network Construction Equipment...................... 46 (1) 45
Furniture and Office Equipment...................... 67 (10) 57
Other............................................... 32 (2) 30
Construction-in-Progress............................ 430 -- 430
------ ----- ------
$1,315 $(254) $1,061
====== ===== ======
1997
Land and Mineral Properties......................... $ 15 $ (11) $ 4
Facility and Leasehold Improvements
Communications.................................... -- -- --
Information Services.............................. 12 (2) 10
Coal Mining....................................... 19 (15) 4
CPTC.............................................. 91 (4) 87
Operating Equipment
Communications.................................... -- -- --
Information Services.............................. 42 (23) 19
Coal Mining....................................... 190 (159) 31
CPTC.............................................. 17 (3) 14
Furniture and Office Equipment...................... 11 (5) 6
Other............................................... 14 (6) 8
Construction-in-Progress............................ 1 -- 1
------ ----- ------
$ 412 $(228) $ 184
====== ===== ======
</TABLE>
Depreciation expense was $48 million in 1998, $20 million in 1997 and $124
million in 1996.
(8) Investments
In 1997, 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 stockholders
received stock in the following companies:
Commonwealth Telephone Enterprises, Inc ("Commonwealth Telephone")
containing the local telephone group and related engineering business.
F-45
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
RCN Corporation ("RCN") 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.
Cable Michigan, Inc. ("Cable Michigan") containing the cable television
operation.
As a result of the restructuring, Level 3 owned less than 50% of each of the
outstanding shares and voting rights of each entity, and therefore began
accounting for each entity using the equity method as of the beginning of 1997.
The following is summarized financial information of the Company had C-TEC
been accounted for utilizing the equity method for the fiscal year ended
December 28, 1996. Fiscal years 1998 and 1997 include C-TEC accounted for
utilizing the equity method and are presented here for comparative purposes
only.
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
(dollars in
millions)
<S> <C> <C> <C>
Revenue.................................................. $ 392 $ 332 $ 285
Costs and Expenses:
Operating expenses..................................... (199) (163) (125)
Depreciation and amortization.......................... (66) (20) (18)
General and administrative expenses.................... (332) (106) (86)
Write-off of in process research and development....... (30) -- --
----- ----- -----
Total costs and expenses............................. (627) (289) (229)
----- ----- -----
Earnings (Loss) from Operations.......................... (235) 43 56
Other Income (Expense):
Interest income........................................ 173 33 36
Interest expense....................................... (132) (15) (5)
Equity losses.......................................... (132) (43) (13)
Gain on investee stock transactions.................... 62 -- --
Gain on disposal of assets............................. 107 10 10
Other, net............................................. 4 7 9
----- ----- -----
Total other income (expense)......................... 82 (8) 37
----- ----- -----
Earnings (Loss) before Income Taxes and Discontinued
Operations.............................................. (153) 35 93
Income Tax Benefit....................................... 25 48 11
----- ----- -----
Income (Loss) from Continuing Operations................. (128) 83 104
Income from Discontinued Operations...................... 932 165 117
----- ----- -----
Net Earnings............................................. $ 804 $ 248 $ 221
===== ===== =====
</TABLE>
On June 4, 1998, Cable Michigan announced that its Board of Directors had
reached a definitive agreement to sell the company to Avalon Cable of Michigan,
Inc. for $40.50 per share in a cash-for-stock transaction. Level 3 received
approximately $129 million when the transaction closed on November 6, 1998 and
recognized a pre-tax gain of approximately $90 million in the fourth quarter.
The $90 million gain was calculated using the Company's carrying value as of
September 30, 1998, as Cable Michigan's results of operations for the period
October 1, 1998 through November 6, 1998 were not considered significant
relative to the Company's results.
F-46
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On September 25, 1998, Commonwealth Telephone announced that it was
commencing a rights offering of 3.7 million shares of its common stock. Under
the terms of the offering, each stockholder received one right for every five
shares of Commonwealth Telephone Common Stock or Commonwealth Telephone Class B
Common Stock held. The rights enabled the holder to purchase Commonwealth
Telephone Common Stock at a subscription price of $21.25 per share. Each right
also carried the right to oversubscribe at the subscription price for the
offered shares not purchased pursuant to the initial exercise of rights.
Level 3, which owned approximately 48% of Commonwealth Telephone prior to
the rights offering, exercised its 1.8 million rights it received with respect
to the shares it held for $38 million. As a result of subscriptions made by
other stockholders, Level 3 maintained its 48% ownership interest in
Commonwealth Telephone after the rights offering.
The following is summarized financial information of the three entities
created as a result of the C-TEC restructuring for each of the three years
ended December 31, 1998 and as of December 31, 1998 and December 27, 1997 (in
millions):
Operations
<TABLE>
<CAPTION>
Year Ended
-----------------
1998 1997 1996
----- ---- ----
<S> <C> <C> <C>
Commonwealth Telephone Enterprises, Inc.:
Revenue................................................... $ 226 $197 $186
Net income available to common shareholders............... 8 20 20
Level 3's Share:
Net income................................................ 4 10 10
Goodwill amortization..................................... (2) (1) (1)
----- ---- ----
Equity in net income.................................... $ 2 $ 9 $ 9
===== ==== ====
RCN Corporation:
Revenue................................................... $ 211 $127 $105
Net loss available to common shareholders................. (205) (52) (6)
Level 3's Share:
Net loss.................................................. (91) (26) (3)
Goodwill amortization..................................... (1) -- (3)
----- ---- ----
Equity in net loss...................................... $ (92) $(26) $ (6)
===== ==== ====
Cable Michigan, Inc.*:
Revenue................................................... $ 66 $ 81 $ 76
Net loss available to common shareholders................. (9) (4) (8)
Level 3's Share*:
Net loss.................................................. (4) (2) (4)
Goodwill amortization..................................... (3) (4) (4)
----- ---- ----
Equity in net loss...................................... $ (7) $ (6) $ (8)
===== ==== ====
</TABLE>
* 1998 revenue and net loss amounts are through September 30, 1998.
F-47
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Financial Position
<TABLE>
<CAPTION>
Commonwealth Cable
Telephone RCN Michigan,
Enterprises, Inc. Corporation Inc.
----------------- ------------- ---------
1998 1997 1998 1997 1997
-------- -------- ------ ------ ---------
<S> <C> <C> <C> <C> <C>
Current Assets.............. $ 79 $ 71 $1,092 $ 703 $ 23
Other Assets................ 354 303 816 448 120
-------- -------- ------ ------ ----
Total assets.............. 433 374 1,908 1,151 143
Current Liabilities......... 85 76 178 70 16
Other Liabilities........... 223 260 1,282 708 166
Minority Interest........... -- -- 77 16 15
-------- -------- ------ ------ ----
Total liabilities......... 308 336 1,537 794 197
-------- -------- ------ ------ ----
Net assets
(liabilities).......... $ 125 $ 38 $ 371 $ 357 $(54)
======== ======== ====== ====== ====
Level 3's Share:
Equity in net assets
(liabilities)............ $ 60 $ 18 $ 150 $ 173 $(26)
Goodwill.................. 56 57 34 41 72
-------- -------- ------ ------ ----
$116 $ 75 $ 184 $ 214 $ 46
======== ======== ====== ====== ====
</TABLE>
The Company recognizes gains from the sale, issuance and repurchase of stock
by its subsidiaries and equity method investees in its statements of earnings.
During 1998, RCN issued stock in a public offering and for certain acquisitions
which diluted the Company's ownership of RCN from 48% at December 27, 1997 to
41% at December 31, 1998. The increase in the Company's proportionate share of
RCN's net assets as a result of these transactions resulted in a pre-tax gain
of $62 million for the Company in 1998.
The market value of the Company's investment in Commonwealth Telephone and
RCN on December 31, 1998, was $352 million, and $466 million, respectively,
based on the closing stock price of each company on December 31, 1998.
Investments also include $23 million for the Company's investment in an
office building in Aurora, Colorado.
(9) Other Assets
At December 31, 1998 and December 27, 1997 other assets consisted of the
following:
<TABLE>
<CAPTION>
1998 1997
----- ----
(in
millions)
<S> <C> <C>
Goodwill:
XCOM, net of accumulated amortization of $15................... $ 100 $--
GeoNet, net of accumulated amortization of $1.................. 20 --
Other, net of accumulated amortization of $1................... 21 --
Deferred Debt Issuance Costs..................................... 67 --
Deferred Development and Financing Costs......................... 15 21
Unrecovered Mine Development Costs............................... 15 16
Leases........................................................... 9 11
Timberlands...................................................... 6 7
Other............................................................ 11 11
----- ----
Total other assets............................................. $ 264 $ 66
===== ====
</TABLE>
F-48
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Goodwill amortization expense, excluding amortization expense attributable
to equity method investees, was $18 million in 1998 and $- in 1997 and 1996.
(10) Long-Term Debt
At December 31, 1998 and December 27, 1997, long-term debt was as follows:
<TABLE>
<CAPTION>
1998 1997
------- ----
(dollars in
millions)
<S> <C> <C>
Senior Notes
(9.125% due 2008).............................................. $ 2,000 $--
Senior Discount Notes
(10.5% due 2008)............................................... 504 --
CPTC Long-term Debt (with recourse only to CPTC):
Bank Note
(7.6% due 2008)................................................ 64 65
Institutional Notes
(9.45% due 2017)............................................... 35 35
OCTA Debt
(9.0% due 2004)................................................ 9 8
Subordinated Debt
(9.3-9.5% no maturity)......................................... 8 6
------- ----
116 114
Other:
Pavilion Towers Debt (8.4% due 2007)........................... 15 15
Capitalized Leases............................................. 8 6
Other.......................................................... 3 5
------- ----
26 26
------- ----
Less current portion............................................. 2,646 140
(5) (3)
------- ----
$ 2,641 $137
======= ====
</TABLE>
9 1/8% Senior Notes
On April 28, 1998, the Company received $1.94 billion of net proceeds from
an offering of $2 billion aggregate principal amount 9 1/8% Senior Notes Due
2008 ("Senior Notes"). Interest on the notes accrues at 9 1/8% per annum and
will be payable in cash semiannually in arrears.
The Senior Notes are subject to redemption at the option of the Company, in
whole or in part, at any time or from time to time on or after May 1, 2003,
plus accrued and unpaid interest thereon to the redemption date, if redeemed
during the twelve months beginning May 1, of the years indicated below:
<TABLE>
<CAPTION>
Year Redemption Price
---- ----------------
<S> <C>
2003..................................................... 104.563%
2004..................................................... 103.042%
2005..................................................... 101.521%
2006 and thereafter...................................... 100.000%
</TABLE>
F-49
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition, at any time or from time to time prior to May 1, 2001, the
Company may redeem up to 35% of the original aggregate principal amount of the
Senior Notes at a redemption price equal to 109.125% of the principal amount of
the Senior Notes so redeemed, plus accrued and unpaid interest thereon to the
redemption date. 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 other things, limit consolidated debt, dividend payments, and
transactions with affiliates. The Company is using the net proceeds of the
Senior Notes 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 technology.
Debt issuance costs of $65 million were capitalized and are being amortized
over the term of the Senior Notes.
10 1/2% Senior Discount Notes
On December 2, 1998, the Company sold $834 million principal amount of 10
1/2% Senior Discount Notes Due 2008 ("Senior Discount Notes"). The sales
proceeds of $500 million, excluding debt issuance costs, were recorded as long
term debt. Interest on Senior Discount Notes will accrete at a rate of 10 1/2%
per annum, compounded semiannually, to an aggregate principal amount of $834
million by December 1, 2003. Cash interest will not accrue on the Senior
Discount Notes prior to December 1, 2003; however, the Company may elect to
commence the accrual of cash interest on all outstanding Senior Discount Notes
on or after December 1, 2001, in which case the outstanding principal amount at
maturity of each Senior Discount Note will on the elected commencement date be
reduced to the accreted value of the Senior Discount Note as of that date and
cash interest shall be payable on that Note on June 1 and December 1
thereafter. Commencing June 1, 2004, interest on the Senior Discount Notes will
accrue at the rate of 10 1/2% per annum and will be payable in cash
semiannually in arrears.
The Senior Discount Notes will be subject to redemption at the option of the
Company, in whole or in part, at any time or from time to time on or after
December 1, 2003 at the following redemption prices (expressed as percentages
of accreted value) plus accrued and unpaid interest thereon to the redemption
date, if redeemed during the twelve months beginning December 1, of the years
indicated below:
<TABLE>
<CAPTION>
Year Redemption Price
---- ----------------
<S> <C>
2003..................................................... 105.25%
2004..................................................... 103.50%
2005..................................................... 101.75%
2006 and thereafter ..................................... 100.00%
</TABLE>
In addition, at any time or from time to time prior to December 1, 2001, the
Company may redeem up to 35% of the original aggregate principal amount at
maturity of the Notes at a redemption price equal to 110.50% of the accreted
value of the notes so redeemed, plus accrued and unpaid interest thereon to the
redemption date. These notes are senior unsecured obligations of the Company,
ranking pari passu with all existing and future senior unsecured indebtedness
of the Company. The Senior Discount Notes contain certain covenants which,
among other things, restrict the Company's ability to incur additional debt,
make certain restricted payments, pay dividends, enter into sale and leaseback
transactions, enter into transactions with affiliates, and sell assets or merge
with another company.
The net proceeds of $486 million are intended to be used to accelerate the
implementation of its Business Plan, primarily the funding for the increase in
committed number of route miles of the Company's U.S. intercity network.
F-50
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Debt issuance costs of $14 million have been capitalized and are being
amortized over the term of the Senior Discount Notes.
The Company capitalized $15 million of interest expense and amortized debt
issuance costs related to network construction and business systems
development projects for the year ended December 31, 1998.
CPTC:
In August 1996, California Private Transportation Company, L.P. ("CPTC")
converted its construction financing note into a term note with a consortium
of banks ("Bank Note"). The interest rate on the Bank Note is based on LIBOR
plus a varying rate with interest payable quarterly. Upon completion of the
SR91 toll road, CPTC entered into an interest rate swap agreement with the
same parties. The swap agreement expires in January 2004 and fixes the
interest rate on the Bank Debt from 9.21% to 9.71% during the term of the swap
agreement.
The institutional notes are held by Connecticut General Life Insurance
Company, a subsidiary of CIGNA Corporation and Lincoln National Life Insurance
Company. The note converted to a term loan upon completion of the SR91 toll
road.
Substantially all the assets of CPTC and the partners' equity interest in
CPTC secure the term debt.
Orange County Transportation Authority ("OCTA") holds $9 million of
subordinated debt which is due in varying amounts through 2004. Interest
accrues at 9% and is payable quarterly beginning when CPTC generates
sufficient cash flows to cover operating expenses and other debt requirements.
In July 1996, CPTC borrowed from the partners $2 million to facilitate the
completion of the project. In 1998 and 1997, CPTC borrowed an additional $2
million and $4 million, respectively, from the partners in order to comply
with equity maintenance provisions of the contracts with the State of
California and its lenders. The debt is generally subordinated to all other
debt of CPTC. Interest on the subordinated debt compounds annually at 9.3-9.5%
and is payable only as CPTC generates excess cash flows.
In 1996, CPTC capitalized $5 million of interest prior to completing
construction of the SR91 tollroad.
Other:
In June 1997, a mortgage loan was obtained from Metropolitan Life. The
Pavilion Towers building in Aurora, Colorado collateralizes this debt.
Scheduled maturities of long-term debt are as follows (in millions): 1999--
$5; 2000--$6; 2001--$6; 2002--$9; 2003--$9 and $2,611 thereafter.
(11) Employee Benefit Plans
The Company adopted the recognition provisions of SFAS No. 123, "Accounting
for Stock Based Compensation" ("SFAS No. 123") in 1998. 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 periods
of the options in accordance with FASB Interpretation No. 28 "Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans"("FIN
28"). The recognition provisions of SFAS No. 123 are applied prospectively
upon adoption. As a result, the recognition provisions 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.
F-51
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 and
consultants; that is, an entity has granted something of value to an employee
and consultants (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 and consultants should be recognized in
financial statements because nonrecognition implies that either the instruments
have no value or that they are free to employees and consultants, 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 or
professional expenses in an entity's financial statements, the expense differs
from other compensation and professional expenses 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 1999 and thereafter. The amount of
the non-cash charge will be dependent upon a number of factors, including the
number of grants and the fair value of each grant estimated at the time of its
award. On a pro forma basis, adopting SFAS No. 123 would not have had a
material effect on the results of operations for the years ended December 27,
1997 and December 28, 1996.
Non-qualified Stock Options and Warrants
In December 1997, stockholders approved amendments to the 1995 Level 3 Stock
Plan ("the Plan"). The amended plan, among other things, increases the number
of shares reserved for issuance upon the exercise of stock based awards to
70,000,000; increases the maximum number of options granted to any one
participant to 10,000,000; provides for the acceleration of vesting in the
event of a change in control; allows for the grant of stock based awards to
directors of Level 3 and other persons providing services to Level 3; and
allows for the grant of nonqualified stock options ("NQSO") with an exercise
price less than the fair market value of Common Stock. In December 1997, Level
3 converted both option and stock appreciation rights plans of a subsidiary, to
the Plan. This conversion resulted in the issuance of 7.4 million options to
purchase Common Stock at $4.50 per share. Level 3 recognized an expense and a
corresponding increase in equity as a result of the transaction. The increase
in equity and the conversion of the stock appreciation rights liability to
equity are reflected as option activity in the Statement of Changes in
Stockholders' Equity. The options vest over three or five years with a five or
ten year life.
In addition to 7,466,247 NQSOs granted in 1998, 1,898,036 warrants were
granted to third parties to acquire shares of Common Stock at exercise prices
ranging from $18.50--$20.00 per share. The warrants vest quarterly through June
30, 2001.
The expense recognized in accordance with SFAS No. 123 for NQSOs and
warrants in 1998 was $6 million and $5 million, respectively. In addition to
the expense recognized, the Company capitalized $2 million of non-cash
compensation costs related to NQSOs for employees directly involved in the
construction of the Internet Protocol network and the development of the
business support systems.
The fair value of NQSOs and warrants granted was calculated using the Black-
Scholes method with a risk free interest rate of 5.5% and expected life of 75%
of the total life of the NQSOs and warrants. The Company used an expected
volatility rate of 25%, except for when the minimum volatility of .001% was
used by the Company prior to becoming publicly traded in April 1998. The fair
value of the NQSO and warrants granted in 1998, in accordance with SFAS No. 123
was $28 million.
The Company exchanged approximately 700,000 options and 100,000 options,
ranging in prices from $0.12 to $1.76 and primarily from $0.90 to $1.79 for the
XCOM and GeoNet acquisitions, respectively.
F-52
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Transactions involving stock options granted under the NQSO plan are
summarized as follows:
<TABLE>
<CAPTION>
Weighted
Exercise Price Average
Shares Per Share Exercise Price
---------- -------------- --------------
<S> <C> <C> <C>
Balance December 30, 1995............. 2,680,000 $ 4.04 $4.04
Options granted..................... 1,790,000 4.95 4.95
Options cancelled................... (30,000) 4.04 4.04
Options exercised................... -- -- --
----------
Balance December 28, 1996............. 4,440,000 $4.04 --$ 4.95 $4.40
============== =====
Options granted..................... 14,990,930 $ 4.50--$ 5.42 $4.96
Options cancelled................... (106,000) 4.95 4.95
Options exercised................... (4,636,930) 4.04-- 4.95 4.46
----------
Balance December 27, 1997............. 14,688,000 $ 4.04--$ 5.42 $4.95
============== =====
Options granted..................... 7,466,247 $ 0.12--$41.25 $8.67
Options cancelled................... (668,849) 0.12-- 34.69 5.52
Options exercised................... (2,506,079) 0.12-- 34.69 4.22
----------
Balance December 31, 1998............. 18,979,319 $ 0.12--$41.25 $6.50
========== ============== =====
Options exercisable
December 28, 1996................... 530,000 $ 4.04 $4.04
December 27, 1997................... 2,590,538 $4.04--$ 4.95 $4.35
December 31, 1998................... 5,456,640 $0.12--$ 41.25 $4.67
</TABLE>
The weighted average remaining contractual life for the 18,979,319 options
outstanding on December 31, 1998 is 8.47 years.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------- -----------------------
Weighted Weighted
Number Average Average Number Weighted
Range of Outstanding Remaining Exercise Exercisable Average
Exercise as of Life Price as of Exercise
Prices 12/31/98 (years) Outstanding 12/31/98 Price
- -------------- ----------- --------- ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 0.12--$ 0.12 187,036 9.04 $ 0.12 39,558 $ 0.12
0.90-- 0.90 34,764 6.26 0.90 21,230 0.90
1.76-- 1.79 78,010 8.50 1.77 19,060 1.79
4.04-- 5.43 12,965,014 8.51 5.04 5,331,448 4.71
6.20-- 8.50 4,875,600 9.06 6.98 45,100 6.82
17.50-- 25.03 272,374 4.62 19.42 -- --
26.80-- 39.13 500,521 4.48 31.37 244 34.69
40.38-- 41.25 66,000 4.62 40.59 -- --
---------- ---------
18,979,319 8.47 $ 6.50 5,456,640 $ 4.67
========== ==== ====== ========= ======
</TABLE>
Outperform Stock Option Plan
In April 1998, the Company adopted an outperform stock option ("OSO")
program that was designed so that the Company's stockholders would 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
F-53
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
general, as measured by the Standard & Poor's ("S&P") 500 Index. Participants
in the OSO program do not realize any value from awards 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 awards
under the OSO plan is based on a formula involving a multiplier related to the
level by which 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 a holder
may exceed the value of non-qualified stock options.
OSO grants are made quarterly to participants employed on the date of the
grant. Each award vests in equal quarterly installments over two years and has
a four-year life. Each award has a two-year moratorium on exercising. Once a
participant is 100% vested, the two year moratorium is lifted. Therefore, each
grant has an exercise window of two years.
The fair value and expense recognized under SFAS No. 123 for OSOs granted to
employees and consultants for services performed in 1998 was $64 million and
$24 million, respectively. In addition, $3 million was capitalized for
employees directly involved in the construction of the Internet Protocol
network and development of business support systems.
The fair value of the options granted was calculated by applying the Black-
Scholes method with an S&P 500 expected dividend yield rate of 1.8% and an
expected life of 2.5 years. The Company used a blended volatility rate of 24%
between the S&P 500 expected volatility rate of 16% and the Level 3 Common
Stock expected volatility rate of 25%. The expected correlation factor of 0.4
was used to measure the movement of Level 3 stock relative to the S&P 500.
Transactions involving stock awards granted in 1998 under the OSO plan are
summarized below:
<TABLE>
<CAPTION>
Weighted
Average
Option Price Option
Shares Per Share Price
--------- -------------- --------
<S> <C> <C> <C>
Options granted............................ 2,139,075 $29.78--$37.13 $34.28
Options cancelled.......................... (46,562) 29.78-- 37.13 35.53
Options exercised.......................... -- -- --
--------- -------------- ------
Balance December 31, 1998................ 2,092,513 $29.78--$37.13 $34.25
========= ============== ======
Options vested but not exercisable as of
December 31, 1998......................... 234,305 $29.78--$37.13 $34.85
========= ============== ======
</TABLE>
The weighted average remaining contractual life for the 2,092,513 outperform
options outstanding on December 31, 1998 is 3.6 years.
Restricted Stock
In 1998, 177,183 shares of restricted stock were granted to employees. The
restricted stock shares are granted to employees at no cost. The shares vest
immediately; however, the employees are restricted from selling these shares
for 3 years. The fair value of restricted stock of $6 million was calculated
using the value of the Common Stock the day prior to the grant. The expense
recognized in 1998 under SFAS No. 123 for restricted stock grants was $3
million.
Shareworks--Level 3 has designed its compensation programs with particular
emphasis on equity-based, long-term incentive programs. The Company has
developed two plans under its Shareworks program: the Match Plan and the Grant
Plan.
F-54
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Match Plan--The Match Plan allows eligible employees to defer between 1% and
7% of their eligible compensation to purchase Common Stock at the average stock
price for the quarter. Any full time employee is considered eligible on the
first day of the calendar quarter after their hire. The Company matches the
shares purchased by the employee on a one-for-one basis. Stock purchased with
payroll deductions is fully vested. Stock purchased with the Company's matching
contributions vests three years after the end of the quarter in which it was
made.
The Company's quarterly matching contribution is amortized over 36 months.
In 1998, the Company's matching contribution was $2 million under the Match
Plan. The compensation expense recognized in 1998 under this plan was less than
$1 million.
Grant Plan--The Grant Plan enables the Company to grant shares of Common
Stock to eligible employees based upon a percentage of that employee's eligible
salary up to a maximum of 3%. Level 3 employees on December 31 of each year,
who are age 21 or older with a minimum of 1,000 hours credited service are
considered eligible. The shares granted are valued at the fair market value as
of the last business day of the calendar year. All prior and future grants vest
immediately upon the employees' third anniversary of joining the Shareworks
Plan.
The annual grant is expensed in the year of the grant. Compensation expense
recorded for the Shareworks Grant Plan for 1998 was approximately $1 million.
In addition to the compensation expense recognized, the Company capitalized
less than $1 million of non-cash compensation costs related to the Shareworks
Plans for employees directly involved in the construction of the Internet
Protocol network and the development of the business support systems.
401(k) Plan
The Company and its subsidiaries offer its qualified employees the
opportunity to participate in a defined contribution retirement plan qualifying
under the provisions of Section 401(k) of the Internal Revenue Code. Each
employee was eligible to contribute, on a tax deferred basis, a portion of
annual earnings not to exceed $10,000 in 1998. The Company does not match
employee contributions and therefore does not incur any expense related to the
401(k) plan.
(12) Income Taxes
An analysis of the income tax (provision) benefit attributable to earnings
(loss) from continuing operations before income taxes for the three years ended
December 31, 1998 follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
(dollars in
millions)
<S> <C> <C> <C>
Current:
U.S. federal............................................. $ (15) $ (54) $ (61)
Foreign.................................................. -- -- (4)
State.................................................... (10) (1) (6)
----- ----- -----
(25) (55) (71)
Deferred:
U.S. federal............................................. 50 103 67
State.................................................... -- -- 1
----- ----- -----
50 103 68
----- ----- -----
$ 25 $ 48 $ (3)
===== ===== =====
</TABLE>
F-55
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The United States and foreign components of earnings (loss) from continuing
operations before income taxes follows:
<TABLE>
<CAPTION>
1998 1997 1996
------ ---- ----
(dollars in
millions)
<S> <C> <C> <C>
United States................................................. $ (142) $ 35 $106
Foreign....................................................... (11) -- 1
------ ---- ----
$ (153) $ 35 $107
====== ==== ====
</TABLE>
A reconciliation of the actual income tax (provision) benefit and the tax
computed by applying the U.S. federal rate (35%) to the earnings (loss) from
continuing operations, before income taxes for the three years ended December
31, 1998 follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ----- ----
(dollars in
millions)
<S> <C> <C> <C>
Computed Tax at Statutory Rate.............................. $ 53 $ (12) $(37)
State Income Taxes.......................................... (7) (1) (3)
Write-off of In Process Research & Development.............. (11) -- --
Coal Depletion.............................................. 2 3 3
Goodwill Amortization....................................... (5) -- (3)
Tax Exempt Interest......................................... -- 2 2
Prior Year Tax Adjustments.................................. -- 62 44
Compensation Expense Attributable to Options................ -- (7) --
Taxes on Unutilized Losses of Foreign Operations............ (4) -- (2)
Other....................................................... (3) 1 (7)
---- ----- ----
$ 25 $ 48 $ (3)
==== ===== ====
</TABLE>
During the two years ended December 27, 1997, the Company settled a number
of disputed tax issues related to prior years that have been included in prior
year tax adjustments.
The components of the net deferred tax liabilities for the years ended
December 31, 1998 and December 27, 1997 were as follows:
<TABLE>
<CAPTION>
1998 1997
------ ------
(dollars
in millions)
<S> <C> <C>
Deferred Tax Liabilities:
Investments in securities...................................... $ 2 $ 7
Investments in joint ventures.................................. 27 33
Asset bases--accumulated depreciation.......................... 83 53
Coal sales..................................................... 32 41
Other.......................................................... 20 16
------ ------
Total Deferred Tax Liabilities................................... 164 150
Deferred Tax Assets:
Compensation--and related benefits............................. 35 25
Investment in subsidiaries..................................... 14 8
Provision for estimated expenses............................... 14 7
Foreign and general business tax credits....................... -- 3
Other.......................................................... 13 9
------ ------
Total Deferred Tax Assets........................................ 76 52
------ ------
Net Deferred Tax Liabilities..................................... $ 88 $ 98
====== ======
</TABLE>
F-56
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(13) Stockholders' Equity
Issuances of Common Stock, for sales, conversions, option exercises and
acquisitions, and repurchases of common shares for the three years ended
December 31, 1998 are shown below. Prior to the Split-off, the Company was
obligated to repurchase Class D shares from stockholders. The Level 3 Stock
Plan permits option holders to tender shares to the Company to cover income
taxes due on option exercises.
<TABLE>
<S> <C>
December 30, 1995.................................................. 230,249,740
Shares Issued.................................................... --
Shares Repurchased............................................... (2,552,160)
Issuances for Class C Stock Conversions.......................... 4,104,850
-----------
December 28, 1996.................................................. 231,802,430
Shares Issued.................................................... 21,589,100
Shares Repurchased............................................... (29,610)
Issuances for Class C Stock Conversions.......................... 13,035,430
Option Activity.................................................. 4,636,930
-----------
December 27, 1997.................................................. 271,034,280
Shares Issued.................................................... 2,240,467
Shares Repurchased............................................... (30,506)
Issuances for Class C Stock Conversions.......................... 20,934,244
Issuances for Class R Stock Conversions.......................... 5,084,568
Option Activity.................................................. 2,506,079
Shares Issued for Acquisitions................................... 6,105,574
-----------
December 31, 1998.................................................. 307,874,706
===========
</TABLE>
(14) Industry and Geographic Data
In the fourth quarter of 1998, the Company adopted SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information". SFAS No. 131
establishes standards for reporting information about operating segments in
annual financial statements and requires selected information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for disclosures about products and services and
geographic areas. Operating segments are components of an enterprise for which
separate financial information is available and which is evaluated regularly by
the Company's chief operating decision maker, or decision making group, in
deciding how to allocate resources and assess performance. Operating segments
are managed separately and represent strategic business units that offer
different products and serve different markets.
The Company's reportable segments include: communications and information
services (including communications, computer outsourcing and systems
integration segments), and coal mining. Other primarily includes CPTC, the C-
TEC investments and other corporate investments and overhead not attributable
to a specific segment.
Industry and geographic data for the Company's discontinued construction and
energy operations are not included.
EBITDA, as defined by the Company, consists of earnings (loss) before
interest, income taxes, depreciation, amortization, non-cash operating expenses
(including stock-based compensation and
F-57
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
in-process research and development charges) and other non-operating income or
expense. The Company excludes non-cash compensation due to its adoption of the
expense recognition provisions of SFAS No. 123. 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.
In 1998, 1997, and 1996 Commonwealth Edison Company, a coal mining customer,
accounted for 34%, 43%, and 23% of Level 3's revenues.
Industry segment financial information follows. Certain prior year
information has been reclassified to conform with the 1998 presentation.
<TABLE>
<CAPTION>
Communications & Information Services
------------------------------------------------
Computer Systems Coal
Communications Outsourcing Integration Mining Other Total
-------------- ----------- --------------------- ------ ------ ------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
1998
Revenue................. $ 24 $63 $ 57 $228 $ 20 $ 392
EBITDA.................. (139) 14 (23) 92 (44) (100)
Identifiable Assets..... 999 59 42 429 3,996 5,525
Capital Expenditures.... 818 25 4 2 61 910
Depreciation and
Amortization........... 37 8 3 5 13 66
1997
Revenue................. $ -- $50 $ 45 $222 $ 15 $ 332
EBITDA.................. -- 13 1 88 (18) 84
Identifiable Assets..... -- 42 19 499 924 1,484
Capital Expenditures.... -- 9 5 3 9 26
Depreciation and
Amortization........... -- 6 2 5 7 20
1996
Revenue................. $ -- $41 $ 1 $234 $ 376 $ 652
EBITDA.................. -- 12 (5) 103 101 211
Capital Expenditures.... -- 8 3 2 104 117
Depreciation and
Amortization........... -- 5 2 9 108 124
</TABLE>
F-58
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents a geographic breakout for revenue, EBITDA, and
identifiable assets:
<TABLE>
<CAPTION>
Communications & Information Services
--------------------------------------
Computer Systems Coal
Communications Outsourcing Integration Mining Other Total
-------------- ----------- ----------- ------ ------ ------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
1998
Revenue:
United States......... $ 23 $ 62 $ 56 $228 $ 20 $ 389
Other................. 1 1 1 -- -- 3
------ ---- ---- ---- ------ ------
$ 24 $ 63 $ 57 $228 $ 20 $ 392
====== ==== ==== ==== ====== ======
EBITDA:
United States......... $ (128) $ 14 $(23) $ 92 $ (44) $ (89)
Other................. (11) -- -- -- -- (11)
------ ---- ---- ---- ------ ------
$ (139) $ 14 $(23) $ 92 $ (44) $ (100)
====== ==== ==== ==== ====== ======
Identifiable Assets:
United States......... $ 886 $ 59 $ 42 $429 $3,996 $5,412
Other................. 113 -- -- -- -- 113
------ ---- ---- ---- ------ ------
$ 999 $ 59 $ 42 $429 $3,996 $5,525
====== ==== ==== ==== ====== ======
1997
Revenue:
United States......... $ -- $ 50 $ 45 $222 $ 15 $ 332
Other................. -- -- -- -- -- --
------ ---- ---- ---- ------ ------
$ -- $ 50 $ 45 $222 $ 15 $ 332
====== ==== ==== ==== ====== ======
EBITDA:
United States......... $ -- $ 13 $ 1 $ 88 $ (18) $ 84
Other................. -- -- -- -- -- --
------ ---- ---- ---- ------ ------
$ -- $ 13 $ 1 $ 88 $ (18) $ 84
====== ==== ==== ==== ====== ======
Identifiable Assets:
United States......... $ -- $ 42 $ 19 $499 $ 924 $1,484
Other................. -- -- -- -- -- --
------ ---- ---- ---- ------ ------
$ -- $ 42 $ 19 $499 $ 924 $1,484
====== ==== ==== ==== ====== ======
1996
Revenue:
United States......... $ -- $ 41 $ 1 $234 $ 376 $ 652
Other................. -- -- -- -- -- --
------ ---- ---- ---- ------ ------
$ -- $ 41 $ 1 $234 $ 376 $ 652
====== ==== ==== ==== ====== ======
EBITDA:
United States......... $ -- $ 12 $ (5) $103 $ 101 $ 211
Other................. -- -- -- -- -- --
------ ---- ---- ---- ------ ------
$ -- $ 12 $ (5) $103 $ 101 $ 211
====== ==== ==== ==== ====== ======
</TABLE>
F-59
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following information provides a reconciliation of EBITDA to income from
continuing operations for the three years ended December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
----- ------------- -----
(in millions)
<S> <C> <C> <C>
EBITDA............................................. $(100) $ 84 $ 211
Depreciation and Amortization Expense.............. (66) (20) (124)
Non-Cash Compensation Expense...................... (39) (21) --
Write-off of In Process Research and Development... (30) -- --
----- ---- -----
Earnings (Loss) from Operations.................. (235) 43 87
Other Income (Expense)............................. 82 (8) 20
Income Tax Benefit (Provision)..................... 25 48 (3)
----- ---- -----
Income (Loss) from Continuing Operations........... $(128) $ 83 $ 104
===== ==== =====
</TABLE>
(15) Commitments and Contingencies
On March 23, 1998, the Company and Frontier Communications International,
Inc. ("Frontier") entered into an agreement ("Frontier Agreement") enabling the
Company to lease for a period of up to five years approximately 8,300 miles of
network capacity on Frontier's new 13,000 mile fiber optic, Internet Protocol
capable network, currently under construction. 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 recognized $4 million of operating expenses
in the second half of 1998 as portions of the network became operational.
On April 2, 1998, the Company announced it had reached a definitive
agreement with Union Pacific Railroad Company ("Union Pacific") granting the
Company 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,
and 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. In 1998, the Company recorded $9 million of payments made under
this agreement in network construction-in-progress.
On June 18, 1998, Level 3 selected Peter Kiewit Sons', Inc. ("Kiewit") to
build the majority of its nearly 16,000 mile U.S. intercity communications
network. The overall cost of the project is estimated at $2 billion.
Construction of the network began in the third quarter of 1998 and is expected
to be completed during the first quarter of 2001. The contract provides that
Kiewit will be reimbursed for its costs relating to all direct and indirect
project level costs. In addition, Kiewit will have the opportunity to earn an
award fee that will be based on cost and speed of construction, quality, safety
and program management. The award fee will be determined by Level 3's
assessment of Kiewit's performance in each of these areas.
On June 23, 1998, the Company signed a master easement agreement with
Burlington Northern and Santa Fe Railway Company ("BNSF"). The agreement grants
Level 3 right-of-way access to BNSF rail routes in as many as 28 states, over
which to build its network. Under the easement agreement, Level 3 will make
annual
F-60
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
payments to BNSF and provide communications capacity to BNSF for its internal
requirements. The amount of the annual payments is dependent upon the number of
conduits installed, the number of conduits with fiber, and the number of miles
of conduit installed along BNSF's route.
On July 20, 1998, Level 3 entered into a network construction cost-sharing
agreement with INTERNEXT, LLC, a subsidiary of NEXTLINK Communications, Inc.
valued at $700 million. The agreement provides for INTERNEXT to acquire the
right to use conduits, fibers and certain associated facilities installed along
the entire route of Level 3's nearly 16,000 mile intercity fiber optic network
in the United States. INTERNEXT paid Level 3 $26 million in 1998 which was
deferred and included in other liabilities as of December 31, 1998 and will pay
the remaining balance as segments of the intercity network are completed. The
Company will recognize income as the segments of the network are completed and
accepted.
The network as provided to INTERNEXT will not include the necessary
electronics that allow the fiber to carry communications transmissions.
INTERNEXT will be restricted from selling or leasing fiber to unaffiliated
companies for four years following the date of the agreement. Also, under the
terms of the agreement, INTERNEXT has the right to an additional conduit for
its exclusive use and to share costs and capacity in certain future fiber cable
installations in Level 3 conduits.
On August 3, 1998, Level 3 and a group of other global telecommunications
companies entered into an agreement to construct an undersea cable system
connecting Japan and the United States by mid-year 2000. The parties to this
agreement are investing in excess of $1 billion to build the network, of which
Level 3 expects to contribute approximately $130 million. Each party will have
joint responsibility for the cost of network oversight, maintenance and
administration. The Company has recorded $24 million of costs associated with
this project in network construction-in-progress at December 31, 1998.
On October 14, 1998, Level 3 announced it signed an agreement with Global
Crossing Ltd. ("Global") for trans-oceanic capacity on Global Crossing's fiber
optic cable network. The agreement, covering 25 years and valued at
approximately $108 million, will provide Level 3 with as-needed dedicated
capacity across the Atlantic Ocean. Additionally, Level 3 will have the option
of utilizing capacity on other segments of Global's worldwide network. In 1998,
the Company recorded as network construction-in-progress, $32 million of costs
associated with this agreement.
On December 18, 1998 Level 3 announced an agreement with IXC Communications,
Inc. ("IXC") to lease capacity on IXC's network. The dedicated network will
enhance the Company's ability to offer a wide array of data and voice services
to a greater number of customers in key U.S. markets. The arrangement is unique
in that IXC will reserve the network for the exclusive use of Level 3, which
expects to begin running traffic across the network beginning in Spring 1999.
The Company paid IXC $40 million under this agreement in 1998 and recorded this
amount in property, plant and equipment.
Operating Leases
The Company is leasing rights of way, communications capacity and premises
under various operating leases which, in addition to rental payments, require
payments for insurance, maintenance, property taxes and other executory costs
related to the lease. Certain leases provide for adjustments in lease cost
based upon adjustments in the consumer price index and increases in the
landlord's management costs. The lease agreements have various expiration dates
through 2014.
F-61
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition to the items described above, future minimum payments for the
next five years, under the non-cancelable operating leases with initial or
remaining terms of one year or more, consist of the following at December 31,
1998 (in millions):
<TABLE>
<S> <C>
1999................................................................. $ 35
2000................................................................. 34
2001................................................................. 31
2002................................................................. 24
2003................................................................. 24
Thereafter........................................................... 182
----
$330
====
</TABLE>
Rent expense under lease agreements was $18 million in 1998, $1 million in
1997 and $3 million in 1996.
(16) Related Party Transactions
Peter Kiewit Sons', Inc. acted as the general contractor on several
projects for the Company in 1998. These projects include the intercity
network, local loops and gateway sites, the Company's new corporate
headquarters in Colorado and a new data center in Tempe, Arizona. Kiewit
provided approximately $130 million of construction services related to these
projects in 1998.
In 1999, the Company entered into an agreement with RCN whereby RCN will
lease cross country capacity on Level 3's nationwide network. Also in 1999,
the Company and RCN announced that it had reached joint construction
agreements in several RCN markets, through which the companies will share the
cost of constructing their respective fiber optic networks.
Level 3 also receives certain mine management services from Peter Kiewit
Sons', Inc. The expense for these services was $34 million for 1998, $32
million for 1997, and $37 million for 1996, and is recorded in general and
administrative expenses. The revenue earned by Peter Kiewit Sons', Inc. in
1997 and 1996 is included in discontinued operations.
(17) Other Matters
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 21 million
shares of Class D Stock (now known as Common 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.
It is customary in Level 3's industries to use various financial
instruments in the normal course of business. These instruments include items
such as letters of credit. Letters of credit are conditional commitments
issued on behalf of Level 3 in accordance with specified terms and conditions.
As of December 31, 1998, Level 3 had outstanding letters of credit of
approximately $22 million. The Company does not believe it is practicable to
estimate the fair value of the letters of credit and does not believe exposure
to loss is likely.
F-62
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(18) Subsequent Events
On January 5, 1999 Level 3 acquired BusinessNet Limited, a leading London-
based Internet service provider in a largely stock-for-stock transaction. The
Company granted approximately 400,000 shares of Common Stock and paid $1
million in cash in exchange for BusinessNet's capital stock. The transaction
was valued at approximately $18 million and will be accounted for as a
purchase.
Level 3 filed a "universal" shelf registration statement covering up to $3.5
billion of common stock, preferred stock, debt securities and depositary shares
that became effective February 17, 1999. On March 9, 1999 the Company sold
28.75 million shares through a primary offering. The net proceeds from the
offering of approximately $1.5 billion will be used for working capital,
capital expenditures, acquisitions and other general corporate purposes in
connection with the implementation of the Company's Business Plan.
On February 25, 1999 the Board approved an increase in the number of
authorized shares outstanding from 500 million to 1 billion. This is subject to
approval of the shareholders which will be voted on at the Company's 1999
Annual Meeting.
(19) Unaudited Quarterly Financial Data
<TABLE>
<CAPTION>
March June September December
------------ ----------------------------------- ---------------
1998 1997 1998 1997 1998 1997 1998 1997
------ ---- ------ ----------------- -------- --------- ----
(in millions except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue................. $ 87 $ 80 $ 103 $ 81 $ 106 $ 81 $ 96 $ 90
Earnings (Loss) from
Operations............. (9) 20 (41) 16 (52) 13 (133) (6)
Net Earnings (Loss)..... 926 35 (34) 56 (49) (10) (39) 167
Earnings (Loss) per
Share (Basic and
Diluted):
Continuing
Operations........... $ (.02) $.06 $ (.11) $ .06 $ (.16) $ .03 $ (.13) $.18
Discontinued
Operations Excluding
Construction
Operations........... 3.19 .02 -- .03 -- (.21) -- .18
Net Earnings Excluding
Construction
Operations............. 3.17 .08 (.11) .09 (.16) (.18) (.13) .36
Net Earnings Excluding
Gains On Split-Off of
Construction Group..... 1.09 .08 (.11) .09 (.16) (.18) (.13) .36
</TABLE>
Earnings (loss) per share was calculated for each three-month period on a
stand-alone basis. As a result of all the stock transactions, the sum of the
earnings (loss) per share for the four quarters of each year may not equal the
earnings (loss) per share for the twelve month periods.
The earnings (loss) per share amounts above are those of Level 3 Common
Stock.
On January 2, 1998 the Company completed the sale of its energy assets to
MidAmerican, as discussed in Note 3, and recognized an after-tax gain on the
disposition of $324 million.
On March 31, 1998, as a result of the Split-off as discussed in Note 1, the
Company recognized 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.
The Company reflected the fair value of the Construction Group as a
distribution to the Class C stockholders.
F-63
<PAGE>
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As described in Note 5, the Company reduced its charge for acquired in-
process research and development related to its acquisition of XCOM, which was
originally recorded in the second quarter of 1998, from $115 million to $30
million, and increased the related goodwill $85 million. The unaudited
quarterly financial data above reflects that revision as if it occurred in the
second quarter of 1998. As a result, the amounts presented above differ from
those reported in the Company's 1998 Forms 10-Q for the second and third
quarters. Loss from operations, net loss and losses per share as reported in
the second quarter Form 10-Q were $123 million, $116 million and $0.39 per
share, respectively, a change of $82 million, $82 million and $0.28 per share,
respectively, from the information presented above due to the reduced charge
for in-process research and development and an increase in goodwill
amortization. Loss from operations, net loss and losses per share as reported
in the third quarter Form 10-Q were $48 million, $45 million and $0.15 per
share, respectively, a change of $4 million, $4 million and $0.01 per share,
respectively, from the information presented above due to an increase in
goodwill amortization.
F-64
<PAGE>
Prospectus
- ----------
Level 3 Communications, Inc.
Debt Securities
Preferred Stock
Depositary Shares
Common Stock
------------
We will provide specific terms of these securities and their offering prices
in supplements to this prospectus.
In the case of debt securities, these terms will include, as applicable, the
specific designation, aggregate principal amount, maturity, rate or formula of
interest, premium, terms for redemption. In the case of shares of preferred
stock, these terms will include, as applicable, the specific title and stated
value, any dividend, liquidation, redemption, conversion, voting and other
rights. In the case of depositary shares, these terms will include the
fractional share of preferred stock represented by each depositary share. In
the case of common stock, these terms will include the aggregate number of
shares offered.
We may sell any combination of these securities in one or more offerings up
to a total dollar amount of $3,500,000,000.
Our common stock is quoted on the Nasdaq National Market under the symbol
LVLT. The closing price of our common stock on the Nasdaq National Market was
$67.063 per share on December 9, 1999. None of the other securities are
currently publicly traded.
You should read this prospectus and any prospectus supplement carefully
before you invest.
See "Risk Factors" on page 1 for a discussion of matters that you should
consider before investing in these securities.
------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
The date of this prospectus is December 10, 1999.
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
----
<S> <C>
About This Prospectus...................................................... 1
Where You Can Find More Information........................................ 1
Risk Factors............................................................... 1
The Company................................................................ 2
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends........... 2
Application of Proceeds.................................................... 2
Description of Debt Securities............................................. 3
General terms of debt securities......................................... 3
Certificated securities.................................................. 4
Book-entry debt securities............................................... 4
Merger................................................................... 5
Events of default, notice and waiver..................................... 6
Modification of the indentures........................................... 7
Defeasance and covenant defeasance....................................... 9
Senior debt securities................................................... 10
Subordination of subordinated securities................................. 10
Definition of senior indebtedness........................................ 11
Convertible debt securities.............................................. 11
Description of Preferred Stock............................................. 12
General.................................................................. 12
Dividends................................................................ 13
Redemption............................................................... 14
Conversion or exchange rights............................................ 15
Rights upon liquidation.................................................. 15
Voting rights............................................................ 16
Description of Depositary Shares........................................... 17
General.................................................................. 17
Dividends and other distributions........................................ 17
Withdrawal of stock...................................................... 17
Redemption of depositary shares.......................................... 17
Voting the preferred stock............................................... 18
Exchange of preferred stock.............................................. 18
Conversion of preferred stock............................................ 18
Amendment and termination of the deposit agreement....................... 19
Charges of preferred stock depositary.................................... 19
Resignation and removal of depositary.................................... 19
Miscellaneous............................................................ 19
Description of Common Stock................................................ 20
Description of Outstanding Capital Stock................................... 20
Common stock............................................................. 20
Preferred stock.......................................................... 21
Anti-takeover provisions................................................. 21
Plan of Distribution....................................................... 21
By agents................................................................ 21
By underwriters.......................................................... 22
To dealers............................................................... 22
Direct sales............................................................. 22
Delayed delivery contracts............................................... 22
General information...................................................... 22
Legal Matters.............................................................. 23
Experts.................................................................... 23
</TABLE>
<PAGE>
About This Prospectus
This prospectus is part of two registration statements that we filed with
the SEC utilizing a shelf registration process. Under this shelf process, we
may, over the next two years, sell any combination of the securities described
in this prospectus in one or more offerings up to a total dollar amount of
$3,500,000,000 or the equivalent denominated in foreign currencies or units of
two or more foreign currencies. This prospectus provides you with a general
description of the securities we may offer. Each time we sell securities, we
will provide a prospectus supplement that will contain specific information
about the terms of that offering. The prospectus supplement may also add,
update or change information contained in this prospectus. You should read
both this prospectus and any prospectus supplement together with additional
information described under the heading "Where You Can Find More Information."
Where You Can Find More Information
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's web site at http://www.sec.gov. You may also read and
copy any document we file at the SEC's public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330
for further information on the public reference room. Our SEC filings are also
available at the offices of the Nasdaq National Market, in Washington, D.C.
The SEC allows us to incorporate by reference the information we file with
them, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
an important part of this prospectus, and information that we file later with
the SEC will automatically update and supersede this information. We
incorporate by reference our documents listed below and any future filings we
make with the SEC under Sections 13(a), 13(c), 14, or 15(d) of the Securities
Exchange Act until we sell all of the securities.
. Annual report on Form 10-K for the fiscal year ended December 31, 1998
. Quarterly reports on Form 10-Q for the quarters ended March 31, 1999,
June 30, 1999 and September 30, 1999
. Current reports on Form 8-K, filed February 24, 1999, March 5, 1999, May
18, 1999, June 3, 1999 and September 20, 1999 and on Form 8-K/A filed
February 17, 1999 and November 9, 1999
. Registration statements on Forms 8-A/A filed March 31, 1998 and June 10,
1998
You may request a copy of these filings at no cost, by writing or
telephoning us at the following address:
Vice President, Investor Relations
Level 3 Communications, Inc.
1025 Eldorado Boulevard
Broomfield, Colorado 80021
(720) 888-1000
You should rely only on the information incorporated by reference or
provided in this prospectus or any prospectus supplement. We have not
authorized anyone else to provide you with different information. We are not
making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information in this prospectus or
any prospectus supplement is accurate as of any date other than the date on
the front of those documents.
Risk Factors
Before you invest in our securities, you should carefully consider the
risks involved. These risks include, but are not limited to:
. the risks described in our current report on Form 8-K/A filed with the
SEC on November 9, 1999, which is incorporated by reference in this
prospectus; and
. any risks that may be described in other filings we make with the SEC or
in the prospectus supplements relating to specific offerings of
securities.
1
<PAGE>
The Company
We engage in the communications, information services and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, we announced a business plan to
increase substantially our information services business and to expand the
range of services we offer. We are implementing our business plan by building
an advanced communications network based on internet protocol technology.
Since late 1997, we have substantially increased the emphasis we place on
and the resources devoted to our communications and information services
business. Since that time we have become a facilities-based provider of a broad
range of integrated communications services. A facilities-based provider is one
that owns or leases a substantial portion of the plant, property and equipment
necessary to provide its services. We have expanded substantially the business
of our subsidiary, PKS Information Services, Inc. and are creating, through a
combination of construction, purchase and leasing of facilities and other
assets, an advanced, international facilities based communications network. We
designed our network based on internet protocol technology in order to leverage
the efficiencies of this technology to provide lower cost communications
services.
Our network will combine both local and long distance networks and will
connect customers end-to-end across the U.S. and in Europe and Asia. We expect
to complete the U.S. intercity portion of the network during the first quarter
of 2001. In the meantime, we have leased a national network over which we began
to offer services in the third quarter of 1998. We intend to provide a full
range of communications services--including local, long distance, international
and internet services.
Our principal executive offices are located at 1025 Eldorado Boulevard,
Broomfield, Colorado 80021 and our telephone number is (720) 888-1000.
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends
The ratio of earnings to fixed charges for each of the periods indicated is
as follows:
<TABLE>
<CAPTION>
Nine Months Ended
September 30, Fiscal Year Ended
----------------- ------------------------
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
-- -- -- 5.73 3.87 -- --
</TABLE>
For this ratio, earnings consist of earnings (loss) before income taxes,
minority interest and discontinued operations plus fixed charges excluding
capitalized interest. Fixed charges consist of interest expensed and
capitalized, plus the portion of rent expense under operating leases deemed by
us to be representative of the interest factor, plus, prior to September 30,
1995, preferred stock dividends on preferred stock of its former subsidiary,
MFS Communications Company, Inc. We had deficiencies of earnings to fixed
charges of $421 million for the nine months ended September 30, 1999, $106
million for the nine months ended September 30, 1998, $36 million for 1998, $32
million for 1995 and $42 million for 1994.
Application of Proceeds
Unless the applicable prospectus supplement states otherwise, the net
proceeds from the sale of the offered securities will be used for working
capital, capital expenditures, acquisitions and other general corporate
purposes. Until we use the net proceeds in this manner, we may temporarily use
them to make short-term investments or reduce short-term borrowings.
2
<PAGE>
Description of Debt Securities
This section describes the general terms and provisions of the debt
securities. The applicable prospectus supplement will describe the specific
terms of the debt securities offered through that prospectus supplement as well
as any general terms described in this section that will not apply to those
debt securities.
The debt securities will be our direct unsecured general obligations and may
include debentures, notes, bonds and/or other evidences of indebtedness. The
debt securities will be either senior debt securities or subordinated debt
securities. The debt securities will be issued under one or more separate
indentures between us and IBJ Whitehall Bank & Trust Company, as trustee.
Senior debt securities will be issued under a senior indenture, and
subordinated debt securities will be issued under a subordinated indenture.
Together, the senior indentures and the subordinated indentures are called
indentures.
We have summarized selected provisions of the indentures below. The summary
is not complete. We have also filed the forms of the indentures as exhibits to
the registration statement. You should read the indentures for provisions that
may be important to you before you buy any debt securities.
General terms of debt securities
The debt securities issued under each indenture may be issued without limit
as to aggregate principal amount, in one or more series. Each indenture
provides that there may be more than one trustee under the indenture, each with
respect to one or more series of debt securities. Any trustee under either
indenture may resign or be removed with respect to one or more series of debt
securities issued under that indenture, and a successor trustee may be
appointed to act with respect to that series.
If two or more persons are acting as trustee with respect to different
series of debt securities issued under the same indenture, each of those
trustees will be a trustee of a trust under that indenture separate and apart
from the trust administered by any other trustee. In that case, except as
otherwise indicated in this prospectus, any action described in this prospectus
to be taken by the trustee may be taken by each of those trustees only with
respect to the one or more series of debt securities for which it is trustee.
A prospectus supplement relating to a series of debt securities being
offered will include specific terms relating to the offering and that series.
These terms will contain some or all of the following:
. the title of the debt securities;
. any limit on the aggregate principal amount of the debt securities;
. the purchase price of the debt securities, expressed as a percentage of
the principal amount;
. the date or dates on which the principal of and any premium on the debt
securities will be payable or the method for determining the date or
dates;
. if the debt securities will bear interest, the interest rate or rates or
the method by which the rate or rates will be determined;
. if the debt securities will bear interest, the date or dates from which
any interest will accrue, the interest payment dates on which any
interest will be payable, the record dates for those interest payment
dates and the basis upon which interest shall be calculated if other
than that of a 360 day year of twelve 30-day months;
. the place or places where payments on the debt securities will be made
and the debt securities may be surrendered for registration of transfer
or exchange;
3
<PAGE>
. if we will have the option to redeem all or any portion of the debt
securities, the terms and conditions upon which the debt securities may
be redeemed;
. the terms and conditions of any sinking fund or other similar provisions
obligating us or permitting a holder to require us to redeem or purchase
all or any portion of the debt securities prior to final maturity;
. the currency or currencies in which the debt securities are denominated
and payable if other than U.S. dollars;
. whether the amount of any payments on the debt securities may be
determined with reference to an index, formula or other method and the
manner in which such amounts are to be determined;
. any additions or changes to the events of default in the respective
indentures;
. any additions or changes with respect to the other covenants in the
respective indentures;
. the terms and conditions, if any, upon which the debt securities may be
convertible into common stock or preferred stock;
. whether the debt securities will be issued in certificated or book-entry
form;
. whether the debt securities will be in registered or bearer form and, if
in registered form, the denominations of the debt securities if other
than $1,000 and multiples of $1,000;
. the applicability of the defeasance and covenant defeasance provisions
of the applicable indenture; and
. any other terms of the debt securities consistent with the provisions of
the applicable indenture.
Debt securities may be issued under the indentures as original issue
discount securities to be offered and sold at a substantial discount from their
stated principal amount. Special U.S. federal income tax, accounting and other
considerations applicable to original issue discount securities will be
described in the applicable prospectus supplement.
Unless otherwise provided with respect to a series of debt securities, the
debt securities will be issued only in registered form, without coupons, in
denominations of $1,000 and multiples of $1,000.
Certificated securities
Except as otherwise stated in the applicable prospectus supplement, debt
securities will not be issued in certificated form. If, however, debt
securities are to be issued in certificated form, no service charge will be
made for any transfer or exchange of any of those debt securities. We may
require payment of a sum sufficient to cover any tax or other governmental
charge payable in connection with the transfer or exchange of those debt
securities.
Book-entry debt securities
The debt securities of a series may be issued in whole or in part in the
form of one or more global securities that will be deposited with the
depositary identified in the applicable prospectus supplement. Unless it is
exchanged in whole or in part for debt securities in definitive form, a global
security may not be transferred. However, transfers of the whole security
between the depositary for that global security and its nominee or their
respective successors are permitted.
4
<PAGE>
Unless otherwise stated, The Depository Trust Company, New York, New York
will act as depositary for each series of global securities. Beneficial
interests in global securities will be shown on, and transfers of global
securities will be effected only through, records maintained by DTC and its
participants.
DTC has provided the following information to us. DTC is a:
. limited-purpose trust company organized under the New York Banking Law;
. a banking organization within the meaning of the New York Banking Law;
. a member of the U.S. Federal Reserve System;
. a clearing corporation within the meaning of the New York Uniform
Commercial Code; and
. a clearing agency registered under the provisions of Section 17A of the
Securities Exchange Act.
DTC holds securities that its direct participants deposit with DTC. DTC also
facilitates the settlement among direct participants of securities
transactions, in deposited securities through electronic computerized book-
entry changes in the direct participant's accounts. This eliminates the need
for physical movement of securities certificates. Direct participants include
securities brokers and dealers, banks, trust companies, clearing corporations
and certain other organizations. DTC is owned by a number of its direct
participants and by the New York Stock Exchange, Inc., the American Stock
Exchange, Inc. and the National Association of Securities Dealers, Inc. Access
to DTC's book-entry system is also available to indirect participants such as
securities brokers and dealers, banks and trust companies that clear through or
maintain a custodial relationship with a direct participant. The rules
applicable to DTC and its direct and indirect participants are on file with the
SEC.
Principal and interest payments on global securities registered in the name
of DTC's nominee will be made in immediately available funds to DTC's nominee
as the registered owner of the global securities. We and the trustee will treat
DTC's nominee as the owner of the global securities for all other purposes as
well. Accordingly, we, the trustee and any paying agent will have no direct
responsibility or liability to pay amounts due on the global securities to
owners of beneficial interests in the global securities. It is DTC's current
practice, upon receipt of any payment of principal or interest, to credit
direct participants' accounts on the payment date according to their respective
holdings of beneficial interests in the global securities. These payments will
be the responsibility of the direct and indirect participants and not of DTC,
the trustee or us.
Debt securities represented by a global security will be exchangeable for
debt securities in definitive form of like amount and terms in authorized
denominations only if:
. DTC notifies us that it is unwilling or unable to continue as
depositary;
. DTC ceases to be a registered clearing agency and a successor depositary
is not appointed by us within 90 days; or
. we determine not to require all of the debt securities of a series to be
represented by a global security and notify the trustee of our decision.
Merger
We generally may consolidate with, or sell, lease or convey all or
substantially all of our assets to, or merge with or into, any other
corporation if:
. we are the continuing corporation; or
. we are not the continuing corporation, the successor corporation,
expressly assumes all payments on all the debt securities and the
performance and observance of all the covenants and conditions of the
applicable indenture; and
5
<PAGE>
. neither we nor the successor corporation is in default immediately after
the transaction under the applicable indenture.
Events of default, notice and waiver
Senior indenture. The senior indenture provides that the following are
events of default with respect to any series of senior debt securities:
. default for 30 days in the payment of any interest on any debt security
of that series;
. default in the payment of the principal of or premium, if any, on any
debt security of that series at its maturity;
. default in making a sinking fund payment required for any debt security
of that series;
. default in the performance of any of our other covenants in the senior
indenture that continues for 60 days after written notice, other than
default in a covenant included in the senior indenture solely for the
benefit of another series of senior debt securities;
. the acceleration of the maturity of more than $25,000,000 in the
aggregate of any of our other indebtedness, where that indebtedness is
not discharged or that acceleration is not rescinded or annulled;
. certain events of bankruptcy, insolvency or reorganization of us or our
property; and
. any other event of default provided with respect to a particular series
of debt securities.
The senior trustee generally may withhold notice to the holders of any
series of debt securities of any default with respect to that series if it
considers the withholding to be in the interest of those holders. However, the
senior trustee may not withhold notice of any default in the payment of the
principal of, or premium, if any, or interest on any debt security of that
series or in the payment of any sinking fund installment in respect of any debt
security of that series.
If an event of default with respect to any series of senior debt securities
occurs and is continuing, the senior trustee or the holders of not less than
25% in principal amount of the outstanding debt securities of that series may
declare the principal amount of all of the debt securities of that series
immediately due and payable. Subject to certain conditions, the holders of a
majority in principal amount of outstanding debt securities of that series may
rescind and annul that acceleration. However, they may only do so if all events
of default, other than the non-payment of accelerated principal or specified
portion of accelerated principal, with respect to debt securities of that
series have been cured or waived.
Holders of a majority in principal amount of any series of outstanding
senior debt securities may, subject to some limitations, waive any past default
with respect to that series and the consequences of the default. The prospectus
supplement relating to any series of senior debt securities which are original
issue discount securities will describe the particular provisions relating to
acceleration of a portion of the principal amount of those original issue
discount securities upon the occurrence and continuation of an event of
default. Within 120 days after the close of each fiscal year, we must file with
the senior trustee a statement, signed by specified of our officers, stating
whether those officers have knowledge of any default under the senior
indenture.
Except with respect to its duties in case of default, the senior trustee is
not obligated to exercise any of its rights or powers at the request or
direction of any holders of any series of outstanding senior debt securities,
unless those holders have offered the senior trustee reasonable security or
indemnity. Subject to those indemnification provisions and limitations
contained in the senior indenture, the holders of a majority in principal
amount of any series of the outstanding debt securities issued thereunder may
direct any proceeding for any remedy available to the senior trustee, or the
exercising of any of the senior trustee's trusts or powers.
6
<PAGE>
Subordinated indenture. The subordinated indenture provides that the
following are events of default with respect to any series of subordinated debt
securities:
. default for 30 days in the payment of any interest on any debt security
of that series;
. default in the payment of the principal of or premium, if any, on any
debt security of that series at its maturity;
. default in making a sinking fund payment required for any debt security
of that series;
. any default in the performance of any of our other covenants in the
subordinated indenture that continues for 60 days after written notice,
other than default in a covenant included in the subordinated indenture
solely for the benefit of another series of subordinated debt
securities;
. the acceleration of more than $25,000,000, where that indebtedness is
not discharged or that acceleration is not rescinded or annulled;
. certain events relating to the bankruptcy, insolvency or reorganization
of us or our property; and
. any other event of default provided with respect to a particular series
of debt securities.
The subordinated trustee generally may withhold notice to the holders of any
series of subordinated debt securities of any default with respect to that
series if it considers the withholding to be in the interest of the holders.
However, the subordinated trustee may not withhold notice of any default in the
payment of the principal of or premium, if any or interest on any debt security
of that series or in the payment of any sinking fund installment in respect of
any debt security of that series.
If an event of default with respect to any series of subordinated debt
securities occurs and is continuing, the subordinated trustee or the holders of
not less than 25% in principal amount of the outstanding debt securities of
that series may declare the principal amount of all of the debt securities of
that series immediately due and payable. Subject to certain conditions, the
holders of a majority in principal amount of outstanding debt securities of
that series may rescind and annul that acceleration. However, they may only do
so if all events of default with respect to debt securities of that series have
been cured or waived. Holders of a majority in principal amount of any series
of the outstanding subordinated debt securities may, subject to some
limitations, waive any past default with respect to that series and the
consequences of the default. The prospectus supplement relating to any series
of subordinated debt securities which are original issue discount securities
will describe the particular provisions relating to acceleration of a portion
of the principal amount of those original issue discount securities upon the
occurrence and continuation of an event of default. Within 120 days after the
close of each fiscal year, we must file with the subordinated trustee a
statement, signed by specified officers of us, stating whether such officers
have knowledge of any default under the subordinated indenture.
Except with respect to its duties in case of default, the subordinated
trustee is not obligated to exercise any of its rights or powers at the request
or direction of any holders of any series of outstanding subordinated debt
securities, unless those holders have offered the subordinated trustee
reasonable security or indemnity. Subject to those indemnification provisions
and limitations contained in the subordinated indenture, the holders of a
majority in principal amount of any series of the outstanding subordinated debt
securities may direct any proceeding for any remedy available to the
subordinated trustee, or the exercising of any of the subordinated trustee's
trusts or powers.
Modification of the indentures
Senior indenture. Modifications and amendments of the senior indenture may
be made only, subject to some exceptions, with the consent of the holders of a
majority in aggregate principal amount of all outstanding debt securities under
the senior indenture which are affected by the modification or amendment.
However, the
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holder of each affected senior debt security must consent to any modification
or amendment of the senior indenture that:
. changes the stated maturity of the principal of, or the premium, if any,
or any installment of interest on, that debt security;
. reduces the principal amount of, or the rate or amount of interest on,
or any premium payable on redemption of, that debt security;
. reduces the amount of principal of an original issue discount security
that would be due and payable upon declaration of acceleration of its
maturity or would be provable in bankruptcy;
. adversely affects any right of repayment of the holder of that debt
security;
. changes the place of payment where, or the currency in which, any
payment on that debt security is payable;
. impairs the right to institute suit to enforce any payment on or with
respect to that debt security; or
. reduces the percentage of outstanding debt securities of any series
necessary to modify or amend the senior indenture or to waive compliance
with some of its provisions or defaults and their consequences.
We and the senior trustee may amend the senior indenture without the consent
of the holders of any senior debt securities in certain limited circumstances,
such as:
. to evidence the succession of another entity to us and the assumption by
the successor of our covenants contained in the senior indenture;
. to secure the securities; and
. to cure any ambiguity, to correct or supplement any provision in the
senior indenture which may be inconsistent with any other provision of
the senior indenture.
Subordinated indenture. Modifications and amendments to the subordinated
indenture may be made only, subject to some exceptions, with the consent of the
holders of a majority in aggregate principal amount of all outstanding debt
securities under the subordinated indenture which are affected by the
modification or amendment. However, the holder of each affected subordinated
debt security must consent to any modification or amendment of the subordinated
indenture that:
. changes the stated maturity of the principal of, or the premium, if any,
or any installment of interest on, that debt security;
. reduces the principal amount of, or the rate or amount of interest on,
or any premium payable on redemption of, that debt security;
. reduces the amount of principal of an original issue discount security
that would be due and payable upon declaration of acceleration of its
maturity or would be provable in bankruptcy;
. adversely affects any right of the repayment of the holder of that debt
security;
. changes the place of payment where, or the currency in which, any
payment on that debt security is payable;
. impairs the right to institute suit to enforce any payment on or with
respect to that debt security;
. reduces the percentage of outstanding debt securities of any series
necessary to modify or amend the subordinated indenture or to waive
compliance with some of its provisions or defaults and their
consequences; or
. subordinates the indebtedness evidenced by that debt security to any of
our indebtedness other than senior indebtedness.
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We and the subordinated trustee also may amend the subordinated indenture
without the consent of the holders of any subordinated securities in certain
limited circumstances, such as:
. to evidence the succession of another entity to us and the assumption by
the successor of our covenants contained in the subordinated indenture;
. to secure the securities; and
. to cure any ambiguity, to correct or supplement any provision in the
subordinated indenture which may be inconsistent with any other
provision of the subordinated indenture.
Defeasance and covenant defeasance
When we establish a series of debt securities, we may provide that that
series is subject to the defeasance and discharge provisions of the applicable
indenture. If those provisions are made applicable, we may elect either:
. to defease and be discharged from, subject to some limitations, all of
our obligations with respect to those debt securities; or
. to be released from our obligations to comply with specified covenants
relating to those debt securities as described in the applicable
prospectus supplement.
To effect that defeasance or covenant defeasance, we must irrevocably
deposit in trust with the relevant trustee an amount in any combination of
funds or government obligations, which, through the payment of principal and
interest in accordance with their terms, will provide money sufficient to make
payments on those debt securities and any mandatory sinking fund or analogous
payments on those debt securities.
On such a defeasance, we will not be released from obligations:
. to pay additional amounts, if any, upon the occurrence of some events;
. to register the transfer or exchange of those debt securities;
. to replace some of those debt securities;
. to maintain an office relating to those debt securities;
. to hold moneys for payment in trust will not be discharged.
To establish such a trust we must, among other things, deliver to the
relevant trustee an opinion of counsel to the effect that the holders of those
debt securities:
. will not recognize income, gain or loss for U.S. federal income tax
purposes as a result of the defeasance or covenant defeasance; and
. will be subject to U.S. federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if the
defeasance or covenant defeasance had not occurred. In the case of
defeasance, the opinion of counsel must be based upon a ruling of the
IRS or a change in applicable U.S. federal income tax law occurring
after the date of the applicable indenture.
Government obligations mean generally securities which are:
. direct obligations of the U.S. or of the government which issued the
foreign currency in which the debt securities of a particular series are
payable, in each case, where the issuer has pledged its full faith and
credit to pay the obligations; or
. obligations of an agency or instrumentality of the U.S. or of the
government which issued the foreign currency in which the debt
securities of that series are payable, the payment of which is
unconditionally guaranteed as a full faith and credit obligation by the
U.S. or that other government.
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In any case, the issuer of government obligations cannot have the option
to call or redeem the obligations. In addition, government obligations
include, subject to certain qualifications, a depository receipt issued
by a bank or trust company as custodian with respect to any government
obligation or a specific payment of interest on or principal of any such
government obligation held by the custodian for the account of a
depository receipt holder.
If we effect covenant defeasance with respect to any debt securities, the
amount on deposit with the relevant trustee will be sufficient to pay amounts
due on the debt securities at the time of their stated maturity. However,
those debt securities may become due and payable prior to their stated
maturity if there is an event of default with respect to a covenant from which
we have not been released. In that event, the amount on deposit may not be
sufficient to pay all amounts due on the debt securities at the time of the
acceleration.
The applicable prospectus supplement may further describe the provisions,
if any, permitting defeasance or covenant defeasance, including any
modifications to the provisions described above.
Senior debt securities
Senior debt securities are to be issued under the senior indenture. Each
series of senior debt securities will constitute senior indebtedness and will
rank equally with each other series of senior debt securities and other senior
indebtedness. All subordinated debt, including, but not limited to, all
subordinated securities, will be subordinated to the senior debt securities
and other senior indebtedness.
Subordination of subordinated securities
Subordinated indenture. Payments on the subordinated securities will be
subordinated to our senior indebtedness, whether outstanding on the date of
the subordinated indenture or incurred after that date. At September 30, 1999,
our aggregate senior indebtedness was approximately $3.019 billion. The
applicable prospectus supplement for each issuance of subordinated securities
will specify the aggregate amount of our outstanding indebtedness as of the
most recent practicable date that would rank senior to and equally with the
offered subordinated securities.
Ranking. No class of subordinated securities is subordinated to any other
class of subordinated debt securities. See "Subordination provisions" below.
Subordination provisions. If any of certain specified events occur, the
holders of senior indebtedness must receive payment of the full amount due on
the senior indebtedness, or that payment must be duly provided for, before we
may make payments on the subordinated securities. These events are:
. any distribution of our assets upon our liquidation, reorganization or
other similar transaction except for a distribution in connection with a
merger or other transaction complying with the covenant described above
under "Merger";
. the occurrence and continuation of a payment default on any senior
indebtedness; or
. a declaration of the principal of any series of the subordinated
securities, or, in the case of original issue discount securities, the
portion of the principal amount specified under their terms, as due and
payable, that has not been rescinded and annulled.
However, if the event is the acceleration of any series of subordinated
securities, only the holders of senior indebtedness outstanding at the time of
the acceleration of those subordinated securities, or, in the case of
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original issue discount securities, that portion of the principal amount
specified under their terms, must receive payment of the full amount due on
that senior indebtedness, or such payment must be duly provided for, before we
make payments on the subordinated securities.
As a result of the subordination provisions, some of our general creditors,
including holders of senior indebtedness, may recover more, ratably, than the
holders of the subordinated securities in the event of insolvency.
Definition of senior indebtedness
Senior indebtedness means the following indebtedness or obligations:
. the principal of and premium, if any, and unpaid interest on
indebtedness for money borrowed;
. purchase money and similar obligations;
. obligations under capital leases;
. guarantees, assumptions or purchase commitments relating to, or other
transactions as a result of which we are responsible for the payment of,
the indebtedness of others;
. renewals, extensions and refunding of that indebtedness;
. interest or obligations in respect of the indebtedness accruing after
the commencement of any insolvency or bankruptcy proceedings; and
. obligations associated with derivative products.
However, indebtedness or obligations are not senior indebtedness if the
instrument by which we become obligated for that indebtedness or those
obligations expressly provides that that indebtedness or those obligations are
junior in right of payment to any other of our indebtedness or obligations.
Convertible debt securities
Unless otherwise provided in the applicable prospectus supplement, the
following provisions will apply to debt securities that will be convertible
into common stock or preferred stock.
Conversion. The holder of unredeemed convertible debt securities may, at any
time during the period specified in the applicable prospectus supplement,
convert those convertible debt securities into shares of common stock or
preferred stock. The conversion price or rate for each $1,000 principal amount
of convertible debt securities will be specified in the applicable prospectus
supplement. The holder of a convertible debt security may convert a portion of
the convertible debt security which is $1,000 principal amount or any multiple
of $1,000. In the case of convertible debt securities called for redemption,
conversion rights will expire at the close of business on the date fixed for
the redemption. However, in the case of repayment at the option of the
applicable holder, conversion rights will terminate upon receipt of written
notice of the holder's exercise of that option.
In certain events, the conversion price or rate will be subject to
adjustment as specified in the applicable indenture. For debt securities
convertible into common stock, those events include:
. the issuance of shares of common stock as a dividend;
. subdivisions and combinations of common stock;
. the issuance to all holders of common stock of rights or warrants
entitling such holders for a period not exceeding 45 days to subscribe
for or purchase shares of common stock at a price per share less than
its current per share market price; and
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. the distribution to all holders of common stock of:
(1) shares of our capital stock, other than common stock;
(2) evidences of our indebtedness or assets excluding cash dividends or
distributions paid from our retained earnings; or
(3) subscription rights or warrants other than those referred to above.
No adjustment of the conversion price or rate will be required in any of
these cases unless an adjustment would require a cumulative increase or
decrease of at least 1% in that price or rate. Fractional shares of common
stock will not be issued upon conversion. In place of fractional shares, we
will pay a cash adjustment. Unless otherwise specified in the applicable
prospectus supplement, convertible debt securities convertible into common
stock surrendered for conversion between any record date for an interest
payment and the related interest payment date must be accompanied by payment of
an amount equal to the interest payment on the surrendered convertible debt
security. However, that payment does not have to accompany convertible debt
securities surrendered for conversion if those convertible debt securities have
been called for redemption during that period.
The adjustment provisions for debt securities convertible into shares of
preferred stock will be determined at the time of an issuance of debt
securities and will be described in the applicable prospectus supplement.
Description of Preferred Stock
This section describes the general terms and provisions of our preferred
stock. The applicable prospectus supplement will describe the specific terms of
the preferred stock offered through that prospectus supplement as well as any
general terms described in this section that will not apply to those shares of
preferred stock.
We have summarized certain selected terms of the preferred stock in this
section. The summary is not complete. You should read our restated certificate
of incorporation that is an exhibit to our annual report on Form 10-K and the
certificate of designation relating to the applicable series of the preferred
stock that we will file with the SEC for additional information before you buy
any preferred stock.
General
Our restated certificate of incorporation and Delaware General Corporation
Law give our board of directors the authority, without further stockholder
action, to issue a maximum of 10,000,000 shares of preferred stock. The board
of directors has the authority to fix the following terms with respect to
shares of any series of preferred stock:
. the designation of the series;
. the number of shares to comprise the series;
. the dividend rate or rates payable with respect to the shares of the
series;
. the redemption price or prices, if any, and the terms and conditions of
any redemption;
. the voting rights;
. any sinking fund provisions for the redemption or purchase of the shares
of the series;
. the terms and conditions upon which the shares are convertible or
exchangeable, if they are convertible or exchangeable; and
. any other relative rights, preferences and limitations pertaining to the
series.
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The preferred stock will have the rights described in this section unless
the applicable prospectus supplement provides otherwise. You should read the
prospectus supplement relating to the particular series of the preferred stock
it offers for specific terms, including:
. the designation, stated value and liquidation preference of that series
of the preferred stock and the number of shares offered;
. the initial public offering price at which the shares will be issued;
. the dividend rate or rates or method of calculation of dividends, the
dividend periods, the date or dates on which dividends will be payable
and whether such dividends will be cumulative or noncumulative and, if
cumulative, the dates from which dividends shall commence to cumulate;
. any redemption or sinking fund provisions;
. any conversion or exchange provisions;
. the procedures for any auction and remarketing, if any, of that series
of preferred stock;
. whether interests in that series of preferred stock will be represented
by our depositary shares; and
. any additional dividend, liquidation, redemption, sinking fund and other
rights, preferences, privileges, limitations and restrictions of that
series of preferred stock.
When we issue shares of preferred stock against payment for the shares, they
will be fully paid and nonassessable. This means that the full purchase price
for those shares will have been paid and the holders of those shares will not
be assessed any additional monies for those shares. Holders of preferred stock
will have no preemptive rights to subscribe for any additional securities that
we may issue.
Because we are a holding company, our rights and the rights of holders of
our securities, including the holders of preferred stock, to participate in the
distribution of assets of any subsidiary of ours upon its liquidation or
recapitalization will be subject to the prior claims of its creditors and
preferred stockholders. We will not be structurally subordinated to the extent
we are a creditor with recognized claims against the subsidiary or are a holder
of preferred stock of the subsidiary.
Dividends
The holders of the preferred stock will be entitled to receive dividends, if
declared by our board of directors out of our assets that we can legally use to
pay dividends. The prospectus supplement relating to a particular series of
preferred stock will describe the dividend rates and dates on which dividends
will be payable. The rates may be fixed or variable or both. If the dividend
rate is variable, the applicable prospectus supplement will describe the
formula used for determining the dividend rate for each dividend period. We
will pay dividends to the holders of record as they appear on our stock books
on the record dates fixed by our board of directors. The applicable prospectus
supplement will specify whether dividends will be paid in the form of cash,
preferred stock or common stock.
The applicable prospectus supplement will also state whether dividends on
any series of preferred stock are cumulative or noncumulative. If our board of
directors does not declare a dividend payable on a dividend payment date on any
noncumulative series of preferred stock, then the holders of that series will
not be entitled to receive a dividend for that dividend period. In those
circumstances, we will not be obligated to pay the dividend accrued for that
period, whether or not dividends on such preferred stock are declared or paid
on any future dividend payment dates.
Our board of directors may not declare and pay a dividend on any of our
stock ranking, as to dividends, equal with or junior to any series of preferred
stock unless full dividends on that series have been declared and
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paid, or declared and sufficient money is set aside for payment. Until either
full dividends are paid, or are declared and payment is set aside, on preferred
stock ranking equal as to dividends, then:
. we will declare any dividends pro rata among the preferred stock of each
series and any preferred stock ranking equal to the preferred stock as
to dividends; in other words, the dividends we declare per share on each
series of such preferred stock will bear the same relationship to each
other that the full accrued dividends per share on each such series of
the preferred stock bear to each other;
. other than such pro rata dividends, we will not declare or pay any
dividends or declare or make any distributions upon any security ranking
junior to or equal with the preferred stock as to dividends or upon
liquidation, except dividends or distributions paid for with securities
ranking junior to the preferred stock as to dividends and upon
liquidation; and
. we will not redeem, purchase or otherwise acquire or set aside money for
a sinking fund for any securities ranking junior to or equal with the
preferred stock as to dividends or upon liquidation except by conversion
into or exchange for stock junior to the preferred stock as to dividends
and upon liquidation.
We will not owe any interest, or any money in lieu of interest, on any
dividend payment(s) on any series of the preferred stock which may be past due.
Redemption
Preferred stock may be redeemable, in whole or in part, at our option, and
may be subject to mandatory redemption through a sinking fund or otherwise, as
described in the applicable prospectus supplement. Redeemed preferred stock
will become authorized but unissued shares of preferred stock that we may issue
in the future.
If a series of preferred stock is subject to mandatory redemption, the
applicable prospectus supplement will specify the number of shares that we will
redeem each year and the redemption price. If preferred stock is redeemed, we
will pay all accrued and unpaid dividends on those shares to, but excluding,
the redemption date. In the case of any noncumulative series of preferred
stock, accrued and unpaid dividends will not include any accumulation of
dividends for prior dividend periods. The applicable prospectus supplement will
also specify whether we will pay the redemption price in cash or other
property. If the redemption price for preferred stock of any series is payable
only from the net proceeds of the issuance of our capital stock, the terms of
that preferred stock may provide for its automatic conversion upon the
occurrence of certain events. These events include if no capital stock has been
issued or if the net proceeds from any issuance are insufficient to pay in full
the aggregate redemption price then due.
If fewer than all of the outstanding shares of any series of the preferred
stock are to be redeemed, our board of directors will determine the number of
shares to be redeemed. We may redeem the shares pro rata from the holders of
record in proportion to the number of shares held by them, with adjustments to
avoid redemption of fractional shares, or by lot in a manner determined by our
board of directors.
Even though the terms of a series of preferred stock may permit redemption
of shares of preferred stock in whole or in part, if any dividends, including
accumulated dividends, on that series are past due:
. we will not redeem any preferred stock of that series unless we
simultaneously redeem all outstanding shares of preferred stock of that
series; and
. we will not purchase or otherwise acquire any preferred stock of that
series.
The prohibition discussed in the prior sentence will not prohibit us from
purchasing or acquiring preferred stock of that series through a purchase or
exchange offer if we make the offer on the same terms to all holders of that
series.
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Unless the applicable prospectus supplement specifies otherwise, we will
give notice of a redemption by mailing a notice to each record holder of the
shares to be redeemed, between 30 to 60 days prior to the date fixed for
redemption. We will mail the notices to the holders' addresses as they appear
on our stock records. Each notice will state:
. the redemption date;
. the number of shares and the series of the preferred stock to be
redeemed;
. the redemption price;
. the place or places where holders can surrender the certificates for the
preferred stock for payment of the redemption price;
. that dividends on the shares to be redeemed will cease to accrue on the
redemption date; and
. the date when the holders' conversion rights, if any, will terminate.
If we redeem fewer than all shares of any series of the preferred stock held
by any holder, we will also specify the number of shares to be redeemed from
the holder in the notice.
If we have given notice of the redemption and have provided the funds for
the payment of the redemption price, then beginning on the redemption date:
. the dividends on the preferred stock called for redemption will no
longer accrue;
. such shares will no longer be considered outstanding; and
. the holders will no longer have any rights as stockholders except to
receive the redemption price.
When the holders of these shares surrender the certificates representing
these shares, in accordance with the notice, the redemption price described
above will be paid out of the funds we provide. If fewer than all the shares
represented by any certificate are redeemed, a new certificate will be issued
representing the unredeemed shares without cost to the holder of those shares.
Conversion or exchange rights
The prospectus supplement relating to a series of preferred stock that is
convertible or exchangeable will state the terms on which shares of that series
are convertible or exchangeable into common stock, another series of preferred
stock or debt securities.
Rights upon liquidation
Unless the applicable prospectus supplement states otherwise, if we
liquidate, dissolve or wind up our business, the holders of shares of each
series of the preferred stock will be entitled to receive:
. liquidation distributions in the amount stated in the applicable
prospectus supplement; and
. all accrued and unpaid dividends whether or not earned or declared.
We will pay these amounts to the holders of shares of each series of the
preferred stock, and all amounts owing on any preferred stock ranking equally
with that series of preferred stock as to liquidating distributions, out of our
assets available for distribution to stockholders. These payments will be made
before any distribution is made to holders of any securities ranking junior to
the series of preferred stock upon liquidation.
If we liquidate, dissolve or wind up our business and the assets available
for distribution to the holders of the preferred stock of any series and any
other shares of our stock ranking equal with that series as to liquidating
distributions are insufficient to pay all amounts to which the holders are
entitled, then we will only
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make pro rata distributions to the holders of all shares ranking equal as to
liquidating distributions. This means that the distributions we pay to these
holders will bear the same relationship to each other that the full
distributable amounts for which these holders are respectively entitled upon
liquidation of our business bear to each other.
After we pay the full amount of the liquidation distribution to which the
holders of a series of the preferred stock are entitled, those holders will
have no right or claim to any of our remaining assets.
Voting rights
Except as indicated below or in the applicable prospectus supplement, or
except as expressly required by applicable law, the holders of preferred stock
will not be entitled to vote.
If we fail to pay dividends on any shares of preferred stock for six
consecutive quarterly periods, the holders of those shares of preferred stock,
voting separately as a class with all other series of preferred stock upon
which the same voting rights have been conferred and are exercisable, will be
entitled to vote for the election of two additional directors to the board of
directors. This may be done at a special meeting called by the holders of
record of at least 10% of those shares of preferred stock or the next annual
meeting of stockholders and at each subsequent meeting until:
. in the case of a series of preferred stock with cumulative dividends,
all dividends accumulated on that series of preferred stock for the past
dividend periods and the then current dividend period have been fully
paid or declared and a sum sufficient for the payment of these dividends
has been set aside for payment; or
. in the case of a series of noncumulative preferred stock, four
consecutive quarterly dividends on that series of noncumulative
preferred stock have been fully paid or declared and a sum sufficient
for the payment of these dividends has been set aside for payment.
In this case, the entire board of directors will be increased by two
directors.
So long as any shares of preferred stock remain outstanding, unless we
receive the consent of the holders of any outstanding series of preferred stock
as specified below, we will not:
. authorize, issue or increase the authorized amount of, any capital stock
ranking prior to the outstanding series of preferred stock as to
dividends or liquidating distributions;
. reclassify any capital stock into any shares with this kind of prior
ranking;
. authorize or issue any obligation or security that represents the right
to purchase any capital stock with this kind of prior ranking; or
. amend or alter the provisions of our restated certificate of
incorporation, so as to materially and adversely affect any right,
preference, privilege or voting power of that series of preferred stock
or the holders of that series of preferred stock.
This consent must be given by the holders of at least two-thirds of each
series of all outstanding preferred stock described in the preceding sentence,
voting separately as a class. We will not be required to obtain this consent
with respect to the actions relating to changes to our restated certificate of
incorporation, however, if we only:
. increase the amount of the authorized preferred stock or any outstanding
series of preferred stock or any of our other capital stock; or
. create and issue another series of preferred stock or any other capital
stock; and
. in either case, this preferred stock ranks equal with or junior to the
outstanding preferred stock as to dividends and liquidating
distributions.
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Description of Depositary Shares
This section describes the general terms and provisions of shares of
preferred stock represented by depositary shares. The applicable prospectus
supplement will describe the specific terms of the depositary shares offered
through that prospectus supplement and any general terms outlined in this
section that will not apply to those depositary shares.
We have summarized in this section certain terms and provisions of the
deposit agreement, the depositary shares and the receipts representing
depositary shares. The summary is not complete. You should read the forms of
deposit agreement and depositary receipt that we have filed with the SEC for
additional information before you buy any depositary shares that represent
preferred stock of that series.
General
We may issue depositary receipts evidencing the depositary shares. Each
depositary share will represent a fraction of a share of preferred stock.
Shares of preferred stock of each class or series represented by depositary
shares will be deposited under a separate deposit agreement among us, the
preferred stock depositary and the holders of the depositary receipts. Subject
to the terms of the deposit agreement, each owner of a depositary receipt will
be entitled, in proportion to the fraction of a share of preferred stock
represented by the depositary shares evidenced by that depositary receipt, to
all the rights and preferences of the preferred stock represented by those
depositary shares. Those rights include any dividend, voting, conversion,
redemption and liquidation rights. Immediately following our issuance and
delivery of the preferred stock to the preferred stock depositary, we will
cause the preferred stock depositary to issue the depositary receipts on our
behalf.
Dividends and other distributions
The preferred stock depositary will distribute all dividends or other cash
distributions received in respect of the preferred stock to the record holders
of depositary receipts in proportion to the number of depositary receipts owned
by those holders.
If there is a distribution other than in cash, the preferred stock
depositary will distribute property it receives to the entitled record holders
of depositary receipts. However, if the preferred stock depositary determines
that it is not feasible to make that distribution, the preferred stock
depositary may, with our approval, sell the property and distribute the net
proceeds from this sale to the holders of depositary shares.
Withdrawal of stock
If a holder of depositary receipts surrenders the depositary receipts at the
corporate trust office of the preferred stock depositary, the holder will be
entitled to receive the number of shares of the preferred stock and any money
or other property represented by those depositary shares. However, the holder
will not be entitled to receive these shares and related assets if the related
depositary shares have previously been called for redemption or converted or
exchanged into other securities of our company. Holders of depositary receipts
will be entitled to receive whole or fractional shares of the preferred stock
on the basis of the proportion of preferred stock represented by each
depositary share specified in the applicable prospectus supplement. Holders of
shares of preferred stock received in exchange for depositary shares will no
longer be entitled to receive depositary shares in exchange for shares of
preferred stock. If the holder delivers depositary receipts evidencing a number
of depositary shares that is more than the number of depositary shares
representing the number of shares of preferred stock to be withdrawn, the
preferred stock depositary will issue the holder a new depositary receipt
evidencing this excess number of depositary shares at the same time.
Redemption of depositary shares
Whenever we redeem shares of preferred stock held by the preferred stock
depositary, the preferred stock depositary will redeem as of that redemption
date the number of depositary shares representing shares of the
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preferred stock so redeemed. However, we must have paid in full the redemption
price of the preferred stock to be redeemed plus any accrued and unpaid
dividends on the preferred stock to the preferred stock depositary.
The redemption price per depositary share will be equal to the redemption
price and any other amounts per share payable with respect to the preferred
stock. If fewer than all the depositary shares are to be redeemed, the
depositary shares to be redeemed will be selected by the preferred stock
depositary pro rata or by lot or another equitable method. In each case, we
will determine the method for selecting the depositary shares.
After the date fixed for redemption, the depositary shares called for
redemption will no longer be outstanding. When the depositary shares are no
longer outstanding, all rights of the holders of the related depositary
receipts will cease, except the right to receive money or other property that
the holders of the depositary receipts were entitled to receive upon such
redemption. These payments will be made when the holders surrender their
depositary receipts to the preferred stock depositary.
Voting the preferred stock
Upon receipt of notice of any meeting at which the holders of the preferred
stock are entitled to vote, the preferred stock depositary will mail
information about the meeting contained in the notice to the record holders of
the depositary shares representing such preferred stock. Each record holder of
depositary shares on the record date will be entitled to instruct the preferred
stock depositary as to how the preferred stock underlying the holder's
depositary shares will be voted. The record date for the depositary shares will
be the same as the record date for the preferred stock.
The preferred stock depositary will vote the amount of preferred stock
represented by the depositary shares according to these instructions. We will
agree to take all reasonable action deemed necessary by the preferred stock
depositary in order to enable the preferred stock depositary to vote the
preferred stock in that manner. The preferred stock depositary will not vote
shares of preferred stock for which it does not receive specific instructions
from the holders of depositary shares representing that preferred stock. The
preferred stock depositary will not be responsible for any failure to carry out
any voting instruction, or for the manner or effect of any vote, as long as its
action or inaction is in good faith and does not result from its negligence or
willful misconduct.
Exchange of preferred stock
Whenever we exchange all of the shares of preferred stock held by the
preferred stock depositary for debt securities or common stock, the preferred
stock depositary will exchange as of that exchange date all depositary shares
representing all of the shares of the preferred stock exchanged for debt
securities or common stock. However, we must have issued and deposited with the
preferred stock depositary debt securities or common stock for all of the
shares of the preferred stock to be exchanged.
The exchange rate per depositary share will be equal to the exchange rate
per share of preferred stock, multiplied by the fraction of a share of
preferred stock represented by one depositary share, plus all money and other
property, if any, represented by such depositary shares, including all accrued
and unpaid dividends on the shares of preferred stock.
Conversion of preferred stock
The depositary shares, as such, are not convertible or exchangeable into
common stock or any of our other securities or property. Nevertheless, the
prospectus supplement relating to an offering of depositary shares may provide
that the holders of depositary receipts may surrender their depositary receipts
to the preferred stock depositary with written instructions to the preferred
stock depositary to instruct us to cause the conversion or exchange of the
preferred stock represented by these depositary shares. We have agreed that
upon receipt of
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these instructions and any related amounts payable we will cause the requested
conversion or exchange. If the depositary shares are to be converted or
exchanged in part only, a new depositary receipt or receipts will be issued for
any depositary shares not to be converted or exchanged.
Amendment and termination of the deposit agreement
The form of depositary receipt evidencing the depositary shares and any
provision of the deposit agreement may be amended by agreement between us and
the preferred stock depositary. However, any amendment that materially and
adversely alters the rights of the holders of depositary shares or that would
be materially and adversely inconsistent with the rights granted to the holders
of the related preferred stock requires the approval of the holders of at least
two thirds of the depositary shares then outstanding.
We may terminate the deposit agreement upon not less than 60 days' notice if
holders of a majority of the depository shares then outstanding consent. If we
terminate the deposit agreement, the preferred stock depositary will deliver or
make available to each holder of depositary receipts that surrenders the
depositary receipts it holds, the number of whole or fractional shares of
preferred stock represented by the depositary shares evidenced by these
depositary receipts.
In addition, the deposit agreement will automatically terminate if:
. all outstanding depositary shares are redeemed, converted or exchanged;
or
. there is a final distribution in respect of the related preferred stock
in connection with any liquidation of our business and the distribution
has been distributed to the holders of the related depositary receipts.
Charges of preferred stock depositary
We will pay all transfer and other taxes and governmental charges arising
solely from the existence of the deposit agreement. In addition, we will pay
the fees and expenses of the preferred stock depositary in connection with the
performance of its duties under the deposit agreement. Holders of depositary
receipts will pay transfer and other taxes and governmental charges and any
other charges that are stated to be their responsibility in the deposit
agreement.
Resignation and removal of depositary
The preferred stock depositary may resign at any time by delivering notice
to us. We also may remove the preferred stock depositary at any time.
Resignations or removals will take effect upon the appointment of a successor
preferred stock depositary. This successor must be appointed within 60 days
after delivery of the notice of resignation or removal and must be a bank or
trust company having its principal office in the United States and having a
combined capital and surplus of at least $50,000,000.
Miscellaneous
The preferred stock depositary will forward to holders of depositary
receipts any reports and communications that we send to the preferred stock
depositary with respect to the related preferred stock.
Neither we nor the preferred stock depositary will be liable if it is
prevented or delayed, by law or any circumstances beyond its control in
performing its obligations under the deposit agreement. Our obligations and the
preferred stock depositary's obligations under the deposit agreement will be
limited to performance in good faith and without negligence or willful
misconduct of the duties described in the deposit agreement. Neither we nor the
preferred stock depositary will be obligated to prosecute or defend any legal
proceeding relating to any depositary receipts, depositary shares or shares of
preferred stock unless satisfactory indemnity is furnished. We and the
preferred stock depositary may rely on written advice of counsel or
accountants, or information
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provided by persons presenting shares of preferred stock for deposit, holders
of depositary receipts or other persons believed to be competent and authorized
to this information and on documents believed to be genuine.
If the preferred stock depositary receives conflicting claims, requests or
instructions from any holders of depositary receipts, on the one hand, and us,
on the other hand, the preferred stock depositary will be entitled to act on
the claims, requests or instructions received from us.
Description of Common Stock
We may issue, either separately or together with other securities, shares of
our common stock. Under our restated certificate of incorporation, we are
authorized to issue up to 1,500,000,000 shares of our common stock. A
prospectus supplement relating to an offering of common stock, or other
securities convertible or exchangeable for, or exercisable into, common stock,
will describe the relevant terms, including the number of shares offered, any
initial offering price, and market price and dividend information, as well as,
if applicable, information on other related securities. See "Description of
Outstanding Capital Stock" below.
Description of Outstanding Capital Stock
We have summarized some of the terms and provisions of our outstanding
capital stock in this section. The summary is not complete. We have also filed
our restated certificate of incorporation, our by-laws and the certificate of
designation relating to the Series A preferred stock as exhibits to our annual
report on Form 10-K. You should read our restated certificate of incorporation
and our by-laws and the certificate of designation relating to the Series A
preferred stock for additional information before you purchase any of our
capital stock.
As of October 29, 1999, our authorized capital stock was 1,518,500,000
shares. Those shares consisted of:
. 1,500,000,000 shares of common stock, par value $.01 per share;
. 10,000,000 shares of preferred stock, par value $.01 per share; and
. 8,500,000 shares of Class R convertible common stock, par value
$.01 per share.
As of October 29, 1999 there were 341,076,021 shares of common stock, no shares
of preferred stock and no shares of Class R convertible common stock
outstanding.
Common stock
Subject to the senior rights of preferred stock which may from time to time
be outstanding, holders of common stock are entitled to receive dividends
declared by the board of directors out of funds legally available for their
payment. Upon dissolution and liquidation of our business, holders of common
stock are entitled to a ratable share of our net assets remaining after payment
to the holders of the preferred stock of the full preferential amounts they are
entitled to. All outstanding shares of common stock are fully paid and
nonassessable.
The holders of common stock are entitled to one vote per share for the
election of directors and on all other matters submitted to a vote of
stockholders. Holders of common stock are not entitled to cumulative voting
for the election of directors. They are not entitled to preemptive rights.
The transfer agent and registrar for the common stock is Norwest Bank
Minnesota, N.A.
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Preferred stock
The preferred stock has priority over the common stock with respect to
dividends and to other distributions, including the distribution of assets upon
liquidation. The board of directors is authorized to fix and determine the
terms, limitations and relative rights and preferences of the preferred stock,
to establish series of preferred stock and to fix and determine the variations
as among series. The board of directors without stockholder approval could
issue preferred stock with voting and conversion rights which could adversely
affect the voting power of the holders of common stock. The board of directors
has designated 500,000 shares of Series A junior participating preferred stock.
Series A junior participating preferred stock will be issued in units
consisting of one one-thousandth of a share of Series A junior participating
preferred stock. Series A junior participating preferred stock is on a parity
with the common stock with respect to dividends and to other distributions,
including the distribution of assets on liquidation. Quarterly dividends per
unit equal the amount of the quarterly dividend paid per share of common stock,
when, as and if declared by the board of directors. The holders of units are
entitled to one vote per unit, voting together with the common stock on all
matters submitted to the stockholders. As of the date of this prospectus, there
are no outstanding shares of preferred stock.
Anti-takeover provisions
We currently have provisions in our restated certificate of incorporation
and by-laws that could have an anti-takeover effect. The provisions in the
restated certificate of incorporation include:
. a classified board of directors;
. a prohibition on our stockholders taking action by written consent;
. the requirement that special meetings of stockholders be called only by
the board of directors or the chairman of the board; and
. the requirement of the affirmative vote of at least 66-2/3% of our
outstanding shares of stock entitled to vote thereon to adopt, repeal,
alter, amend or rescind our by-laws.
The by-laws contain specific procedural requirements for the nomination of
directors and the introduction of business by a stockholder of record at an
annual meeting of stockholders where such business is not specified in the
notice of meeting or brought by or at the discretion of the board of directors.
In addition to these provisions, the board of directors has adopted a
stockholder's rights plan, under which rights were distributed in a dividend.
These rights entitle the holder to acquire units of Series A junior
participating preferred stock, which is exercisable upon the occurrence of
certain events, including the acquisition by a person or group of a specified
percentage of the common stock.
Plan of Distribution
We may sell the offered securities as follows:
. through agents;
. through underwriters;
. to dealers; or
. directly to one or more purchasers.
By agents
Offered securities may be sold through agents designated by us. Unless
otherwise indicated in a prospectus supplement, the agents will use their best
efforts to solicit purchases for the period of their appointment.
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By underwriters
If underwriters are used in the sale, the offered securities will be
acquired by the underwriters for their own account. The underwriters may
resell the securities in one or more transactions, including negotiated
transactions, at a fixed public offering price or at varying prices determined
at the time of sale. The obligations of the underwriters to purchase the
securities will be subject to certain conditions. The underwriters will be
obligated to purchase all the securities of the series offered if any of the
securities are purchased. Any initial public offering price and any discounts
or concessions allowed or re-allowed or paid to dealers may be changed from
time to time.
To dealers
If a dealer is used in the sale, we will sell the offered securities to the
dealer, as principal. The dealer may then resell those securities to the
public at varying prices to be determined by the dealer at the time of resale.
Direct sales
We may also sell offered securities directly to institutional investors or
others. These sales may include ones made under arrangements with the
investors under which we have the right to require the investors to purchase
the offered securities from us from time to time at prices tied to the market
price for those securities.
Delayed delivery contracts
We may authorize underwriters, dealers and agents to solicit offers by
certain institutional investors to purchase offered securities under contracts
providing for payment and delivery on a future date specified in the
prospectus supplement. The prospectus supplement will also describe the public
offering price for the securities and the commission payable for solicitation
of these delayed delivery contracts. Delayed delivery contracts will contain
definite fixed price and quantity terms. The obligations of a purchaser under
these delayed delivery contracts will be subject to only two conditions:
. that the institution's purchase of the securities at the time of
delivery of the securities is not prohibited under the law of any
jurisdiction to which the institution is subject; and
. that we shall have sold to the underwriters the total principal amount
of the offered securities, less the principal amount covered by the
delayed delivery contracts.
General information
Underwriters, dealers, agents and direct purchasers that participate in the
distribution of the offered securities may be underwriters as defined in the
Securities Act and any discounts or commissions they receive from us and any
profit on the resale of the offered securities by them may be treated as
underwriting discounts and commissions under the Securities Act. Any
underwriters, dealers or agents will be identified and their compensation
described in a prospectus supplement.
We may have agreements with the underwriters, dealers and agents to
indemnify them against certain civil liabilities, including liabilities under
the Securities Act, or to contribute with respect to payments which the
underwriters, dealers or agents may be required to make.
Underwriters, dealers and agents may engage in transactions with, or
perform services for, us or our subsidiaries in the ordinary course of their
businesses.
The place, time of delivery and other terms of the sale of the offered
securities will be described in the prospectus supplement.
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Legal Matters
Willkie Farr & Gallagher will issue an opinion for us about the legality of
the offered securities. Any underwriters will be advised about other issues
relating to any offering by their own legal counsel.
Experts
The consolidated financial statements of Level 3 Communications, Inc. as of
December 31, 1998 and for the year then ended, incorporated by reference in
this registration statement have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and have been incorporated herein in reliance upon the authority of
said firm as experts in giving said report.
The consolidated balance sheet of Level 3 Communications, Inc. as of
December 27, 1997, and the related statements of earnings, cash flows,
comprehensive income, and changes in stockholders' equity for each of the two
years in the period ended December 27, 1997, as well as the consolidated
balance sheets of RCN Corporation and Subsidiaries as of December 31, 1997 and
1998 and the related statements of operations, cash flows, comprehensive
income, and changes in stockholders' equity, for each of the three years in the
period ended December 31, 1998, incorporated by reference in this registration
statement, have been incorporated herein in reliance on the reports of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
that firm as experts in accounting and auditing.
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[ARTWORK APPEARING ON INSIDE BACK COVER OF PROSPECTUS SUPPLEMENT]
LEVEL 3 NETWORK
Level 3 Communications is building the first international end-to-end
communications network based entirely on Internet Protocol (IP) technology. To
implement this new technology, Level 3 plans to offer services in 56 markets
across the United States and 21 European and Pacific Rim markets, all
connected by intercity networks.
[MAP SHOWING LEVEL 3 NETWORK PLANNED OR IN DEVELOPMENT]
UPGRADEABLE NETWORK
[PICTURES SHOWING INSTALLATION OF CONDUITS]
[DIAGRAM SHOWING MULTIPLE CONDUITS IN PLACE]
Level 3 is installing multiple conduits 42" below ground in its continuously
upgradeable network. Ten to twelve 1 1/4" conduits are grouped together. Fiber
will initially be drawn through only one of the conduits, leaving the others for
future expansion as technology changes, to meet customer demand and to provide
Level 3 the flexibility to offer conduit to others.
[LOGO OF LEVEL 3]
<PAGE>
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15,000,000 Shares
Level 3 Communications, Inc.
Common Stock
[LOGO OF LEVEL(3)/SM/ COMMUNICATIONS]
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U.S. PROSPECTUS SUPPLEMENT
, 2000
(Including Prospectus dated December 10, 1999)
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Salomon Smith Barney
Goldman, Sachs & Co.
J.P. Morgan & Co.
Morgan Stanley Dean Witter
Chase H&Q
Credit Suisse First Boston
Merrill Lynch & Co.
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