FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2001
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period__________to__________
Commission file number 0-15658
LEVEL 3 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 47-0210602
(State of Incorporation) (I.R.S. Employer
Identification No.)
1025 Eldorado Blvd., Broomfield, CO 80021
(Address of principal executive offices) (Zip Code)
(720) 888-1000
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports(s)), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
The number of shares outstanding of each class of the issuer's common
stock, as of July 31, 2001:
Common Stock 368,266,866 shares
Page
Part I - Financial Information
Item 1. Unaudited Financial Statements:
Consolidated Condensed Statements of Operations 2
Consolidated Condensed Balance Sheets 3
Consolidated Statements of Cash Flows 5
Consolidated Statement of Changes in Stockholders' Equity 6
Consolidated Statements of Comprehensive Loss 7
Notes to Consolidated Condensed Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25
Part II - Other Information
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 6. Exhibits and Reports on Form 8-K 34
Signatures 35
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
(dollars in millions, except per share data) 2001 2000 2001 2000
---- ---- ---- ----
Revenue......................................................... $ 389 $ 234 $ 838 $ 411
Costs and Expenses:
Cost of revenue............................................ 211 154 479 284
Depreciation and amortization.............................. 329 139 568 227
Selling, general and administrative........................ 345 249 707 485
Restructuring charges...................................... 40 -- 50 --
Impairments................................................ 61 -- 61 --
----- ----- ----- -----
Total Costs and Expenses........................................ 986 542 1,865 996
----- ----- ----- -----
Loss from Operations............................................ (597) (308) (1,027) (585)
Other Income (Expense):
Interest income............................................ 47 104 108 168
Interest expense, net...................................... (174) (81) (312) (131)
Equity in earnings (losses) of
unconsolidated subsidiaries, net........................ 4 (61) 2 (116)
Gain on equity investee stock transactions................. -- 57 -- 95
Other, net................................................. (11) (3) (37) (3)
----- ----- ----- -----
Total Other Income (Expense).................................... (134) 16 (239) 13
----- ----- ----- -----
Loss Before Income Taxes........................................ (731) (292) (1,266) (572)
Income Tax Benefit.............................................. -- 11 -- 20
----- ----- ----- -----
Net Loss........................................................ $ (731) $ (281) $ (1,266) $ (552)
====== ======= ======== ======
Net Loss Per Share (Basic and Diluted).......................... $ (1.99) $ (0.77) $ (3.44) $ (1.54)
======= ======= ======= =======
Total Number of Weighted Average Shares
Outstanding Used to Compute Basic and
Diluted Loss Per Share (in thousands)...................... 368,211 365,916 368,012 358,008
======= ======= ======= =======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(unaudited)
June 30, December 31,
(dollars in millions, except per share data) 2001 2000
---- ----
Assets
Current Assets:
Cash and cash equivalents...................................................... $ 1,418 $ 1,265
Marketable securities.......................................................... 1,743 2,742
Restricted securities.......................................................... 148 219
Receivables, less allowances for doubtful accounts
of $34 and $33, respectively............................................... 484 617
Recoverable income taxes....................................................... 25 67
Other.......................................................................... 78 135
------- -------
Total Current Assets................................................................ 3,896 5,045
Net Property, Plant and Equipment................................................... 10,480 9,383
Investments......................................................................... 111 146
Other Assets, net................................................................... 401 345
------- -------
$ 14,888 $ 14,919
======== ========
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(unaudited)
June 30, December 31,
(dollars in millions, except per share data) 2001 2000
---- ----
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable............................................................. $ 1,341 $ 1,486
Current portion of long-term debt............................................ 9 7
Accrued payroll and employee benefits........................................ 114 90
Accrued interest............................................................. 124 124
Deferred revenue............................................................. 87 68
Restructuring liability..................................................... 39 --
Other........................................................................ 174 147
----- -----
Total Current Liabilities......................................................... 1,888 1,922
Long-Term Debt, less current portion.............................................. 7,959 7,318
Deferred Revenue.................................................................. 1,168 652
Accrued Reclamation Costs......................................................... 94 94
Other Liabilities................................................................. 394 384
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, authorized 10,000,000 shares: no
shares outstanding....................................................... -- --
Common stock:
Common stock, $.01 par value, authorized 1,500,000,000 shares:
368,249,281 outstanding in 2001 and 367,599,870
outstanding in 2000................................................ 4 4
Class R, $.01 par value, authorized 8,500,000 shares: no
shares outstanding.................................................. -- --
Additional paid-in capital................................................... 5,336 5,167
Accumulated other comprehensive loss......................................... (140) (73)
Accumulated deficit.......................................................... (1,815) (549)
----- -----
Total Stockholders' Equity........................................................ 3,385 4,549
----- -----
$ 14,888 $ 14,919
======== ========
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended
June 30,
(dollars in millions) 2001 2000
---- ----
Cash Flows from Operating Activities:
Net Loss.................................................................................... $(1,266) $ (552)
Adjustments to reconcile net loss to net cash provided by operating activities:
Equity earning (losses), net............................................................ (2) 115
Depreciation and amortization........................................................... 568 228
Dark fiber cost of revenue.............................................................. 131 17
Amortization of debt issuance costs..................................................... 14 10
(Gain) loss on sale of assets........................................................... (13) 1
Compensation expense attributable to stock awards....................................... 162 97
Impairments............................................................................. 98 --
Gain on equity investee stock transactions.............................................. -- (95)
Amortization of discounts on marketable securities...................................... -- (17)
Federal income tax refunds.............................................................. 43 245
Deferred revenue........................................................................ 516 215
Deposits................................................................................ 50 (148)
Accrued interest on long-term debt...................................................... 59 87
Changes in working capital items:
Receivables........................................................................... 114 (99)
Other assets.......................................................................... 4 (22)
Payables.............................................................................. (82) 354
Other liabilities..................................................................... 53 48
Other (47) (17)
----- -----
Net Cash Provided by Operating Activities.................................................... 402 467
Cash Flows from Investing Activities:
Proceeds from sales and maturities of marketable securities............................. 2,120 3,413
Purchases of marketable securities...................................................... (1,112) (5,888)
Decrease (increase) in restricted securities............................................ 70 (4)
Capital expenditures.................................................................... (1,952) (3,038)
Other 17 (1)
----- -----
Net Cash Used in Investing Activities........................................................ (857) (5,518)
Cash Flows from Financing Activities:
Long-term debt borrowings, net of issuance costs........................................ 636 3,088
Payments on long-term debt, including current portion................................... (3) (3)
Issuances of common stock, net of issuance costs........................................ -- 2,407
Other................................................................................... 11 12
----- -----
Net Cash Provided by Financing Activities.................................................... 644 5,504
Effect of Exchange Rates on Cash and Cash Equivalents........................................ (36) (19)
----- -----
Net Change in Cash and Cash Equivalents...................................................... 153 434
Cash and Cash Equivalents at Beginning of Period............................................. 1,265 1,214
----- -----
Cash and Cash Equivalents at End of Period................................................... $ 1,418 $ 1,648
======= =======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity
For the six months ended June 30, 2001
(unaudited)
Accumulated
Additional Other
Common Paid-in Comprehensive Accumulated
(dollars in millions) Stock Capital Loss Deficit Total
Balances at December 31, 2000........... $ 4 $ 5,167 $ (73) $ (549) $ 4,549
Common Stock:
Stock options exercised............ -- 2 -- -- 2
Stock plan grants.................. -- 162 -- -- 162
Shareworks plan grants............. -- 5 -- -- 5
Net Loss................................ -- -- -- (1,266) (1,266)
Other Comprehensive Loss................ -- -- (67) -- (67)
----- ----- ----- ----- -----
Balances at June 30, 2001............... $ 4 $ 5,336 $ (140) $ (1,815) $ 3,385
======= ======== ======= ======== ========
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Loss
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
(dollars in millions) 2001 2000 2001 2000
---- ---- ---- ----
Net Loss...................................................... $ (731) $ (281) $(1,266) $ (552)
Other Comprehensive Loss Before Tax:
Foreign currency translation losses...................... (28) (28) (69) (47)
Unrealized holding gains (losses) arising during
period............................................... (2) -- 2 (3)
Reclassification adjustment for gains included
in net loss.......................................... -- -- -- --
----- ----- ----- -----
Other Comprehensive Loss Before Tax........................... (30) (28) (67) (50)
Income Tax Benefit Related to Items of Other
Comprehensive Loss....................................... -- -- -- --
----- ----- ----- -----
Other Comprehensive Loss Net of Taxes......................... (30) (28) (67) (50)
----- ----- ----- -----
Comprehensive Loss............................................ $ (761) $ (309) $(1,333) $ (602)
====== ====== ======= ======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARES
Notes to Consolidated Condensed Financial Statements
1. Summary of Significant Accounting Policies
The consolidated condensed financial statements include the accounts of
Level 3 Communications, Inc. and subsidiaries (the "Company" or "Level 3") in
which it has control, which are engaged in enterprises primarily related to
communications, 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 owns less than fifty-percent of the voting stock,
but exercises significant influence over operating and financial policies, are
accounted for by the equity method. All significant intercompany accounts and
transactions have been eliminated.
The consolidated condensed balance sheet of Level 3 Communications, Inc.
and subsidiaries at December 31, 2000 has been condensed from the Company's
audited balance sheet as of that date. All other financial statements contained
herein are unaudited and, in the opinion of management, contain all adjustments
(consisting only of normal recurring accruals) necessary for a fair presentation
of financial position, results of operations and cash flows for the periods
presented. The Company's accounting policies and certain other disclosures are
set forth in the notes to the consolidated financial statements contained in the
Company's Annual Report on Form 10-K as amended, for the year ended December 31,
2000. 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 is 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. The Company has created, through a
combination of construction, purchase and leasing of facilities and other
assets, an advanced international, end-to-end, facilities-based communications
network. The Company has built and continues to build the network based on
Internet Protocol technology in order to leverage the efficiencies of this
technology to provide lower cost communications services.
Effective July 1, 1999, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 43, "Real Estate Sales, an Interpretation of FASB
Statement No. 66." Certain sale and long-term indefeasible right-to-use ("IRU")
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. Dark fiber is considered integral
equipment and accordingly, a lease must include a provision allowing title to
transfer to the lessee in order for the lease to be accounted for as a
sales-type lease. Failure to satisfy the requirements of the FASB Interpretation
results in the deferral of revenue recognition for these agreements over the
term of the agreement (currently up to 20 years). This FASB Interpretation does
not have a current effect on the Company's cash flows however, it will result in
substantial amounts of deferred revenue related to long-term dark fiber and
capacity IRU agreements.
Accounting practice and guidance with respect to the accounting treatment
of the above transactions is evolving. Any changes in the accounting treatment
could affect the manner in which the Company accounts for revenue and expenses
associated with sub-sea IRU agreements in the future.
In 2000, Level 3 utilized a portion of its accumulated net operating tax
losses to offset prior year taxable income. The remaining net operating losses
not utilized can be carried forward for 20 years to offset future taxable
income. A valuation allowance has been recorded against the entire balance of
net deferred tax assets as the Company is unable to conclude under relevant
accounting standards that it is more likely than not that net operating losses
will be realizable.
In June 2001, the FASB approved Statement of Financial Accounting Standard
("SFAS") No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interest
method of accounting for business combinations initiated after June 30, 2001.
SFAS No. 142 requires companies to cease amortizing goodwill on December 31,
2001. Any goodwill resulting from acquisitions completed after June 30, 2001
will not be amortized. SFAS No. 142 also establishes a new method of testing
goodwill for impairment on an annual basis or on an interim basis if an event
occurs or circumstances change that would reduce the fair value of a reporting
unit below its carrying value, beginning in the first quarter of 2002.
The results of operations for the six months ended June 30, 2001 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. Loss Per Share
Basic loss per share amounts have been computed using the weighted average
number of shares during each period. The Company had a net loss for the three
and six month periods ended June 30, 2001 and 2000. Therefore, the dilutive
impact of the approximate 19 million shares attributable to the Company's
convertible subordinated notes, and the approximate 33 million options and
warrants outstanding at June 30, 2001 and approximate 19 million shares
attributable to the Company's convertible subordinated notes and approximate 21
million options and warrants outstanding at June 30, 2000 have not been included
in the computation of diluted loss per share because the resulting computation
would have been anti-dilutive.
3. Restructuring and Impairment Charges
On June 18, 2001, the Company announced that due to the duration and
severity of the economic slowdown for the telecommunications industry, it was
reducing its revenue and EBITDA forecasts for 2001 and 2002. In conjunction with
this revised revenue outlook, the Company also announced that it would be
necessary to reduce operating expenses as well as reduce and reprioritize
capital expenditures in an effort to be in a position to benefit when the
economy recovers. As a result of this action, the Company is reducing its global
work force by approximately 1,400 employees, primarily in the communications
business. A restructuring charge of approximately $40 million was recorded in
the second quarter of 2001, of which $35 million related to staff reduction and
related costs and $5 million to real estate lease termination costs. The Company
had previously recorded a $10 million charge for a workforce realignment action
taken in the first quarter. In total, the Company has paid $11 million in
severance and related fringe benefit costs as of June 30, 2001 for both of these
actions. The remaining cash expenditures relating to the workforce reduction and
the lease terminations are expected to be substantially paid by the end of 2001.
The capital reprioritization discussed above resulted in certain
telecommunications assets being identified as excess or impaired. As a result,
the Company recorded a non-cash impairment charge of $61 million, representing
the excess of the carrying value over the fair value of these assets. The fair
value of the excess equipment was based on recent cash sales of similar
equipment. The impaired assets were written-off, as the Company does not expect
to utilize them to generate future cash flows.
4. Marketable Securities
At June 30, 2001 and December 31, 2000, marketable securities consisted of
the following:
June 30, December 31,
(dollars in millions) 2001 2000
---- ----
U.S. Treasury Securities ......................................................... $1,743 $2,538
Commercial Paper.................................................................. -- 204
----- -----
$1,743 $2,742
====== ======
5. Receivables
Receivables at June 30, 2001 and December 31, 2000 were as follows:
Information
(dollars in millions) Communications Services Coal Other Total
June 30, 2001
Accounts Receivable - Trade:
Services.................... $ 174 $ 23 $ 10 $ 1 $ 208
Dark Fiber.................. 50 -- -- -- 50
Joint Build Costs.................. 204 -- -- -- 204
Other Receivables.................. 56 -- -- -- 56
Allowance for Doubtful
Accounts................... (31) (3) -- -- (34)
----- ----- ----- ----- -----
$ 453 $ 20 $ 10 $ 1 $ 484
====== ===== ===== ===== ======
December 31, 2000
Accounts Receivable - Trade:
Services.................... $ 147 $ 26 $ 19 $ 1 $ 193
Dark Fiber.................. 161 -- -- -- 161
Joint Build Costs.................. 247 -- -- -- 247
Other Receivables.................. 49 -- -- -- 49
Allowance for Doubtful
Accounts................... (29) (4) -- -- (33)
----- ----- ----- ----- -----
$ 575 $ 22 $ 19 $ 1 $ 617
====== ===== ===== ===== ======
Joint build receivables primarily relate to costs incurred by the Company
for construction of network assets in which Level 3 is partnering with other
companies. Generally, under these types of agreements, the sponsoring partner
will initially incur all of the construction costs and subsequently bill the
other party as certain construction milestones are accomplished. Joint build
receivables at June 30, 2001 and December 31, 2000 include $72 million and $90
million, respectively, attributable to FLAG Telecom Limited for its share of the
costs of the Northern Asia submarine cable system.
6. Property, Plant and Equipment, net
Construction-in-Progress
The Company continues to construct its communications network. Costs
associated directly with the uncompleted network, including employee related
costs, are capitalized, and interest expense incurred during construction is
capitalized based on the weighted average accumulated construction expenditures
and the interest rates related to borrowings associated with the construction
(Note 9). Intercity segments, gateway facilities, local networks and operating
equipment that have been placed in service are being depreciated over their
estimated useful lives, primarily ranging from 3-25 years.
The Company continues to develop 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 a project, the total cost of the
business support system is amortized over a useful life of three years.
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.
Accumulated Book
(dollars in millions) Cost Depreciation Value
June 30, 2001
Land and Mineral Properties...................................... $ 222 $ (12) $ 210
Facility and Leasehold Improvements
Communications.............................................. 1,921 (95) 1,826
Information Services........................................ 25 (4) 21
Coal Mining................................................. 67 (64) 3
CPTC........................................................ 92 (13) 79
Network Infrastructure........................................... 4,923 (207) 4,716
Operating Equipment
Communications.............................................. 2,166 (809) 1,357
Information Services........................................ 61 (31) 30
Coal Mining................................................. 82 (73) 9
CPTC........................................................ 17 (10) 7
Network Construction Equipment................................... 121 (29) 92
Furniture, Fixtures and Office Equipment......................... 154 (60) 94
Construction-in-Progress......................................... 2,036 -- 2,036
----- ----- -----
$11,887 $ (1,407) $10,480
======= ======== =======
Accumulated Book
(dollars in millions) Cost Depreciation Value
December 31, 2000
Land and Mineral Properties...................................... $ 166 $ (11) $ 155
Facility and Leasehold Improvements
Communications.............................................. 1,384 (53) 1,331
Information Services........................................ 25 (4) 21
Coal Mining................................................. 68 (64) 4
CPTC........................................................ 92 (12) 80
Network Infrastructure........................................... 3,400 (43) 3,357
Operating Equipment
Communications.............................................. 1,584 (555) 1,029
Information Services........................................ 50 (26) 24
Coal Mining................................................. 93 (85) 8
CPTC........................................................ 17 (9) 8
Network Construction Equipment................................... 139 (27) 112
Furniture, Fixtures and Office Equipment......................... 150 (45) 105
Construction-in-Progress......................................... 3,149 -- 3,149
----- ----- -----
$10,317 $ (934) $ 9,383
======= ======= =======
It is the Company's policy to review the carrying amount of long lived
assets for impairment whenever events or changes in circumstances indicate the
carrying amount may not be recoverable. The determination of any impairment
includes a comparison of estimated undiscounted future operating cash flows
anticipated to be generated during the remaining useful life of the asset to the
net carrying value of the asset.
Due to the current economic conditions in the telecommunications industry
and previously discussed reductions in the Company's estimated short-term
revenue, the Company performed an impairment review in accordance with SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" to determine whether its telecommunications network
required any write down to fair value. No financial statement adjustments were
required as a result of the analysis. The Company will continue to monitor
expected cash flows from the telecommunications business and the carrying value
of its network to determine if future impairments are necessary.
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 bundled local
and long distance phone, cable television and Internet services to residential
markets primarily on the East and West coasts as well as Chicago. Commonwealth
Telephone holds Commonwealth Telephone Company, an incumbent local exchange
carrier operating in various rural Pennsylvania markets.
On June 30, 2001, Level 3 owned approximately 27% and 46% 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 RCN and Commonwealth Telephone was $146 million and $452 million,
respectively, on June 30, 2001.
During the fourth quarter of 2000, Level 3's proportionate share of RCN's
losses exceeded the remaining carrying value of Level 3's investment in RCN.
Level 3 does not have additional financial commitments to RCN; therefore it
recognized equity losses only to the extent of its investment in RCN. If RCN
becomes profitable, Level 3 will not record its equity in RCN's earnings until
unrecorded equity in losses have been offset. The Company's investment in RCN,
including goodwill, was zero at June 30, 2001 and December 31, 2000. The Company
did not recognize an estimated $197 million and $276 million of additional
equity losses attributable to RCN for the three and six months ended June 30,
2001, respectively, bringing the total amount of estimated suspended equity
losses to approximately $296 million at June 30, 2001.
The Company recognizes gains from the sale, issuance and repurchase of
stock by its equity method investees in its statements of operations. 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 $57 million and $95 million for
the Company for the three and six months ended June 30, 2000, respectively. The
Company does not expect to recognize future gains on RCN stock activity until
the Company recognizes suspended equity losses.
The following is summarized financial information of RCN for the three and
six months ended June 30, 2001 and 2000, and as of June 30, 2001 and December
31, 2000 (dollars in millions).
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
Operations:
RCN Corporation:
Revenue ........................................ $ 111 $ 79 $ 217 $ 150
Net loss available to common shareholders....... (677) (208) (935) (362)
Level 3's Share:
Net loss........................................ $ -- (63) $ -- (119)
Goodwill amortization........................... -- -- -- (1)
----- ----- ----- -----
$ -- $ (63) $ -- $(120)
===== ===== ===== =====
June 30, December 31,
2001 2000
---- ----
Financial Position:
Current Assets.................................................................. $ 1,244 $ 1,854
Other Assets ................................................................... 2,678 2,922
----- -----
Total assets............................................................... 3,922 4,776
Current Liabilities............................................................. 394 531
Other Liabilities............................................................... 2,366 2,284
Minority Interest............................................................... 61 75
Preferred Stock................................................................. 2,065 1,991
----- -----
Total liabilities and preferred stock...................................... 4,886 4,881
----- -----
Common equity......................................................... $ (964) $ (105)
======= =======
Level 3's Investment:
Equity in net assets....................................................... $ -- $ --
Goodwill................................................................... -- --
----- -----
$ -- $ --
======= =======
The Company's investment in Commonwealth Telephone, including goodwill, was
$107 million and $105 million at June 30, 2001 and December 31, 2000,
respectively.
The Company has made investments in certain public and private early stage
IP centric entities in connection with those entities agreeing to purchase
various services from the Company. The Company records these transactions as
investments and deferred revenue. The value of the investment and deferred
revenue is equal to the estimated fair value of the securities at the time of
the transaction or the value of the services to be provided, whichever is more
readily determinable. Level 3 closely monitors the success of these investees in
executing their business plans. For those companies that are publicly traded,
Level 3 also monitors current and historical market values of the investee as it
compares to the carrying value of the investment. The Company recorded a charge
of $9 million and $37 million during the three and six months ended June 30,
2001, respectively, for an other-than temporary decline in the value of such
investments which is included in Other, net on the consolidated condensed
statements of operations. If any of the privately held investments become
publicly-traded and meet the criteria for "available-for-sale" securities
pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," they will be accounted for accordingly. Otherwise, future
appreciation will be recognized only upon sale or other disposition of these
securities. After the $9 million charge recorded in the second quarter, the
carrying amount of the investments was zero. The carrying amount of the
investments was $37 million at December 31, 2000. The Company recognized revenue
of approximately $2 million and $10 million for services related to this program
for the three and six months ended June 30, 2001, respectively. The Company
recognized revenue of less than $1 million for services related to this program
for the three and six months ended June 30, 2000.
8. Other Assets, net
At June 30, 2001 and December 31, 2000 other assets consisted of the
following:
June 30, December 31,
(dollars in millions) 2001 2000
---- ----
Debt Issuance Costs, net................................................... $158 $161
Goodwill, net of accumulated amortization of $130 and $102................. 40 68
Deposits................................................................... 52 53
Prepaid Network Assets..................................................... 32 35
Deferred Network Costs..................................................... 37 --
Assets Held for Sale, net.................................................. 50 --
CPTC Deferred Development and Financing Costs.............................. 13 14
Other...................................................................... 19 14
----- -----
$401 $345
==== ====
Goodwill amortization expense, excluding amortization expense attributable
to equity method investees, was $6 million and $28 million for the three and six
months ended June 30, 2001. Goodwill amortization expense, excluding
amortization expense attributable to equity method investees, was $9 million and
$19 million for the three and six months ended June 30, 2000, respectively.
Assets held for sale include certain corporate facilities that the Company
has elected to dispose. The Company recorded an impairment charge in
depreciation expense of $35 million in the second quarter representing the
difference between the carrying value and market value of these facilities, as
determined by a commercial real estate broker. Also included in assets held for
sale is certain telecommunications equipment identified as excess due to the
Company's decision in June 2001 to reprioritize its capital expenditures.
9. Long-Term Debt
At June 30, 2001 and December 31, 2000, long-term debt was as follows:
June 30, December 31,
(dollars in millions) 2001 2000
---- ----
Senior Notes (9.125% due 2008).............................................. $2,000 $2,000
Senior Notes (11% due 2008)................................................. 800 800
Senior Discount Notes (10.5% due 2008)...................................... 651 619
Senior Euro Notes (10.75% due 2008)......................................... 422 465
Senior Discount Notes (12.875% due 2010).................................... 425 399
Senior Euro Notes (11.25% due 2010)......................................... 253 279
Senior Notes (11.25% due 2010).............................................. 250 250
Senior Secured Credit Facility:
Term Loan Facility:
Tranche A (6.77% due 2007)......................................... 450 200
Tranche B (7.77% due 2008)......................................... 275 275
Tranche C (7.75% due 2008)......................................... 400 --
Commercial Mortgage:
GMAC (6.46% due 2003)................................................... 120 120
Lehman (7.97% due 2001-2004)............................................ 113 113
Convertible Subordinated Notes (6.0% due 2010).............................. 863 863
Convertible Subordinated Notes (6.0% due 2009).............................. 823 823
CPTC Long-term Debt (with recourse only to CPTC):
(7.6%-9.5% due 2004 -2017).............................................. 115 115
Other ...................................................................... 8 4
----- -----
7,968 7,325
Less current portion........................................................ (9) (7)
----- -----
$7,959 $7,318
====== ======
Senior Secured Credit Facility
On January 8, 2001, the Company borrowed the remaining $250 million
available under the existing tranche A of the Senior Secured Credit Facility. On
March 22, 2001, Level 3 entered into an amendment to increase the borrowing
capacity under the Senior Secured Credit Facility by $400 million, to $1.775
billion. As part of the agreement, Level 3 borrowed $400 million under a new
tranche C of the term loan facility. The net proceeds will be used for
implementing the business plan, including the purchase of telecommunications
assets.
The equipment that is purchased with the proceeds of the term loan facility
secures all obligations under the term loan facility.
Amounts drawn under the new tranche C will bear interest, at the option of
the Company, at an alternate base rate or reserve-adjusted LIBOR plus applicable
margins. The new tranche C applicable margins are fixed at 300 basis points over
the alternate base rate and 400 basis points over LIBOR. Simultaneously with the
addition of tranche C, the applicable LIBOR margin for tranche B of the term
loan facility was increased by 25 basis points, to 375 basis points over LIBOR.
Interest on tranche C of the term loan facility will be payable based on the
interest rate option chosen by the Company.
Tranche C of the term loan facility amortizes in consecutive quarterly
payments beginning on June 30, 2004, commencing at $1 million per quarter and
increasing to $97 million per quarter in 2007, with the final installment due
January 30, 2008.
The Senior Secured Credit Facility contains certain covenants, which among
other things, limit additional indebtedness, dividend payments, certain
investments and transactions with affiliates. Level 3 and certain Level 3
subsidiaries must also comply with specific financial and operational tests and
maintain certain financial ratios. The Company believes it is in compliance with
all such covenants at June 30, 2001. In addition to the original Senior Secured
Credit Facility debt issuance costs, $14 million of debt issuance costs
associated with tranche C were capitalized and are amortized as interest expense
over the remaining term of the Senior Secured Credit Facility.
The Senior Secured Credit Facility also contains a $650 million senior
secured revolving credit facility. As of June 30, 2001, Level 3 had not borrowed
any funds under this revolving facility. The availability of funds is contingent
upon the continued compliance with the relevant debt covenants.
In an effort to reduce the risk of increased interest rates related to the
Lehman commercial mortgage, in January 2001 the Company entered into an interest
rate cap agreement. The interest rate cap notional amount is $113 million and
has a maturity date of January 31, 2004. The terms of the agreement provide that
the net interest expense related to the Lehman commercial mortgage will not
exceed 8% plus 400 basis points. The Company has elected not to account for this
transaction as a hedge as permitted by SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). Upon inception of the
agreement, the Company recorded an asset equal to the fair value of the interest
rate cap of less than $1 million. For the three and six months ended June 30,
2001, the Company recorded, in the statement of operations, less than $1 million
in losses related to the change in the fair value of the interest rate cap.
The Company capitalized $14 million and $57 million of interest expense and
amortized debt issuance costs related to network construction and business
systems development projects for the three and six month periods ending June 30,
2001, respectively. Capitalized interest for the three and six months ended June
30, 2000 was $90 million and $157 million, respectively.
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 in accordance with FASB Interpretation No. 28 "Accounting For Stock
Appreciation Rights and Other Variable Stock Option or Award Plans". 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 may not
be settled in cash, but rather, generally, are settled through issuance of
common stock.
The adoption of SFAS No. 123 has resulted in material non-cash charges to
operations since its adoption in 1998, and will continue to do so. 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. The Company recognized a total of $85 million and $162 million of
non-cash compensation for the three and six months ended June 30, 2001,
respectively. In addition, the Company capitalized $5 million and $9 million of
non-cash compensation for those employees directly involved in the construction
of the network or development of the business support systems for the three and
six months ended June 30, 2001, respectively.
The Company recognized a total of $49 million and $97 million of non-cash
compensation for the three and six months ended June 30, 2000, respectively. In
addition, the Company capitalized $2 million and $5 million of non-cash
compensation for those employees directly involved in the construction of the
network or development of the business support systems for the three and six
months ended June 30, 2000, respectively.
Non-Qualified Stock Options and Warrants
The Company granted warrants to purchase approximately 900,000 shares of
common stock to consultants in 2001 for services to be provided. These warrants
vest in equal quarterly installments over 33 months commencing in March 2001
with each portion expiring seven years from the vesting date. The exercise price
of these warrants is $29. The fair value determined pursuant to SFAS No. 123 for
these warrants at issuance was $14 million. The Company did not grant any
nonqualified stock options ("NQSO") to employees during the three and six months
ended June 30, 2001. The expense recognized for the three and six months ended
June 30, 2001 for NQSOs and warrants outstanding at June 30, 2001 in accordance
with SFAS No. 123 was $5 million and $11 million, respectively. In addition to
the expense recognized, the Company capitalized less than $1 million of non-cash
compensation costs for the three and six months ended June 30, 2001 related to
NQSOs and warrants for employees directly involved in the construction of the
network and the development of the business support systems. As of June 30,
2001, the Company had not reflected $16 million of unamortized compensation
expense in its financial statements for NQSOs and warrants previously granted.
The Company did not grant any NQSOs or warrants to employees during the six
months ended June 30, 2000. The Company recognized $1 million and $2 million of
expense for the three and six months ended June 30, 2000, respectively, for
NQSOs and warrants outstanding at June 30, 2000. In addition to the expense
recognized, the Company capitalized less than $1 million of non-cash
compensation costs for the three and six months ended June 30, 2000.
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 participants'
and stockholders' interests by basing stock option value on the Company's
ability to outperform the market in general, as measured by the Standard &
Poor's ("S&P") 500 Index. Participants in the OSO program do not realize any
value from awards unless Level 3's Common Stock 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 Level 3's common stock
outperforms the S&P 500 Index, the value of OSOs to a holder may exceed the
value of non-qualified stock options.
OSO awards are made quarterly to eligible participants on the date of the
grant. Each award vests in equal quarterly installments over two years and has a
four-year life. Awards granted prior to December 2000 typically have a two-year
moratorium on exercise from the date of grant. As a result, once a participant
is 100% vested in the grant, the two-year moratorium expires. Therefore, awards
granted prior to December 2000 have an exercise window of two years. Level 3
granted 3.1 million OSOs to employees in December 2000. Included in the grant
were 2.1 million OSOs that vest 25% after six months with the remaining 75%
vesting after 18 months. These OSOs and all additional OSOs granted after March
31, 2001 are exercisable immediately upon vesting and have a four-year life.
The fair value recognized under SFAS No. 123 for the approximately 6.9
million OSOs awarded to participants during the six months ended June 30, 2001
was approximately $161 million. The Company recognized $63 million and $115
million of compensation expense for the three and six months ended June 30,
2001, respectively, for OSOs granted since 1999. In addition to the expense
recognized, $3 million and $5 million of non-cash compensation was capitalized
for the three and six months ended June 30, 2001, respectively, for employees
directly involved in the construction of the network and development of business
support systems. As of June 30, 2001, the Company had not reflected $180 million
of unamortized compensation expense in its financial statements for OSOs granted
previously. The Company recognized $44 million and $87 million of expense for
the three and six months ended June 30, 2000, respectively, for
OSOs outstanding at June 30, 2000. In addition to the expense recognized, the
Company capitalized $2 million and $4 million of non-cash compensation for the
three and six months ended June 30, 2000, respectively.
In July 2000, the Company adopted a convertible outperform stock option
program, ("C-OSO") as an extension of the existing OSO plan. The program is a
component of the Company's ongoing employee retention efforts and offers the
same features of an OSO, but provides an employee with the greater of the value
of a single share of the Company's common stock at exercise, or the calculated
OSO value of a single OSO at the time of exercise.
C-OSO awards were made to eligible employees employed on the date of the
grant. The awards were made in September 2000 and December 2000. Each award
vests over three years as follows: 1/6 of each grant at the end of the first
year, a further 2/6 at the end of the second year and the remaining 3/6 in the
third year. Each award is immediately exercisable upon vesting. Awards expire
four years from the date of the grant.
The Company recognized $11 million and $26 million of compensation expense
for the three and six months ended June 30, 2001, respectively for C-OSOs
awarded in 2000. In addition to the expense recognized, $1 million and $2
million of non-cash compensation was capitalized for the three and six months
ended June 30, 2001, respectively for employees directly involved in the
construction of the network and development of business support systems. As of
June 30, 2001, the Company had not reflected $72 million of unamortized
compensation expense in its financial statements for C-OSOs awarded in 2000.
Shareworks and Restricted Stock
The Company recorded $6 million and $10 million of non-cash compensation
expense for the three and six months ended June 30, 2001, respectively, related
to the Shareworks and restricted stock programs. In addition to the expense
recognized, $1 million of non-cash compensation was capitalized for the three
and six months ended June 30, 2001 for employees directly involved in the
construction of the network and development of business support systems. The
non-cash compensation expense for the Shareworks and restricted stock programs
was $4 million and $8 million for the three and six months ended June 30, 2000,
respectively.
As of June 30, 2001, the Company had not reflected unamortized compensation
expense of $22 million for Shareworks and restricted stock granted in prior
years in its financial statements.
11. Industry and Segment Data
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information" defines operating segments as 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, information services, and coal mining. Other
primarily includes the California Private Transportation Company, L.P. ("CPTC"),
equity investments, and other corporate assets and overhead not attributable to
a specific segment.
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 impairments) 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 presented and is not recognized under Generally Accepted Accounting
Principles ("GAAP").
The information presented in the tables following includes information for
three and six months ended June 30, 2001 and 2000 for all income statement and
cash flow information presented, and as of June 30, 2001 and December 31, 2000
for all balance sheet information presented. Revenue and the related expenses
are attributed to foreign countries based on where services are provided.
Industry and geographic segment financial information follows. Certain
prior year information has been reclassified to conform to the 2001
presentation.
Information Coal
(dollars in millions) Communications Services Mining Other Total
Three Months Ended June 30, 2001
Revenue:
North America............... $ 277 $ 27 $ 21 $ 6 $ 331
Europe...................... 51 4 -- -- 55
Asia........................ 3 -- -- -- 3
----- ----- ----- ----- -----
$ 331 $ 31 $ 21 $ 6 $ 389
======= ======= ======= ======= ========
EBITDA:
North America............... $ (98) $ 3 $ 5 $ 1 $ (89)
Europe...................... (21) 1 -- -- (20)
Asia........................ (13) -- -- -- (13)
----- ----- ----- ----- -----
$ (132) $ 4 $ 5 $ 1 $ (122)
======= ======= ======= ======= ========
Capital Expenditures:
North America............... $ 713 $ 5 $ 1 $ -- $ 719
Europe...................... 45 -- -- -- 45
Asia........................ 8 -- -- -- 8
----- ----- ----- ----- -----
$ 766 $ 5 $ 1 $ -- $ 772
======== ====== ======= ====== ========
Depreciation and Amortization:
North America............... $ 257 $ 3 $ -- $ 1 $ 261
Europe...................... 62 1 -- -- 63
Asia........................ 5 -- -- -- 5
----- ----- ----- ----- -----
$ 324 $ 4 $ -- $ 1 $ 329
======== ======= ======= ======= ========
Industry and geographic segment financial information follows. Certain
prior year information has been reclassified to conform to the 2001
presentation.
Information Coal
(dollars in millions) Communications Services Mining Other Total
Six Months Ended June 30, 2001
Revenue:
North America............... $ 633 $ 56 $ 46 $ 12 $ 747
Europe...................... 79 8 87
Asia........................ 4 -- -- -- 4
----- ----- ----- ----- -----
$ 716 $ 64 $ 46 $ 12 $ 838
======== ======= ======= ======= ========
EBITDA:
North America............... $ (177) $ 4 $ 12 $ 4 $ (157)
Europe...................... (57) 1 -- -- (56)
Asia........................ (23) -- -- -- (23)
----- ----- ----- ----- -----
$ (257) $ 5 $ 12 $ 4 $ (236)
======== ======= ====== ======= ========
Capital Expenditures:
North America............... $ 1,700 $ 10 $ 3 $ -- $ 1,713
Europe...................... 151 -- -- -- 151
Asia........................ 88 -- -- -- 88
----- ----- ----- ----- -----
$ 1,939 $ 10 $ 3 $ -- $ 1,952
========= ======= ====== ===== =========
Depreciation and Amortization:
North America............... $ 446 $ 6 $ 1 $ 3 $ 456
Europe...................... 101 1 -- -- 102
Asia........................ 10 -- -- -- 10
----- ----- ----- ----- -----
$ 557 $ 7 $ 1 $ 3 $ 568
========= ======= ====== ======= =========
Three Months Ended June 30, 2000
Revenue:
North America............... $ 141 $ 24 $ 48 $ 5 $ 218
Europe...................... 12 4 -- -- 16
Asia........................ -- -- -- -- --
----- ----- ----- ----- -----
$ 153 $ 28 $ 48 $ 5 $ 234
========= ======= ======= ======= =========
EBITDA:
North America............... $ (106) $ 2 $ 21 $ (3) $ (86)
Europe...................... (26) 1 -- -- (25)
Asia........................ (9) -- -- -- (9)
----- ----- ----- ----- -----
$ (141) $ 3 $ 21 $ (3) $ (120)
======== ======= ======= ======= ==========
Capital Expenditures:
North America............... $ 1,248 $ 2 $ 4 $ -- $ 1,254
Europe...................... 468 -- -- -- 468
Asia........................ 30 -- -- -- 30
----- ----- ----- ----- -----
$ 1,746 $ 2 $ 4 $ -- $ 1,752
========= ======= ======= ======= =========
Depreciation and Amortization:
North America............... $ 114 $ 3 $ 2 $ -- $ 119
Europe...................... 19 1 -- -- 20
Asia........................ -- -- -- -- --
----- ----- ----- ----- -----
$ 133 $ 4 $ 2 $ -- $ 139
========= ======= ======= ======= =========
Information Coal
(dollars in millions) Communications Services Mining Other Total
Six Months Ended June 30, 2000
Revenue:
North America............... $ 225 $ 48 $ 96 $ 11 $ 380
Europe...................... 25 6 -- -- 31
Asia........................ -- -- -- -- --
----- ----- ----- ----- -----
$ 250 $ 54 $ 96 $ 11 $ 411
======== ======= ======= ======== ========
EBITDA:
North America............... $ (237) $ 3 $ 43 $ (1) $ (192)
Europe...................... (57) 1 -- -- (56)
Asia........................ (13) -- -- -- (13)
----- ----- ----- ----- -----
$ (307) $ 4 $ 43 $ (1) $ (261)
======== ======= ======= ======== ======
Capital Expenditures
North America............... $ 2,240 $ 3 $ 4 $ -- $ 2,247
Europe...................... 752 -- -- -- 752
Asia........................ 39 -- -- -- 39
----- ----- ----- ----- -----
$ 3,031 $ 3 $ 4 $ -- $ 3,038
========= ======= ======= ======= ========
Depreciation and Amortization:
North America............... $ 185 $ 6 $ 3 $ 2 $ 196
Europe...................... 30 1 -- -- 31
Asia........................ -- -- -- -- --
----- ----- ----- ----- -----
$ 215 $ 7 $ 3 $ 2 $ 227
========= ======= ======= ======== ========
Identifiable Assets
- ----------------------------------
June 30, 2001
North America............... $ 9,076 $ 71 $ 302 $ 3,161 $ 12,610
Europe...................... 1,814 8 -- 53 1,875
Asia........................ 383 -- -- 20 403
----- ----- ----- ----- -----
$ 11,273 $ 79 $ 302 $ 3,234 $ 14,888
========= ======= ======= ======== =========
December 31, 2000
North America............... $ 8,197 $ 78 $ 310 $ 4,009 $ 12,594
Europe...................... 1,877 9 -- 107 1,993
Asia........................ 304 -- -- 28 332
----- ----- ----- ----- -----
$ 10,378 $ 87 $ 310 $ 4,144 $ 14,919
========= ======= ======= ======== =========
Long-Lived Assets
- ----------------------------------
June 30, 2001
North America............... $ 8,479 $ 51 $ 16 $ 438 $ 8,984
Europe...................... 1,637 3 -- -- 1,640
Asia........................ 368 -- -- -- 368
----- ----- ----- ----- -----
$ 10,484 $ 54 $ 16 $ 438 $ 10,992
========= ======= ====== ======== =========
December 31, 2000
North America............... $ 7,640 $ 49 $ 15 $ 217 $ 7,921
Europe...................... 1,633 3 -- -- 1,636
Asia........................ 317 -- -- -- 317
----- ----- ----- ----- -----
$ 9,590 $ 52 $ 15 $ 217 $ 9,874
========= ======= ====== ======== =========
Product information for the Company's communications segment follows:
Reciprocal
(dollars in millions) Services Compensation Dark Fiber Total
Communications Revenue
- ------------------------------------------
Three Months Ended June 30, 2001
North America....................... $ 176 $ 40 $ 61 $ 277
Europe.............................. 51 -- -- 51
Asia................................ 3 -- -- 3
----- ----- ----- -----
$ 230 $ 40 $ 61 $ 331
======== ======= ======= ========
Six Months Ended June 30, 2001
North America....................... $ 339 $ 77 $ 216 $ 632
Europe.............................. 80 -- -- 80
Asia................................ 4 -- -- 4
----- ----- ----- -----
$ 423 $ 77 $ 216 $ 716
======== ======= ======= ========
Three Months Ended June 30, 2000
North America....................... $ 92 $ 14 $ 35 $ 141
Europe.............................. 12 -- -- 12
Asia................................ -- -- -- --
----- ----- ----- -----
$ 104 $ 14 $ 35 $ 153
======== ======= ======= ========
Six Months Ended June 30, 2000
North America....................... $ 167 $ 22 $ 36 $ 225
Europe.............................. 25 -- -- 25
Asia................................ -- -- -- --
----- ----- ----- -----
$ 192 $ 22 $ 36 $ 250
======== ======= ======= ========
The majority of North American revenue consists of services and products
delivered within the United States. The majority of European revenue consists of
services and products delivered within the United Kingdom.
The following information provides a reconciliation of EBITDA to loss from
continuing operations for the three and six months ended June 30, 2001 and 2000
(dollars in millions):
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
EBITDA ...................................... $ (122) $ (120) $ (236) $ (261)
Depreciation and Amortization Expense........ (329) (139) (568) (227)
Non-Cash Compensation Expense................ (85) (49) (162) (97)
Impairment Charges........................... (61) -- (61) --
----- ----- ----- -----
Loss from Operations.................... (597) (308) (1,027) (585)
Other Income (Expense)....................... (134) 16 (239) 13
Income Tax Benefit........................... -- 11 -- 20
----- ----- ----- -----
Net Loss..................................... $ (731) $ (281) $ (1,266) $ (552)
====== ====== ======== ======
12. Related Party Transactions
Peter Kiewit Sons', Inc. ("Kiewit") acted as the general contractor on
several significant projects for the Company in 2001 and 2000. These projects
include the U.S. intercity network, local loops and gateway sites, and the
Company's corporate headquarters in Colorado. Kiewit provided approximately $516
million and $972 million of construction services related to these projects in
the first six months of 2001 and 2000, respectively.
Level 3 also receives certain mine management services from Kiewit. The
expense for these services was $1 million and $3 million for the three and six
months ended June 30, 2001, respectively, and is recorded in selling, general
and administrative expenses. The expense for these services was $8 million and
$16 million for the three and six months ended June 30, 2000, respectively.
13. Other Matters
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 plaintiff's 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 the 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. 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 the ultimate outcome of this litigation,
management believes 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.
On January 18, 2001, Level 3 announced that in order to provide the Company
with additional flexibility in funding its business plan, it filed a "universal"
shelf registration statement with the Securities and Exchange Commission
relating to $3.0 billion of common stock, preferred stock, debt securities,
warrants, stock purchase agreements and depositary shares. The registration
statement, (declared effective by the Securities and Exchange Commission on
January 31, 2001), allows Level 3 to publicly offer these securities from time
to time at prices and terms to be determined at the time of the offering. When
combined with the remaining availability under its previously existing effective
universal shelf registration statement, the availability under the registration
statements allows Level 3 to offer an aggregate of up to $3.156 billion of
securities.
Level 3 intends to use the net proceeds of any offering of these securities
for working capital, capital expenditures, acquisitions, and other general
corporate purposes. Consistent with this approach, Level 3 may use the net
proceeds for additions or expansions to its currently funded business plan.
On January 9, 2001, the Company announced that it signed an agreement in
December 2000 to collaborate with FLAG Telecom on the development of the
Northern Asia submarine cable system connecting Hong Kong, Japan, Korea and
Taiwan. The system includes Level 3's previously announced eastern link
connecting Hong Kong, Taiwan and Japan and a new western link that FLAG Telecom
is constructing to connect Hong Kong, Korea and Japan. The Hong Kong to Japan
segment of the eastern link was placed in service during the second quarter of
2001. The Company expects the eastern link's Taiwan segment to follow in early
2002 and the entire western link to be ready for service in mid 2002. Level 3
and FLAG Telecom will each own three fiber pairs throughout the new system. The
total cost of the entire Northern Asia system is estimated to be approximately
$900 million. Level 3's share of the cost is approximately $450 million.
On April 26, 2001, the Company announced it has signed a new agreement with
XO Communications, Inc. ("XO"), that amends the companie' previously announced
dark fiber agreements. The original agreements between the companies included
the purchase of 24 fibers, an empty conduit and tag-along rights for additional
fibers in certain conduits of Level 3's North America network by XO for $700
million. At the date of the announcement, over 60 percent of this commitment had
been accepted and paid for. The previous agreements also provided that XO
purchase nine European fiber networks and a pan-European intercity fiber network
from Level 3 for $148 million, as well as transatlantic capacity for an
additional $15 million. The new agreement provides that XO and Level 3 have
canceled agreements relating to the purchase of the European metro and
inter-city fiber networks from Level 3. The related $128 million in payments
that have already been made to Level 3 have been applied as a reduction in the
remaining amounts payable by XO under its $700 million North American intercity
network commitment. Additionally, XO will purchase wavelength services from
Level 3. XO will transfer certain transmission equipment it has purchased to
Level 3, the value of which will be applied toward the purchase price of these
services. Furthermore, XO will purchase transatlantic capacity per the original
European agreement and give up certain previous contractual provisions including
the tag-along rights for additional fibers in the North American network.
14. Subsequent Events
On July 26, 2001, Level 3 announced that it had amended its Senior Secured
Credit Facility to permit the Company to acquire certain of its outstanding
indebtedness in exchange for shares of common stock. At the date of this
announcement, various issuances of Level 3's outstanding senior notes, senior
discount notes and convertible subordinated notes were trading at discounts to
their respective face or accreted amounts. Level 3 may exchange shares of Level
3 common stock for these outstanding debt securities in open market or privately
negotiated transactions. The amounts involved in any such transactions,
individually or in the aggregate, may be material.
On July 30, 2001, CPTC announced that it had completed the refinancing of
its development and construction debt. The $135 million financing proceeds were
used to repay CPTC's original lenders, repay subordinated debt carried by Orange
County Transportation Authority and cover refinancing expenses. The debt carries
an interest rate of 7.63% and requires principal payments in varying amounts
through 2028. The debt is the obligation of CPTC and is nonrecourse to Level 3
Communications, Inc.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARES
Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion should be read in conjunction with the Company's
consolidated condensed financial statements (including the notes thereto),
included elsewhere herein.
This document contains forward looking statements and information that are
based on the beliefs of management as well as assumptions made by and
information currently available to the Company. When used in this document, the
words "anticipate", "believe", "plans", "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 and factors, please see the Company's
additional filings with the Securities and Exchange Commission.
Recent Developments
Recent Accounting Developments
In June 1998, the Financial Accounting Standards Board, ("FASB"), SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"). SFAS No. 133, as amended by SFAS Nos. 137 and 138, is effective for
fiscal years beginning January 1, 2001. SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at 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 designated by the
transaction. The Company currently makes minimal use of derivative instruments
as defined by SFAS No. 133. Derivative instruments, as defined by SFAS No. 133,
held by the Company at June 30, 2001 include an interest rate cap with a market
value of less than $1 million. The Company did not designate the interest rate
cap as part of a hedge transaction. If the Company does not increase the
utilization of derivatives, the adoption of this standard is expected to have a
minimal effect on the Company's results of operations or its financial position.
Effective July 1, 1999, the FASB issued Interpretation No. 43, "Real Estate
Sales, an Interpretation of FASB Statement No. 66." Certain sale and long-term
indefeasible 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 FASB Interpretation results in the deferral of
revenue recognition for these agreements over the term of the agreement
(currently up to 20 years). This FASB Interpretation does not have an effect on
the Company's cash flows however, it results in substantial amounts of deferred
revenue being recorded on the balance sheet.
In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides
interpretive guidance on the recognition, presentation and disclosures of
revenue in the financial statements effective for all transactions on or after
January 1, 2000. The adoption of SAB 101 in 2000 did not have a material affect
on the Company's financial results.
On July 19, 2001, the Emerging Issues Task Force ("EITF") of the FASB
reached a consensus on Issue No. 00-11 "Meeting the Ownership Transfer
Requirements of FASB Statement No. 13 for Leases of Real Estate", ("EITF
00-11"). EITF 00-11 specifically addresses the transfer of ownership
requirements for leases involving integral equipment or property improvements
for which no formal title registration system exists and is effective for all
transactions occurring after July 19, 2001. The EITF stated in order to meet the
criteria for sales-type lease accounting, the lease agreement must obligate the
lessor to deliver to the lessee documents that convey ownership to the lessee by
the end of the lease term.
Telecommunications companies have historically applied sales-type lease
accounting to certain capacity contracts that, among other required criteria,
contained a provision that permitted the lessee the option to obtain ownership
to the rights of way and/or the integral equipment at the end of the lease term
in exchange for a nominal fee. Under EITF 00-11, the lessee must obtain title or
its equivalent to the asset if sales-type lease accounting is to be used.
Currently, Level 3 is treating certain transoceanic capacity agreements that
meet the accounting requirements as sales-type leases but does not believe the
issuance of EITF 00-11 will have a significant impact on its future operating
results or financial condition.
Accounting practice and guidance with respect to the accounting treatment
of the above transactions is evolving. Any changes in the accounting treatment
could affect the manner in which the Company accounts for revenue and expenses
associated with these agreements in the future.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" ("SFAS
No. 141"). SFAS No. 141 requires all business combinations initiated after June
30, 2001, to be accounted for using the purchase method of accounting. Prior to
the issuance of SFAS No. 141, companies had the flexibility to account for some
mergers and acquisitions as pooling of interests. Level 3 has generally
accounted for acquisitions using the purchase method and does not believe the
issuance of SFAS No. 141 will have a material impact on the Company's future
results of operations or financial position.
In June 2001, the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"). SFAS No. 142 is effective for fiscal years
beginning January 1, 2002. SFAS No. 142 requires companies to segregate
identifiable intangible assets acquired in a business combination from goodwill.
The remaining goodwill is no longer subject to amortization over its estimated
useful life. However, the fair value of the goodwill must be assessed at least
annually for impairment using a fair value based test. Goodwill attributable to
equity method investments will also no longer by amortized but is still subject
to impairment analysis using existing guidance for equity method investments.
The Company estimates that under previous accounting standards, amortization
expense in 2002 would be approximately $25 million. The Company has not
segregated the identifiable intangible assets from goodwill but does not believe
the adoption of SFAS No. 142 will have a material impact on the Company's
results of operations or its financial position.
On April 26, 2001, the Company announced it has signed a new agreement with
XO Communications, Inc. ("XO"), that amends the companies' previously announced
dark fiber agreements. The original agreements between the companies included
the purchase of 24 fibers, an empty conduit and tag-along rights for additional
fibers in certain conduits of Level 3's North America network by XO for $700
million. At the date of the announcement, over 60 percent of this commitment had
been accepted and paid for. The previous agreements also provided that XO
purchase nine European fiber networks and a pan-European intercity fiber network
from Level 3 for $148 million, as well as transatlantic capacity for an
additional $15 million. The new agreement provides that XO and Level 3 have
canceled agreements relating to the purchase of the European metro and
inter-city fiber networks from Level 3. The related $128 million in payments
that have already been made to Level 3 have been applied as a reduction in the
remaining amounts payable by XO under its $700 million North American intercity
network commitment. Additionally, XO will purchase wavelength services from
Level 3. XO will transfer certain transmission equipment it has purchased to
Level 3, the value of which will be applied toward the purchase price of these
services. Furthermore, XO will purchase transatlantic capacity per the original
European agreement and give up certain previous contractual provisions including
the tag-along rights for additional fibers in the North American network.
Results of Operations 2001 vs. 2000
Revenue for the respective periods ended June 30, is summarized as follows (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
Communications........................... $331 $153 $716 $250
Information Services..................... 31 28 64 54
Coal Mining.............................. 21 48 46 96
Other ................................... 6 5 12 11
----- ----- ----- -----
$389 $234 $838 $411
==== ==== ==== ====
Communications revenue for the three months ended June 30, 2001 increased
116% compared to the same period in 2000. Included in total communications
revenue of $331 million, was $230 million of services revenue and $61 million of
non-recurring revenue from dark fiber contracts entered into before June 30,
1999. Also, included in total communications revenue for the quarter was $40
million attributable to reciprocal compensation. Communications revenue for the
second quarter of 2000 was comprised of $104 million of service revenue, $35
million of dark fiber revenue and $14 million of reciprocal compensation. The
increase in service revenue from 2000 was due to growth in both existing
customers as well as new customer contracts. Due to the current economic
conditions of the telecommunications industry, the Company has recently
experienced a significant increase in the numbers of customers terminating
service in 2001. These terminations will result in slower growth of service
revenue for the remainder of the year. The increase in dark fiber revenue is
attributable to the completion of several segments of the Company's intercity
network during the second quarter of 2001. Dark fiber revenue is expected to
decline beginning in the third quarter, as the majority of the Company's
intercity network is now complete and dark fiber on the intercity segments has
been delivered to customers. The increase in reciprocal compensation in the
second quarter of 2001 is a result of the Company receiving regulatory approval
from several states regarding its agreements with SBC Communications and Bell
South. These agreements established a rate structure for transmission and
switching services provided by one carrier to complete or carry traffic
originating on another carrier's network. It is the Company's policy not to
recognize revenue from these agreements until the relevant regulatory
authorities approve the agreements.
Communications revenue increased during the first six months of 2001 by
186% compared to the same period in 2000. Included in total communications
revenue of $716 million for the six months ended June 30, 2001 was $423 million
of service revenue, $216 million of non-recurring revenue from dark fiber
contracts entered into before June 30, 1999 and $77 million attributable to
reciprocal compensation. Communications revenue for the six months ended June
30, 2000 was comprised of $192 million of services revenue, $36 million of dark
fiber revenue and $22 million of reciprocal compensation.
Information services revenue, which is comprised of applications and
outsourcing businesses, increased from $28 million in the quarter ended June 30,
2000 to $31 million for the respective period in 2001, and from $54 million in
the six months ended June 30, 2000 to $64 million for the same period in 2001.
These increases are primarily attributable to outsourcing revenue which
increased to $21 million for the second quarter of 2001 from $15 million for the
same period in 2000 and $42 million for the six months ended June 30, 2001
compared to $29 million for the same period in 2000. The increases in
outsourcing revenue for the respective periods are primarily due to new
long-term contracts signed in the last half of 2000.
The communications business generated Cash Revenue of $642 million during
the three months ended June 30, 2001. The Company defines Cash Revenue as
communications revenue plus changes in cash deferred revenue during the
respective period. Communications Cash Revenue reflects up front cash received
for
dark fiber and other capacity sales that are recognized over the term of the
contract under GAAP. Cash deferred revenue for the communications business for
the second quarter increased $179 million compared to the same period in 2000.
This increase is a result of growth in services provided to existing customers
and new customer contracts and cash collections from those customers.
Communications Cash Revenue was $285 million for the three months ended June 30,
2000. Cash Revenue is not intended to represent revenue under GAAP.
Cash Revenue for the six months ended June 30, 2001 was $1.299 billion, an
increase from $412 million for the same period in 2000. This increase can be
attributed to the growth in both services provided to existing customers as well
as new customer contracts, and cash collections from those customers.
Coal mining revenue decreased $27 million in the second quarter of 2001
compared to the same period in 2000. Coal mining revenue for the first six
months of 2001 was $46 million compared to $96 million for the same period in
2000. These decreases in revenue are primarily attributable to the expiration of
long-term coal contracts with Commonwealth Edison, the sale of the Company's
interest in Walnut Creek Mining Company in September 2000 and the deferral of
certain 2001 coal customer purchase commitments to the latter half of the year.
Other revenue for the three and six months ended June 30, 2001 was
comparable to the respective periods in 2000 and is primarily attributable to
California Private Transportation Company, L.P. ("CPTC") the owner-operator of
the SR91 tollroad in southern California.
Cost of Revenue for the second quarter 2001 was $211 million, representing
a 37% increase over second quarter 2000 cost of revenue of $154 million. This
increase is a result of the expanding communications business. Overall the cost
of revenue for the communications business, as a percentage of revenue,
decreased significantly from 75% during the quarter ended June 30, 2000 to 53%
during the same period of 2001. The cost of revenue for the six months ended
June 30, 2001 was $479 million, an increase from $284 million for the same
period in 2000. Cost of revenue for the six months ended June 30, 2001 for the
communications business, as a percentage of revenue, was 56% as compared to 83%
during the same period of 2000. The decreases for both periods can be attributed
to the migration of customer traffic from a leased network to the Company's own
operational network.
The cost of revenue for the information services businesses, as a
percentage of its revenue, was 71% for the second quarter of 2001, and 77% for
the six months ended June 30, 2001 and approximates the figures for the
respective periods in 2000. The cost of revenue for the coal mining business, as
a percentage of revenue, was 71% for the second quarter of 2001 up from 38% for
the same period in 2000. Cost of revenue for the coal mining business, as a
percentage of revenue, was 67% for the six months ended June 30, 2001 as
compared to 39% for the same period in 2000. The increases related to coal are
attributable to the expiration of high margin long-term coal contracts in 2000.
Depreciation and Amortization expenses for the quarter were $329 million, a
137% increase from the second quarter 2000 depreciation and amortization
expenses of $139 million. Depreciation and amortization expenses for the six
months ended June 30, 2001 were $568 million, a 150% increase from $227 million
for the respective period in 2000. Included in depreciation expense for the
three and six months ended June 30, 2001 is $35 million for the impairment
charge on the corporate facility the Company has elected to dispose. The
remaining increases are a direct result of the communications assets placed in
service in the latter half of 2000 and during the six months ended June 30,
2001, including gateways, local networks and intercity segments.
Selling, General and Administrative expenses were $345 million in the three
months ended June 30, 2001, a 39% increase over the second quarter 2000. This
increase is primarily a result of the Company's additional employees hired since
the end of second quarter 2000. Compensation costs, excluding non-cash
compensation, increased 23% due to the additional employees. The Company also
recorded $85 million in non-cash compensation for the second quarter 2001 for
expenses recognized under SFAS No. 123 related
to grants of stock options, warrants and other stock based compensation
programs. The Company recorded $49 million of non-cash compensation for the same
period in 2000. The increase in non-cash compensation is predominantly due to an
increase in the number of employees and the C-OSOs granted in September and
December of 2000. Costs attributable to the communications business such as
rent, property taxes, software and hardware maintenance and bad debt expense
also contributed to the higher selling, general and administrative expenses.
Partially offsetting these additional costs were declines in travel, advertising
and mine management expenses. Selling, general and administrative costs for the
remainder of 2001 are expected to remain consistent or decline slightly from
second quarter 2001 levels due to the reduction in force.
Selling, general and administrative expenses were $707 million in the six
months ended June 30, 2001, a 46% increase over the respective period of 2000.
This increase is primarily attributable to the factors identified above.
Increases in cash and non-cash compensation, facility related expenses and bad
debt expenses were partially offset by declines in travel expenses and mine
management fees.
Restructuring Charges of $40 million were recorded in the second quarter of
2001. The Company announced that due to the duration and severity of the
economic slowdown for the telecommunications industry, it was reducing its
revenue and EBITDA forecasts for 2001 and 2002. In conjunction with this revised
revenue outlook, the Company also announced that it would be necessary to reduce
operating expenses in an effort to be in a position to benefit when the economy
recovers. As a result of this action, the Company is reducing its global work
force by approximately 1,400 employees, primarily in the communications
business. The restructuring charge is comprised of $35 million for staff
reduction costs and $5 million for real estate lease termination costs. The
Company had previously recorded a $10 million charge for a workforce realignment
action taken in the first quarter. In total, the Company has paid $11 million in
severance and fringe benefit costs as of June 30, 2001 for both of these
actions. The remaining cash expenditures relating to the workforce reduction and
the lease terminations are expected to be substantially paid by the end of 2001.
Impairments of $61 million were recorded in the three month period ending
June 30, 2001. As part of the restructuring announcement, the Company also
announced that it was reducing and reprioritizing capital expenditures. The
capital reprioritization resulted in certain telecommunications assets being
identified as excess or impaired. As a result, the Company recorded a non-cash
impairment charge of $61 million representing the excess of the carrying value
over the fair value of these assets. The value of the excess equipment was based
on recent cash sales of similar equipment. The impaired assets were written-off,
as the Company does not expect to utilize them to generate future cash flows.
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 impairment 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
declined to a loss of $122 million in the second quarter of 2001 from a $120
million loss for the same period in 2000. EBITDA for the six months ended June
30, 2001 was a loss of $236 million as compared to $261 million loss for the
same period in 2000. Excluding the two restructuring charges recorded in the
first and second quarter of 2001, EBITDA would have been losses of $82 million
and $186 million for the three and six months ended June 30, 2001, respectively.
These improvements were predominantly due to the higher margins earned by the
communications business.
Adjusted EBITDA, as defined by the Company, is EBITDA as defined above plus
the change in cash deferred revenue and excluding the non-cash cost of goods
sold associated with certain capacity sales and dark fiber contracts. For the
quarter ended June 30, 2001, Adjusted EBITDA was $238 million compared to $29
million for the same period in 2000. For the six months ended June 30, 2001,
Adjusted EBITDA was $478 million compared to loss of $82 million for the same
period in 2000. These increases can be attributed to increases in cash deferred
revenue and increased pre-June 30, 1999 dark fiber revenue recognized in 2001.
EBITDA and Adjusted EBITDA are not intended to represent operating cash
flow for the periods indicated and are not GAAP. See Consolidated Statement of
Cash Flows.
Interest Income was $47 million for the second quarter of 2001 and $104
million for the second quarter of 2000. The decrease is primarily attributable
to the average cash and marketable securities balance declining from $7.1
billion during the three month period ending June 30, 2000 to $3.6 billion for
the three month period ended June 30, 2001. In February 2000, the Company raised
approximately $5.5 billion in cash through debt and equity offerings. The
Company has subsequently utilized these proceeds to fund its business plan. In
addition, the weighted average interest rate on the portfolio decreased by
approximately 60 basis points for the three months ended June 30, 2001 from the
same period in 2000. Interest income for the six months ending June 30, 2001 and
2000 was $106 million and $168 million, respectively. The decrease is again
attributable to a decline in the average portfolio balance and an approximately
10 basis point decline in the weighted average interest rate earned on the
portfolio. Pending utilization of the cash, cash equivalents and marketable
securities, the Company invests the funds primarily in government and government
agency securities. The 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 Company's business plan.
Interest Expense, net increased by $93 million to $174 million in the
second quarter of 2001 compared to the respective period in 2000. Interest
expense increased due to the commercial mortgages entered into the latter half
of 2000 and the additional credit facility draws in the first quarter of 2001.
The amortization of the related debt issuance costs also contributed to the
increased interest expense in 2001. Additionally, the increase can be attributed
to a decrease in the amount of interest capitalized in the second quarter of
2001 as compared to the same period in 2000. The Company completed a significant
portion of the network by the end of 2000, therefore reducing the amount of
interest capitalization. Capitalized interest was $14 million in the second
quarter of 2001 and $90 million in the second quarter of 2000.
Interest expense, net for the first six months of 2001 was $312 million as
compared to $131 million for the same period in 2000. In addition to the
explanations provided above, interest expense increased in the six months ended
June 30, 2001 as compared to the respective period in 2000 due to the debt
offerings completed in late February 2000. Capitalized interest was $57 million
in the six months ended June 30, 2001 and $157 million for the same period in
2000.
Equity in Earnings (Losses) of Unconsolidated Subsidiaries was $4 million
in the second quarter of 2001, compared to loss of ($61) million for the same
period in 2000. The equity losses in 2000 are predominantly attributable to RCN
Corporation, Inc. ("RCN"). RCN is a facilities-based provider of communications
services to the residential markets primarily on the East and West coasts as
well as in Chicago and the largest regional Internet service provider in the
Northeast. RCN is incurring significant costs in developing its business plan.
The Company's proportionate share of RCN's losses exceeded the remaining
carrying value of Level 3's investment in RCN during the fourth quarter of 2000.
Level 3 does not have additional financial commitments to RCN; therefore it only
recognizes equity losses equal to its investment in RCN. The Company will not
record any equity in RCN's future profits, if any, until unrecorded equity
losses have been offset. The Company, as of June 30, 2001, had unrecorded equity
losses attributable to RCN of $296 million. Since RCN did not become profitable
in the second quarter of 2001, the Company did not record any previously
unrecorded losses attributable to RCN. Additionally, the Company recorded $4
million and $2 million of equity earnings for the three month periods ended June
30, 2001 and 2000, respectively, related to the investment in Commonwealth
Telephone Enterprises, Inc.
Equity in earnings of Commonwealth was $2 million for the six months ended
June 30, 2001. Equity losses and earnings attributable to RCN and Commonwealth
during the six months ended June 30, 2000, were losses of ($120) million and
earnings of $4 million, respectively.
Gain on Equity Investee Stock Transactions was $57 million and $95 million
for the three and six months ended June 30, 2000, respectively. Specifically,
RCN issued stock for certain transactions, which diluted the Company's ownership
interest. The pre-tax gains resulted from the increase in the Company's
proportionate share of RCN's net assets related to these transactions. The
Company did not record any gains on equity investee stock transactions during
2001 due to the suspended equity losses attributable to RCN.
Other, net decreased to a $11 million loss in the second quarter of 2001
from a $3 million loss in the same period of 2000 and from a loss of $3 million
for the six month period ended June 30, 2000 to a loss of $37 million the same
period in 2001. These declines are primarily attributable to the other-than
temporary changes in the value of investments of $9 million and $37 million
recorded in the three and six month periods ended June 30, 2001, respectively.
Additionally, the Company recorded a loss of $15 million in the first quarter of
2001 related to losses on certain asset disposals. These losses were partially
offset by $14 million of realized gains from the sale of marketable securities
denominated in foreign currency.
Income Tax Benefit for the first and second quarter of 2001 was zero as a
result of the Company exhausting the taxable income in the carryback period in
2000, and that it is unable to determine when the tax benefits attributable to
the net operating losses will be realizable. The tax benefit for 2000 differs
from the statutory rate due to the limited availability of taxable income in the
carryback period for which current year losses can be offset. In 2000, Level 3
recognized a portion of the expected annual benefit equal to the ratio of
pre-tax loss for the period to the total estimated loss for the year.
Financial Condition -- June 30, 2001
The Company's working capital decreased from $3.1 billion at December 31,
2000 to $2.0 billion at June 30, 2001 due primarily to the use of available
funds in payment of selling, general and administrative expenses, interest
expense and construction of the Level 3 network. Proceeds from the Senior
Secured Credit Facility borrowings increased working capital.
Cash provided by operations decreased from $467 million in the six months
ended June 30, 2000 to $402 million in the same period of 2001. Excluding income
tax refunds of $43 million in 2001 and $245 million in 2000, cash flows from
operations actually increased from $222 million in 2000 to $359 million in 2001.
An increase in revenue and deferred revenue and fluctuations in components of
working capital, particularly accounts receivable, are primarily responsible for
the increase in cash flow from operations.
Investing activities include using the proceeds from the first quarter
Senior Secured Credit Facility draws and cash on hand to purchase $1.1 billion
of marketable securities and complete approximately $2.0 billion of capital
expenditures, primarily for the communications network. The Company also
realized $2.1 billion of proceeds from the sales and maturities of marketable
securities and $17 million of proceeds from the sale of construction equipment.
Financing sources in 2001 consisted primarily of the net proceeds of $636
million from the first quarter 2001 Senior Secured Credit Facility draws. The
Company also repaid long-term debt of $3 million during the six months ended
June 30, 2001 primarily attributable to capitalized leases and non-recourse debt
at CPTC.
Liquidity and Capital Resources
The Company is 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.
The Company has created, through a combination of construction, purchase and
leasing of facilities and other assets, an advanced, international, end-to-end,
facilities-based communications network. The Company has designed its network
based on Internet Protocol technology in order to leverage the efficiencies of
this technology to provide lower cost communications services.
The continued development of the communications business will require
significant expenditures. These expenditures may result in substantial negative
operating cash flow and substantial net operating losses for the Company for the
foreseeable future. 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 its business plan were approximately $2.0
billion during the first half of 2001. 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 transoceanic cable network. Through June 30,
2001, the total cost of the Level 3 network by region, including intercity and
metropolitan networks, optronic and other transmission equipment, transmission
facilities including gateway facilities and the regions allocated portion of
undersea cables was $8.8 billion for North America, $1.7 billion for Europe and
$0.4 billion for Asia. Total capital expenditures for 2001 are expected to be
approximately $3.0 billion. The cash and marketable securities already on hand
and the undrawn commitments of $650 million at June 30, 2001 under the expanded
Senior Secured Credit Facility, provided Level 3 with approximately $3.8 billion
of funds available at the end of the second quarter 2001. The Company's current
liquidity, cash flows from committed contracts for communications services and
dark fiber IRUs and anticipated future cash flows from operations should be
sufficient to fund the currently committed portions of the business plan through
early 2004.
The Company currently estimates that the implementation of the business
plan from its inception through free cash flow breakeven will require
approximately $13 billion to $14 billion on a cumulative basis. The Company also
currently estimates that its operations will reach free cash flow breakeven in
early 2004. The Company's successful debt and equity offerings have given the
Company the ability to implement the committed portions of the business plan.
However, if additional opportunities should present themselves, the Company may
be required to secure additional financing in the future. In order to pursue
these possible opportunities and provide additional flexibility to fund its
business plan, in January 2001 the Company filed a "universal" shelf
registration statement for an additional $3 billion of common stock, preferred
stock, debt securities, warrants, stock purchase agreements and depositary
shares. This shelf filing, in combination with the remaining availability under
a previously existing universal shelf registration statement, will allow Level 3
to offer an aggregate of up to $3.156 billion of additional securities to fund
its business plan.
In addition to raising capital through the debt and equity markets, the
Company may sell or dispose of existing businesses or investments to fund
portions of the business plan. The Company may also 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 values. 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 material adverse effect on the implementation of the business plan.
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 business and if a suitable buyer can be found, the Company may
dispose of that business.
On July 26, 2001, Level 3 announced that it had amended its Senior Secured
Credit Facility to permit the Company to acquire certain of its outstanding
indebtedness in exchange for shares of common stock. At the date of this
announcement, various issuances of Level 3's outstanding senior notes, senior
discount notes and convertible subordinated notes were trading at discounts to
their respective face or accreted amounts. In order to reduce future cash
interest payments, as well as future amounts due at maturity, Level 3 may
exchange shares of Level 3 common stock for these outstanding debt securities in
open market or privately negotiated transactions. The amounts involved in any
such transactions, individually or in the aggregate, may be material and could
result in significant non-operating income to the Company.
Market Risk
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, the additional $400 million added
to the Senior Secured Credit Facility during the first quarter of 2001 and the
commercial mortgages entered into in 2000. As of June 30, 2001, the Company had
borrowed $1.125 billion under the Senior Secured Credit Facility and $233
million under the commercial mortgages. Amounts drawn on the debt instruments
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 credit facility and mortgages. The
weighted average interest rate based on outstanding amounts under these variable
rate instruments of $1.358 billion at June 30, 2001, was approximately 7.3%. A
hypothetical increase in the variable portion of the weighted average rate by 1%
(i.e. a weighted average rate of 8.3%), would increase annual interest expense
of the Company by approximately $14 million. In an effort to reduce the risk of
increased interest rates related to the Lehman commercial mortgage, in January
2001 the Company entered into an interest rate cap agreement. The terms of the
agreement provide that the net interest expense related to the Lehman commercial
mortgage will not exceed 8% plus the original spread. The agreement therefore
caps the LIBOR portion of the interest rate at 8%. At June 30, 2001, the Company
had $6.5 billion of fixed rate debt bearing interest ranging from 6% to 12.875%.
A decline in interest rates in the future will not benefit the Company due to
the terms and conditions of the loan agreements require the Company to
repurchase the debt at specified premiums. The Company may reduce is exposure to
interest rate risk by, as outlined above, acquiring certain outstanding
indebtedness in exchange for shares of common stock. The Company continues to
evaluate other 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 was
approximately $598 million at June 30, 2001, which is significantly higher than
their carrying value of $107 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
$120 million decrease in fair value of these investments. The Company does not
currently utilize financial instruments to minimize its exposure to price
fluctuations in equity securities.
The Company's business plan includes developing and constructing networks
in Europe and Asia. As of June 30, 2001, the Company had invested significant
amounts of capital in both regions and will continue to expand its presence in
Europe and Asia throughout 2001. The Company issued 800 million in Senior Euro
Notes in February 2000 as an economic hedge against its net investment in its
European subsidiaries. Due to the historically low exchange rates involving the
U.S. Dollar and the Euro during the fourth quarter of 2000, Level 3 elected to
set aside, and continues to hold, the remaining Euros received from the debt
offerings and purchase on the spot market the Euros required to fund its current
European investing and operating activities. Other than the issuance of the Euro
denominated debt and the purchase of the Euros on the spot market, the Company
has not made significant use of financial instruments to minimize its exposure
to foreign currency fluctuations. The Company continues to analyze risk
management strategies to reduce foreign currency exchange risk.
The change in interest rates and equity security prices is based on
hypothetical movements and are 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.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders held on May 23, 2001 the following
matters were submitted to a vote:
1. To reelect the five Class I Directors to the Board of Directors of Level
3 for a three-year term until the 2004 Annual Meeting of Stockholders:
In Favor Withheld
Walter Scott, Jr. 297,326,681 559,556
James Q. Crowe 295,264,543 2,621,694
Charles C. Miller, III 293,628,586 4,259,651
Mogens C. Bay 297,390,160 496,077
Colin V.K. Williams 293,189,004 4,697,233
2. In their discretion, the proxies are authorized to vote upon such other
business as may properly come before the meeting or any adjournments or
postponements thereof:
Affirmative votes: 278,441,343
Negative votes: 11,896,944
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed as part of this report are listed below.
Exhibit
Number
3 Amended and Restate By-laws.
(b) On April 18, 2001, the Company filed a Current Report on Form 8-K
related to financial results for the three months ended March 31, 2001 and
revised financial projections.
On June 18, 2001, the Company filed a Current Report on Form 8-K related to
revised financial projections and disclosing an open letter to stockholders from
James Q. Crowe, Level 3's Chief Executive Officer, addressing Level 3 stock
transactions of certain executives of the Company.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEVEL 3 COMMUNICATIONS, INC.
Dated: August 10, 2001 \s\ Eric J. Mortensen
Eric J. Mortensen
Vice President, Controller
and Principal Accounting Officer