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 September 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 November 2, 2001:
Common Stock 382,934,153 shares
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
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 26
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K 37
Signatures 38
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Operations
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
(dollars in millions, except per share data) 2001 2000 2001 2000
Revenue......................................................... $ 375 $ 341 $1,213 $ 752
Costs and Expenses:
Cost of revenue............................................ 150 199 629 483
Depreciation and amortization.............................. 314 164 882 391
Selling, general and administrative........................ 331 298 1,038 783
Restructuring and impairment charges....................... - - 111 -
---- ---- ----- -----
Total Costs and Expenses........................................ 795 661 2,660 1,657
---- ---- ----- -----
Loss from Operations............................................ (420) (320) (1,447) (905)
Other Income (Expense):
Interest income............................................ 34 87 142 255
Interest expense, net...................................... (183) (64) (495) (195)
Equity in earnings (losses) of
unconsolidated subsidiaries, net........................ 5 (70) 7 (186)
Gain on equity investee stock transactions................. - - - 95
Other, net................................................. 33 6 (4) 3
---- ---- ---- ----
Total Other Expense............................................. (111) (41) (350) (28)
---- ---- ---- ----
Loss Before Income Taxes........................................ (531) (361) 1,797) (933)
Income Tax Benefit.............................................. - 10 - 30
---- ---- ---- ----
Net Loss Before Extraordinary Items............................. (531) (351) (1,797) (903)
Extraordinary Gain on Debt Extinguishments, net................. 94 - 94 -
---- ---- ---- ----
Net Loss........................................................ $ (437) $ (351) $ (1,703) $(903)
====== ====== ======== =====
Loss Per Share (Basic and Diluted):
Net Loss Before Extraordinary Items....................... $ (1.42) $(0.96) $ (4.85) $(2.50)
Extraordinary Gain on Debt Extinguishments, net........... .25 - .25 -
---- ---- ---- ----
Net Loss.................................................. $ (1.17) $(0.96) $ (4.60) $(2.50)
======= ====== ======= ======
Total Number of Weighted Average Shares
Outstanding Used to Compute Basic and
Diluted Loss Per Share (in thousands)...................... 375,638 366,788 370,582 360,956
======= ======= ======= =======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(unaudited)
September 30, December 31,
(dollars in millions, except per share data) 2001 2000
Assets
Current Assets:
Cash and cash equivalents..................................................... $ 1,491 $ 1,265
Marketable securities......................................................... 1,077 2,742
Restricted securities......................................................... 152 219
Receivables, less allowances for doubtful accounts
of $34 and $33, respectively.............................................. 326 617
Other......................................................................... 102 202
------ ------
Total Current Assets............................................................... 3,148 5,045
Net Property, Plant and Equipment.................................................. 10,604 9,383
Other Assets, net.................................................................. 499 491
------ ------
$ 14,251 $ 14,919
======== ========
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(unaudited)
September 30, December 31,
(dollars in millions, except per share data) 2001 2000
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable............................................................. $ 972 $ 1,486
Current portion of long-term debt............................................ 7 7
Accrued payroll and employee benefits........................................ 131 90
Accrued interest............................................................. 95 124
Deferred revenue............................................................. 170 68
Restructuring liability...................................................... 17 -
Other........................................................................ 179 147
---- ----
Total Current Liabilities......................................................... 1,571 1,922
Long-Term Debt, less current portion.............................................. 7,910 7,318
Deferred Revenue.................................................................. 1,167 652
Accrued Reclamation Costs......................................................... 95 94
Other Liabilities................................................................. 385 384
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:
382,861,734 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................................................... 5,479 5,167
Accumulated other comprehensive loss......................................... (108) (73)
Accumulated deficit.......................................................... (2,252) (549)
------ ------
Total Stockholders' Equity........................................................ 3,123 4,549
------ ------
$ 14,251 $ 14,919
======== ========
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended
September 30,
(dollars in millions) 2001 2000
Cash Flows from Operating Activities:
Net Loss.................................................................................. $(1,703) $ (903)
Adjustments to reconcile net loss to net cash provided by operating activities:
Equity (earnings) losses, net........................................................... (7) 186
Depreciation and amortization........................................................... 882 391
Dark fiber and other noncash cost of revenue............................................ 152 59
Amortization of debt issuance costs..................................................... 21 16
Gain on sale of assets.................................................................. (12) (21)
Compensation expense attributable to stock awards....................................... 244 158
Extraordinary gain on debt extinguishments, net......................................... (94) -
Impairments............................................................................. 61 -
Writedown of investments................................................................ 37 17
Gain on equity investee stock transactions.............................................. - (95)
Federal income tax refunds.............................................................. 72 245
Deferred revenue 581 403
Deposits................................................................................ 60 (91)
Accrued interest on marketable securities............................................... 22 53
Accrued interest on long-term debt...................................................... 60 47
Changes in working capital items:
Receivables........................................................................... 287 (234)
Other assets.......................................................................... 7 (99)
Payables (502) 290
Other liabilities..................................................................... 65 37
Other (84) 53
---- ----
Net Cash Provided by Operating Activities.................................................... 149 512
Cash Flows from Investing Activities:
Proceeds from sales and maturities of marketable securities............................. 2,769 5,882
Purchases of marketable securities...................................................... (1,112) (7,482)
Decrease in restricted securities....................................................... 63 3
Capital expenditures.................................................................... (2,322) (4,450)
Proceeds from sale of property, plant and equipment and other assets.................... 47 67
Investments............................................................................. - (28)
---- ----
Net Cash Used in Investing Activities........................................................ (555) (6,008)
Cash Flows from Financing Activities:
Long-term debt borrowings, net of issuance costs........................................ 761 3,088
Payments on long-term debt, including current portion................................... (116) (18)
Issuances of common stock, net of issuance costs........................................ - 2,407
Other................................................................................... 21 14
---- ----
Net Cash Provided by Financing Activities.................................................... 666 5,491
Effect of Exchange Rates on Cash and Cash Equivalents........................................ (34) (42)
---- ----
Net Change in Cash and Cash Equivalents...................................................... 226 (47)
Cash and Cash Equivalents at Beginning of Period............................................. 1,265 1,214
----- -----
Cash and Cash Equivalents at End of Period................................................... $ 1,491 $ 1,167
======= =======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity
For the nine months ended September 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.................. - 243 - - 243
Shareworks plan grants............. - 6 - - 6
Debt extinguishment................ - 61 - - 61
Net Loss................................ - - - (1,703) (1,703)
Other Comprehensive Loss................ - - (35) - (35)
---- ---- ---- ---- ----
Balances at September 30, 2001.......... $ 4 $ 5,479 $ (108) $ (2,252) $ 3,123
==== ======== ======= ======== ========
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Loss
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
(dollars in millions) 2001 2000 2001 2000
Net Loss...................................................... $ (437) $ (351) $(1,703) $ (903)
Other Comprehensive Loss Before Tax:
Foreign currency translation gains (losses).............. 37 (21) (34) (68)
Unrealized holding losses arising during
period............................................... (3) (25) (1) (28)
Reclassification adjustment for gains included
in net loss.......................................... - - - -
---- ---- ---- ----
Other Comprehensive Gain (Loss) Before Tax.................... 34 (46) (35) (96)
Income Tax Benefit Related to Items of Other
Comprehensive Loss....................................... - - - -
---- ---- ---- ----
Other Comprehensive Gain (Loss) Net of Taxes.................. 34 (46) (35) (96)
---- ---- ---- ----
Comprehensive Loss............................................ $ (403) $ (397) $(1,738) $ (999)
====== ====== ======= ======
See accompanying notes to consolidated condensed financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
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 unaudited 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.
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 the Company 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 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 issued 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 existing 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 Company 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.
In June 2001, the FASB also issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 establishes accounting standards for
recognition and measurement of a liability for an asset retirement obligation
and the associated asset retirement cost. The fair value of a liability for an
asset retirement obligation is to be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
retirement costs are capitalized and included as part of the carrying value of
the long-lived asset and amortized over the useful life of the asset. SFAS No.
143 will be effective for the Company beginning on January 1, 2003. The Company
is currently evaluating the impact, if any, of SFAS No. 143 on its results of
operations and financial position.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Disposal
or Impairment of Long-Lived Assets" ("SFAS No. 144), which is effective for the
Company on January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, but retains
its requirements to (a) recognize an impairment loss only if the carrying amount
of a long-lived asset is not recoverable from its undiscounted cash flows and
(b) measure an impairment loss as the difference between the carrying amount and
fair value of the asset. It removes goodwill from its scope and, therefore,
eliminates the requirement to allocate goodwill to long-lived assets to be
tested for impairment. It also describes a probability-weighted cash flow
estimation approach to deal with situations in which alternative courses of
action to recover the carrying amount of a long-lived asset are under
consideration or a range is estimated for possible future cash flows. It
requires that a long-lived asset to be abandoned, exchanged for a similar
productive asset, or distributed to owners in a spin-off be considered held and
used until it is disposed of. In these situations, SFAS No. 144 requires that an
impairment loss be recognized at the date a long-lived asset is exchanged for a
similar productive asset or distributed to owners in a spin-off if the carrying
amount of the asset exceeds its fair value. The Company continues to monitor and
review long-lived assets for possible impairment in accordance with SFAS No.
121. Since SFAS No. 144 retains similar requirements for recognizing and
measuring any impairment loss, the fact that the Company will adopt SFAS No. 144
effective January 1, 2002, is not expected to have a significant effect on the
Company's procedures for monitoring and reviewing long-lived assets for possible
impairment.
The results of operations for the three and nine months ended September 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 nine month periods ended September 30, 2001 and 2000. Therefore, the
dilutive impact of the approximate 17 million shares attributable to the
Company's convertible subordinated notes, and the approximate 41 million options
and warrants outstanding at September 30, 2001 and approximate 19 million shares
attributable to the Company's convertible subordinated notes and approximate 22
million options and warrants outstanding at September 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 has reduced 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 $33 million in
severance and related fringe benefit costs as of September 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,
in the second quarter of 2001 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 September 30, 2001 and December 31, 2000, marketable securities
consisted of the following:
September 30, December 31,
(dollars in millions) 2001 2000
U.S. Treasury Securities ........................................................ $1,077 $2,538
Commercial Paper................................................................. - 204
---- ----
$1,077 $2,742
====== ======
5. Receivables
Receivables at September 30, 2001 and December 31, 2000 were as follows:
Information
(dollars in millions) Communications Services Coal Other Total
September 30, 2001
Accounts Receivable - Trade:
Services.................... $ 196 $ 22 $ 11 $ 1 $ 230
Dark Fiber.................. 46 - - - 46
Joint Build Costs.................. 59 - - - 59
Other Receivables.................. 25 - - - 25
Allowance for Doubtful
Accounts................... (31) (3) - - (34)
---- ---- ---- ---- ----
$ 295 $ 19 $ 11 $ 1 $ 326
====== ===== ===== ===== ======
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 September 30, 2001 and December 31, 2000 include $3 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 has substantially completed the construction of 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 8). 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
September 30, 2001
Land and Mineral Properties...................................... $ 304 $ (13) $ 291
Facility and Leasehold Improvements
Communications.............................................. 2,308 (135) 2,173
Information Services........................................ 25 (5) 20
Coal Mining................................................. 65 (62) 3
CPTC........................................................ 92 (13) 79
Network Infrastructure........................................... 5,314 (276) 5,038
Operating Equipment
Communications.............................................. 2,436 (953) 1,483
Information Services........................................ 70 (37) 33
Coal Mining................................................. 81 (72) 9
CPTC........................................................ 18 (11) 7
Network Construction Equipment................................... 93 (27) 66
Furniture, Fixtures and Office Equipment......................... 149 (63) 86
Construction-in-Progress......................................... 1,316 - 1,316
----- ---- -----
$12,271 $ (1,667) $10,604
======= ======== =======
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. During the three and nine months ended
September 30, 2001, the Company recorded $20 million of impairments in
depreciation expense for transatlantic submarine assets that were considered
impaired under this criteria.
As required by SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of", the Company continues to
monitor and review long-lived assets for possible impairment as events or
changes in circumstances indicate that the carrying amount of the long-lived
assets may not be recoverable. To the extent events or circumstances indicate
that the carrying amount of long-lived assets may not be recoverable, and an
impairment charge is deemed necessary, the impact on the Company's results of
operations or its financial position could be material.
7. Other Assets, net
At September 30, 2001 and December 31, 2000 other assets consisted of the
following:
September 30, December 31,
(dollars in millions) 2001 2000
Debt Issuance Costs, net.................................................... $151 $161
Investments................................................................. 118 146
Goodwill, net of accumulated amortization of $136 and $102................. 34 68
Deposits.................................................................... 12 53
Prepaid Network Assets...................................................... 59 35
Deferred Network Costs...................................................... 37 -
Assets Held for Sale, net................................................... 48 -
Notes Receivable - Employees................................................ 9 -
CPTC Deferred Development and Financing Costs............................... 20 14
Other....................................................................... 11 14
---- ----
$499 $491
==== ====
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 September 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 $85 million and $394 million,
respectively, on September 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 September 30, 2001 and December 31, 2000. The
Company did not recognize an estimated $31 million and $307 million of
additional equity losses attributable to RCN for the three and nine months ended
September 30, 2001, respectively, bringing the total amount of estimated
suspended equity losses to approximately $327 million at September 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 $95 million for the Company for
the nine months ended September 30, 2000. 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
nine months ended September 30, 2001 and 2000, and as of September 30, 2001 and
December 31, 2000 (dollars in millions).
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
Operations:
RCN Corporation:
Revenue ........................................ $ 116 $ 88 $ 333 $ 238
Net loss available to common shareholders....... (112) (234) (1,046) (595)
Level 3's Share:
Net loss........................................ $ - (70) $ - (189)
Goodwill amortization........................... - - - (1)
---- ---- ---- ----
$ - $ (70) $ - $ (190)
==== ===== ==== ======
September 30, December 31,
2001 2000
Financial Position:
Current Assets.................................................................. $1,243 $1,854
Other Assets................................................................... 2,663 2,922
----- -----
Total assets............................................................... 3,906 4,776
Current Liabilities............................................................. 290 531
Other Liabilities............................................................... 2,513 2,284
Minority Interest............................................................... 55 75
Preferred Stock................................................................. 2,103 1,991
----- -----
Total liabilities and preferred stock...................................... 4,961 4,881
----- -----
Common equity......................................................... $ (1,055) $ (105)
========= ==========
Level 3's Investment:
Equity in net assets....................................................... $ - $ -
Goodwill................................................................... - -
---- ----
$ - $ -
==== ====
The Company's investment in Commonwealth Telephone, including goodwill, was
$112 million and $105 million at September 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 $37 million during the first six months of 2001, 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. Future appreciation will be
recognized only upon sale or other disposition of these securities. The carrying
amount of the investments was $37 million at December 31, 2000.
In August, 2001, the Company and divine, Inc., entered into an agreement
whereby divine would repurchase shares of common stock issued to Level 3 and
absolve Level 3 of any further obligations with respect to the deferred revenue
recorded at the time of the original transaction for services to be provided to
divine in the future. As a result, Level 3 recorded a $27 million gain in Other,
net on the consolidated condensed statement of operations in the third quarter
of 2001. The Company recognized revenue of
approximately $3 million and $11 million for actual services provided to
other entities involved in the program for the three and nine months ended
September 30, 2001, respectively. The Company recognized revenue of less than $1
million for services related to this program for the three and nine months ended
September 30, 2000. As of September 30, 2001, the Company had deferred revenue
obligations of $10 million with respect to these transactions.
Goodwill amortization expense, excluding amortization expense attributable
to equity method investees, was $6 million and $34 million for the three and
nine months ended September 30, 2001. Goodwill amortization expense, excluding
amortization expense attributable to equity method investees, was $23 million
and $42 million for the three and nine months ended September 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 $10 million for the three months ended September 30,
2001 and $45 million for the nine months ended September 30, 2001, representing
the difference between the carrying value and adjusted 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.
8. Long-Term Debt
At September 30, 2001 and December 31, 2000, long-term debt was as follows:
September 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)..................................... 668 619
Senior Euro Notes (10.75% due 2008)........................................ 456 465
Senior Discount Notes (12.875% due 2010)................................... 439 399
Senior Euro Notes (11.25% due 2010)........................................ 273 279
Senior Notes (11.25% due 2010)............................................. 250 250
Senior Secured Credit Facility:
Term Loan Facility:
Tranche A (6.33% due 2007)........................................ 450 200
Tranche B (7.73% due 2008)........................................ 275 275
Tranche C (6.66% due 2008)........................................ 400 -
Commercial Mortgage:
GMAC (6.15% due 2003).................................................. 120 120
Lehman (7.19% due 2001-2004)........................................... 112 113
Convertible Subordinated Notes (6.0% due 2010)............................. 824 863
Convertible Subordinated Notes (6.0% due 2009)............................. 693 823
CPTC Long-term Debt (with recourse only to CPTC):
(7.63% due 2004-2028).................................................. 140 115
Other...................................................................... 17 4
---- ----
7,917 7,325
Less current portion....................................................... (7) (7)
---- ----
$7,910 $7,318
====== ======
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. Various issuances of Level
3's outstanding senior notes, senior discount notes and convertible subordinated
notes have been trading at discounts to their respective face or accreted
amounts. Level 3 may exchange shares of its common stock for these outstanding
debt securities in open market or privately negotiated transactions.
The Company purchased $130 million of its 6% Convertible Subordinated Notes
due in 2009 and $39 million of its 6% Convertible Subordinated Notes due in 2010
during the three month period ending September 30, 2001. The Company issued
approximately 14.3 million shares of its common stock worth approximately $61
million in exchange for the debt. The net gain on the extinguishment of the
debt, including transaction costs and unamortized debt issuance costs, was $103
million and is classified as an extraordinary item in the consolidated condensed
statement of operations. Level 3 will continue to evaluate these transactions in
the future. The amounts involved in any such transactions, individually or in
the aggregate, may be material.
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 September 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 September 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 nine months ended September
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 $1 million and $58 million of interest expense and
amortized debt issuance costs related to network construction and business
systems development projects for the three and nine month periods ending
September 30, 2001, respectively. Capitalized interest for the three and nine
months ended September 30, 2000 was $106 million and $263 million, respectively.
In July, 2001, California Private Transportation Company, L.P. ("CPTC")
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 and prepayment costs. The prepayment costs of $9 million are
reflected as an extraordinary item on the condensed statement of operations. 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.
9. 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 $82 million and $244 million of
non-cash compensation for the three and six months ended September 30, 2001,
respectively. In addition, the Company capitalized $4 million and $13 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
nine months ended September 30, 2001, respectively.
The Company recognized a total of $61 million and $158 million of non-cash
compensation for the three and nine months ended September 30, 2000,
respectively. In addition, the Company capitalized $3 million and $8 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
nine months ended September 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 nine
months ended September 30, 2001. The expense recognized for the three and nine
months ended September 30, 2001 for NQSOs and warrants outstanding at September
30, 2001 in accordance with SFAS No. 123 was $4 million and $15 million,
respectively. In addition to the expense recognized, the Company capitalized
less than $1 million of non-cash compensation costs for the three and nine
months ended September 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 September 30, 2001, the Company had not
reflected $9 million of unamortized compensation expense in its financial
statements for NQSOs and warrants previously granted.
The Company recognized $6 million and $8 million of expense for the three
and nine months ended September 30, 2000, respectively, for NQSOs and warrants
outstanding at September 30, 2000. In addition to the expense recognized, the
Company capitalized less than $1 million of non-cash compensation costs for the
three and nine months ended September 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 out
performs the S&P 500 Index. To the extent that Level 3's common stock out
performs 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
1, 2001 are exercisable immediately upon vesting and have a four-year life.
The fair value recognized under SFAS No. 123 for the approximately 11.5
million OSOs awarded to participants during the nine months ended September 30,
2001 was approximately $190 million. The Company recognized $58 million and $174
million of compensation expense for the three and nine months ended September
30, 2001, respectively, for OSOs granted since 1999. In addition to the expense
recognized, $2 million and $8 million of non-cash compensation was capitalized
for the three and nine months ended September 30, 2001, respectively, for
employees directly involved in the construction of the network and development
of business support systems. As of September 30, 2001, the Company had not
reflected $141 million of unamortized compensation expense in its financial
statements for OSOs granted previously. The Company recognized $46 million and
$133 million of expense for the three and nine months ended September 30, 2000,
respectively, for OSOs outstanding at September 30, 2000. In addition to the
expense recognized, the Company capitalized $2 million and $6 million of
non-cash compensation for the three and nine months ended September 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, December 2000 and September 2001.
The awards granted in 2000 vest 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. The September 2001 award vests in equal
quarterly installments over three years. Each award is immediately exercisable
upon vesting. Awards expire four years from the date of the grant.
The fair value recognized under SFAS No. 123 for the approximately 4.8
million C-OSOs awarded to participants during the nine months ended September
30, 2001 was approximately $36 million. The Company recognized $15 million and
$41 million of compensation expense for the three and nine months ended
September 30, 2001, respectively for C-OSOs awarded. In addition to the expense
recognized, $1 million and $3 million of non-cash compensation was capitalized
for the three and nine months ended September 30, 2001, respectively for
employees directly involved in the construction of the network and development
of business support systems. As of September 30, 2001, the Company had not
reflected $90 million of unamortized compensation expense in its financial
statements for C-OSOs awarded.
The Company recognized $4 million of noncash expense for the three and nine
months ended September 30, 2000 for C-OSOs outstanding at September 30, 2000. In
addition to the expense recognized, the Company capitalized less than $1 million
of compensation for the three and nine months ended September 30, 2000.
Shareworks and Restricted Stock
The Company recorded $5 million and $14 million of non-cash compensation
expense for the three and nine months ended September 30, 2001, respectively,
related to the Shareworks and restricted stock programs. In addition to the
expense recognized, $1 million and $2 million of non-cash compensation was
capitalized for the three and nine months ended September 30, 2001,
respectively, 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 $5 million and $13 million
for the three and nine months ended September 30, 2000, respectively. The
Company also capitalized $1 million and $2 million of noncash compensation for
the same three and nine month periods in 2000.
As of September 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.
10. 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 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 nine months ended September 30, 2001 and 2000 for all income statement
and cash flow information presented, and as of September 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 September 30, 2001
Revenue:
North America............... $ 278 $ 28 $ 20 $ 6 $ 332
Europe...................... 38 2 - - 40
Asia........................ 3 - - - 3
---- ---- ---- ---- ----
$ 319 $ 30 $ 20 $ 6 $ 375
======== ======= ======= ======= =========
EBITDA:
North America............... $ (6) $ 3 $ 5 $ (2) $ -
Europe...................... (13) 1 - - (12)
Asia........................ (12) - - - (12)
---- ---- ---- ---- ----
$ (31) $ 4 $ 5 $ (2) $ (24)
======== ====== ====== ======= =========
Capital Expenditures:
North America............... $ 283 $ 3 $ 1 $ 1 $ 288
Europe...................... 6 - - - 6
Asia........................ 76 - - - 76
---- ---- ---- ---- ----
$ 365 $ 3 $ 1 $ 1 $ 370
======== ====== ====== ======= =========
Depreciation and Amortization:
North America............... $ 245 $ 3 $ 1 $ 1 $ 250
Europe...................... 58 - - - 58
Asia........................ 6 - - - 6
---- ---- ---- ---- ----
$ 309 $ 3 $ 1 $ 1 $ 314
======== ====== ====== ======= =========
Nine Months Ended September 30, 2001
Revenue:
North America............... $ 910 $ 84 $ 66 $ 18 $ 1,078
Europe...................... 118 10 - - 128
Asia........................ 7 - - - 7
---- ---- ---- ---- ----
$ 1,035 $ 94 $ 66 $ 18 $ 1,213
======== ====== ======= ======= ========
EBITDA:
North America............... $ (183) $ 7 $ 17 $ 2 $ (157)
Europe...................... (70) 2 - - (68)
Asia........................ (35) - - - (35)
---- ---- ---- ---- ----
$ (288) $ 9 $ 17 $ 2 $ (260)
======== ====== ======= ======== ========
Capital Expenditures:
North America............... $ 1,983 $ 13 $ 4 $ 1 $ 2,001
Europe...................... 157 - - - 157
Asia........................ 164 - - - 164
---- ---- ---- ---- ----
$ 2,304 $ 13 $ 4 $ 1 $ 2,322
======== ======= ======= ======= =========
Depreciation and Amortization:
North America............... $ 691 $ 9 $ 2 $ 4 $ 706
Europe...................... 159 1 - - 160
Asia........................ 16 - - - 16
---- ---- ---- ---- ----
$ 866 $ 10 $ 2 $ 4 $ 882
======== ======= ======= ======= =========
Information Coal
(dollars in millions) Communications Services Mining Other Total
Three Months Ended September 30, 2000
Revenue:
North America............... $ 238 $ 27 $ 50 $ 6 $ 321
Europe...................... 17 3 - - 20
Asia........................ - - - - -
---- ---- ---- ---- ----
$ 255 $ 30 $ 50 $ 6 $ 341
======== ======= ======= ======= ========
EBITDA:
North America............... $ (84) $ 3 $ 22 $ 6 $ (53)
Europe...................... (32) 1 - - (31)
Asia........................ (11) - - - (11)
---- ---- ---- ---- ----
$ (127) $ 4 $ 22 $ 6 $ (95)
======== ======= ======= ======= ========
Capital Expenditures:
North America............... $ 1,145 $ 4 $ - $ - $ 1,149
Europe...................... 182 1 - - 183
Asia........................ 80 - - - 80
---- ---- ---- ---- ----
$ 1,407 $ 5 $ - $ - $ 1,412
========= ======= ===== ==== ========
Depreciation and Amortization:
North America............... $ 131 $ 8 $ 1 $ 3 $ 143
Europe...................... 21 - - - 21
Asia........................ - - - - -
---- ---- ---- ---- ----
$ 152 $ 8 $ 1 $ 3 $ 164
======== ======= ======= ====== ========
Nine Months Ended September 30, 2000
Revenue:
North America............... $ 463 $ 75 $ 146 $ 17 $ 701
Europe...................... 42 9 - - 51
Asia........................ - - - - -
---- ---- ---- ---- ----
$ 505 $ 84 $ 146 $ 17 $ 752
======== ======= ======= ======= ========
EBITDA:
North America............... $ (321) $ 6 $ 65 $ 5 $ (245)
Europe...................... (89) 2 - - (87)
Asia........................ (24) - - - (24)
---- ---- ---- ---- ----
$ (434) $ 8 $ 65 $ 5 $ (356)
======== ======= ====== ====== ========
Capital Expenditures
North America............... $ 3,383 $ 7 $ 4 $ - $ 3,394
Europe...................... 936 1 - - 937
Asia........................ 119 - - - 119
---- ---- ---- ---- ----
$ 4,438 $ 8 $ 4 $ - $ 4,450
========= ======= ======= ===== =========
Depreciation and Amortization:
North America............... $ 316 $ 14 $ 4 $ 5 $ 339
Europe...................... 51 1 - - 52
Asia........................ - - - - -
---- ---- ---- ---- ----
$ 367 $ 15 $ 4 $ 5 $ 391
======== ======= ======= ====== =========
Information Coal
(dollars in millions) Communications Services Mining Other Total
Identifiable Assets
- ---------------------------------
September 30, 2001
North America............... $ 8,972 $ 79 $ 327 $ 2,548 $ 11,926
Europe...................... 1,832 7 - 35 1,874
Asia........................ 383 - - 68 451
---- ---- ---- ---- ----
$ 11,187 $ 86 $ 327 $ 2,651 $ 14,251
========= ====== ======= ======== =========
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
- --------------------------------
September 30, 2001
North America............... $ 8,469 $ 52 $ 17 $ 447 $ 8,985
Europe...................... 1,709 2 - - 1,711
Asia........................ 407 - - - 407
---- ---- ---- ---- ----
$ 10,585 $ 54 $ 17 $ 447 $ 11,103
======== ===== ====== ======= ========
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 September 30, 2001
North America.......................... $ 192 $ 26 $ 60 $ 278
Europe................................. 38 - - 38
Asia................................... 3 - - 3
---- ---- ---- ----
$ 233 $ 26 $ 60 $ 319
======== ======= ======= ========
Nine Months Ended September 30, 2001
North America.......................... $ 531 $ 103 $ 276 $ 910
Europe................................. 118 - - 118
Asia................................... 7 - - 7
---- ---- ---- ----
$ 656 $ 103 $ 276 $ 1,035
======== ======= ======= ========
Three Months Ended September 30, 2000
North America.......................... $ 118 $ 18 $ 101 $ 237
Europe................................. 18 - - 18
Asia................................... - - - -
---- ---- ---- ----
$ 136 $ 18 $ 101 $ 255
======== ======= ======= ========
Nine Months Ended September 30, 2000
North America.......................... $ 285 $ 40 $ 137 $ 462
Europe................................. 43 - - 43
Asia................................... - - - -
---- ---- ---- ----
$ 328 $ 40 $ 137 $ 505
======== ======= ======= ========
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 nine months ended September 30, 2001 and
2000 (dollars in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
EBITDA . $ (24) $ (95) $ (260) $ (356)
Depreciation and Amortization Expense........ (314) (164) (882) (391)
Non-Cash Compensation Expense................ (82) (61) (244) (158)
Impairment Charges........................... - - (61) -
---- ---- ---- ----
Loss from Operations...................... (420) (320) (1,447) (905)
Other Income (Expense)....................... (111) (41) (350) (28)
Income Tax Benefit........................... - 10 - 30
Extraordinary Gain on Debt
Extinguishments, net...................... 94 - 94 -
---- ---- ---- ----
Net Loss..................................... $ (437) $ (351) $(1,703) $ (903)
======== ====== ======= =======
11. 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 $662
million and $1,322 million of construction services related to these projects in
the first nine 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 $4 million for the three and nine
months ended September 30, 2001, respectively, and is recorded in selling,
general and administrative expenses. The expense for these services was $8
million and $24 million for the three and nine months ended September 30, 2000,
respectively.
In September 2000, the Company sold its entire interest in Walnut Creek
Mining Company to Kiewit for $37 million. The sale resulted in a pre-tax gain of
$22 million to the Company.
12. 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.
13. Subsequent Events
On September 10, 2001, the Company announced that its first tier, wholly
owned subsidiary, Level 3 Finance, LLC was commencing a "Modified Dutch Auction"
tender offer for a portion of the Company's senior debt and convertible debt
securities. Under the "Modified Dutch Auction" procedures, Level 3 Finance
accepted tendered notes in each offer in the order of the lowest to the highest
tender prices specified by the tendering holders within the applicable price
range for the applicable series of notes (see table below.) The tender offer for
each series of notes expired on October 22, 2001.
On October 23, 2001, Level 3 announced that Level 3 Finance had purchased
Company debt with a face value of approximately $1.7 billion, plus accrued
interest, if applicable, for a total purchase price of approximately $731
million. The net gain on the extinguishment of the debt, including transaction
costs and unamortized debt issuance costs, is estimated to be approximately $935
million and will be recorded as an extraordinary item in the fourth quarter of
2001.
Maximum Purchase Actual Actual
Principal Price Principal Weighted
Amount at Range per Amount Average
Maturity Sought $1,000 Repurchased Purchase
($ millions) Principal ($millions) Price/$1,000
Senior Notes (9.125%)........................... $ 725 $350 - $450 $ 570 $450
Senior Notes (11%).............................. 450 380 - 480 359 480
Senior Discount Notes (10.5%)................... 125 210 - 250 125 210
Senior Euro Notes (10.75%)...................... 267 370 - 440 136 440
Senior Discount Notes (12.875%)................. 100 150 - 180 100 150
Senior Euro Notes (11.25%)...................... 178 370 - 440 173 440
Senior Notes (11.25%)........................... 150 370 - 460 121 460
Convertible Subordinated Notes (due 2010)....... 325 190 - 220 71 220
Convertible Subordinated Notes (due 2009)....... 525 190 - 220 80 220
---- ----
$ 2,845 $ 1,735
======= =======
Assumes 1Euro = .89 USD
On October 25, 2001, the Company announced that due to the continued
economic uncertainty, it was implementing certain additional cost management
initiatives, specifically targeting general and administrative expenses, and
continuing its efforts to further reduce capital expenditures and network
expenses. The Company expects to reduce its global work force by approximately
750 additional employees, primarily during the fourth quarter of 2001 through a
combination of work force reductions and attrition. Level 3 expects to record a
significant charge in the fourth quarter associated with the work force
reduction. These actions are intended to bring expenses and capital expenditures
in line with existing revenue levels.
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"), issued
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 September 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. The adoption
of SFAS No. 133 has not had a material 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 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.
In June 2001, the FASB also approved SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 establishes accounting standards for
recognition and measurement of a liability for an asset retirement obligation
and the associated asset retirement cost. The fair value of a liability for an
asset retirement obligation is to be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
retirement costs are capitalized and included as part of the carrying value of
the long-lived asset and amortized over the useful life of the asset. SFAS No.
143 will be effective for the Company beginning on January 1, 2003. The Company
is currently evaluating the impact, if any, of SFAS No. 143 on its results of
operations and financial position.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Disposal
or Impairment of Long-Lived Assets" ("SFAS No. 144"), which is effective for the
Company on January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, but retains
its requirements to (a) recognize an impairment loss only if the carrying amount
of a long-lived asset is not recoverable from its undiscounted cash flows and
(b) measure an impairment loss as the difference between the carrying amount and
fair value of the asset. It removes goodwill from its scope and, therefore,
eliminates the requirement to allocate goodwill to long-lived assets to be
tested for impairment. It also describes a probability-weighted cash flow
estimation approach to deal with situations in which alternative courses of
action to recover the carrying amount of a long-lived asset are under
consideration or a range is estimated for possible future cash flows. It
requires that a long-lived asset to be abandoned, exchanged for a similar
productive asset, or distributed to owners in a spin-off be considered held and
used until it is disposed of. In these situations, SFAS No. 144 requires that an
impairment loss be recognized at the date a long-lived asset is exchanged for a
similar productive asset or distributed to owners in a spin-off if the carrying
amount of the asset exceeds its fair value. The Company continues to monitor and
review long-lived assets for possible impairment in accordance with SFAS No.
121. Since SFAS No. 144 retains similar requirements for recognizing and
measuring any impairment loss, the fact that the Company will adopt SFAS No. 144
effective January 1, 2002, is not expected to have a significant effect on the
Company's procedures for monitoring and reviewing long-lived assets for possible
impairment.
Results of Operations 2001 vs. 2000
Revenue for the respective periods ended September 30, is summarized as
follows (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
Communications........................... $319 $255 $ 1,035 $505
Information Services..................... 30 30 94 84
Coal Mining.............................. 20 50 66 146
Other ................................... 6 6 18 17
---- ---- ---- ----
$375 $341 $ 1,213 $752
==== ==== ======= ====
Communications revenue for the three months ended September 30, 2001
increased 25% compared to the same period in 2000. Included in total
communications revenue of $319 million, was $233 million of services revenue and
$60 million of non-recurring revenue from dark fiber contracts entered into
before June 30, 1999 for which sales type lease accounting was used. Also,
included in total communications revenue for the quarter was $26 million
attributable to reciprocal compensation. Communications revenue for the third
quarter of 2000 was comprised of $136 million of services revenue, $101 million
of dark fiber revenue and $18 million of reciprocal compensation. The increase
in services revenue from 2000 was primarily 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 experienced a
significant increase in the number of customers terminating service in 2001.
These terminations will result in slower growth of service revenue for the
remainder of the year. The decrease in dark fiber revenue reflects the
substantial completion of the intercity network during the second quarter of
2001. Dark fiber revenue in the third quarter of 2001 includes $18 million of
revenue attributable to segments delivered to a customer in the second quarter
of 2001. The revenue attributable to these segments was deferred as the customer
had approached Level 3 about returning the dark fiber in exchange for purchasing
other services. The subsequent negotiations with the customer in the third
quarter did not result in the return of the dark fiber; therefore, the Company
recognized the deferred revenue in the statement of operations. Dark fiber
revenue is expected to decline further in the fourth quarter of 2001, as the
last remaining segments are delivered to customers. The increase in reciprocal
compensation in the third 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 nine months of 2001 by
105% compared to the same period in 2000. Included in total communications
revenue of $1,035 million for the nine months ended September 30, 2001 was $656
million of services revenue, $276 million of non-recurring revenue from dark
fiber contracts entered into before June 30, 1999 for which sales type lease
accounting was used and $103 million attributable to reciprocal compensation.
Communications revenue for the nine months ended September 30, 2000 was
comprised of $328 million of services revenue, $137 million of dark fiber
revenue and $40 million of reciprocal compensation.
Information services revenue, which is comprised of applications and
outsourcing businesses, remained consistent at $30 million for the three months
ended September 30, 2001 and 2000, and increased from $84 million in the nine
months ended September 30, 2000 to $94 million for the same period in 2001. The
nine month increase is primarily attributable to outsourcing revenue which
increased to $64 million for the nine months ended September 30, 2001 compared
to $46 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. Revenue attributable to the applications business
declined due to the expiration of certain contracts.
The communications business generated Cash Revenue of $395 million during
the three months ended September 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 or other
communications assets received for dark fiber and other capacity sales that are
recognized over the term of the contract under GAAP. This increase is a result
of growth in service revenue provided to existing customers and new customer
contracts and cash collections from those customers. Communications Cash Revenue
was $365 million for the three months ended September 30, 2000. Cash Revenue is
not intended to represent revenue under GAAP.
Cash Revenue for the nine months ended September 30, 2001 was $1.694
billion, an increase from $777 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 $30 million in the third quarter of 2001
compared to the same period in 2000. Coal mining revenue for the first nine
months of 2001 was $66 million compared to $146 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 part of the year.
Other revenue for the three and nine months ended September 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 third quarter 2001 was $150 million, representing a
25% decrease over third quarter 2000 cost of revenue of $199 million. This
decrease is a result of the continued migration of customers off of leased
capacity to the Company's network and a decrease in the costs associated with
dark fiber sales. Overall the cost of revenue for the communications business,
as a percentage of revenue, decreased significantly from 62% during the quarter
ended September 30, 2000 to 36% during the same period of 2001. The cost of
revenue for the nine months ended September 30, 2001 was $629 million, an
increase from $483 million for the same period in 2000. Cost of revenue for the
nine months ended September 30, 2001 for the communications business, as a
percentage of revenue, was 50% as compared to 72% during the same period of
2000. The decreases for both periods can again be attributed to the migration of
customer traffic from a leased network to the Company's own operational network
and increased margins on segments delivered to dark fiber customers for which
revenue is recognized as a sales type lease.
The cost of revenue for the information services businesses, as a
percentage of its revenue, was 70% for the third quarter of 2001, and 74% for
the nine months ended September 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 70% for the third quarter of 2001 up from 42% for
the same period in 2000. Cost of revenue for the coal mining business, as a
percentage of revenue, was 68% for the nine months ended September 30, 2001 as
compared to 40% 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 $314 million, a
91% increase from the third quarter 2000 depreciation and amortization expenses
of $164 million. Depreciation and amortization expenses for the nine months
ended September 30, 2001 were $882 million, a 126% increase from $391 million
for the respective period in 2000. Included in depreciation expense for the
three and nine months ended September 30, 2001 is $10 million and $45 million,
respectively, for the impairment charge on the corporate facility the Company
has elected to dispose. The Company also included in depreciation expense in the
third quarter of 2001, $20 million of impairments related to a transatlantic
submarine system completed by a consortium of telecommunications companies for
which the Company has determined the cost is not fully recoverable due to the
decline in the prices of transoceanic bandwidth. The
remaining increases are a direct result of the communications assets placed
in service in the latter part of 2000 and during the nine months ended September
30, 2001, including gateways, local networks and intercity segments.
Selling, General and Administrative expenses were $331 million in the three
months ended September 30, 2001, an 11% increase over the third quarter 2000.
Excluding noncash compensation expenses of $82 million and $61 million from the
2001 and 2000, respectively, operating expenses would have increased 5% from the
prior year. This increase is attributable to higher professional fees, facility
related costs, and systems maintenance expenses, partially offset by declines in
travel, mine management services and recruiting expenses. The increase in
non-cash compensation is predominantly due to the C-OSOs granted in 2000 and
2001. Selling, general and administrative costs for the remainder of 2001 are
expected to remain consistent or decline slightly from third quarter 2001 levels
due to the further reduction in force announced in October 2001.
Selling, general and administrative expenses were $1,038 million in the
nine months ended September 30, 2001, a 33% 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 and Impairment Charges of $101 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
reduced its global work force during the second and third quarters by
approximately 1,400 employees, primarily in the communications business and
recorded a restructuring charge of $40 million. 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 $33 million in severance and fringe benefit costs as
of September 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.
Level 3 expects to record a significant charge in the fourth quarter of
2001 associated with the further work force reduction announced on October 25,
2001.
An impairment charge of $61 million was recorded in June 2001 related to
the restructuring. 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.
As required by SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of", the Company continues to
monitor and review long-lived assets for possible impairment as events or
changes in circumstances indicate that the carrying amount of the long-lived
assets may not be recoverable. To the extent events or circumstances indicate
that the carrying amount of long-lived assets may not be recoverable, and an
impairment charge is deemed necessary, the impact on the Company's results of
operations or its financial position could be material.
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 $24 million in the third quarter of 2001 from a $95
million loss for the same period in
2000. EBITDA for the nine months ended September 30, 2001 was a loss of $260
million as compared to $356 million loss for the same period in 2000. Excluding
the two restructuring charges recorded in the first half of 2001, EBITDA would
have been a loss of $210 million for the nine months ended September 30, 2001.
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 September 30, 2001, Adjusted EBITDA was $73 million compared to
$57 million for the same period in 2000. For the nine months ended September 30,
2001, Adjusted EBITDA was $551 million compared to a loss of $25 million for the
same period in 2000. These increases, in addition to the higher margins noted
above, can be attributed to up-front payments received from customers for
multi-year contracts.
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 $34 million for the third quarter of 2001, a decline of
$53 million compared to the third quarter of 2000. The decrease is primarily
attributable to the average cash and marketable securities balance declining
from $5.8 billion during the three month period ending September 30, 2000 to
$2.9 billion for the three month period ended September 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 150 basis points for the three months ended
September 30, 2001 from the same period in 2000. Interest income for the nine
months ending September 30, 2001 and 2000 was $142 million and $255 million,
respectively. The decrease is again attributable to an approximately 40% decline
in the average portfolio balance and an approximately 60 basis point decline in
the weighted average interest rate earned on the portfolio. The Company expects
interest income to continue to decline in the fourth quarter of 2001 primarily
due to utilization of funds to repurchase debt, pay operating expenses and fund
capital expenditures. 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 to $183 million from $64 million in the
third 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 third quarter of 2001
as compared to the same period in 2000. The Company completed a significant
portion of the network and other communications related facilities during the
last year, therefore reducing the amount of interest capitalization. Capitalized
interest was $1 million in the third quarter of 2001 and $106 million in the
third quarter of 2000. Partially offsetting these increases, was the retirement
of $169 million of convertible subordinated debt in August of this year and
lower variable interest rates attributable to the Secured Credit facility and
GMAC mortgage.
Interest expense, net for the first nine months of 2001 was $495 million as
compared to $195 million for the same period in 2000. In addition to the
explanations provided above, interest expense increased in the nine months ended
September 30, 2001 as compared to the respective period in 2000 due to the debt
offerings completed in late February 2000. Capitalized interest was $58 million
in the nine months ended September 30, 2001 and $263 million for the same period
in 2000.
Interest expense is expected to decline in future periods as a result of
the convertible subordinated debt repurchased during the third quarter of 2001
and the senior debt and convertible debt securities repurchased in the "Modified
Dutch Auction" completed in October of this year. These transactions will
reduce annualized interest expense and cash interest expense by
approximately $175 million and $155 million, respectively.
Equity in Earnings (Losses) of Unconsolidated Subsidiaries was $5 million
in the third quarter of 2001, compared to loss of $70 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, until unrecorded equity losses have
been offset. The Company, as of September 30, 2001, had unrecorded equity losses
attributable to RCN of $327 million. Since RCN did not become profitable in the
third quarter of 2001, the Company did not record any previously unrecorded
losses attributable to RCN. Additionally, the Company recorded $5 million and $-
million of equity earnings for the three month periods ended September 30, 2001
and 2000, respectively, related to the investment in Commonwealth Telephone
Enterprises, Inc.
Equity in earnings of Commonwealth was $7 million for the nine months ended
September 30, 2001. Equity losses and earnings attributable to RCN and
Commonwealth during the nine months ended September 30, 2000, were losses of
$190 million and earnings of $4 million, respectively.
Gain on Equity Investee Stock Transactions was $95 million for the nine
months ended September 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 increased to a $33 million gain in the third quarter of 2001
from a $6 million gain in the same period of 2000. Other, net is primarily
comprised of the $27 million of income recognized when divine, Inc. agreed to
release Level 3 from a deferred revenue obligation in 2001. In 2000, the Company
recognized a gain of $22 million from the sale of Walnut Creek Mining Company
and a loss of $17 million from the other-than temporary decline in the value of
investments.
Other, net decreased from a gain of $3 million for the nine month period
ended September 30, 2000 to a loss of $4 million for the same period in 2001. In
addition to the income from divine described above, the Company recorded a
charge for an other-than temporary change in the value of investments of $37
million during the first and second quarters of 2001. Additionally, the Company
recorded a loss of $15 million in 2001 related to losses on certain asset
disposals and $14 million of realized gains from the sale of marketable
securities denominated in foreign currency.
Income Tax Benefit for the three and nine months ended September 30, 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.
Extraordinary Gain on Debt Extinguishment was $94 million for the three and
nine months ended September 30, 2001. The Company purchased $169 million of its
convertible subordinated notes during the three month period ending September
30, 2001. The Company issued approximately 14.3 million shares of its common
stock worth approximately $61 million in exchange for the debt. The net gain on
the extinguishment of the debt, including transaction costs and unamortized debt
issuance costs, was $103 million. Offsetting this gain were $9 million of
prepayment expenses CPTC incurred to refinance its development and construction
debt.
Level 3 expects to recognize an extraordinary gain of approximately $935
million in the fourth quarter of 2001 as a result of the Modified Dutch Auction
completed in October 2001.
Financial Condition - September 30, 2001
The Company's working capital decreased from $3.1 billion at December 31,
2000 to $1.6 billion at September 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 in the first quarter increased working
capital.
Cash provided by operations decreased from $512 million in the nine months
September 30, 2000 to $157 million in the same period of 2001. Fluctuations in
the components of working capital are primarily responsible for the decline.
Reductions in accounts payable and lower income tax refunds were partially
offset by an increase in deferred revenue and lower receivable balances.
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 $2.3 billion of capital
expenditures, primarily for the communications network. The Company also
realized $2.8 billion of proceeds from the sales and maturities of marketable
securities and $47 million of proceeds from the sale of certain operating assets
and construction equipment.
Financing activities in 2001 consisted primarily of the net proceeds of
$636 million from the first quarter 2001 Senior Secured Credit Facility draws
for the telecommunications business. CPTC received $125 million of net cash from
its refinancing and repaid long-term debt of $114 million. In addition, Level 3,
in a noncash transaction, exchanged approximately $169 million of its
convertible subordinated notes for approximately $61 million of its common
stock.
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. The Company's capital expenditures in connection with its
business plan were approximately $2.3 billion during the first nine months 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 September 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 $9.1
billion for North America, $1.7 billion for Europe and $0.5 billion for Asia.
Total capital expenditures for 2001 are expected to be approximately $2.7
billion. The Company's capital expenditures are expected to decline as
construction of its North American and European networks are now substantially
complete, and the remainder of the Company's initial build-out in Asia will be
completed during 2002. The substantial majority of the Company's ongoing capital
expenditures are expected to be success-based, or tied to incremental revenue.
The Company estimates that its base capital expenditures, excluding
success-based capital expenditures, will total approximately $200 million in
2002.
The cash and marketable securities already on hand and the undrawn
commitments of $650 million at September 30, 2001 under the expanded Senior
Secured Credit Facility, provided Level 3 with approximately $3.2 billion of
funds available at the end of the third quarter 2001. The Company's current
liquidity, cash flows from committed contracts for communications services and
anticipated future cash
flows from operations should be sufficient to fund the currently committed
portions of the business plan through free cash flow breakeven.
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
without a requirement for additional financing. The timing of free cash flow
breakeven will be a function of revenue and cash revenue growth as well as the
Company's management of network, selling, general and administrative, and
capital expenditures. 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 a material adverse effect on the implementation of the business plan.
In connection with the implementation of the Company's business plan,
management continues to review the existing businesses, including portions of
its communications business, to determine how those businesses will assist with
the Company's focus on delivery of communications services and reaching cash
flow breakeven. To the extent that certain businesses are not considered to be
compatible with the delivery of communication services or with obtaining cash
flow breakeven objectives, the Company may exit those businesses. It is possible
that the decision to exit these businesses could result in the Company not
recovering its investment in the businesses, and in those cases, a significant
charge to earnings could result.
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. During 2001, various
issuances of Level 3's outstanding senior notes, senior discount notes and
convertible subordinated notes have traded at discounts to their respective face
or accreted amounts. As of September 30, 2001, the Company had exchanged
approximately $169 million of its convertible subordinated debt for shares of
its common stock valued at approximately $61 million.
On September 10, 2001, the Company announced that its first tier, wholly
owned subsidiary, Level 3 Finance, LLC was commencing a "Modified Dutch Auction"
tender offer for a portion of the Company's senior debt and convertible debt
securities. On October 23, 2001, Level 3 Finance announced that it had
repurchased debt, with a face value of approximately $1.7 billion, plus accrued
interest, if applicable, for a total purchase price of approximately $731
million. The net gain on the extinguishment of the debt, including transaction
costs and unamortized debt issuance costs, is estimated to be approximately $935
million and will be recorded as an extraordinary item in the fourth quarter of
2001.
Level 3 is aware that the various issuances of its outstanding senior
notes, senior discount notes and convertible subordinated notes continue to
trade at discounts to their respective face or accreted amounts. In order to
continue to reduce future cash interest payments, as well as future amounts due
at maturity, Level 3 or its affiliates may, from time to time, purchase these
outstanding debt securities for cash or
exchange shares of Level 3 common stock for these outstanding debt securities
pursuant to the exemption provided by Section 3(a)(9) of the Securities Act of
1933, as amended, in open market or privately negotiated transactions. Level 3
will evaluate any such transactions in light of then existing market conditions.
The amounts involved in any such transactions, individually or in the aggregate,
may be material.
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 September 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 $1.4 billion at September 30, 2001, was approximately 6.7%.
A hypothetical increase in the variable portion of the weighted average rate by
1% (i.e. a weighted average rate of 7.7%), 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 September 30,
2001, the Company had $6.5 billion of fixed rate debt bearing a weighted average
interest rate of 9.27%. 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
has reduced its exposure to interest rate risk by acquiring certain outstanding
indebtedness in exchange for shares of common stock or cash. As a result of the
Modified Dutch Auction completed on October 22, 2001, the Company was able to
reduce its fixed rate debt outstanding to $4.8 billion. 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 $479 million at September 30, 2001, which is significantly higher
than their carrying value of $112 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 $96 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
telecommunications assets in Europe and Asia. As of September 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 Euro 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 the remaining Euros
received from the debt offerings. During the third quarter of 2001, Level 3
elected to start funding its current European investing and operating activities
with the Euros that had previously been set aside. Other than the issuance of
the Euro denominated debt and the holding of the Euros, 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 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed as part of this report are listed below.
None
(b) On July 27, 2001, the Company filed a Current Report on
Form 8-K announcing that it had amended its credit agreement to permit
Level 3 to acquire certain of its outstanding indebtedness in
exchange for shares of its common stock.
On September 10, 2001 and September 25, 2001, the Company filed
Current Reports on Form 8-K disclosing that its wholly owned
subsidiary had taken actions with respect to a Modified Dutch Auction
tender offer for Level 3 senior notes and convertible subordinated
notes and that Level 3 had posted on its web site certain "Questions
and Answers" relating to the tender offers commenced by its
subsidiary, Level 3 Finance, LLC.
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: November 14, 2001 \s\ Eric J. Mortensen
---------------------
Eric J. Mortensen
Vice President, Controller
and Principal Accounting Officer