Rule No. 424(b)(5)
Registration No. 333-91899
Registration No. 333-68887
PROSPECTUS SUPPLEMENT
(To Prospectus Dated December 10, 1999)
[LOGO OF LEVEL 3]
$750,000,000
Level 3 Communications, Inc.
6% Convertible Subordinated Notes due 2010
------------
Interest on the notes is payable on March 15 and September 15 of each year,
beginning on September 15, 2000. The notes will be unsecured obligations of
Level 3 and will be subordinated in right of payment to all of our senior
indebtedness. The notes are convertible by holders at any time prior to
maturity (unless certain events described in this prospectus supplement occur)
into shares of our common stock at a conversion rate of 7.416 shares per $1,000
principal amount of notes (subject to adjustment in certain events). This is
equivalent to a conversion price of approximately $134.84 per share. The notes
will mature on March 15, 2010.
Prior to March 18, 2003, we may redeem the notes, in whole or in part, at
the redemption prices set forth in this prospectus supplement plus accrued
interest, if the current market price of our common stock equals or exceeds
certain triggering levels for a period of time. Level 3 will make a make-whole
payment with respect to notes converted into common stock between the date the
notes are called for redemption and the redemption date. On or after March 18,
2003, we may cause the conversion rights of holders of notes to expire if the
current market price of our common stock exceeds 140% of the conversion price
for a period of time. In the event of a change of control as described in this
prospectus supplement, holders of notes will have the right to require us to
repurchase the notes at a price equal to 100% of the principal amount plus
accrued interest. We will pay the repurchase price in cash or, at our option
but subject to the satisfaction of certain conditions, in shares of common
stock.
Our common stock is quoted on the Nasdaq National Market under the symbol
"LVLT," and the last reported price of the common stock on February 23, 2000,
was $108.875 per share.
We have also granted the underwriters named in this prospectus supplement an
option to purchase up to an additional $112,500,000 principal amount of notes
under certain circumstances.
------------
Investing in the notes involves certain risks. See "Risk Factors" beginning
on page S-11.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus supplement or the related prospectus is truthful or complete. Any
representation to the contrary is a criminal offense.
------------
Per note Total
---------- -------
Initial Public Offering Price 100.00% $750,000,000
Underwriting Discount 2.95% $ 22,125,000
Proceeds to Level 3 (before expenses) 97.05% $727,875,000
Interest on the notes will accrue from February 29, 2000 to the date of
delivery.
------------
The underwriters are offering the notes subject to various conditions. The
underwriters expect to deliver the notes to purchasers on or about February 29,
2000.
The underwriters expect to deliver the notes in book-entry form only through
the facilities of The Depository Trust Company against payment in New York, New
York on February 29, 2000.
------------
Joint Book-Running Managers
Goldman, Sachs & Co. Salomon Smith Barney
J.P. Morgan & Co.
Morgan Stanley Dean Witter
Credit Suisse First Boston
------------
Global Coordinator
Salomon Smith Barney
February 23, 2000
[ARTWORK APPEARING ON INSIDE FRONT COVER OF PROSPECTUS SUPPLEMENT]
LEVEL 3 COMMUNICATIONS
- ----------------------------------------------------- -------------------------------------------------------------
OUR PROGRESS OUR SERVICES
- ----------------------------------------------------- -------------------------------------------------------------
- - 27 U.S. markets served and London, Paris, - Transport Services
Amsterdam and Frankfurt
- Colocation
- - Launched initial services to customers
over a leased network - Internet Access
- - Completed facilities based local metropolitan - Managed Modem
networks in 22 U.S. markets and 3
European markets - (3)Voice(/SM*/)
- - Completed construction of 9,334 miles of North
American intercity network and 2,139 miles of
European intercity network
- - Secured approximately 3.4 million square feet of
space for Gateway facilities (/*/)Long distance only
- ----------------------------------------------------- -------------------------------------------------------------
[LOGO OF LEVEL 3]
- ----------------------------------------------------- -------------------------------------------------------------
OUR NETWORK* OUR STRATEGY
- ----------------------------------------------------- -------------------------------------------------------------
- - An intercity network covering nearly - Become the low cost provider of communications
16,000 miles in North America services
- - Leased or owned local networks in 56 North - Combine latest generations of fiber
American markets and electronics
- - An intercity network covering approximately - Offer comprehensive range of communications
4,750 miles across Europe services
- - Leased or owned local networks in 21 - Provide significant colocation facilities
European and Pacific Rim markets
- Provide seamless interconnection to PSTN
- - Approximately 6.5 million square feet of
Gateway facilities in North America, Europe - Accelerate market roll-out
and the Pacific Rim
- Target web centric customers
- - Undersea capacity, including a 1.28 Tbps
transatlantic cable system and a 2.56 Tbps - Develop advanced business support systems
Northern Asia cable system initally
connecting Hong Kong to Tokyo - Leverage existing information services
capabilities
- Attract and motivate high quality
employees
(/*/) At completion
- ----------------------------------------------------- -------------------------------------------------------------
[ARTWORK APPEARING ON INSIDE FRONT COVER OF PROSPECTUS SUPPLEMENT]
LEVEL 3 GATEWAYS
We created the term Gateway site to describe the major communications hubs of
our network. Our gateways are advanced technical facilities which provide
colocation space for customers' equipment and facilities, link our networks to
other communications networks, and house our own network equipment. Each of our
Gateway facilities is served by redundant, fault tolerant connections to our
network.
REPRESENTATIVE COLOCATION GATEWAY FACILITY
Los Angeles [PICTURE OF TECHNICAL SPACE IN
Modem equipment is used for our Managed Modem LOS ANGELES GATEWAY FACILITY]
service. This equipment will also be used for
voice service.
London [PICTURE OF COLOCATION SPACE IN
Level 3's facilities have been designed to anticipate LONDON GATEWAY FACILITY]
and embrace the rapid pace of technological advances.
We have constructed our Gateway facilities to be
more readily upgradeable and capable of evolving as
technology changes and to meet customer demand.
Denver [PICTURE OF BACKUP POWER AND BATTERY
Level 3 Gateways provide climate-controlled SPACE IN DENVER GATEWAY FACILITY]
environments and managed power with UPS
battery and generator backup.
[ARTWORK APPEARING ON INSIDE FRONT COVER OF PROSPECTUS SUPPLEMENT]
- -----------------------------------------------------------------------------------------------------
MARKETS SERVED IN 2000
- -----------------------------------------------------------------------------------------------------
United States Europe Pacific Rim
- ----------------------------------------------------------------------- ---------- -----------
Atlanta El Paso* Manchester Orlando San Francisco Amsterdam Hong Kong*
Austin* Fort Worth* Memphis* Philadelphia San Jose Brussels* Tokyo*
Baltimore Houston Miami Phoenix* San Luis Obispo* Dusseldorf*
Boston Indianapolis* Nashville* Princeton* Seattle Frankfurt
Charlotte* Jacksonville* New Orleans* Providence St. Louis London
Chicago Jersey City New York City Raleigh* Stamford Munich*
Cincinnati Kansas City* Newark Richmond* Tampa Paris
Dallas Long Island Oakland* Sacramento* Washington, D.C.
Denver Los Angeles Omaha* San Antonio* Wilmington*
Detroit Louisville* Orange County* San Diego
* Not in service; final market selection subject to change
[PICTURE OF TECHNICAL SPACE IN CHICAGO GATEWAY FACILITY]
Chicago
Level 3 Gateway facilities house
sophisticated optical and electronic
equipment, bringing together all of
Level 3's technology.
[DIAGRAM OF LAYOUT
OF TYPICAL
GATEWAY FACILITY
(NOT TO SCALE.)]
[PICTURE OF TECHNICAL SPACE IN WASHINGTON, D.C.
GATEWAY FACILITY]
Washington, D.C.
Network surveillance equipment in our
Gateways is used by our Network
Operations Center in Denver to monitor
the network 24 hours a day, 7 days a week.
[PICTURE OF COLOCATION SPACE IN NEW YORK
GATEWAY FACILITY]
New York
Level 3's Colocation facilities are among
the largest and most modern in the
industry, housing a state-of-the-art
network of telephone and web hosting
equipment. Colocation services from
Level 3 provide customers a quick,
cost-efficient way to launch their services.
You should rely only on the information contained in or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We
have not authorized anyone to provide you with different information. We are
not making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information contained in or
incorporated by reference in this prospectus supplement or the accompanying
prospectus is accurate as of any date other than the date on the front of this
prospectus supplement.
------------
TABLE OF CONTENTS
Prospectus Supplement
Page
-----
Prospectus Supplement Summary........................................... S-1
Risk Factors............................................................ S-11
Information Regarding Forward-Looking Statements........................ S-21
Use of Proceeds......................................................... S-22
Capitalization.......................................................... S-22
Common Stock Price Range and Dividends.................................. S-23
Management's Discussion and Analysis of Financial Condition and Results
of Operations.......................................................... S-24
Industry Overview....................................................... S-37
Business................................................................ S-43
Management.............................................................. S-64
Security Ownership of Certain Beneficial Owners and Management.......... S-68
Certain Transactions and Relationships.................................. S-70
Description of Other Indebtedness of Level 3............................ S-73
Description of Notes.................................................... S-80
Certain United States Federal Income Tax Considerations................. S-96
Underwriting............................................................ S-103
Legal Matters........................................................... S-105
Experts................................................................. S-105
Glossary of Terms....................................................... S-106
Index to Financial Statements........................................... F-1
Prospectus
About This Prospectus....................................................... 1
Where You Can Find More Information......................................... 1
Risk Factors................................................................ 1
The Company................................................................. 2
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends............ 2
Application of Proceeds..................................................... 2
Description of Debt Securities.............................................. 3
Description of Preferred Stock.............................................. 12
Description of Depositary Shares............................................ 17
Description of Common Stock................................................. 20
Description of Outstanding Capital Stock.................................... 20
Plan of Distribution........................................................ 21
Legal Matters............................................................... 23
Experts..................................................................... 23
(i)
PROSPECTUS SUPPLEMENT SUMMARY
This summary contains a general summary of the information contained in this
prospectus supplement. It may not include all the information that is important
to you. You should read the entire prospectus supplement, our prospectus dated
December 10, 1999, and the documents incorporated by reference before making an
investment decision.
Level 3 Communications, Inc. was known as "Peter Kiewit Sons', Inc." prior
to the March 31, 1998 split-off of its construction and mining management
business from its other businesses. See "Business--History." See "Risk Factors"
for factors that you should consider before investing in the notes and
"Information Regarding Forward-Looking Statements" for information relating to
statements contained in this prospectus supplement that are not historical
facts. Capitalized terms used but not defined in this prospectus supplement
have the meaning given to them in "Glossary of Terms."
Level 3
We engage in the communications, information services and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, we announced a business plan to
increase substantially our communications and information services business and
to expand the range of services we offer. This plan is referred to in this
prospectus supplement as the "Business Plan." We are implementing the Business
Plan by building an advanced, international, facilities based communications
network based on Internet Protocol technology.
As our Business Plan is implemented, our network will combine both local and
long distance networks and connect customers end-to-end across North America
and in Europe and the Pacific Rim. Over the next two to three years, our
network is expected to encompass:
. an intercity network covering nearly 16,000 miles in North America;
. leased or owned local networks in 56 North American markets;
. an intercity network covering approximately 4,750 miles across Europe;
. leased or owned local networks in 21 European and Pacific Rim markets;
. approximately 6.5 million square feet of gateway facilities in North
America, Europe and the Pacific Rim; and
. undersea capacity, including a 1.28 Tbps transatlantic cable system and
a 2.56 Tbps Northern Asia cable system initially connecting Hong Kong to
Tokyo.
We expect to substantially complete the North American intercity portion of
our network by the end of the year 2000. In the interim, we have leased a
national network over which we began to offer services in the third quarter of
1998. We also expect to substantially complete the first two rings of our
three-ring European intercity network by the end of the year 2000. In the
interim, we have also leased a European intercity network over which we began
to offer services in early 1999. As of December 31, 1999, we had secured 100%
of the rights-of-way required for our planned North American intercity network,
had completed construction of 9,334 route miles of this network and had
approximately 6,200 route miles under construction. Also, as of December 31,
1999, we had secured substantially all of the rights-of-way required for the
first two rings of our planned European intercity network, completed
construction of 2,139 route miles of this network and had approximately 3,400
route miles under construction.
S-1
In December 1999, we began carrying customer traffic between Dallas and
Houston on the first completed and lit segment of our North American intercity
network. We have operational facilities based local metropolitan networks in 22
U.S. markets and 3 European markets. We have secured approximately 3.4 million
square feet of space for our gateway facilities, which vary in size and the
nature of services currently offered. We have completed the buildout of
approximately 1.3 million square feet of this space. Our gateways are advanced
technical facilities which provide colocation space for our customers'
equipment and facilities, link our networks to other communications networks
and house our own network equipment. We have gateway facilities in 25 U.S.
markets and in London, Paris, Amsterdam and Frankfurt. We have announced the
development and construction of a 1.28 Tbps transatlantic undersea cable
system, as well as the development and construction of a 2.56 Tbps Northern
Asia undersea cable system initially connecting Hong Kong to Tokyo.
We believe that, as technology advances, a comprehensive range of both
consumer and business communications services will be provided over networks,
such as ours, utilizing Internet Protocol technology. These services will
include traditional voice services, as well as other data services such as
Internet access. We believe this shift has begun, and over time should
accelerate, since Internet Protocol networks offer:
. more efficient use of network capacity than the traditional public
switched telephone networks;
. an open protocol which allows for market driven development of new uses
and applications;
. the prospect of technological advances that will address problems
currently associated with Internet Protocol based applications that use
the public Internet; and
. an open architecture that enables new competition among suppliers and
should ultimately lead to lower network costs.
Level 3's Strategy
Key elements of our strategy include:
. Become the Low Cost Provider of Communications Services. Our network is
designed to provide high quality communications services at a lower cost
by taking advantage of efficiencies in new technologies such as packet-
switching, using open, non-proprietary interfaces in the network design
and by having an upgradable network that can more readily incorporate
future technological improvements.
. Combine Latest Generations of Fiber and Electronics. In order to achieve
unit cost reductions for transmission capacity, we have designed our
network with multiple conduits to deploy successive generations of fiber
to exploit improvements in transmission electronics. Optimizing
transmission electronics to exploit specific generations of fiber optic
technology currently provides transmission capacity on the new fiber
more cost effectively than deploying new electronics on previous
generations of fiber.
. Offer a Comprehensive Range of Communications Services. We provide a
comprehensive range of communications services over our network,
including private line, (3)VoiceSM long distance services, colocation,
Internet access and managed modem. We expect to begin commercial testing
of some features associated with local voice services during the first
quarter of 2000. We are also offering dark fiber and conduits along our
local metropolitan networks and intercity networks on a long-term lease
basis.
. Provide Significant Colocation Facilities. We have been experiencing
higher demand for our colocation services from our web centric customers
than we anticipated in preparing our Business Plan. We believe that
providing colocation services on our network attracts web centric
customers by allowing us to offer those customers reduced bandwidth
costs, rapid provisioning of additional bandwidth, interconnection with
other third-party networks and improved network performance. Therefore,
we believe that controlling significant colocation facilities in our
gateways provides us
S-2
with a competitive advantage. In addition, having significant colocation
facilities in a gateway allows the intra-facility exchange of traffic
amongst a large number of customers to occur at a substantially lower
cost than would be the case for traffic transported to other locations.
As of December 31, 1999, we had secured approximately 3.4 million square
feet of space for our gateway facilities and had completed the buildout
of approximately 1.3 million square feet of this space. We believe we
currently have more colocation space than any of our competitors. In
January 2000, we announced an expansion of our Business Plan to increase
significantly the aggregate amount of our global gateway facilities to
6.5 million square feet over the next two to three years.
. Provide Seamless Interconnection to the Public Switched Telephone
Network. In December 1999 we began to offer (3)Voice long distance
service to allow the seamless interconnection of Internet Protocol networks
with the public switched telephone network for long distance voice
transmissions. Seamless interconnection allows customers to use our
Internet Protocol based services without modifying existing telephone
equipment or dialing procedures (that is, without the need to dial access
codes or follow other similar special procedures). Our managed modem
service uses similar softswitch technology to seamlessly interconnect to
the public switched telephone network.
. Accelerate Market Roll-out. To support the launch of our services and
develop a customer base in advance of completing our network build, we
offer services over a combination of leased local and intercity
facilities. Over time, these leased networks will be displaced by the
networks that we are constructing.
. Target Web Centric Customers. To increase revenue-producing traffic on
our network more rapidly, we are using a direct sales force focused on
communications intensive and web centric businesses. These businesses
include ISPs, application service providers, content providers, systems
integrators, next generation carriers, web-hosting companies, streaming
media companies and Internet Protocol based storage providers. Providing
continually declining bandwidth costs to these companies is at the core
of our market enabling strategy because bandwidth generally represents a
substantial portion of web centric businesses' costs.
. Develop Advanced Business Support Systems. We are developing a
substantial, scalable and web-enabled business support system
infrastructure specifically designed to enable us to offer services
efficiently to targeted customers. We believe that this system will
reduce our operating costs, give our customers direct control over some
of the services they buy from us and allow us to grow rapidly without
redesigning the architecture of the business support system.
. Leverage Existing Information Services Capabilities. We are expanding
our existing capabilities in computer network systems integration,
consulting, outsourcing and software reengineering, with particular
emphasis on the conversion of legacy software systems to systems that
are compatible with Internet Protocol networks and web browser access.
. Attract and Motivate High Quality Employees. We have developed programs
designed to attract and retain employees with the technical skills
necessary to implement the Business Plan. The programs include our
Shareworks stock purchase plan and our Outperform Stock Option program.
Competitive Advantages
We believe that we have the following competitive advantages that, together
with our strategy, will assist us in implementing the Business Plan:
. Experienced Management Team. We have assembled a management team that we
believe is well suited to implement the Business Plan. Most of our
senior management has been involved in leading the development and
marketing of telecommunications products and in designing, constructing
and managing intercity, metropolitan and international networks.
S-3
. A More Readily Upgradable Network Infrastructure. Our network design
strategy takes advantage of recent innovations, incorporating many
features that are not present in older communications networks, and
provides us flexibility to take advantage of future developments and
innovations. We have designed the transmission network to optimize all
aspects of fiber and electronics simultaneously as a system to deliver
the lowest unit cost to our customers. As fiber and transmission
electronic technology changes, we expect to realize new unit cost
improvements by deploying the latest fiber and transmission electronics
technology in available empty or spare conduit in our multiple conduit
network. We believe that the spare conduit design of our network will
enable us to effect this deployment more quickly and at lower cost than
other carriers.
. Integrated End-to-End Network Platform with Significant Colocation
Facilities. We believe that the integration of our local and intercity
networks with our colocation facilities will expand the scope and reach
of our on-net customer coverage and facilitate the uniform deployment of
technological innovations as we manage our future upgrade paths.
. Systems Integration Capabilities. We believe that our ability to offer
computer outsourcing and systems integration services, particularly
services relating to allowing a customer's legacy systems to be accessed
with web browsers, will provide additional opportunities for selling our
products and services.
Our principal executive offices are located at 1025 Eldorado Boulevard,
Broomfield, Colorado 80021 and our telephone number is (720) 888-1000.
S-4
The Offering
Issuer...................... Level 3 Communications, Inc.
Notes Offered............... $750,000,000 aggregate principal amount of 6%
convertible subordinated notes due 2010, plus
an additional $112,500,000 aggregate principal
amount of notes subject to the underwriters'
over-allotment option.
Offering Price.............. 100% of the principal amount plus accrued
interest, if any, from February 29, 2000.
Interest.................... Interest on the notes is payable semiannually
on March 15 and September 15 of each year,
beginning on September 15, 2000.
Conversion.................. You may convert your notes into shares of
common stock at a rate of 7.416 shares of
common stock per $1,000 principal amount of
notes, which is equal to a conversion price of
approximately $134.84 per share, subject to
adjustment in certain events.
You may convert notes at any time after their
initial issuance and before the close of
business on the business day immediately before
their maturity date, at the conversion rate set
forth above, unless previously redeemed,
repurchased or unless we have caused the
conversion rights to expire. If your notes are
called for redemption or subject to repurchase,
you will be entitled to convert the notes up to
and including, but not after, the business day
immediately before the day fixed for redemption
or repurchase. If we have caused the conversion
rights to expire, you will be entitled to
convert the notes up to and including, but not
after, the conversion expiration date.
See "Description of Notes--Conversion Rights."
Subordination............... The notes are subordinated to all of our
existing and future senior indebtedness.
Assuming that on December 31, 1999 we had
raised gross proceeds of $2.21 billion from the
other debt offerings described below, we would
have had on that date:
. approximately $5.244 billion of outstanding
senior debt, including $475 million of our
subsidiaries' debt guaranteed by us; and
. our subsidiaries would have had $900 million
in additional borrowings or available under
the senior secured credit facility
guaranteed by us on a senior basis.
We are a holding company, and the notes will be
effectively subordinated to all obligations of
our subsidiaries. As of December 31, 1999, our
subsidiaries had approximately $1.983 billion
in aggregate indebtedness and other balance
sheet
S-5
liabilities, excluding intercompany
liabilities, and $900 million in additional
borrowings available under our senior secured
credit facility.
The notes indenture does not restrict our
ability or our subsidiaries' ability to incur
additional debt. See "Description of Notes--
Subordination."
Provisional Redemption ..... Prior to March 18, 2003, we may from time to
time, at our option, redeem any of the notes at
the redemption prices set forth in this
prospectus supplement plus accrued and unpaid
interest, if the current market price of our
common stock equals or exceeds certain
triggering levels for at least 20 trading days
within any period of 30 consecutive trading
days, including the last trading day of the
period. Level 3 will make a make-whole payment
with respect to notes converted into common
stock between the date the notes are called for
redemption and the redemption date. See
"Description of the Notes--Provisional
Redemption."
Expiration of Conversion On or after March 18, 2003, we may, at our
Rights..................... option, cause the conversion rights to expire.
We may exercise this option only if for at
least 20 trading days within any period of 30
consecutive trading days, including the last
trading day of that period, the current market
price of common stock exceeded 140% of the
conversion price, subject to adjustment in
certain circumstances. In order to exercise our
option to cause the conversion rights to
expire, we must issue a press release and
provide notice to you as provided in the notes
indenture. See "Description of Notes--
Expiration of Conversion Rights."
Change of Control........... If an event treated as a change of control
occurs, you will have the right, subject to
certain conditions and restrictions, to require
us to repurchase all or a portion of your notes
at 100% of the principal amount thereof, plus
accrued and unpaid interest. We will pay the
repurchase price in cash or, at our option but
subject to the satisfaction of certain
conditions, in shares of common stock, valued
at 95% of the average closing sales prices of
the common stock for the five trading days
before and including the third trading day
before the repurchase date.
However, the subordination provisions would
likely restrict our ability to repurchase the
notes prior to the repayment in full of all
amounts outstanding under our senior debt,
including our senior notes and senior secured
credit facility. See "Description of Notes--
Repurchase at Option of Holders Upon a Change
of Control."
Global Note; Book-Entry The notes will be issued only in fully
System..................... registered form without coupons and in minimum
denominations of $1,000. The notes will be
evidenced by one or more global notes, in fully
S-6
registered form and without coupons, deposited
with the trustee for the notes, as custodian
for DTC. Beneficial interests in the global
notes will be shown on, and transfers will be
effected only through, records maintained by
DTC and its participants and indirect
participants. See "Description of Notes--Form,
Denomination, Transfer, Exchange and Book-Entry
Procedures."
Nasdaq National Market
Symbol for Our Common
Stock......................
"LVLT"
Absence of a Public Market
for The Notes..............
The notes will not be listed on any securities
exchange or quoted on the Nasdaq National
Market. The underwriters have advised us that
they intend to make a market in the notes. The
underwriters are not obligated, however, to
make a market in the notes, and any market
making may be discontinued at any time at their
sole discretion without notice. See
"Underwriting."
Use of Proceeds............. The net proceeds to us from this offering are
estimated to be approximately $727,435,000. We
will use the net proceeds from this offering
for working capital, capital expenditures,
acquisitions and other general corporate
purposes in connection with the implementation
of our Business Plan. See "Use of Proceeds."
Risk Factors................ See "Risk Factors" to read about important
factors you should consider before purchasing
the notes.
Other Offerings
We are also offering senior notes and senior discount notes, which will
generate aggregate gross proceeds of approximately $1,410,000,000,
(Euro)800,000,000 (approximately $800,000,000) of senior notes and 20,000,000
shares of our common stock, each in a separate offering pursuant to a separate
prospectus supplement or offering memorandum. No offering is conditioned on the
closing of any other. We may not complete any of the other offerings. This
prospectus supplement relates only to this offering of convertible notes and
not to the other offerings. The senior notes and senior discount notes and the
euro-denominated senior notes will not be registered under the Securities Act
of 1933 and may not be offered or sold in the United States absent registration
or an applicable exemption from registration requirements.
S-7
Summary Financial Data
The summary financial data presented below as of and for the fiscal years
ended the last Saturday in December of 1995, 1996, 1997 and December 31, 1998
and 1999 have been derived from Level 3's audited consolidated financial
statements and the notes related to those financial statements. The following
information should be read in conjunction with Level 3's audited consolidated
financial statements and the notes related to those financial statements, which
are included in this prospectus supplement. Since the Business Plan represents
a significant expansion of Level 3's communications and information services
business, Level 3 does not believe that the following information serves as a
meaningful indicator of Level 3's future financial condition or results of
operations. Level 3 expects to incur substantial net operating losses for the
foreseeable future, and Level 3 may not be able to achieve or sustain operating
profitability in the future.
Fiscal Year Ended (1)
-----------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(in millions)
Results of Operations:
Revenue.................................. $ 515 $ 392 $ 332 $ 652 $ 580
Income (loss) from continuing
operations(2)........................... (487) (128) 83 104 126
Net earnings (loss)(3)................... (487) 804 248 221 244
Financial Position:
Total assets............................. 8,904 5,522 2,776 3,063 2,942
Current portion of long-term debt........ 6 5 3 57 40
Long-term debt, less current portion(4).. 3,989 2,641 137 320 361
Stockholders' equity(5).................. 3,405 2,165 2,230 1,819 1,607
- --------
(1) In October 1993, Level 3 acquired 35% of the outstanding shares of C-TEC
Corporation, which shares entitled Level 3 to 57% of the available voting
rights of C-TEC Corporation. C-TEC Corporation is sometimes referred to in
this prospectus supplement as "C-TEC." At December 28, 1996, Level 3 owned
48% of the outstanding shares and 62% of the voting rights of C-TEC.
As a result of the restructuring of C-TEC in 1997, Level 3 owned less than
50% of the outstanding shares and voting rights of each of the three
entities into which C-TEC was divided, and therefore accounted for each
entity using the equity method beginning in 1997. Level 3 consolidated C-
TEC in its financial statements from 1995 to 1996.
The financial position and results of operations of the construction and
mining management businesses of Level 3 have been classified as
discontinued operations due to the March 31, 1998 split-off of Level 3's
construction and mining management businesses from its other businesses.
Level 3's construction and mining management businesses are referred to in
this prospectus supplement as the "Construction Group."
In 1995, Level 3 dividended its investment in its former subsidiary, MFS
Communications Company, Inc. to the holders of the Class D Stock. MFS
Communications Company, Inc. is sometimes referred to in this prospectus
supplement as "MFS." MFS' results of operations have been classified as a
single line item on the statement of operations for 1995.
Level 3 sold its energy segment to MidAmerican Energy Holdings Company
(formerly known as CalEnergy Company, Inc.) in 1998 and classified it as
discontinued operations within the financial statements. MidAmerican
Energy Holdings Company is sometimes referred to in this prospectus
supplement as "MidAmerican."
Certain prior year amounts have been reclassified to conform to current year
presentation.
S-8
(2) Level 3 incurred significant expenses in conjunction with the expansion of
its communications and information services businesses in 1998 and 1999.
During 1999, RCN Corporation, sometimes referred to in this prospectus
supplement as "RCN," issued stock in a public offering and for certain
transactions that diluted Level 3's ownership of RCN from 41% at December
31, 1998 to 35% at December 31, 1999. The increase in Level 3's
proportionate share of RCN's net assets as a result of these transactions
resulted in a pre-tax gain of $117 million for Level 3 in 1999. Level 3
recognized gains of $62 million in 1998 for RCN stock activity and $3
million in 1995 for MFS stock activity.
In 1998, Level 3 acquired XCOM Technologies, Inc. and its developing
telephone-to-Internet Protocol network bridge technology. XCOM
Technologies, Inc. is sometimes referred to in this prospectus supplement
as "XCOM." Level 3 recorded a $30 million nondeductible charge against
earnings for the write-off of in-process research and development acquired
in the transaction.
In 1998, Cable Michigan, Inc. was acquired by Avalon Cable of Michigan,
Inc. Level 3 received approximately $129 million for its shares of Cable
Michigan, Inc. in the acquisition and recognized a pre-tax gain of
approximately $90 million in 1998.
(3) In 1998, Level 3 recognized a gain of $608 million equal to the difference
between the carrying value of the Construction Group and its fair value.
No taxes were provided on this gain due to the tax-free nature of the
split-off.
Level 3 also recognized in 1998 an after-tax gain of $324 million on the
sale of its energy segment to MidAmerican.
(4) In 1998, Level 3 issued $2 billion of 9 1/8% senior notes due 2008 and
$834 million principal amount at maturity of 10 1/2% senior discount notes
due 2008. The issue price of the 10 1/2% senior discount notes was
approximately 60% of the principal amount at maturity. In 1999, Level 3
issued $823 million of 6% convertible subordinated notes due 2009 and
entered into a $1.375 billion senior secured credit facility of which $475
million was outstanding as of December 31, 1999.
(5) In March 1999, Level 3 received approximately $1.5 billion of net proceeds
from the sale of 28.75 million shares of its common stock.
S-9
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends
Our ratio of earnings to fixed charges and preferred stock dividends for
each of the periods indicated was as follows:
Fiscal Year Ended
------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Ratio of earnings to fixed charges and preferred
stock dividends .................................... -- -- 5.73 3.87 --
For this ratio, earnings consist of earnings (loss) before income taxes,
minority interest and discontinued operations plus fixed charges excluding
capitalized interest. Fixed charges and preferred stock dividends consist of
interest expensed and capitalized, plus the portion of rent expense under
operating leases deemed by us to be representative of the interest factor,
plus, prior to September 30, 1995, preferred stock dividends on preferred stock
of our former subsidiary, MFS. We had deficiencies of earnings to fixed charges
and preferred stock dividends of $695 million for the fiscal year ended 1999,
$36 million for the fiscal year ended 1998 and $32 million for the fiscal year
ended 1995.
S-10
RISK FACTORS
Before you invest in the notes, you should carefully consider the following
risks.
We are dependent on our new Business Plan that relies on Internet Protocol
technology
The current status of our Business Plan makes evaluation of its risks and
rewards extremely difficult and speculative. The Business Plan depends upon a
shift in providing communications services over Internet Protocol based
networks instead of the traditional public-switched networks. Our strategy
assumes that the technology that we and others have developed solves the
problems currently associated with Internet Protocol based applications and
will scale for full deployment, and that others will continue to develop new
uses and applications for Internet Protocol based networks. The success of our
Business Plan depends on other assumptions as well, such as our ability to use
open, non-proprietary interfaces in our network software and hardware that
allow us to buy equipment in the future from multiple vendors. We must generate
substantial traffic volume at acceptable prices on our network in order to
realize the anticipated operating efficiencies and cost benefits of the
network.
Substantial operating losses are expected for the foreseeable future
The development of our Business Plan requires significant capital
expenditures. We expect to incur a large portion of these capital expenditures
before we receive any significant related revenues from our Business Plan.
Because of these capital expenditures and the related early operating expenses,
we expect substantial negative operating cash flow and net losses for the
foreseeable future. For 1999, we incurred a loss from continuing operations of
$487 million. We expect our operating losses for the foreseeable future to be
substantially higher. We may never establish a significant customer base for
our communications and information services business, and even if we do, we may
continue to sustain substantial negative operating cash flow and net losses as
a result of low prices or higher costs. In addition, we will incur
substantially higher selling, general and administrative expenses as we develop
our Business Plan.
Since our Business Plan is a significant expansion of our communications and
information services business, we believe that our historical financial results
will not provide investors with a meaningful indicator of our future financial
condition or results of operations.
A failure to finance our substantial capital requirements could adversely
affect our Business Plan
The implementation of our Business Plan and our ability to meet our
projected growth depends on our ability to secure substantial additional
financing. We estimate that the implementation of our Business Plan, as
currently contemplated, requires between $13 and $14 billion over the 10-year
period of the plan. However, the amount of additional financing we need could
be higher than we currently estimate. The implementation of our Business Plan
and our future financial results could be adversely affected if we are
unsuccessful in obtaining required financing through:
. raising debt or equity capital at the times we need on terms that we
consider acceptable;
. generating cash flow from our operations; and
. offering others fiber optic capacity on our network or access to our
conduits.
If we fail to obtain the required financing, we may be required to delay or
abandon some of our future expansion or spending plans. Our existing level of
debt and its terms may limit our ability to raise additional capital and
otherwise restrict our activities. Additional equity issuances would dilute
your ownership interest. In addition, if our operations do not produce positive
cash flow in sufficient amounts to pay our financing obligations, our future
financial results and our ability to implement our Business Plan will be
materially and adversely affected.
S-11
Difficulties in constructing our network could increase its estimated cost and
delay its scheduled completion
The construction, operation and any upgrading of our network is a
significant undertaking. Administrative, technical, operational and other
problems that could arise may be more difficult to address and solve due to the
significant size and complexity of the planned network. We are also dependent
on timely performance by third-party suppliers and contractors. In addition,
important aspects of our network, such as voice capability, will rely on
technology that is in the development stage or that is largely commercially
unproven. This new technology also may not be compatible with existing
technology. Many of these factors and problems are beyond our control. As a
result, the entire network may not be completed as planned for the cost and in
the time frame that we currently estimate. We may be materially adversely
affected as a result of any significant increase in the estimated cost of the
network or any significant delay in its anticipated completion.
After its initial completion, future expansions and adaptations of our
network's electronic and software components may be necessary in order to
respond to:
. a growing number of customers;
. increased demands by our customers to transmit larger amounts of data;
. changes in our customers' service requirements; and
. technological advances by our competitors.
Any expansion or adaptation of our network will require substantial
additional financial, operational and managerial resources. If we are unable to
expand or adapt our network to respond to these developments on a timely basis
and at a commercially reasonable cost, then our business will be materially
adversely affected.
Our business could be materially affected by problems arising from the
commercial deployment of our voice technology for Internet Protocol networks
We and others have developed technology that we believe will avoid the need
for customers on a private Internet Protocol based network to dial access codes
or follow other special procedures to initiate a voice call. We began to
commercially deploy this technology for long distance voice service in December
1999 and problems with it may be discovered as it continues to be deployed. Our
efforts to commercially deploy this technology in a timely manner and at an
acceptable cost may not be successful, and such a failure could have a material
adverse effect on us. We are currently testing some features associated with
local voice service such as caller ID, voicemail and call forwarding. To date,
Internet Protocol voice telephony using the public Internet has had significant
problems with quality, latency, reliability and security. Until we more fully
commercially deploy our voice telephony services, we cannot predict whether our
plans for solving these problems will work.
The commercial deployment of our voice telephony services also requires that
we develop related business support systems. Our failure to develop these
business support systems could have an adverse effect on the commercial
deployment of these services.
Our Business Plan requires the development of effective business support
systems to implement customer orders and to provide and bill for services
Our Business Plan depends on our ability to develop effective business
support systems. This is a complicated undertaking requiring significant
resources and expertise and support from third-party vendors. Business support
systems are needed for:
. implementing customer orders for services;
. provisioning, installing and delivering these services; and
. monthly billing for these services.
S-12
Since our Business Plan provides for rapid growth in the number and volume
of products and services we offer, we need to develop these business support
systems on a schedule sufficient to meet our proposed service rollout dates. In
addition, we will require these business support systems to expand and adapt
with our rapid growth. The failure to develop effective business support
systems could have a material adverse effect on our ability to implement our
Business Plan.
We may be unable to hire and retain sufficient qualified personnel; the loss of
any of our key executive officers could adversely affect us
We believe that our future success will depend in large part on our ability
to attract and retain highly skilled, knowledgeable, sophisticated and
qualified managerial, professional and technical personnel. To implement our
Business Plan, we need to have a substantial number of additional employees. We
have experienced significant competition in attracting and retaining personnel
who possess the skills that we are seeking. As a result of this significant
competition, we may experience a shortage of qualified personnel. Our
businesses are managed by a small number of key executive officers,
particularly James Q. Crowe, Chief Executive Officer, R. Douglas Bradbury,
Chief Financial Officer, Kevin J. O'Hara, Chief Operating Officer and Colin
V.K. Williams, Executive Vice President. The loss of any of these key executive
officers could have a material adverse effect on us.
Inability to manage effectively our planned rapid expansion could adversely
affect our operations
Our Business Plan contemplates rapid expansion of our business for the
foreseeable future. This growth will increase our operating complexity and
require that we, among other things, rapidly:
. expand our employee base with highly skilled personnel;
. develop, introduce and market new products and services;
. integrate any acquired operations and joint ventures;
. secure space suitable for colocation facilities;
. develop financial and management controls and systems; and
. control expenses related to our Business Plan.
The significant size and complexity of our planned network and planned rate
of expansion will make it more difficult to satisfy these requirements. Our
failure to satisfy any of these requirements, or otherwise manage our growth
effectively, could have a material adverse effect on us.
If we were to make strategic investments, acquisitions or joint ventures,
our resources and management time could be diverted and we may be unable to
integrate them successfully with our existing network and services.
We must obtain and maintain permits and rights-of-way to develop our network
The operation of our networks requires that we obtain many local franchises
and other permits. We also must obtain rights to use underground conduit and
aerial pole space and other rights-of-way and fiber capacity. The process of
obtaining these franchises, permits and rights is time consuming and
burdensome. If we are unable, on acceptable terms and on a timely basis, to
obtain and maintain the franchises, permits and rights needed to implement our
Business Plan, the buildout of our network could be materially adversely
affected. In addition, the cancellation or non-renewal of the franchises,
permits or rights we do obtain, or the loss of the rights-of-way we have
obtained, could materially adversely affect us.
Termination of relationships with key suppliers could cause delay and costs
Until we complete the company-owned portion of our network, we will lease
substantially all of our intercity communications capacity in North America,
Europe and possibly elsewhere. As a result, we will be dependent on the
providers of this capacity. In addition, we intend to lease a significant
amount of capacity
S-13
from local exchange carriers to connect our customers to our gateway sites. We
are also dependent on third-party suppliers for substantial amounts of fiber,
conduit, computers, software, switches/routers and related components that we
will assemble and integrate into our network. If any of these relationships are
terminated or a supplier fails to provide reliable services or equipment and we
are unable to reach suitable alternative arrangements quickly, we may
experience significant delays and additional costs. If that happens, we could
be materially adversely affected.
Our industry is highly competitive with participants that have greater
resources and existing customers
The communications and information services industry is highly competitive.
Many of our existing and potential competitors have financial, personnel,
marketing and other resources significantly greater than ours. Many of these
competitors have the added competitive advantage of an existing customer base.
In addition, significant new competitors could arise as a result of:
. increased consolidation and strategic alliances in the industry
resulting from recent Congressional and FCC actions;
. allowing foreign carriers to compete in the U.S. market;
. further technological advances; and
. further deregulation and other regulatory initiatives.
If we are unable to compete successfully, our business could be materially
adversely affected.
Rapid technological changes can lead to further competition
The communications and information services industry is subject to rapid and
significant changes in technology. In addition, the introduction of new
products or technologies may reduce the cost or increase the supply of certain
services similar to those that we plan to provide. As a result, our most
significant competitors in the future may be new entrants to the communications
and information services industry. These new entrants may not be burdened by an
installed base of outdated equipment. Technological changes and the resulting
competition on our operations could have a material adverse effect on us.
Increased industry capacity and other factors could lead to lower prices for
our products and services
AT&T, MCI WorldCom, Sprint and Qwest currently own nationwide long distance
fiber optic networks. MCI WorldCom has entered into an agreement to acquire
Sprint. In Europe, GTS, MCI WorldCom and Viatel currently own intercity
networks. Qwest's network, as well as the intercity networks being deployed by
others, including Broadwing and Williams Communications in the United States
and KPNQwest, i-21 and Global Crossing in Europe, use advanced technology
similar to that of our network. In addition, there are numerous local and
regional networks. Increased capacity may cause significant decreases in the
prices for services. Prices may also decline due to capacity increases
resulting from technological advances and strategic alliances, such as long
distance capacity purchasing alliances among regional Bell operating companies.
These price declines may be particularly severe if recent trends causing
increased demand for capacity, such as Internet usage, change. Rapid growth in
the use of the Internet is a recent phenomenon, and may not continue at the
same rate. Increased competition has already led to a decline in rates charged
for various telecommunications services.
We are subject to significant regulation that could change in an adverse manner
Communications services are subject to significant regulation at the
federal, state, local and international levels. These regulations affect us and
our existing and potential competitors. Delays in receiving required regulatory
approvals, completing interconnection agreements with incumbent local exchange
carriers or the enactment of new and adverse regulations or regulatory
requirements may have a material adverse effect on us. In addition, future
legislative, judicial, and regulatory agency actions could have a material
adverse effect on us.
S-14
Recent federal legislation provides for a significant deregulation of the
U.S. telecommunications industry, including the local exchange, long distance
and cable television industries. This legislation remains subject to judicial
review and additional FCC rulemaking. As a result, we can not predict the
legislation's effect on our future operations. Many regulatory actions are
under way or are being contemplated by federal and state authorities regarding
important items. These actions could have a material adverse effect on us.
Canadian law currently does not permit us to offer services in Canada
Ownership of facilities that originate or terminate traffic in Canada is
currently limited to Canadian carriers. This restriction will block our entry
into the Canadian market unless appropriate arrangements can be made to address
it.
Potential regulation of Internet service providers could adversely affect our
operations
The FCC has to date treated Internet service providers as enhanced service
providers. Enhanced service providers are currently exempt from federal and
state regulations governing common carriers, including the obligation to pay
access charges and contribute to the universal service fund. The FCC is
currently examining the status of Internet service providers and the services
they provide. If the FCC were to determine that Internet service providers, or
the services they provide, are subject to FCC regulation, including the payment
of access charges and contribution to the universal service funds, it could
have a material adverse effect on us.
The FCC has also been considering whether local carriers are obligated to
pay compensation to each other for the transport and termination of calls to
Internet service providers when a local call is placed from an end user of one
carrier to an Internet service provider served by a competing local exchange
carrier. Recently, the FCC determined that it had no rule addressing inter-
carrier compensation for these calls. In the absence of a federal rule, state
commissions may elect not to require payment of reciprocal compensation for
these calls. The FCC also released for comment alternative federal rules to
govern compensation for these calls in the future. If state commissions, the
FCC or the courts determine that inter-carrier compensation does not apply,
carriers, including us, may be unable to recover their costs or will be
compensated at a significantly lower rate and may be required to refund
compensation previously paid.
Network failure or delays and errors in transmissions expose us to potential
liability
Our network will use a collection of communications equipment, software,
operating protocols and proprietary applications for the high speed
transportation of large quantities of data among multiple locations. Given the
complexity of our proposed network, it may be possible that data will be lost
or distorted. Delays in data delivery may cause significant losses to a
customer using our network. Our network may also contain undetected design
faults and software bugs that, despite our testing, may be discovered only
after the network has been installed and is in use. The failure of any
equipment or facility on the network could result in the interruption of
customer service until we effect necessary repairs or install replacement
equipment. Network failures, delays and errors could also result from natural
disasters, power losses, security breaches and computer viruses. These
failures, faults or errors could cause delays, service interruptions, expose us
to customer liability or require expensive modifications that could have a
material adverse effect on our business.
Intellectual property and proprietary rights of others could prevent us from
using necessary technology to provide Internet Protocol voice services
While we do not know of any technologies that are patented by others that we
believe are necessary for us to provide Internet Protocol voice services, this
necessary technology may in fact be patented by other parties either now or in
the future. If this technology were held under patent by another person, we
would have to negotiate a license for the use of that technology. We may not be
able to negotiate such a license at a price that is acceptable to us. The
existence of such a patent, or our inability to negotiate a license for any
such technology on acceptable terms, could force us to cease using the
technology and offering products and services incorporating the technology.
S-15
Our subsidiaries must make payments to us in order for us to make payments on
the notes
We are a holding company with no material assets other than the stock of our
subsidiaries. Accordingly, we depend upon cash payments from our subsidiaries
to meet our payment obligations, including our obligation to pay you as a
holder of notes. Our subsidiaries may not generate earnings sufficient to
enable us to meet our payment obligations. The senior secured credit facility
imposes significant restrictions on the ability of our subsidiaries to make
distributions or other payments to us. In addition, our subsidiaries may enter
into debt agreements in the future that contain similar restrictions.
The notes will rank below our existing and future senior debt, and we may be
unable to repay our obligations under the notes
The notes will be unsecured and subordinated in right of payment to all of
our existing and future senior debt, including both issues of our outstanding
senior notes, and the issues of our senior notes and senior discount notes
being offered concurrently with this offering and our guaranty of borrowings by
our subsidiaries under our senior secured credit facility. Because the notes
are subordinated to our senior debt, in the event of:
. our bankruptcy, liquidation or reorganization,
. the acceleration of the notes due to an event of default under the
indenture, and
. certain other events,
we will make payments on the notes only after we have satisfied all of our
senior debt obligations. Therefore, we may not have sufficient assets remaining
to pay amounts on any or all of the notes. Assuming that on December 31, 1999
we had raised gross proceeds of $2.21 billion from the other debt offerings, we
would have had on that date $5.244 billion of outstanding senior debt,
including $475 million of our subsidiaries' debt guaranteed by us, and our
subsidiaries would have had $900 million in additional borrowings available
under the senior secured credit facility guaranteed by us on a senior basis.
Our senior secured credit facility is secured by substantially all of our
assets and, subject to certain exceptions, all of the assets of our wholly
owned domestic subsidiaries.
In addition, all payments on the notes will be prohibited in the event of a
payment default on senior debt obligations and may be prohibited in the event
of some non-payment defaults according to the terms of the notes and our
existing and proposed senior debt obligations.
Because the notes are structurally subordinated to the obligations of our
subsidiaries, you may not be fully repaid if we become insolvent
Substantially all of our operating assets are held directly by our
subsidiaries. Holders of any preferred stock of any of our subsidiaries and
creditors of any of our subsidiaries, including trade creditors, have and will
have claims relating to the assets of that subsidiary that are senior to the
notes and each issue of our outstanding and proposed notes. As a result, the
notes and each issue of our outstanding and proposed debt are structurally
subordinated to the debt, preferred stock and other obligations of our
subsidiaries. Holders of the notes have no claim to the assets of any of our
subsidiaries. As of December 31, 1999, our subsidiaries had approximately
$1.983 billion in aggregate indebtedness and other balance sheet liabilities,
excluding intercompany liabilities, and $900 million in additional borrowings
available under our senior secured credit facility.
Because the notes that you hold are unsecured, you may not be fully repaid if
we become insolvent
The notes will not be secured by any of our assets or our subsidiaries'
assets. The indentures relating to the notes, the other notes we are offering
and our outstanding notes permit us to incur secured debt. Our subsidiaries'
obligations under our $1.375 billion senior secured credit facility are secured
by substantially all of our assets and are guaranteed by us. If we became
insolvent the holders of any secured debt would receive payments from the
assets used as security before you receive payments.
S-16
We have substantial existing debt and expect to incur substantial additional
debt, so we may be unable to make payments on the notes
Assuming that on December 31, 1999 we had completed this offering and raised
gross proceeds of $2.21 billion from the other debt offerings, we would have
had approximately $6.95 billion of indebtedness, and our subsidiaries would
have had $900 million in additional borrowings available under our senior
secured credit facility. The indentures relating to the notes and each issue of
our outstanding and proposed notes permit us to incur substantial additional
debt, and we fully expect to borrow substantial additional funds, which may
include secured borrowings, in connection with implementing the Business Plan.
A substantial level of debt makes it more difficult for us to repay you.
Substantial amounts of our existing debt will, and our future debt may, mature
prior to the notes.
We may be unable to generate cash flow from which to make payments on the notes
We had deficiencies in our ratios of earnings to fixed charges and preferred
stock dividends of approximately $695 million for the fiscal year 1999 and
approximately $36 million for the fiscal year 1998. We expect to incur
substantial net operating losses for the foreseeable future. We may not become
profitable or sustain profitability in the future. Accordingly, we may not have
sufficient funds to make payments on the notes.
Future additional debt that we incur in implementing our Business Plan may have
a negative effect on our financial flexibility and stability
Our Business Plan will require us and our subsidiaries to incur substantial
amounts of additional indebtedness in the future. The extent to which we incur
additional debt, and the restrictive and financial covenants that we will be
subject to, will have important consequences to the holders of the notes. These
include the following:
. a potential impairment of our ability to obtain additional financing for
the Business Plan, including financing necessary to fund the substantial
net losses incurred in connection with the Business Plan;
. the requirement that a substantial portion of our cash flow from
operations must be dedicated to the payment of debt service, thus
reducing the funds available for the Business Plan; and
. potential limits on our ability to adjust rapidly to changing market
conditions and vulnerability in the event of a downturn in general
economic conditions or in the communications and information services
business.
If we experience a change in control, we may be unable to purchase the notes
you hold as required under the indenture
Upon the occurrence of certain change of control events, we must make an
offer to purchase all outstanding notes at a purchase price equal to 100% of
the principal amount of the notes, plus accrued interest. We may not have
sufficient funds to pay the purchase price for all notes tendered by holders
seeking to accept the offer to purchase. In addition, the indentures relating
to the notes and each issue of our outstanding and proposed notes, the senior
secured credit facility and our other debt agreements may require us to
repurchase the other debt upon a change in control or may prohibit us from
purchasing any notes before their stated maturity, including upon a change of
control. Our failure to purchase all validly tendered notes would result in an
event of default under the indenture. See "Description of Notes--Repurchase at
Option of Holders Upon a Change of Control."
Our senior secured credit facility may prohibit us from making payment on the
notes
Our senior secured credit facility generally does not permit us or our
subsidiaries to make payments on any outstanding indebtedness other than
regularly scheduled interest and principal payments as and when due. As a
result, our senior secured credit facility would prohibit us from making any
payment on the notes in the
S-17
event that the notes are accelerated or tendered for redemption upon a change
in control. Any such failure to make payments on the notes would cause us to
default under our indentures, which in turn is likely to be a default under the
senior secured credit facility and other outstanding and future indebtedness.
PKS Systems Integration LLC may have liability from its Year 2000 customer
projects
PKS Information Services, Inc. derived a substantial portion of its revenue
from projects that its subsidiary, PKS Systems Integration LLC, or PKSSI,
conducted involving Year 2000 assessment and renovation services. These
activities of PKSSI expose us to potential risks that may include problems with
services provided by PKSSI to its customers and the potential for claims
arising under PKSSI's customer contracts. PKSSI's attempts to contractually
limit its exposure to liability for Year 2000 compliance issues may not be
effective. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000."
Foreign currency exchange rate fluctuations or repatriation could result in
losses
Our international expansion will cause our results of operations and the
value of our assets to be affected by the exchange rates between the U.S.
dollar and the currencies of the additional countries in which we have
operations and assets. In some of these countries, prices of our products and
services will be denominated in a currency other than the U.S. dollar. As a
result, we may experience economic losses solely as a result of foreign
currency exchange rate fluctuations, including a foreign currency's devaluation
against the U.S. dollar. We may also in the future acquire interests in
companies that operate in countries where the removal or conversion of currency
is restricted. In addition, similar restrictions could be imposed in countries
where we conduct business after we begin our operations.
Environmental liabilities from our historical operations could be material
Our operations and properties are subject to a wide variety of laws and
regulations relating to environmental protection, human health and safety.
These laws and regulations include those concerning the use and management of
hazardous and non-hazardous substances and wastes. We have made and will
continue to have to make significant expenditures relating to our environmental
compliance obligations. We may not at all times be in compliance with all these
requirements.
In connection with certain historical operations, we are a party to, or
otherwise involved in, legal proceedings under state and federal law involving
investigation and remediation activities at approximately 110 contaminated
properties. We could be held liable, jointly and severally, and without regard
to our own fault, for such investigation and remediation. The discovery of
additional environmental liabilities related to our historical operations or
changes in existing environmental requirements could have a material adverse
effect on us.
Significant future declines in cash flow from coal operations
Approximately 40% of our net revenues for 1999 were attributable to our coal
mining operations. The level of cash flows generated in recent periods by our
coal operations will not continue after the year 2000. These cash flow levels
will decrease because the delivery requirements under our current long-term
contracts decline significantly after that date. Moreover, without those
contracts, our coal mining operations would not be able to operate profitably
by selling their production on the spot markets. A substantial majority of our
coal mining revenues are provided by three customer contracts.
Potential liabilities and claims arising from our coal operations could be
significant
Our coal operations are subject to extensive laws and regulations that
impose stringent operational, maintenance, financial assurance, environmental
compliance, reclamation, restoration and closure requirements.
S-18
These requirements include those governing air and water emissions, waste
disposal, worker health and safety, benefits for current and retired coal
miners, and other general permitting and licensing requirements. We may not at
all times be in compliance with all of these requirements. Liabilities or
claims associated with this non-compliance could require us to incur material
costs or suspend production. Mine reclamation costs that exceed our reserves
for these matters also could require us to incur material costs.
Anti-takeover provisions could limit our share price and delay a change of
management
Our certificate of incorporation and by-laws contain provisions that could
make it more difficult or even prevent a third party from acquiring our company
without the approval of our incumbent board of directors. These provisions,
among other things:
. divide our board of directors into three classes, with members of each
class to be elected in staggered three-year terms;
. prohibit stockholder action by written consent in place of a meeting;
. limit the right of stockholders to call special meetings of
stockholders;
. limit the right of stockholders to present proposals or nominate
directors for election at annual meetings of stockholders; and
. authorize our board of directors to issue preferred stock in one or more
series without any action on the part of stockholders.
If there is a change of control of Level 3, we may be required under the
provisions of our indentures and senior secured credit facility to repurchase
or repay the debt outstanding under those agreements.
These provisions could limit the price that investors might be willing to
pay in the future for shares of our common stock and significantly impede the
ability of the holders of our common stock to change management. In addition,
we have adopted a poison pill rights plan, which has anti-takeover effects. Our
rights plan, if triggered, will cause substantial dilution to a person or group
that attempts to acquire our company on terms not approved by our board of
directors. Provisions and agreements that inhibit or discourage takeover
attempts could reduce the market value of our common stock.
Sales of a large number of shares by Level 3 or by stockholders could depress
our stock price
The market price of our common stock could drop as a result of sales of a
large number of our shares in the public market after the offering. The
perception that sales may occur could have the same results. We will be subject
to a 90-day black-out period following the date of this prospectus supplement.
During this black-out period, we are not allowed to issue additional common
stock or securities convertible into common stock except in certain
circumstances or unless Salomon Smith Barney consents. One exception allows us
to issue additional stock in connection with acquisitions. A second exception
applies if we are included in a major market index.
Our officers and directors will not be subject to any lock-up provision.
Additional shares are issuable under our benefit program depending on the
extent to which, if any, our stock outperforms the S&P 500 by either rising at
a higher rate or falling at a lower rate. The number of such shares that would
be issued is based on a multiplier related to how much our stock outperforms
the S&P 500.
There may be no public market for the notes, so you may be unable to sell the
notes
The notes are a new issue of securities for which there is currently no
market. Consequently, the notes may be relatively illiquid, and you may be
unable to sell your notes. We do not intend to apply for listing of the notes
on any securities exchange or for the inclusion of the notes in any automated
quotation system. Although the underwriters have advised us that they intend to
make a market in the notes, they have no obligation to do so and may
discontinue any market making at any time without notice. In addition, any
market
S-19
making activity will be subject to the limits imposed by the Securities Act and
the Exchange Act. As a result, a market for the notes may not develop or, if it
does, may not be maintained.
Various factors could have a materially adverse effect on the trading price
of the notes, including the failure of an active market to develop and
fluctuations in the prevailing interest rates. In addition, our operating
results and prospects could from time to time be below the expectations of
public market analysts and investors, which could adversely affect public
perception of our creditworthiness and, therefore, the trading price of the
notes. The trading price of the notes could also be significantly affected by
the market price of our common stock, which has fluctuated significantly since
it has been publicly traded and may continue to do so in the future.
If you convert any notes, the value of the common stock you receive may
fluctuate significantly
Since our common stock has been publicly traded, its market price has
fluctuated significantly and may continue to do so in the future. Significant
fluctuations in the market price of our common stock may occur in response to
various factors and events, including, among other things:
. the depth and liquidity of the trading market for our common stock;
. quarterly variations in actual or anticipated operating results;
. changes in estimates by securities analysts;
. market conditions in the communications and information services
industry;
. announcements and performance by competitors;
. regulatory actions; and
. general economic conditions.
The terms of our debt agreements restrict us from making payments with respect
to our common stock
Our ability to pay cash dividends on, or repurchase shares of, our common
stock is limited under the terms of our indentures and senior secured credit
facility. We do not currently intend to pay any cash dividends in the
foreseeable future.
Certain Foreign Holders may be subject to adverse U.S. federal income tax
consequences
Generally, if a Foreign Holder, as defined under "Certain United States
Federal Income Tax Considerations," disposes of a note, that holder must treat
such gain as income effectively connected with a U.S. trade or business if we
were a "United States real property holding corporation" at any time during the
shorter of the five years before the disposition or the holding period of the
holder. We may be, or may become, a United States real property holding
corporation. If the notes were considered to be "regularly traded" on an
"established securities market" within the meaning of Treasury Regulations,
then this rule would only apply to a Foreign Holder that owns, actually or
constructively, at any time during the period described in the first sentence
of this paragraph, more than 5% of the total fair market value of the notes
outstanding. See "Certain United States Federal Income Tax Considerations--
Foreign Holders."
S-20
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus supplement contains or incorporates by reference forward-
looking statements. These forward-looking statements include, among others,
statements concerning:
. the Business Plan, its advantages and our strategy for implementing the
Business Plan;
. anticipated growth of the communications and information services
industry;
. plans to devote significant management time and capital resources to our
business;
. expectations as to our future revenues, margins, expenses and capital
requirements;
. anticipated dates on which we will begin providing certain services or
reach specific milestones in the Business Plan; and
. other statements of expectations, beliefs, future plans and strategies,
anticipated developments and other matters that are not historical
facts.
You should be aware that these forward-looking statements are subject to
risks and uncertainties, including financial, regulatory, environmental,
industry growth and trend projections, that could cause actual events or
results to differ materially from those expressed or implied by the statements.
The most important factors that could prevent us from achieving our stated
goals include, but are not limited to, our failure to:
. achieve and sustain profitability based on the creation and
implementation of our advanced, international, facilities based
communications network based on Internet Protocol technology;
. overcome significant early operating losses;
. produce sufficient capital to fund the Business Plan;
. develop financial and management controls, as well as additional
controls of operating expenses as well as other costs;
. attract and retain qualified management and other personnel;
. install on a timely basis the switches/routers, fiber optic cable and
associated electronics required for successful implementation of the
Business Plan;
. successfully complete commercial testing of our softswitch technology
for voice and fax transmission services;
. negotiate new and maintain existing peering agreements; and
. develop and implement effective business support systems for processing
customer orders and provisioning.
For a discussion of certain of these factors, see "Risk Factors."
S-21
USE OF PROCEEDS
Our net proceeds from this offering are estimated to be $727,435,000, or
$836,616,000 if the underwriters' over-allotment option is exercised in full.
Our net proceeds from this offering and from the other offerings will be used
for working capital, capital expenditures, acquisitions and other general
corporate purposes in connection with the implementation of our Business Plan.
Although we evaluate potential acquisitions from time to time, we currently
have no agreement or understanding with any person to effect any material
acquisition.
Pending this utilization, we intend to invest the net proceeds of this
offering in short-term investments.
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of December 31, 1999 and that capitalization as adjusted to give
effect to the net proceeds from this offering, assuming no exercise of the
underwriters' over-allotment option, and as further adjusted to give effect to
the net proceeds from the other offerings. These further adjustments assume
that all the other offerings are completed for the amounts indicated below.
The table below also assumes the conversion of the euro-denominated senior
notes at an exchange rate of approximately 1.00 euro per dollar, the spot
trading rate of the euro at the end of the London business day on February 23,
2000.
December 31, 1999
-----------------------------
As
Further
Adjusted
As Adjusted for the
for this other
Actual Offering Offerings
------ ----------- ---------
(dollars in millions)
Cash and marketable securities................... $3,446 $4,173 $ 8,420
====== ====== =======
Current portion of long-term debt................ $ 6 $ 6 $ 6
====== ====== =======
Long-term debt, less current portion............. $3,989 $3,989 $ 3,989
Dollar-denominated notes......................... -- -- 1,410
Euro-denominated notes........................... -- -- 800
Notes offered by this prospectus supplement...... -- 750 750
------ ------ -------
Total long-term debt, less current portion..... 3,989 4,739 6,949
Stockholders' equity
Preferred Stock, $.01 par value; authorized
10,000,000 shares; no shares outstanding,
actual, as adjusted and as further adjusted... -- -- --
Common Stock, $.01 par value; authorized
1,500,000,000 shares; 341,396,727 shares
outstanding, actual and as adjusted and
361,396,727 shares outstanding as further
adjusted...................................... 3 3 4
Additional paid-in capital..................... 2,501 2,501 4,593
Accumulated other comprehensive loss........... (5) (5) (5)
Retained earnings.............................. 906 906 906
------ ------ -------
Total stockholders' equity................... 3,405 3,405 5,498
------ ------ -------
Total capitalization............................. $7,394 $8,144 $12,447
====== ====== =======
We are also offering senior notes and senior discount notes which will
generate aggregate gross proceeds of approximately $1,410,000,000,
(Euro)800,000,000 (approximately $800,000,000) of senior notes and 20,000,000
shares of our common stock, each in a separate offering pursuant to a separate
prospectus supplement or offering memorandum. No offering is conditioned on
the closing of any other. We may not complete any of the other offerings. This
prospectus supplement relates only to this offering of convertible notes and
not to the other offerings. The senior notes and senior discount notes and the
euro-denominated senior notes will not be registered under the Securities Act
of 1933 and may not be offered or sold in the United States absent
registration or an applicable exemption from registration requirements.
S-22
COMMON STOCK PRICE RANGE AND DIVIDENDS
Our common stock is quoted on the Nasdaq National Market under the symbol
"LVLT." It began trading on the Nasdaq National Market on April 1, 1998, the
day following the split-off of the Construction Group from our other
businesses. The table below sets forth, for the calendar quarters indicated,
the high and low per share closing sale prices of our common stock as reported
by the Nasdaq National Market. The prices set forth in the table have been
adjusted to reflect the two-for-one split of our common stock effected as a
stock dividend in August 1998.
High Low
Year Ended December 31, 1998 ------ ------
Second Quarter (from April 1, 1998)......................... $37.13 $24.00
Third Quarter............................................... 42.13 29.78
Fourth Quarter.............................................. 43.13 24.00
Year Ended December 31, 1999
First Quarter............................................... 72.81 39.75
Second Quarter.............................................. 93.06 60.06
Third Quarter .............................................. 65.50 46.88
Fourth Quarter.............................................. 84.56 51.19
Year Ended December 31, 2000
First Quarter (through February 23, 2000)................... 123.50 73.81
On February 23, 2000, the closing price per share of our common stock was
$108.875. We urge you to obtain current market quotations of our common stock
before making any decision with respect to an investment in the notes.
We intend to retain future earnings for use in our business, and we do not
anticipate paying any cash dividends on our common stock in the foreseeable
future. In addition, our indentures and senior secured credit facility contain
limits on our ability to declare and pay cash dividends.
S-23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This document contains forward looking statements and information that are
based on the beliefs of management as well as assumptions made by and
information currently available to the Company. When used in this document, the
words "anticipate," "believe," "estimate" and "expect" and similar expressions,
as they relate to the Company or its management, are intended to identify
forward-looking statements. Such statements reflect the current views of the
Company with respect to future events and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those described in this document. For a
more detailed description of these risks, please see "Risk Factors" and
"Information Regarding Forward-Looking Statements."
Recent Developments
BusinessNet Ltd. Acquisition
On January 5, 1999, Level 3 acquired BusinessNet Ltd., a leading London-
based Internet service provider, in a largely stock-for-stock transaction
valued at $12 million and accounted for as a purchase. After completion of
certain adjustments, the Company agreed to issue approximately 400,000 shares
of common stock and paid $1 million in cash in exchange for all of the issued
and outstanding shares of BusinessNet's capital stock. Of the approximately
400,000 shares Level 3 agreed to issue in connection with the acquisition,
approximately 150,000 shares of its common stock have been pledged to Level 3
to secure certain indemnification obligations of the former BusinessNet
stockholders. In October 1999, Level 3 released approximately 42,000 shares of
the pledged shares. The pledge of the remaining shares will terminate in July
2000 unless otherwise extended pursuant to the terms of the acquisition
agreement. Liabilities exceeded assets acquired, and goodwill of $16 million
was recognized from the transaction and is being amortized over five years.
Common Stock Offering
On March 9, 1999, the Company closed the offering of 28.75 million shares of
its common stock through a public offering. The net proceeds from the offering
of approximately $1.5 billion, after underwriting discounts and offering
expenses, are being used for working capital, capital expenditures,
acquisitions and other general corporate purposes in connection with the
implementation of the Business Plan.
Increase in Authorized Shares Outstanding
On February 25, 1999, the Company's Board of Directors approved an increase
in the number of authorized shares of common stock from 500 million to 1
billion. On April 12, 1999, the Board of Directors approved a further increase
in the number of authorized shares of common stock by 500 million to 1.5
billion. The Company's stockholders approved the increase in authorized shares
at its 1999 Annual Meeting held on May 27, 1999.
Transatlantic Undersea Cable System
On April 23, 1999, Level 3 announced that it had contracted with Tyco
Submarine Systems Ltd. to design and build a transatlantic 1.28 Tbps undersea
cable system from Long Island, New York to North Cornwall, UK. The cable system
is expected to be in service by September 2000 and is expected to cost between
$600 to $800 million. The total cost will depend on how the cable is upgraded
over time. Level 3 has prefunded the purchase of significant amounts of
undersea capacity as part of the Business Plan, but may require additional
funding depending on the cable's ultimate structure, pre-construction sales and
ownership. On February 17, 2000, Level 3 announced an agreement whereby Global
Crossing Ltd. will acquire a 50% ownership interest in the Level 3
transatlantic undersea cable system. Under this agreement, Level 3 and Global
Crossing will each
S-24
separately own and operate two of the four fiber pairs on this transatlantic
cable. Level 3 also announced that it will acquire capacity on Global
Crossing's transatlantic cable Atlantic Crossing 1 (AC 1) as restoration
capacity for its transatlantic undersea cable system.
European Network
Level 3 announced on April 29, 1999 that it had finalized contracts relating
to construction of Ring 1 of its European network in France, Belgium, the
Netherlands, Germany and the United Kingdom. Ring 1, which is approximately
1,800 miles, will connect Paris, Frankfurt, Amsterdam, Brussels and London. The
network is expected to be ready for service by September 2000. Ring 1 is part
of the approximately 4,750 mile intercity network. This European network will
be linked to the Level 3 North American intercity network by the Level 3
transatlantic 1.28 Tbps cable system currently under development, also expected
to be ready for service by September 2000.
On July 26, 1999, the Company announced two important developments of its
European network build with agreements with Eurotunnel and Alcatel. Eurotunnel
will install and supply Level 3 with multiple cross-Channel cables between the
United Kingdom and France through the high-security service tunnel. The first
of these cables will be completed by the end of the first quarter of 2000.
Subsequent cables will be installed to upgrade and expand the network as and
when required or when new fiber technology becomes available. Alcatel will
design, develop and install an undersea cable to link the Level 3 network
between the United Kingdom and Belgium. The cable system is already under
development and will be completed by the end of the first half of 2000.
COLT Cost Sharing Agreement
On May 4, 1999, Level 3 and COLT Telecom Group plc announced an agreement to
share costs for the construction of European networks. The agreement calls for
Level 3 to share construction costs of COLT's planned 1,600 mile intercity
German network linking Berlin, Cologne, Dusseldorf, Frankfurt, Hamburg, Munich
and Stuttgart. In return, COLT will share construction costs of Ring 1 of Level
3's planned European network.
Lucent Agreement
On June 23, 1999, the Company announced a minimum four year, $250 million
strategic agreement with Lucent Technologies to purchase Lucent systems,
including new software switches or "softswitches." The minimum purchase
commitment is subject to certain conditions and has the potential to grow to $1
billion over five years.
Under this nonexclusive agreement, Lucent will provide Level 3 its Lucent
Technologies Softswitch, a software switch for Internet Protocol networks that
is intended to combine the reliability and features that customers expect from
the public switched telephone network with the cost effectiveness and
flexibility of Internet Protocol technology. With the Lucent Softswitch, Level
3 expects to provide a full range of Internet Protocol based communications
services similar in quality and ease of use to services on traditional circuit
voice networks. In addition, the companies also agreed to collaborate on future
enhancements of softswitches and gateway products to support next-generation
broadband services for business and consumers that will combine high-quality
voice and video communications with Internet-style web data services.
6% Convertible Subordinated Notes
On September 20, 1999, the Company closed the offering of $823 million
aggregate principal amount of its 6% convertible subordinated notes due 2009.
The net proceeds from the offering of approximately $798 million, after
underwriting discounts and offering expenses, are being used for working
capital, capital expenditures, acquisitions and other general corporate
purposes in connection with the implementation of the Business Plan.
S-25
Senior Secured Credit Facility
On September 30, 1999, the Company entered into a senior secured credit
facility in the aggregate principal amount of $1.375 billion. The facility is
comprised of a senior secured revolving credit facility in the amount of $650
million and a two-tranche senior secured term loan facility aggregating $725
million. At December 31, 1999 the Company had $475 million in outstanding
aggregate borrowings under the two-tranche senior secured term loan facility.
The facility is sometimes referred to in this prospectus supplement as the
senior secured credit facility.
(3)Voice SM
During December 1999, Level 3 commercially launched (3)Voice, its Internet
Protocol long distance service, which utilizes softswitch technology. This long
distance service is currently available in 10 markets. The Company expects to
begin commercial testing of some features associated with local service, such
as caller ID, voice mail and call forwarding, during the first quarter of 2000.
Customers access the (3)Voice long distance service by using existing telephone
equipment and dialing procedures.
Northern Asia Undersea Cable System
On January 24, 2000, Level 3 announced its intention to develop and
construct a 2.56 Tbps Northern Asia undersea cable system initially connecting
Hong Kong and Tokyo. This connection is expected to be in service by the end of
the second quarter of 2001. The Hong Kong-Tokyo cable is intended to be the
first stage of the Company's construction of an undersea network in the region.
The Company plans to share construction and operating expenses of the system
with one or more industry partners.
Expansion of Business Plan
On January 24, 2000, Level 3 announced the expansion of its Business Plan to
increase the amount of gateway space it intends to secure to approximately 6.5
million square feet. Level 3 currently has secured approximately 3.4 million
square feet of gateway space. The Company has completed the buildout of
approximately 1.3 million square feet of gateway space.
Recent Accounting Developments
In December 1999, the SEC staff released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." SAB 101 provides interpretive
guidance on the recognition, presentation and disclosure of revenue in the
financial statements. SAB 101 must be applied to the financial statements no
later than the first quarter of 2000. The Company does not believe that the
adoption of SAB 101 will have a material affect on the Company's financial
results.
Effective July 1, 1999, the Financial Accounting Standards Board, or the
FASB, issued Interpretation No. 43, "Real Estate Sales, an interpretation of
FASB Statement No. 66." Certain sale and long-term right-to-use agreements of
dark fiber and capacity entered into after June 30, 1999 are required to be
accounted for in the same manner as sales of real estate with property
improvements or integral equipment. Failure to satisfy the requirements of the
Interpretation will result in the deferral of revenue recognition for these
contracts. The adoption of this Interpretation does not have a current effect
on the Company's cash flows.
Accounting practice and guidance with respect to the accounting treatment of
these transactions is evolving. Any changes in the accounting treatment could
affect the way the Company accounts for revenue and expenses associated with
these agreements in the future.
Results of Operations
In late 1997, the Company announced a plan to increase substantially its
information services business and to expand the range of services it offers by
building an advanced, international, facilities based communications
S-26
network based on Internet Protocol technology. Since the Business Plan
represents a significant expansion of the Company's communications and
information services business, the Company does not believe that the Company's
financial condition and results of operations for prior periods will serve as a
meaningful indication of the Company's future financial condition or results of
operations. The Company expects to incur substantial net operating losses for
the foreseeable future and it may not be able to achieve or sustain operating
profitability in the future.
1999 vs. 1998
The following discussion should be read in conjunction with the Company's
consolidated financial statements (including the notes thereto) included
elsewhere herein.
Revenue. Revenue for the years ended December 31, 1999 and December 31, 1998
is summarized as follows (in millions):
1999 1998
---- ----
Communications and Information Services........................... $289 $144
Coal Mining....................................................... 207 228
Other............................................................. 19 20
---- ----
$515 $392
==== ====
Communications and information services revenue increased from $144 million
for the year ended December 31, 1998 to $289 million for the year ended
December 31, 1999. Revenue attributable to the communications business
increased from $24 million in 1998 to $159 million in 1999. In May 1999 the
Massachusetts Department of Public Utilities ruled that Bell Atlantic was no
longer required to pay the established reciprocal compensation rates for
certain services. As a result, beginning in the second quarter, Level 3 elected
not to recognize additional revenue from these agreements until the
uncertainties were resolved. The Company reached a tentative agreement with
Bell Atlantic in October 1999. The agreement established new intercarrier or
reciprocal compensation rates between the two carriers and assures that the
Company will be paid for the traffic it terminates from Bell Atlantic. As part
of the agreement, the Company and Bell Atlantic have also settled past disputes
over reciprocal compensation billing issues. The implementation of the new rate
structure and reciprocal compensation billing settlement was contingent upon
certain conditions including approval by relevant regulatory authorities.
During the fourth quarter, Massachusetts and other states approved the
agreement and therefore, the Company recognized $16 million of reciprocal
compensation revenue. Also during the fourth quarter the Company completed
certain sections of its intercity and metropolitan networks and recognized $26
million of revenue from IRU contracts entered into before June 30, 1999. In
1999 the Company recognized a total of $24 million and $37 million of revenue
attributable to reciprocal compensation agreements and IRU contracts,
respectively. In addition the Company recognized in 1999 $33 million of revenue
attributable to private line services, $24 million of revenue attributable to
managed modem services, $23 million attributable to colocation services, and
$18 million of revenue attributable to Internet access services.
Systems integration revenue increased 11% to $63 million in 1999. Revenue
for the computer outsourcing business increased 6% to $67 million in 1999.
Revenue attributable to new customers and additional services for existing
customers led to the increase in computer outsourcing and systems integration
revenue.
Mining revenue in 1999 decreased to $207 million from $228 million in 1998
due to reduced tonnage requirements under existing contracts with Commonwealth
Edison Company and the expiration of a long-term contract with Commonwealth in
1998. If current market conditions continue, the Company will experience a
significant decline in coal revenue and earnings beginning in 2001 as long-term
contracts begin to expire.
Other revenue was consistent with 1998 and is primarily attributable to a
privately owned tollroad in southern California.
S-27
Cost of Revenue. Cost of revenue increased $161 million or 81% to $360
million in 1999 as a result of the expanding communications business. In 1999,
communications network expenses were $183 million as compared to $12 million in
the prior year. The increase in costs is primarily attributable to the Frontier
and IXC Communications leased network expenses, the costs associated with the
XCOM and GeoNet acquisitions, and costs attributable to the products the
Company began offering in late 1998 and 1999. The cost of revenue for the
information services business, as a percentage of revenue, decreased for the
year ended December 31, 1999 compared to the same period in 1998. This decrease
is primarily due to an increase in the utilization rates of systems integration
personnel in 1999. The cost of revenue for the coal business, as a percentage
of revenue, increased due to the expiration of a high margin long-term contract
in 1998.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased from $66 million in 1998 to $228 million in 1999. The significant
increase in the amount of assets placed in service during the latter part of
1998 and throughout 1999 for the communications business resulted in the
increase in depreciation expense. The acquisitions of XCOM, GeoNet and
BusinessNet in 1998 and 1999 also contributed to the increase in depreciation
and amortization expense in 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased significantly to $668 million in 1999 from
$332 million in 1998 primarily due to the cost of activities associated with
the expanding communications business. Compensation, travel and facilities
costs increased substantially due to the additional employees that have been
hired to implement the Business Plan. The total number of employees of the
Company increased to approximately 3,850 at December 31, 1999 from
approximately 2,200 at December 31, 1998. Professional fees, including legal
costs associated with obtaining licenses, agreements and technical facilities
and other development costs associated with the Company's plans to expand
services offered in U.S., European and Asian markets, consulting fees incurred
to develop and implement the Company's business support systems, and
advertising, marketing and other selling costs contributed to the higher
selling, general and administrative expenses. The Company also recorded $126
million of non-cash compensation in 1999 for expenses recognized under SFAS No.
123 related to grants of stock options and warrants, up from $39 million in
1998. In addition to the expenses noted above, the Company capitalized $116
million and $52 million of selling, general and administrative expenses in 1999
and 1998, respectively, which consisted primarily of compensation expense for
employees and consultants working on capital projects. As the Company continues
to implement the Business Plan, selling, general and administrative costs are
expected to continue to increase significantly.
Write-off of In-Process Research and Development. Write-off of in-process
research and development of $30 million in 1998 was the portion of the purchase
price allocated to the telephone network-to-Internet Protocol network bridge
technology acquired by the Company in the XCOM transaction and was estimated
through formal valuation. In accordance with generally accepted accounting
principles, the $30 million was taken as a nondeductible charge against
earnings in the second quarter of 1998.
EBITDA. EBITDA, as defined by the Company, consists of earnings (losses)
before interest, income taxes, depreciation, amortization, non-cash operating
expenses (including stock-based compensation and in process research and
development charges) and other non-operating income or expenses. The Company
excludes non-cash compensation due to its adoption of the expense recognition
provisions of SFAS No. 123. EBITDA decreased from ($100) million in 1998 to
($387) million in 1999 primarily due to the significant increase in selling,
general and administrative expenses, described above, incurred in connection
with the implementation of the Company's Business Plan. EBITDA is commonly used
in the communications industry to analyze companies on the basis of operating
performance. EBITDA is not intended to represent cash flow for the periods
indicated. See "Consolidated Statements of Cash Flows."
Interest Income. Interest income increased from $173 million in 1998 to $212
million in 1999 primarily as a function of the Company's increasing average
cash, cash equivalents and marketable securities balances. The average cash
balance increased from approximately $3.7 billion during 1998 to approximately
$4.2 billion during 1999 as a result of the December 1998 senior discount notes
offering, the March 1999 equity offering
S-28
and the September 1999 subordinated notes offering and senior secured credit
facility agreement. Yields on the portfolio, however, have declined by
approximately 50 basis points in 1999 from the yields in 1998 primarily due to
the funds being invested in shorter term treasury securities. The accelerating
Business Plan has required the Company to shorten the average term of treasury
securities in which it invested in 1999. Pending utilization of the cash
equivalents and marketable securities in implementing the Business Plan, the
Company intends to invest the funds primarily in United States government and
governmental agency securities. This investment strategy will provide lower
yields on the funds, but is expected to reduce the risk to principal in the
short term prior to using the funds in implementing the Business Plan.
Interest Expense, Net. Interest expense, net increased $42 million to $174
million in 1999 due to the completion of the offering of $2 billion aggregate
principal amount of Senior Notes in April 1998, $834 million aggregate
principal amount at maturity of Senior Discount Notes offered in December 1998,
the Convertible Subordinated Notes issued in September 1999, and Senior Secured
Credit Facility entered into in September 1999. The amortization of the related
debt issuance costs also contributed to the increased interest expense in 1999.
The Company capitalized $116 million and $15 million of interest expense on
network construction and business support systems in 1999 and 1998,
respectively.
Equity in Losses of Unconsolidated Subsidiaries. Equity in losses of
unconsolidated subsidiaries are $127 million in 1999 and are primarily
attributable to RCN. RCN is the largest single source, facilities-based
provider of communications services to the residential markets primarily in the
Northeast and California and the largest regional Internet service provider in
the Northeast. RCN is also incurring significant costs in developing its
business plan. RCN's losses increased from $205 million in 1998 to $369 million
in 1999. The Company's proportionate share of these losses, including goodwill
amortization, was $135 million and $92 million in 1999 and 1998, respectively.
In 1998, the Company elected to discontinue its funding of Gateway Opportunity
Fund, LP, or Gateway, which provided venture capital to developing businesses.
The Company recorded losses of $28 million in 1998, to reflect Level 3's equity
in losses of the underlying businesses of Gateway. Also included are equity
earnings and losses of other equity method investments not individually
significant.
Gain on Equity Investee Stock Transactions. Gain on equity investee stock
transactions increased to $118 million in 1999. RCN issued stock in a public
offering and for certain transactions in 1998 and 1999 which diluted the
Company's ownership of RCN from 41% at December 31, 1998 to 35% at December 31,
1999. The increase in the Company's proportionate share of RCN's net assets as
a result of these transactions resulted in a pre-tax gain of $117 million from
subsidiary stock sales for the Company in 1999. The Company recognized $62
million of gains for similar stock transactions of RCN in 1998. The Company
also recognized $1 million of gains attributable to other equity method
investees.
Gains (Losses) on Sale of Assets. Gains (losses) on sale of assets decreased
significantly in 1999 due to the sale of Cable Michigan to Avalon Cable of
Michigan, Inc. in November 1998. The Company recognized a gain of approximately
$90 million from the cash-for-stock transaction. Included in gains (losses) on
the disposal of assets are ($3) million of losses and $8 million of gains on
the disposal of property, plant and equipment in 1999 and 1998 respectively,
and $1 million and $9 million of gains on the sale of marketable securities in
1999 and 1998 respectively.
Income Tax Benefit. Income tax benefit in 1999 and 1998 differs from the
statutory rate of 35% primarily due to losses incurred by the Company's
international subsidiaries which cannot be included in the consolidated U.S.
federal return, nondeductible goodwill amortization expense and state income
taxes. The income tax benefit in 1999 also differs from the statutory rate due
to foreign tax credits expected to be released upon carryback of 1999 net
operating losses that the Company will be unable to utilize. The income tax
benefit in 1998 also differs from the statutory rate due to the $30 million
nondeductible write-off of the research and development costs acquired in the
XCOM acquisition.
S-29
Discontinued Operations. Discontinued operations includes the one-time gain
of $608 million recognized upon the distribution of the Construction Group to
former Class C stockholders on March 31, 1998. Also included in discontinued
operations is the gain, net of tax, of $324 million from the Company's sale of
its energy assets to MidAmerican on January 2, 1998.
1998 vs. 1997
In 1998 the Company's Board of Directors changed Level 3's fiscal year end
from the last Saturday in December to a calendar year end. The additional five
days in the 1998 fiscal year are reflected in the period ended December 31,
1998. There were 52 weeks in fiscal years 1997 and 1996.
Revenue. Revenue for the years ended December 31, 1998 and December 27, 1997
is summarized as follows (in millions):
1998 1997
---- ----
Communications and Information Services....................... $144 $ 95
Coal Mining................................................... 228 222
Other......................................................... 20 15
---- ----
$392 $332
==== ====
Communications and Information Services revenue increased 52% in 1998. The
Internet Protocol business generated revenues of approximately $24 million in
1998, of which $22 million is attributable to the acquisition of XCOM.
Approximately 87% of XCOM's revenue is attributable to reciprocal compensation
agreements with Bell Atlantic. These agreements require the company originating
a call to compensate the company terminating the call. The FCC has been
considering whether local carriers are obligated to pay compensation to each
other for the transport and termination of calls to Internet service providers
when a local call is placed from an end user of one carrier to an Internet
service provider served by the competing local exchange carrier. Recently, the
FCC determined that it had no rule addressing inter-carrier compensation for
these calls. In the absence of a federal rule, the FCC determined that it would
not be unreasonable for a state commission, in some circumstances, to require
payment of compensation for these calls. The FCC also released for comment
alternative federal rules to govern compensation for these calls in the future.
If state commissions, the FCC or the courts determine that inter-carrier
compensation does not apply, carriers, including us, may be unable to recover
their costs or will be compensated at a significantly lower rate and may be
required to refund amounts previously received. Bell Atlantic has notified the
Company that it will be escrowing all amounts due the Company under the
reciprocal compensation agreements until the issue is resolved. An unfavorable
resolution of this matter may have a material adverse effect on the Company's
communications revenues.
The computer outsourcing business experienced significant revenue growth in
1998. The inclusion of a full year of revenue from customers which began
service in 1997 and an increase in revenue from the existing customer base,
resulted in a 26% increase in outsourcing revenue. The systems integration
business experienced a 27% increase in revenue in 1998. This increase is
primarily attributable to new acquisitions and a strong demand for Year 2000
renovation during the first six months of 1998 and other systems reengineering
services.
Revenue from coal mines increased slightly in 1998. An increase in alternate
source coal sales to Commonwealth was partially offset by the expiration of a
long-term contract also with Commonwealth. In 1998 the Company and Commonwealth
amended their contract to allow Commonwealth to accelerate delivery of coal.
The amended contract requires Commonwealth to take delivery of its year 2001
coal commitments in 1998, 1999 and 2000. Of the 2001 commitments, 50% was taken
in 1998 and 25% will be taken in both 1999 and 2000. The expiration of the
long-term contract was partially offset by contracts with new customers in
1998. If current market conditions continue, the Company will experience a
significant decline in coal revenue and earnings over the next several years as
delivery requirements under long-term contracts decline as these long-term
contracts begin to expire.
S-30
Other revenue is primarily attributable to CPTC, the owner operator of the
SR91 toll road in southern California. Revenues increased in 1998 primarily due
to higher traffic counts and increases in toll rates.
Cost of Revenue. Operating expenses increased 22% from $163 million in 1997
to $199 million in 1998 primarily due to expenses incurred in connection with
the Business Plan to expand the communications and information services
businesses. Operating expenses related to communications and information
services revenue in 1998 were $98 million up from $62 million in 1997. Costs
attributable to the XCOM and GeoNet acquisitions as well as costs associated
with the Frontier lease are responsible for an $11 million increase in
operating expenses. Operating expenses for the computer outsourcing and systems
integration business increased $5 million and $20 million in 1998,
respectively. The increase in the computer outsourcing operating expenses is
primarily attributable to the startup expenses associated with the second data
center in Tempe, Arizona. Higher than expected costs for Year 2000 work
resulted in the significant increase in systems integration operating expenses
in 1998. The Company also incurred expenses to refocus its efforts away from
Year 2000 services to systems and software reengineering for Internet Protocol
related applications. Operating expenses related to coal mining were consistent
with the prior year.
Depreciation and Amortization Expense. Depreciation and amortization expense
has increased $46 million from $20 million in 1997. The primary reason for this
increase is the $910 million of capital expenditures in 1998, of which
approximately $481 million was placed in service in 1998. The majority of
the assets placed in service are associated with 15 gateway sites constructed
for the expansion of the communications business. Also contributing to the
increase was the depreciation and amortization on equipment purchased for
computer outsourcing contracts, assets acquired through business acquisitions
in 1998 and the amortization of goodwill related to these acquisitions.
Depreciation and amortization will continue to increase in 1999 as additional
facilities are placed in service.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $226 million to $332 million in 1998. This
increase of 213% from 1997 is primarily attributable to the implementation of
the Business Plan, including additional communications and information services
personnel. The total number of communications and information services
employees at December 31, 1998 was approximately 2,200 as compared to
approximately 1,000 at December 27, 1997. Cash compensation included in expense
increased from $14 million in 1997 to $51 million in 1998. In addition, $39
million of non-cash stock based compensation expense was recorded in 1998, of
which $24 million was related to the Company's Outperform Stock Option program
introduced in the second quarter of 1998. These costs are accounted for in
accordance with SFAS No. 123. Professional fees increased $74 million in 1998
primarily for legal costs associated with obtaining licenses, agreements and
technical facilities and other development costs associated with starting to
offer services in U.S. cities. Also included in professional fees is third
party software and associated development costs incurred in developing
integrated business support systems. These expenses were recorded in accordance
with the AICPA Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use", which specifically
identifies those costs that should be expensed or capitalized for internally
developed software. Selling, general and administrative expenses are expected
to increase significantly in future periods as the Company continues to
implement the Business Plan.
Write-off of In-process Research and Development. Write-off of in process
research and development was $30 million in 1998. On April 23, 1998 the Company
completed the acquisition of XCOM, a privately held company that developed
certain components necessary for the Company to develop an interface between
its Internet Protocol based network and the existing public switched telephone
network.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated to
acquired in-process research and development, and was taken as a nondeductible
charge to earnings in the second quarter of 1998. In October 1998, the SEC
issued new guidelines for valuing acquired research and development which are
applied retroactively. Consequently, the Company has reduced the charge by $85
million, which also increases goodwill by a corresponding amount. Goodwill
associated with the XCOM transaction is being amortized over a five-year
period.
S-31
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guideline and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
EBITDA. EBITDA, as defined by the Company, consists of earnings (losses)
before interest, income taxes, depreciation, amortization, non-cash operating
expenses (including stock-based compensation and in process research and
development charges) and other non-operating income or expenses. The Company
excludes non-cash compensation due to its adoption of the expense recognition
provisions of SFAS No. 123. EBITDA decreased from $84 million in 1997 to $(100)
million in 1998 primarily due to the significant increase in general and
administrative expenses, described above, incurred in connection with the
implementation of the Company's Business Plan. EBITDA is commonly used in the
communications industry to analyze companies on the basis of operating
performance. EBITDA is not intended to represent cash flow for the periods. See
"Consolidated Statements of Cash Flows."
Interest Income. Interest income increased significantly in 1998 to $173
million from $33 million in 1997 as the Company's cash, cash equivalents and
marketable securities balances increased to $3.7 billion at December 31, 1998
from $765 million at December 27, 1997 as a result of the two debt offerings
and the proceeds from the sale of its energy business. Pending utilization of
the cash equivalents and marketable securities in implementing the Business
Plan, the Company intends to continue investing the funds primarily in
government and governmental agency securities. This investment strategy will
provide lower yields on the funds, but is expected to reduce the risk to
principal in the short term prior to using the funds in implementing the
Business Plan.
Interest Expense, Net. Interest expense, net increased significantly from
$15 million in 1997 to $132 million in 1998 due to the completion of the
offering of $2 billion aggregate principal amount of 9 1/8% senior notes due
2008 issued on April 28, 1998 and $834 million aggregate principal amount at
maturity of 10 1/2% senior discount notes due 2008 issued on December 2, 1998.
The amortization of a portion of the $79 million of debt issuance costs
associated with the senior notes and senior discount notes also increased
interest expense in 1998. The Company capitalized $15 million of interest
expense on network construction and business support systems development
projects in 1998.
Equity Losses in Unconsolidated Subsidiaries. Equity losses in
unconsolidated subsidiaries increased to $132 million in 1998 primarily due to
the equity losses attributable to RCN. RCN is the largest single source,
facilities based provider of communications services to the residential markets
primarily in the Northeast and the largest regional Internet service provider
in the Northeast. RCN is also incurring significant costs in developing its
business plan including the acquisitions of several Internet service providers.
RCN's losses increased from $52 million in 1997 to $205 million in 1998. The
Company's proportionate share of these losses, including goodwill amortization,
was $92 million and $26 million in 1998 and 1997, respectively. In 1998, the
Company elected to discontinue its funding of Gateway, which provided venture
capital to developing businesses. The Company recorded losses of $28 million
and $15 million in 1998 and 1997, respectively, to reflect Level 3's equity in
losses of the underlying businesses of Gateway. Also included in equity losses
are equity earnings of Commonwealth, a Pennsylvania public utility providing
telephone services, and equity losses of Cable Michigan prior to its sale in
1998, a cable television operator in the State of Michigan.
Gain on Equity Investee Stock Transactions. Gain on equity investee stock
transactions was $62 million in 1998. During 1998, RCN issued stock in a public
offering and for certain acquisitions. These transactions decreased the
Company's ownership in RCN from 48% in 1997 to 41% in 1998, but increased its
proportionate share of RCN's net assets. The Company recorded a pre-tax gain of
approximately $62 million to reflect this increase in value.
Gains on Sale of Assets. Gains on sale of assets increased significantly in
1998 due to the sale of Cable Michigan to Avalon Cable of Michigan, Inc. in
November 1998. The Company recognized a gain of
S-32
approximately $90 million from the cash for stock transaction. Also included in
gains on the disposal of assets are $8 million and $1 million of gains on the
disposal of property, plant and equipment in 1998 and 1997 respectively, and $9
million of gains on the sale of marketable securities in both periods.
Income Tax (Provision) Benefit. Income tax (provision) benefit differs from
the expected statutory rate of 35% primarily due to the nondeductible write-off
of the in process research and development costs allocated in the XCOM
transaction, losses incurred by the Company's international subsidiaries which
cannot be included in the consolidated U.S. federal income tax return and state
income taxes. In 1997 the effective rate was less than the expected statutory
rate primarily due to prior year tax adjustments, partially offset by the
effect of nondeductible compensation expense associated with the conversion of
the information services option and SAR plans to the Level 3 Stock Plan.
Discontinued Operations. Discontinued operations includes the one-time gain
of $608 million recognized upon the distribution of the Construction Group to
former Class C stockholders on March 31, 1998. Also included in discontinued
operations is the gain, net of tax, of $324 million from the Company's sale of
its energy assets to MidAmerican on January 2, 1998.
Financial Condition
The Company's working capital decreased approximately $0.7 billion during
1999 from $3.5 billion at December 31, 1998 to $2.8 billion at December 31,
1999. The decrease was primarily due to the capital expenditures and operating
expenses incurred to implement the Business Plan. Partially offsetting these
expenditures were the proceeds from the $1.5 billion equity offering completed
in March 1999, the $823 million offering of 6% convertible subordinated notes
and the $475 million proceeds from the $1.375 billion senior secured credit
facility. Both the 6% convertible subordinated notes offering and the senior
secured credit facility were completed in September 1999.
Cash provided by continuing operations increased from approximately $170
million in 1998 to approximately $438 million in 1999 primarily due to the
changes in components of working capital and an increase in interest income. An
increase in the costs paid to implement the Business Plan also reduced cash
provided by continuing operations. Interest income increased in 1999 as a
result of the proceeds received from the senior notes, senior discount notes,
6% convertible subordinated notes, the senior secured credit facility and the
March 1999 equity offering. The increase in cash provided by interest income
was partially offset by the semi-annual payment of interest on the senior
notes. The initial interest payment on the 6% convertible subordinated notes is
due in 2000. Interest payments on amounts outstanding under the senior secured
credit facility are due periodically based on the Company's selection of
alternative base rate and LIBOR loans. A commitment fee on the unused portions
of the senior secured credit facility is payable on the last business day of
each calendar quarter. Interest payments on the senior discount notes are
deferred until 2004.
Investing activities include the purchase and sale of approximately $4.6
billion and $5.2 billion, respectively, of marketable securities. The Company
also incurred costs of $3.4 billion for capital expenditures, primarily for the
expanding communications business. In 1999, the Company invested $1.4 billion
on its U.S. intercity network, $.5 billion on its international networks and
gateway facilities, $.3 billion on transoceanic networks and $.7 billion on
gateway facilities and local networks.
Financing sources in 1999 consisted primarily of the net proceeds of $451
million from the senior secured credit facility, net proceeds of $798 million
from the offering of $823 million aggregate principal amount of 6% convertible
subordinated notes due 2009, net proceeds of $1.5 billion from the issuance of
28.75 million shares of common stock and the exercise of Company stock options
for $22 million. The Company also repaid long-term debt of approximately $6
million during 1999.
Liquidity and Capital Resources
Since late 1997, the Company has substantially increased the emphasis it
places on and the resources devoted to its communications and information
services business. The Company has commenced the implementation of a plan to
become a facilities based provider (that is, a provider that owns or leases a
S-33
substantial portion of the property, plant and equipment necessary to provide
its services) of a broad range of integrated communications services. To reach
this goal, the Company is expanding substantially the business of its
subsidiary, PKS Information Services, Inc. to create, through a combination of
construction, purchase and leasing of facilities and other assets, an advanced,
international, facilities based communications network. The Company is
designing its network based on Internet Protocol technology in order to
leverage the efficiencies of this technology to provide lower cost
communications services.
The development of the Business Plan will require significant capital
expenditures, a substantial portion of which will be incurred before any
significant related revenues from the Business Plan are expected to be
realized. These expenditures, together with the associated early operating
expenses, may result in substantial negative operating cash flow and
substantial net operating losses for the Company for the foreseeable future.
Although the Company believes that its cost estimates and build-out schedule
are reasonable, the actual construction costs or the timing of the expenditures
may deviate from current estimates. The Company's capital expenditures in
connection with the Business Plan were approximately $3.4 billion in 1999. The
Company estimates that its capital expenditures in connection with the Business
Plan will approximate $3.5 billion in 2000. The Company's current liquidity and
the agreement with INTERNEXT should be sufficient to fund the currently
committed portions of the Business Plan.
On January 24, 2000 the Company announced that it was expanding the scope of
its Business Plan to include a significant increase in the amount of colocation
space available to the Company's web-centric customers, and additional local
fiber facilities. The Company currently estimates that the implementation of
the Business Plan will require between $13 and $14 billion over the 10-year
period of the Business Plan. The Company's ability to implement the Business
Plan and meet its projected growth is dependent upon its ability to secure
substantial additional financing in the future. The Company expects to meet its
additional capital needs with the proceeds from credit facilities and other
borrowings, including the senior secured credit facility entered into on
September 30, 1999, and sales or issuance of additional equity securities or
additional debt securities, including this offering and the other offerings.
The 9 1/8% senior notes and the 10 1/2% senior discount notes were issued under
indentures which permit the Company and its subsidiaries to incur substantial
amounts of debt. The senior secured credit facility also permits the Company to
incur substantial amounts of unsecured debt.
In addition, the Company may sell or dispose of existing businesses or
investments to fund portions of the Business Plan. The Company may sell or
lease fiber optic capacity, or access to its conduits. The Company may not be
successful in producing sufficient cash flow, raising sufficient debt or equity
capital on terms that it will consider acceptable, or selling or leasing fiber
optic capacity or access to its conduits. In addition, proceeds from
dispositions of the Company's assets may not reflect the assets' intrinsic
value. Further, expenses may exceed the Company's estimates and the financing
needed may be higher than estimated. Failure to generate sufficient funds may
require the Company to delay or abandon some of its future expansion or
expenditures, which could have a material adverse effect on the implementation
of the Business Plan.
The Company may not be able to obtain such financing if and when it is
needed and, if available, such financing may not be on terms acceptable to the
Company. If the Company is unable to obtain additional financing when needed,
it may be required to scale back significantly its Business Plan and, depending
upon cash flow from its existing businesses, reduce the scope of its plans and
operations.
In connection with implementing the Business Plan, management will continue
reviewing the existing businesses of the Company to determine how those
businesses will complement the Company's focus on communications and
information services. If it is decided that an existing business is not
compatible with the communications and information services business and if a
suitable buyer can be found, the Company may dispose of that business.
S-34
Year 2000
Level 3 Communications, LLC
Level 3's wholly owned subsidiary, Level 3 Communications, LLC, is a new
company that is implementing new technologies to provide Internal Protocol
technology-based communications services to its customers. The expenses
associated with Level 3 Communications, LLC's Year 2000 remediation program did
not have a material effect on the operating results or financial condition of
Level 3 Communications, LLC through December 31, 1999. There can be no
assurance, however, that the Year 2000 problem, and any loss incurred by any
customers of Level 3 as a result of the Year 2000 problem, will not have a
material adverse effect on Level 3 Communications, LLC's financial condition or
results of operations in the future.
PKSIS
PKS Information Services, Inc., or PKSIS, provides a wide variety of
information technology services. PKSIS has two main lines of business: computer
outsourcing and systems integration. The computer outsourcing business is
managed by PKS Computer Services LLC, or PKSCS. The systems integration is
managed by PKS Systems Integration LLC, or PKSSI.
PKSIS derived a substantial portion of its revenues in 1999 from projects
that its subsidiary, PKSSI, conducted involving Year 2000 assessment and
renovation services. This exposes PKSSI to potential risks that may include
problems with services provided by PKSSI to its customers and the potential
claims arising under PKSSI's customer contracts. PKSSI attempts to
contractually limit its exposure to liability for Year 2000 compliance issues.
However, these contractual limitations may not be effective.
The expenses associated with PKSIS' Year 2000 efforts, did not, and the
related potential effect on PKSIS' earnings are not expected to, have a
material effect on the future operating results or financial condition of Level
3. There can be no assurance, however, that the Year 2000 problem, and any loss
incurred by any customers of PKSIS as a result of the Year 2000 problem, will
not have a material adverse effect on Level 3's financial condition or results
of operations in the future.
Costs of Year 2000 Issues. Level 3 Communications, LLC incurred
approximately $2 million of costs in 1999. These costs primarily arise from
direct costs of Level 3 employees verifying equipment and software as Year 2000
ready. However, Level 3 does not separately track the internal employee costs
incurred for its Year 2000 projects. Level 3 does track all material costs
incurred for its Year 2000 projects as well as all costs incurred by the Year
2000 program office. Level 3 estimated the time and effort expended by its
employees on Year 2000 projects based on an analysis of Year 2000 project
plans.
PKSIS incurred approximately $4 million of costs to implement its Year 2000
program through 1998, and incurred an additional approximately $4 million of
costs in 1999. These costs primarily arise from direct costs of PKSCS employees
working on upgrades per vendor specifications of operating system software for
PKSCS outsourcing customers and the cost of vendor supplied operating systems
software upgrades and the cost of additional hardware. However, PKSIS does not
separately track the internal costs incurred for its Year 2000 projects and
does not track the cost and time its employees spend on Year 2000 projects.
PKSCS has estimated the time and effort expended by its employees on Year 2000
projects based on an analysis of Year 2000 project plans. Labor costs for
PKSCS' Year 2000 projects were estimated to be $2 million for 1998 and $1
million in 1999. Costs for software upgrades, additional equipment costs and a
test system for PKSCS' Year 2000 projects were estimated to be $2 million for
1998 and $3 million in 1999. Such costs are not available for PKSSI but are not
believed to be material. Year 2000 costs for PKSSI are believed to be
substantially less than PKSCS and focus primarily on the cost of evaluating
and, if necessary, upgrading network and desktop hardware and software. The
costs incurred by PKSSI for performing Year 2000 services for its customers are
included within PKSSI's pricing for such services.
S-35
Quantitative and Qualitative Disclosures About 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. As of December 31, 1999, the
Company had borrowed $475 million under the senior secured credit facility.
Amounts drawn on the term loan and revolving credit facilities bear interest at
the alternate base rate or LIBOR rate plus applicable margins. As the alternate
base rate and LIBOR rate fluctuate, so too will the interest expense on amounts
borrowed under the facility. A hypothetical 10 percent increase in interest
rates would increase interest expense of the Company by approximately $5
million. The Company continues to evaluate alternatives to limit interest rate
risk.
Level 3 continues to hold positions in certain publicly traded entities,
primarily Commonwealth Telephone and RCN. The Company accounts for these two
investments using the equity method. The market value of these investments is
approximately $1.866 billion as of December 31, 1999, which is significantly
higher than their carrying value of $292 million. The Company does not
currently have plans to dispose of these investments; however, if any such
transaction occurred, the value received for the investments would be affected
by the market value of the underlying stock at the time of any such
transaction. A 20% decrease in the price of Commonwealth Telephone and RCN
stock would result in approximately a $373 million decrease in fair market
value of these investments. The Company does not currently utilize financial
instruments to minimize its exposure to price fluctuations in equity
securities.
The Company's Business Plan includes developing and constructing networks in
Europe and Asia. As of December 31, 1999, the Company had invested significant
amounts of capital in Europe and will continue to expand its presence in Europe
and Asia in 2000. As of December 31, 1999, the Company has not made significant
use of financial instruments to minimize its exposure to foreign currency
fluctuations. The Company will continue to analyze risk management strategies
to reduce foreign currency exchange risk in the future.
The change in equity security prices is based on hypothetical movements and
is not necessarily indicative of the actual results that may occur. Future
earnings and losses will be affected by actual fluctuations in interest rates,
equity prices and foreign currency rates.
S-36
INDUSTRY OVERVIEW
History and Industry Development
Telecommunications Industry. Prior to its court-ordered breakup in 1984 (the
"Divestiture"), AT&T largely monopolized the telecommunications services in the
United States even though technological developments had begun to make it
economically possible for companies (primarily entrepreneurial enterprises) to
compete for segments of the communications business.
The present structure of the U.S. telecommunications market is largely the
result of the Divestiture. As part of the Divestiture, seven local exchange
holding companies were created to offer services in geographically defined
areas called LATAs. The RBOCs were separated from the long distance provider,
AT&T, resulting in the creation of two distinct market segments: local exchange
and long distance. The Divestiture provided for direct, open competition in the
long distance segment.
The Divestiture did not provide for competition in the local exchange
market. However, several factors served to promote competition in the local
exchange market, including: (i) customer desire for an alternative to the
RBOCs, also referred to as the ILECs; (ii) technological advances in the
transmission of data and video requiring greater capacity and reliability than
ILEC networks were able to accommodate; (iii) a monopoly position and rate of
return-based pricing structure which provided little incentive for the ILECs to
upgrade their networks; and (iv) the significant fees, called "access charges,"
that long distance carriers were required to pay to the ILECs to access the
ILECs' networks.
The first competitors in the local exchange market, designated as CAPs by
the FCC, were established in the mid-1980s. Most of the early CAPs were
entrepreneurial enterprises that operated limited networks in the central
business districts of major cities in the United States where the highest
concentration of voice and data traffic is found. Since most states prohibited
competition for local switched services, early CAP services primarily consisted
of providing dedicated, unswitched connections to long distance carriers and
large businesses. These connections allowed high-volume users to avoid the
relatively high prices charged by ILECs for dedicated, unswitched connections.
As CAPs proliferated during the latter part of the 1980s, certain federal
and state regulators issued rulings which favored competition and promised to
open local markets to new entrants. These rulings allowed CAPs to offer a
number of new services, including, in certain states, a broad range of local
exchange services, including local switched services. Companies providing a
combination of CAP and switched local services are sometimes referred to as
CLECs. This pro-competitive trend continued with the passage of the
Telecommunications Act of 1996 (the "Telecom Act"), which provided a legal
framework for introducing competition to local telecommunications services
throughout the United States.
Over the last three years, several significant transactions have been
announced representing consolidation of the U.S. telecom industry. Among the
ILECs, Bell Atlantic and NYNEX merged in August 1997, Pacific Telesis Group and
SBC Communications merged in April 1997, SBC Communications and Ameritech
merged in October 1999, GTE and Bell Atlantic have proposed a merger and MCI
WorldCom has agreed to acquire Sprint. Long distance providers have sought to
enhance their positions in local markets, through transactions such as AT&T's
acquisition of Teleport Communications Group and of Tele-Communications, Inc.,
WorldCom's mergers with MFS and Brooks Fiber Properties and Qwest's proposed
acquisition of US West. They have also sought to otherwise improve their
competitive positions, through transactions such as WorldCom's merger with MCI.
Many international markets resemble that of the United States prior to the
Divestiture. In many countries, traditional telecommunications services have
been provided through a monopoly provider, frequently controlled by the
national government, such as a Post, Telegraph and Telephone Company. In recent
years, there has been a trend toward liberalization of many of these markets,
particularly in Europe. Led by the introduction of competition in the United
Kingdom, the European Union mandated open competition as of January 1998.
Similar trends are emerging, albeit more slowly, in Asia.
S-37
Internet Industry. The Internet is a global collection of interconnected
computer networks that allows commercial organizations, educational
institutions, government agencies and individuals to communicate
electronically, access and share information and conduct business. The Internet
originated with the ARPAnet, a restricted network that was created in 1969 by
the United States Department of Defense Advanced Research Projects Agency to
provide efficient and reliable long distance data communications among the
disparate computer systems used by government-funded researchers and academic
organizations. The networks that comprise the Internet are connected in a
variety of ways, including by the public switched telephone network and by high
speed, dedicated leased lines. Communications on the Internet are enabled by
Internet Protocol, an inter-networking standard that enables communication
across the Internet regardless of the hardware and software used.
Over time, as businesses have begun to utilize e-mail, file transfer and,
more recently, intranet and extranet services, commercial usage has become a
major component of Internet traffic. In 1989, the U.S. government effectively
ceased directly funding any part of the Internet backbone. In the mid-1990s,
contemporaneous with the increase in commercial usage of the Internet, a new
type of provider called an ISP became more prevalent. ISPs offer access, e-
mail, customized content and other specialized services and products aimed at
allowing both commercial and residential customers to obtain information from,
transmit information to, and utilize resources available on the Internet.
ISPs generally operate networks composed of dedicated lines leased from
ILECs, CLECs and ISPs using Internet Protocol based switching and routing
equipment and server-based applications and databases. Customers are connected
to the ISP's POP by facilities obtained by the customer or the ISP from either
ILECs or CLECs through a dedicated access line or the placement of a circuit-
switched local telephone call to the ISP.
Internet Protocol Communications Technology. There are two widely used
switching technologies in currently deployed communications networks: circuit-
switching systems and packet-switching systems. Circuit-switch based
communications systems establish a dedicated channel for each communication
(such as a telephone call for voice or fax), maintain the channel for the
duration of the call, and disconnect the channel at the conclusion of the call.
Packet-switch based communications systems format the information to be
transmitted, such as e-mail, voice, fax and data into a series of shorter
digital messages called "packets." Each packet consists of a portion of the
complete message plus the addressing information to identify the destination
and return address.
Packet-switch based systems offer several advantages over circuit-switch
based systems, particularly the ability to commingle packets from several
communications sources together simultaneously onto a single channel. For most
communications, particularly those with bursts of information followed by
periods of "silence," the ability to commingle packets provides for superior
network utilization and efficiency, resulting in more information being
transmitted through a given communication channel. There are, however, certain
disadvantages to packet-switch based systems as currently implemented. Rapidly
increasing demands for data, in part driven by the Internet traffic volumes,
are straining capacity and contributing to latency (delays) and interruptions
in communications transmissions.
On June 23, 1999, Level 3 announced a minimum four year, $250 million
strategic agreement with Lucent Technologies to purchase Lucent systems,
including software switches or "softswitches." The minimum purchase commitment
is subject to certain conditions and has the potential to grow to $1 billion
over five years.
Under this nonexclusive agreement, Lucent will provide Level 3 its Lucent
Technologies Softswitch, a software switch for Internet Protocol networks that
is intended to combine the reliability and features that customers expect from
the public switched telephone network with the cost effectiveness and
flexibility of Internet Protocol technology. With the Lucent Softswitch, Level
3 expects to provide a full range of Internet Protocol based communications
services similar in quality and ease of use to services on traditional circuit
voice networks. In addition, the companies also agreed to collaborate on future
enhancements of softswitches and gateway products to support next-generation
broadband services for business and consumers that will combine high-quality
voice and video communications with Internet-style web data services.
S-38
Telecommunications Services Market
Overview of U.S. Market. The traditional U.S. market for telecommunications
services can be divided into three basic sectors: long distance services, local
exchange services and Internet access services. It has been estimated that in
1998 local exchange services accounted for revenues of $96.8 billion, long
distance services generated revenues of $110.5 billion and Internet access
revenues totaled $8.3 billion. Revenues for both local exchange and long
distance services include amounts charged by long distance carriers and
subsequently paid to ILECs (or, where applicable, CLECs) for long distance
access.
Long Distance Services. A long distance telephone call can be envisioned as
consisting of three segments. Starting with the originating customer, the call
travels along an ILEC or CLEC network to a long distance carrier's POP. At the
POP, the call is combined with other calls and sent along a long distance
network to a POP on the long distance carrier's network near where the call
will terminate. The call is then sent from this POP along an ILEC or CLEC
network to the terminating customer. Long distance carriers provide only the
connection between the two local networks, and pay access charges to LECs for
originating and terminating calls.
The following diagram is a simplified illustration of a typical long
distance call:
[GRAPHIC OF A LONG DISTANCE CALL]
Local Exchange Services. A local call is one that does not require the
services of a long distance carrier. In general, the local exchange carrier
connects end user customers within a LATA and also provides the local portion
of most long distance calls.
S-39
The following diagram is a simplified illustration of a typical local call:
[GRAPHIC OF SERVICE PROVIDED BY ILECS AND CLECS]
Internet Service. Internet services are generally provided in at least two
distinct segments. A local network connection is required from the ISP customer
to the ISP's local facilities. For large, communication-intensive users and for
content providers, these connections are typically unswitched, dedicated
connections provided by ILECs or CLECs, either as independent service providers
or, in some cases, by a company which is both a CLEC and an ISP. For
residential and small/medium business users, these connections are generally
PSTN connections obtained on a dial-up access basis as a local exchange
telephone call. Once a local connection is made to the ISP's local facilities,
information can be transmitted and obtained over a packet-switched Internet
Protocol data network, which may consist of segments provided by many
interconnected networks operated by a number of ISPs. This collection of
interconnected networks makes up the Internet. A key feature of Internet
architecture and packet-switching is that a single dedicated channel between
communication points is never established, which distinguishes Internet-based
services from the PSTN.
The following diagram is a simplified illustration of a typical Internet
access service:
[GRAPHIC OF TYPICAL INTERNET ACCESS SERVICE]
Overview of International Market. The traditional market for
telecommunications services outside of the United States can also be divided
into three basic sectors: long distance services, local exchange services and
Internet access services. It has been estimated that in 1998 local exchange
services accounted for revenues of $124.6 billion, long distance services
generated revenues of $199.6 billion and Internet access revenues totaled $7.1
billion.
S-40
Internet Protocol Network and Interconnection. The Company designed the
Level 3 network to be optimized for Internet Protocol based communications,
rather than circuit-switch based communications such as that utilized by the
PSTN. The network was designed with the goal of providing the Company with the
ability to adapt its facilities, hardware and software to future technology
developments in packet-switch based communications systems.
There are many Internet Protocol networks currently in operation. While
generally adequate for data transmission needs, these networks usually are not
configured to provide the voice quality, real-time communications requirements
of a traditional telephone call. With current technology, this quality can only
be achieved by providing a substantial cushion of communications capacity. In
addition, existing voice-over Internet Protocol services generally require
either customized end-user equipment or the dialing of "access codes" or the
following of other similar special procedures to initiate a call. There are
also concerns about the reliability and security of existing Internet Protocol
voice networks.
The Company has developed its Internet Protocol voice services so that
customers will not be required to dial access codes or follow other special
procedures to initiate a call. The Company and other technology providers have
developed, and we are commercially testing, softswitch technology to enable the
transmission of traffic seamlessly between a router-based Internet Protocol
network and the circuit-based PSTN. When commercially deployed, this technology
will provide the Level 3 network with the same ubiquity of the PSTN.
Specifically, this technology will provide Level 3 with (1) the ability to
originate PSTN telephone traffic from an ILEC's switch (when the origination
point is not on the Level 3 network), (2) route the traffic over the Level 3
network and (3) deliver the traffic either (a) directly to its destination (if
the destination is on the Level 3 network) or (b) to an interconnection point
where the traffic is transferred back to the PSTN (the routing of traffic to
this interconnection point will be determined based on a least-cost routing
criteria). Level 3 expects to be able to obtain the benefits of packet-switch
based communications protocols on its network, while allowing its customers to
use their existing equipment, telephone numbers and dialing procedures, without
additional access codes, for routing the call to the Level 3 network. Level 3
believes that by building its own network with significant excess capacity,
expandability and the latest technological advances in network design and
equipment and having the ability to route calls over the PSTN in the event of
service disruptions, the other significant issues associated with Internet
Protocol voice transmission (quality, latency, reliability and security) will
have been satisfactorily addressed. The Company commercially launched its
Internet Protocol long distance voice transmission services in December 1999.
The Company expects to begin commercial testing of some features associated
with local service, such as caller ID, voice mail and call forwarding, during
the first quarter of 2000. See "Risk Factors--Our business could be materially
affected by problems arising from the commercial deployment of our voice
technology for Internet Protocol networks."
On November 16, 1998, Level 3 and Bell Communications Research Inc.
announced the merger of their respective specifications for a new protocol
designed to bridge between the current circuit-based PSTN and emerging Internet
Protocol based networks. The merged specification, called the Media Gateway
Control Protocol, or MGCP, represents a combination of the Internet Protocol
Device Control, or lPDC, specification developed by a consortium formed by
Level 3 and made up of leading communications hardware and software companies,
and the Simple Gateway Control protocol, developed by Bell Communications
Research and Cisco Systems. The MGCP specification is available without a fee
to service providers and hardware and software vendors interested in
implementing it in their networks and equipment.
The significance of MGCP is that when implemented it will provide customers
with a seamless interconnection between traditional PSTN and the newer Internet
Protocol technology networks. Level 3 believes that this integration will
enable customers to benefit from the lower cost of Internet Protocol network
services, including voice and fax, without modifying existing telephone and fax
equipment or dialing access codes. Level 3 plans to use MGCP in the development
of its own network.
S-41
On May 13, 1999, a group of leading telecommunications companies announced
the formation of the International Softswitch Consortium, or the "Consortium."
Level 3 was one of the founding members of this Consortium. The Consortium
currently has approximately 100 members. The purpose of the organization is to
promote open standards and protocols and new application development for the
distributed set of hardware and software platforms that are referred to as
softswitches and can seamlessly interconnect the PSTN with information and
applications currently available only over the Internet. The Consortium is the
first group to focus exclusively on interconnection between Internet Protocol
networks and the PSTN, and is promoting worldwide compatibility and
interoperability of these networks. The Consortium's charter also calls for it
to act as a catalyst in stimulating independent software vendors to develop
value-added services for service providers and network users of Internet
Protocol networks.
S-42
BUSINESS
Level 3 engages in the communications, information services and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, the Company announced the Business
Plan to increase substantially its information services business and to expand
the range of services it offers by building an advanced, international
facilities based communications network based on Internet Protocol technology.
History
The Company was incorporated as Peter Kiewit Sons', Inc. in Delaware in 1941
to continue a construction business founded in Omaha, Nebraska in 1884. In
subsequent years, the Company invested a portion of the cash flow generated by
its construction activities in a variety of other businesses. The Company
entered the coal mining business in 1943, the telecommunications business
(consisting of MFS and, more recently, an investment in C-TEC Corporation and
its successors RCN, Commonwealth Telephone and Cable Michigan, Inc.) in 1988,
the information services business in 1990 and the alternative energy business,
through an investment in MidAmerican, in 1991. Level 3 also has made
investments in several development-stage ventures.
In 1995, the Company distributed to the holders of Class D Stock all of its
shares of MFS. In the seven years from 1988 to 1995, the Company invested
approximately $500 million in MFS; at the time of the distribution to
stockholders in 1995, the Company's holdings in MFS had a market value of
approximately $1.75 billion. In December 1996, MFS was purchased by WorldCom in
a transaction valued at $14.3 billion.
In December 1997, the Company's stockholders ratified the decision of the
Board to effect the split-off separating the Construction Group. As a result of
the split-off, which was completed on March 31, 1998, the Company no longer
owns any interest in the Construction Group. In conjunction with the split-off,
the Company changed its name to "Level 3 Communications, Inc.," and the
Construction Group changed its name to "Peter Kiewit Sons', Inc."
In January 1998, the Company completed the sale to MidAmerican of its energy
investments, consisting primarily of a 24% equity interest in MidAmerican. The
Company received proceeds of approximately $1.16 billion from this sale, and as
a result recognized an after-tax gain of approximately $324 million in 1998.
In November 1998, Avalon Cable of Michigan, Inc. acquired all the
outstanding stock of Cable Michigan. Level 3 received approximately $129
million in cash for its interest in Cable Michigan and recognized a pre-tax
gain of approximately $90 million.
Business Plan
Since late 1997, the Company has substantially increased the emphasis it
places on and the resources devoted to its communications and information
services business. Since that time, the Company has become a facilities based
provider (that is, a provider that owns or leases a substantial portion of the
plant, property and equipment necessary to provide its services) of a broad
range of integrated communications services. The Company has expanded
substantially the business of its subsidiary PKSIS and is creating, through a
combination of construction, purchase and leasing of facilities and other
assets, an advanced, international, facilities based communications network.
The Company designed the Level 3 network based on Internet Protocol technology
in order to leverage the efficiencies of this technology to provide lower cost
communications services.
S-43
Market and Technology Opportunity. The Company believes that, as technology
advances, a comprehensive range of both consumer and business communications
and information services will be provided over networks utilizing Internet
Protocol technology. These services will include traditional voice services, as
well as other data services such as Internet access and virtual private
networks. The Company believes this shift has begun, and over time should
accelerate, for the following reasons:
. Efficiency. As a packet-switched technology, Internet Protocol
technology generally uses network capacity more efficiently than the
traditional circuit-switched PSTN. This is because capacity in a packet
switched network is shared between end points only when they are
communicating at any given time, whereas in circuit switched networks,
capacity is reserved between communicating end points even when no
information is actually being transmitted. Therefore, services including
voice, e-mail and file transfer can be provided for lower cost over a
network using Internet Protocol technology.
. Open Protocol. Internet Protocol technology is an open protocol (a non-
proprietary standard) which allows for market driven development of new
services and applications for Internet Protocol networks. In contrast,
the PSTN is based on proprietary protocols, which are governed and
maintained by international standards bodies that are generally
controlled by government-affiliated entities and slower to accept
change.
. Improving Technologies. The Company and other technology companies have
developed solutions to address problems associated with certain Internet
Protocol based applications that use the public Internet. For example,
typical voice over Internet Protocol solutions are characterized by
cumbersome two-stage dialing requirements, latency (delay through the
network which can negatively affect timing sensitive communications such
as voice), quality and concerns about adequate security and reliability.
During December 1999, Level 3 commercially launched (3)Voice long
distance service in 10 markets, the first voice service to utilize
softswitch technology. Level 3 expects to begin commercial testing of
some features associated with local service, such as caller ID, voice
mail and call forwarding, during the first quarter of 2000. Level 3's
Internet Protocol voice technology provides a seamless interconnection
with the PSTN using softswitch architecture.
. Open Architecture. The open architecture of Level 3's distributed
network enables new competition among suppliers for the individual
components of the Internet Protocol voice switching system. The Company
believes that this competition amongst vendors will enable more rapid
improvement in the price/performance ratio of individual network
components and thereby lower network cost.
Level 3's Strategy. The Company is seeking to capitalize on the benefits of
Internet Protocol technology by pursuing the Business Plan. Key elements of the
Company's strategy include:
. Become the Low Cost Provider of Communications Services. Our network is
designed to provide high quality communications services at a lower
cost. For example, the Level 3 network is being constructed using
multiple conduits to allow the Company to cost-effectively deploy future
generations of optical networking components and thereby expand capacity
and reduce unit costs. In addition, the Company's strategy is to
maximize the use of open, non-proprietary interfaces in the design of
its network software and hardware. This approach is intended to provide
Level 3 with the ability to purchase the most cost-effective network
equipment from multiple vendors. New technologies such as packet-
switching will also enhance the efficiencies of our network.
. Combine Latest Generations of Fiber and Electronics. In order to achieve
unit cost reductions for transmission capacity, Level 3 has designed its
network with multiple conduits to deploy successive generations of fiber
to exploit improvements in transmission electronics. Optimizing
transmission electronics to exploit specific generations of fiber optic
technology currently provides transmission capacity on the new fiber
more cost effectively than deploying new electronics on previous
generations of fiber.
. Offer a Comprehensive Range of Communications Services. The Company
provides a comprehensive range of communications services over the Level
3 network, including private line, (3)Voice long distance services,
colocation, Internet access and managed modem.
S-44
Level 3 expects to begin commercial testing of some features associated
with local service, such as caller ID, voice mail and call forwarding,
during the first quarter of 2000. Level 3 is also offering dark fiber
and conduits along its local and intercity networks on a long-term lease
basis.
. Provide Significant Colocation Facilities. Level 3 has been experiencing
higher demand for its colocation services from its web centric customers
than was anticipated in preparing the Business Plan. Level 3 believes
that providing colocation services on its network attracts web centric
customers by allowing Level 3 to offer those customers reduced bandwidth
costs, rapid provisioning of additional bandwidth, interconnection with
other third-party networks and improved network performance. Therefore,
Level 3 believes that controlling significant colocation facilities in
its gateways provides it with a competitive advantage. In addition,
significant colocation facilities in a gateway allow Level 3 to price
the exchange of traffic between its customers that are colocated in the
same facility at significantly lower cost than the exchange of traffic
between a customer located outside the facility and a customer located
within the facility.
As of December 31, 1999, Level 3 had secured approximately 3.4 million
square feet of space for its gateway facilities and had completed the
buildout of approximately 1.3 million square feet of this space. Level 3
believes it currently has more colocation space than any of its
competitors. In January 2000, Level 3 announced an expansion of its
Business Plan to increase significantly the aggregate amount of its
global gateway facilities to 6.5 million square feet over the next two
to three years.
. Provide Seamless Interconnection to the PSTN. During December 1999, the
Company launched its (3)Voice long distance service that allows the
seamless interconnection of the Level 3 network with the PSTN for long
distance voice transmissions. Seamless interconnection allows customers
to use Level 3's Internet Protocol based services without modifying
existing telephone equipment or dialing procedures (that is, without the
need to dial access codes or follow other similar special procedures).
The Company's managed modem service uses similar softswitch technology
to seamlessly interconnect to the PSTN.
. Accelerate Market Roll-out. To support the launch of its services and
develop a customer base in advance of completing the construction of its
network, Level 3 offers services over a combination of leased local and
intercity facilities. Over time, these leased networks will be displaced
by the networks that the Company is constructing.
. Target Web Centric Customers. The Company's distribution strategy is to
utilize a direct sales force focused on communications intensive and web
centric businesses. These businesses include ISPs, application service
providers, content providers, systems integrators, next generation
carriers, web-hosting companies, streaming media companies and Internet
Protocol based storage providers. Providing continually declining
bandwidth costs to these companies is at the core of the Company's
market enabling strategy because bandwidth generally represents a
substantial portion of web centric businesses' costs.
. Develop Advanced Business Support Systems. The Company is developing a
substantial, scalable and web-enabled business support system
infrastructure specifically designed to enable the Company to offer
services efficiently to its targeted customers. The Company believes
that this system will reduce its operating costs, give its customers
direct control over some of the services they buy from the Company and
allow the Company to grow rapidly without redesigning the architecture
of its business support system.
. Leverage Existing Information Services Capabilities. The Company is
expanding its existing capabilities in computer network systems
integration, consulting, outsourcing and software reengineering, with
particular emphasis on the conversion of legacy software systems to
systems that are compatible with Internet Protocol networks and web
browser access.
S-45
. Attract and Motivate High Quality Employees. The Company has developed
programs designed to attract and retain employees with the technical
skills necessary to implement the Business Plan. The programs include
the Company's Shareworks stock purchase plan and its Outperform Stock
Option program.
Competitive Advantages. The Company believes that it has the following
competitive advantages that, together with its strategy, will assist it in
implementing the Business Plan:
. Experienced Management Team. Level 3 has assembled a management team
that it believes is well suited to implement the Business Plan. Most of
Level 3's senior management was involved in leading the development and
marketing of telecommunications products and in designing, constructing
and managing intercity, metropolitan and international networks.
. A More Readily Upgradable Network Infrastructure. Level 3's network
design takes advantage of recent innovations, incorporating many of the
features that are not present in older communication networks, and
provides Level 3 flexibility to take advantage of future developments
and innovations. Level 3 has designed the transmission network to
optimize all aspects of fiber and electronics simultaneously as a system
to deliver the lowest unit cost to its customers. As fiber and
transmission electronic technology changes, Level 3 expects to realize
new unit cost improvements by deploying the latest fiber and
transmission electronics technology in available empty or spare conduit
in the multiple conduit Level 3 network. The Company believes that the
spare conduit design of the Level 3 network will enable Level 3 to
effect this deployment more quickly and at lower cost than other
carriers.
. Integrated End-to-End Network Platform. Level 3's strategy is to deploy
network infrastructure in major metropolitan areas and to link these
networks with significant intercity networks in North America and
Europe. The Company believes that the integration of its local and
intercity networks with its colocation facilities will expand the scope
and reach of its on-net customer coverage, and facilitate the uniform
deployment of technological innovations as the Company manages its
future upgrade paths.
. Systems Integration Capabilities. The Company believes that its ability
to offer computer outsourcing and systems integration services,
particularly services relating to allowing a customer's legacy systems
to be accessed with web browsers, will provide additional opportunities
for selling the Company's products and services.
The Level 3 Network
An important element of the Business Plan is the development of the Level 3
network, an advanced, international, facilities based communications network
optimized for Internet Protocol technology. Today, the Company is primarily
offering its communications services using local and intercity facilities that
are leased from third parties. This enables the Company to offer services
during the construction of its own facilities. Over time, the portion of the
Company's network that is owned by the Company will increase and the portion of
the facilities leased will decrease. Over the next two to three years, the
Company's network is expected to encompass:
. an intercity network covering nearly 16,000 miles in North America;
. leased or owned local networks in 56 North American markets;
. an intercity network covering approximately 4,750 miles across Europe;
. leased or owned local networks in 21 European and Pacific Rim markets;
. approximately 6.5 million square feet of gateway facilities in North
America, Europe and the Pacific Rim; and
. undersea capacity, including a 1.28 Tbps transatlantic cable system and
a 2.56 Tbps Northern Asia cable system initially connecting Hong Kong to
Tokyo.
See "Risk Factors--Difficulties in constructing our network could increase its
estimated cost and delay its scheduled completion."
S-46
Intercity Networks. The Company's nearly 16,000 mile fiber optic intercity
network in North America will consist of the following:
. Rights-of-way ("ROW") from a number of third parties including
railroads, highway commissions and utilities. The Company has procured
these rights from sources that maximize the security and quality of the
Company's installed network. The Company has secured 100% of the ROW
required for the planned North American intercity network. It has
obtained these rights pursuant to agreements with railroads, state and
local departments of transportation, utilities, pipeline companies and
others.
. Multiple conduits connecting local networks in approximately 200 North
American cities. In general, Level 3 will install groups of 10 to 12
conduits in its intercity network. The Company believes that the
availability of spare conduit will allow it to deploy future
technological innovations in optical networking components as well as
providing Level 3 with the flexibility to offer conduit to other
entities.
. Initial installation of optical fiber strands designed to accommodate
dense wave division multiplexing transmission technology. This fiber
allows deployment of equipment which transmits signals on 32 or more
individual wavelengths of light per strand, thereby significantly
increasing the capacity of the Company's network relative to older
networks which generally use optical fiber strands that transmit fewer
wavelengths of light per strand. In addition, the Company believes that
the installation of newer optical fibers will allow a combination of
greater wavelengths of light per strand, higher digital transmission
speeds and greater spacing of network electronics. The Company also
believes that each new generation of optical fiber will allow increases
in the performance of these aspects of the fiber and will result in
lower unit costs.
. High speed SONET transmission equipment employing self-healing
protection switching and designed for high quality and reliable
transmission.
. A design that maximizes the use of open, non-proprietary hardware and
software interfaces to allow less costly upgrades as hardware and
software technology improves.
In December 1999, Level 3 began carrying customer traffic between Dallas and
Houston on the first completed and lit segment of its North American intercity
network.
To support the launch of its services in the third quarter of 1998, the
Company leased intercity capacity from two providers. This leased capacity will
be displaced over time by Level 3's North American intercity network.
On July 20, 1998, Level 3 entered into a network construction cost-sharing
agreement with INTERNEXT, LLC, a subsidiary of NEXTLINK Communications, Inc.
The agreement, which is valued at $700 million, calls for INTERNEXT to acquire
the right to use 24 fibers and certain associated facilities installed along
the entire route of Level 3's North American intercity network in the United
States. INTERNEXT will pay Level 3 as segments of the intercity network are
completed which will reduce the overall cost of the network to the Company. The
network as provided to INTERNEXT will not include the necessary electronics
that allow the fiber to carry communications transmissions. Also, under the
terms of the agreement, INTERNEXT has the right to an additional conduit for
its exclusive use and to share costs and capacity in certain future fiber cable
installations in Level 3 conduits.
S-47
The following diagram depicts the currently planned North American intercity
network when fully constructed:
[MAP APPEARS HERE]
The Company expects to substantially complete its North American intercity
network by the end of the year 2000. Deployment of the North American intercity
network will be accomplished through simultaneous construction efforts in
multiple locations, with different portions being completed at different times.
As of December 31, 1999, the Company had completed 9,334 route miles of the
intercity network and had approximately 6,200 route miles under construction.
In Europe, the Company is deploying an approximately 4,750 mile fiber optic
intercity network with characteristics similar to those of the North American
intercity network. As in North America, the Company will provide initial
service in Europe over a leased network that will be displaced over time by the
intercity network owned by the Company.
On April 29, 1999, Level 3 announced that it had finalized contracts
relating to construction of Ring 1 of its European network in France, Belgium,
the Netherlands, Germany and the United Kingdom. Ring 1, which is approximately
1,800 miles, will connect Paris, Frankfurt, Amsterdam, Brussels and London. The
network is expected to be ready for service by September 2000. Ring 1 is part
of the approximately 4,750 mile intercity network. This European network will
be linked to the Level 3 North American intercity network by the Level 3
transatlantic 1.28 Tbps cable system currently under development, also expected
to be ready for service by September 2000.
On July 26, 1999, the Company announced two important developments of its
European network build with agreements with Eurotunnel and Alcatel. Eurotunnel
will install and supply Level 3 with multiple cross-Channel cables between the
United Kingdom and France through the high-security service tunnel. The first
of these cables will be completed by the end of the first quarter of 2000.
Subsequent cables will be installed to upgrade and expand the network as and
when required or when new fiber technology becomes available. Alcatel will
design, develop and install an undersea cable to link the Level 3 network
between the United Kingdom and Belgium. The cable system is already under
development and will be completed by the end of the first half of 2000.
S-48
In addition, on May 4, 1999, Level 3 and COLT Telecom Group plc announced an
agreement to share costs for the construction of European networks. The
agreement calls for Level 3 to share construction costs of COLT's planned 1,600
mile intercity German network linking Berlin, Cologne, Dusseldorf, Frankfurt,
Hamburg, Munich and Stuttgart. In return, COLT will share construction costs of
Ring 1 of Level 3's planned European network.
The Company has entered into transoceanic capacity agreements that will link
Level 3's North American, European and Pacific Rim intercity networks. One
agreement provides for Level 3's participation in the construction of an
undersea cable system that will connect Japan and the United States by the end
of the year 2000. The remaining agreements relate to the Company's
transatlantic capacity. These agreements are in addition to the agreement
relating to the Company's 1.28 Tbps transatlantic undersea cable system.
In the Pacific Rim, the Company currently intends to provide service over a
leased line intercity network and long-term leases of submarine cable capacity.
In 1999, Level 3 opened its Asia Pacific headquarters in Hong Kong. On January
24, 2000, Level 3 announced two important developments of its Asian network
with the planned construction of a 2.56 Tbps undersea cable initially
connecting Hong Kong to Tokyo and gateway facilities in each city. This
connection between Hong Kong and Tokyo is intended to be the first stage in the
construction by Level 3 of an undersea network in the region and is scheduled
for completion in the second quarter of 2001. The Company plans to share
construction and operating expenses of the system with one or more industry
partners.
Local Market Infrastructure. The Company's local facilities include fiber
optic networks, in a SONET ring configuration, connecting Level 3's intercity
network gateway sites to ILEC and CLEC central offices, long distance carrier
POPs, buildings housing communication-intensive end users and Internet peering
and transit facilities.
The Company had secured approximately 3.4 million square feet of space for
its gateway facilities as of December 31, 1999 and had completed the buildout
of approximately 1.3 million square feet of this space. The Company's gateway
facilities are being designed to house local sales staff, operational staff,
the Company's transmission and Internet Protocol routing/switching facilities
and technical space to accommodate colocation of equipment by high-volume Level
3 customers, such as ISPs, in an environmentally controlled, secure site with
direct access to the Level 3 network through dual, fault tolerant connections.
The Company is offering private line, (3)Voice, colocation services, Internet
access and managed modem at its gateway sites. The availability of these
services varies by location.
As of December 31, 1999, the Company had operational facilities based local
metropolitan networks in 22 U.S. markets and 3 European markets. Also, as of
December 31, 1999, the Company had entered into interconnection agreements with
RBOCs covering 49 markets.
The Company has negotiated master leases with several CLECs and ILECs to
obtain leased capacity from those providers so that the Company can provide its
clients with local transmission capabilities before its own local networks are
complete and in locations not directly accessed by the Company's owned
facilities.
The launches of services in London and Frankfurt followed the Company's
acquisitions of BusinessNet Limited, a leading UK ISP, in January 1999 and
miknet Internet Based Services GmbH, a leading German ISP, in September 1998.
In addition, in June 1999, the Company completed the construction of its
metropolitan network in the City of London. The Company launched its
international gateway in London in January 1999 and Paris, Amsterdam and
Frankfurt in June 1999. The 75,000 square foot office and operations facility
in London is the hub of European operations and houses the operational center
and network equipment, along with additional space for expansion and colocation
services. In addition, in July 1999, Level 3 acquired a building with an
additional approximately 263,000 square feet of space to serve as colocation
technical space in London. The Company is currently offering services in and
among London, Paris, Amsterdam and Frankfurt.
S-49
Communications and Information Services
In connection with the Business Plan, the Company is substantially
increasing the emphasis it places on and the resources devoted to its
communications and information services business. The Company is building on
the strengths of its information services business and the benefits of the
Level 3 network to offer a broad range of other services to business and other
end users.
As the Business Plan is being implemented, the Company is offering a
comprehensive range of communications services, including the following:
. Transport Services. The Company's transport services consist of private
line and special access services and long-term leases of dark fiber and
conduits.
[_]Private Line and Special Access. Private line and special access
services are established as a permanent physical connection between
locations for the exclusive use of the customer. The Company is
offering the following types of private line and special access
services:
. Private Line. This type of link is a dedicated line connecting
two end-user locations for voice and data applications, including
ISPs.
. Carrier-to-Carrier Special Access. This type of link connects
carriers (long distance providers, wireless providers, ILECs and
CLECs) to other carriers.
. End-user to Long Distance Provider Special Access. This type of
link connects an end-user, such as a large business, with the
local POP of its chosen long distance provider.
The Company is currently offering its special access and private
line services with available transmission speeds from T1 to OC3 and
OC48.
[_]Dark Fiber and Conduits. The Company is offering dark fiber and
conduit along its local and intercity networks on a long-term lease
basis. Customers can lease dark fiber and conduit in any combination
of three ways: (1) segment by segment, (2) full ring or (3) the
entire Level 3 network. Level 3 offers colocation space in its
gateway and intercity retransmission facilities to these customers
for their transmission electronics. Although Level 3 will not be
responsible for the management of the transmission electronics,
Level 3 is contemplating providing installation and maintenance
services for this equipment on a fee for service basis.
. Colocation. The Company is offering its customers and other service
providers the ability to locate their communications and networking
equipment at Level 3's gateway sites in a safe and secure technical
operating environment. The demand for these colocation services has
increased as companies expand into geographic areas in which they do not
have appropriate space or technical personnel to support their equipment
and operations. At its operational colocation sites, the Company is
offering customers AC/DC power, optional UPS power, emergency back-up
generator power, HVAC, fire protection and security. Level 3 is also
offering high-speed, reliable connectivity to the Level 3 leased network
and other networks, including both local and wide area networks, the
PSTN and Internet. These sites are being monitored and maintained 24
hours a day, seven days a week.
Level 3 is offering customers, including ISPs, the opportunity to
colocate their web-server computers at the Company's larger gateway
sites, enabling them to take advantage of the marketing, customer
service, internal company information networks ("intranets") and other
benefits offered by such web presence. By colocating its web-server in a
Level 3 facility, a customer has the ability to deploy a high-quality,
high-reliability Internet presence without investing capital in data
center space, multiple high-speed connections or other capital intensive
infrastructure. Although the customer is responsible for maintaining the
content and performance of its server, the Company's technicians will be
available to monitor basic server operation. The Company will also offer
redundant infrastructure consisting of multiple routers and connections
to Internet backbones.
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. Internet Access. The Company is offering Internet access to business
customers, other carriers and ISPs. These services include high-capacity
Internet connections ranging from 45 Mbps to 1,000 Mbps.
. Managed Modem. The Company is offering to its customers an outsourced,
turn-key infrastructure solution for the management of dial up access to
either the public Internet or a corporate data network that may include
access to the public Internet ("Managed Modem"). This service was the
first offered by the Company that used softswitch technology to
seamlessly interconnect to the PSTN. While ISPs are provided a fully
managed dial-up network infrastructure for access to the public
Internet, corporate customers that purchase Managed Modem services
receive connectivity for remote users to support data applications such
as telecommuting, e-mail retrieval, and client/server applications. For
Managed Modem customers, Level 3 arranges for the provision of local
network coverage, dedicated local telephone numbers (which the Managed
Modem customer distributes to its customers in the case of an ISP or to
its employees in the case of a corporate customer), racks and modems as
well as dedicated connectivity from the customer's location to the Level
3 gateway facility. Level 3 also provides monitoring of this
infrastructure 24 hours a day, seven days a week. By providing a turn-
key infrastructure modem solution, Level 3 believes that this product
allows its customers to save both capital and operating costs.
. Voice. During December 1999, Level 3 commercially launched (3)Voice, its
Internet Protocol based long distance service, which uses softswitch
technology. This long distance service is currently available in 10
markets. The Company expects to begin commercial testing of some
features associated with local service, such as caller ID, voice mail
and call forwarding, during the first quarter of 2000. Customers access
(3)Voice long distance service by using existing telephone equipment and
dialing procedures. The Company believes that (3)Voice long distance
service is offered at a quality level equal to that of the PSTN.
Level 3 currently offers, through its subsidiary PKSIS, computer operations
outsourcing and systems integration services to customers located throughout
the United States as well as abroad. The Company's systems integration services
help customers define, develop and implement cost-effective information
services. The computer outsourcing services offered by the Company include
networking and computing services necessary for older mainframe-based systems
and newer client/server-based systems. The Company provides its outsourcing
services to clients that want to focus their resources on core businesses,
rather than expend capital and incur overhead costs to operate their own
computing environments. PKSIS believes that it is able to utilize its expertise
and experience, as well as operating efficiencies, to provide its outsourcing
customers with levels of service equal to or better than those achievable by
the customers themselves, while at the same time reducing the customers' cost
for such services. This service is particularly useful for those customers
moving from older computing platforms to more modern client/server networks.
PKSIS offers reengineering services that allow companies to convert older
legacy software systems to modern networked computing systems, with a focus on
reengineering software to enable older software application and data
repositories to be accessed by web browsers over the Internet or over private
or limited access Internet Protocol networks. PKSIS also provides customers
with a combination of workbench tools and methodologies that provide a complete
strategy for converting mainframe-based application systems to client/server
architecture.
Distribution Strategy
Level 3's distribution strategy is to utilize a direct sales force focused
on communications intensive and web centric businesses. These businesses
include ISPs, application service providers, content providers, systems
integrators, next generation carriers, web-hosting companies, streaming media
companies and Internet Protocol
S-51
based storage providers. Level 3 believes that these companies are the most
significant drivers of bandwidth demand. The past distinctions between retail
and wholesale have been blurred as these communications intensive and web
centric businesses purchase Level 3 services, add value to our services and
then remarket the services to end-users. Bandwidth constitutes a significant
portion of these companies' cost structure and their needs for bandwidth in
many cases are growing at an exponential rate. Providing continually declining
bandwidth costs to these companies is at the core of Level 3's market enabling
strategy.
Level 3 expects that approximately 85% of its sales will be to web centric
customers that package communications services into value added services and
directly sell into the residential and business markets. The remaining
approximately 15% of Level 3's sales will be to other customers that are
communications intensive and have high growth in communications and information
services consumption. Level 3 has segmented its sales organization into four
channels to implement this distribution strategy. These include a
Regional/Account Sales Group, a Carrier Sales Group and a Dark Fiber Sales
Group.
Business Support System
In order to pursue its sales and distribution strategies, the Company is
developing a set of integrated software applications designed to automate the
Company's operational processes. Through the development of a robust, scalable
business support system, the Company believes that it has the opportunity to
develop a competitive advantage relative to traditional telecommunications
companies. Whereas traditional telecommunications companies operate extensive
legacy business support systems with compartmentalized architectures that limit
their ability to scale rapidly and introduce enhanced services and features,
the Company has developed a business support system architecture intended to
maximize both reliability and scalability. See "Risk Factors--Our Business Plan
requires the development of effective business support systems to implement
customer orders and to provide and bill for services."
Key design aspects of the business support system development program are:
. integrated modular applications to allow the Company to upgrade specific
applications as new products are available;
. a scalable architecture that allows certain functions that would
otherwise have to be performed by Level 3 employees to be performed by
the Company's alternative distribution channel participants;
. phased completion of software releases designed to allow the Company to
test functionality on an incremental basis;
. ""web-enabled" applications so that on-line access to all order entry,
network operations, billing, and customer care functions is available to
all authorized users, including Level 3's customers and resellers;
. use of a three-tiered, client/server architecture that is designed to
separate data and applications, and is expected to enable continued
improvement of software functionality at minimum cost; and
. maximum use of pre-developed or "shrink wrapped" applications, which
will interface to Level 3's enterprise resource planning suites.
The first four releases of the business support system have been delivered
and contain functionality necessary to support the set of services presently
offered. See "--Communications and Information Services."
Interconnection and Peering
As a result of the Telecom Act, properly certificated companies may, as a
matter of law, interconnect with ILECs on terms designed to help ensure
economic, technical and administrative equality between the interconnected
parties. The Telecom Act provides, among other things, that ILECs must offer
competitors the services and facilities necessary to offer local switched
services. See "--Regulation."
S-52
As of December 31, 1999, the Company had entered into interconnection
agreements covering 49 markets. The Company may be required to negotiate new or
renegotiate existing interconnection agreements as Level 3 expands its
operations in current and additional markets in the future and as existing
agreements expire or are terminated.
Peering agreements between the Company and ISPs are necessary in order for
the Company to exchange traffic with those ISPs without having to pay transit
costs. The Company has peering arrangements with approximately 90 domestic ISPs
and approximately 50 international ISPs and is currently purchasing transit
from one major ISP. The basis on which the large national ISPs make peering
available or impose settlement charges is evolving as the provision of Internet
access and related services has expanded. Recently, companies that have
previously offered peering have cut back or eliminated peering relationships
and are establishing new, more restrictive criteria for peering. In order to
maintain certain of its peering relationships, Level 3 will have to meet these
more restrictive criteria.
Employee Recruiting and Retention
As of December 31, 1999, Level 3 had 3,175 employees in the communications
portion of its business and PKSIS had approximately 681 employees, for a total
of 3,856 employees. The Company believes that its ability to implement the
Business Plan will depend in large part on its ability to attract and retain
substantial numbers of additional qualified employees. In order to attract and
retain highly qualified employees, the Company believes that it is important to
provide (i) a work environment that encourages each individual to perform to
his or her potential, (ii) a work environment that facilitates cooperation
towards shared goals and (iii) a compensation program designed to attract the
kinds of individuals the Company seeks and to align employees' interests with
the Company's. The Company believes the Business Plan and its relocation to new
facilities in the Denver metropolitan area help provide such a work
environment. With respect to compensation programs, while the Company believes
financial rewards alone are not sufficient to attract and retain qualified
employees, the Company believes a properly designed compensation program is a
necessary component of employee recruitment and retention. In this regard the
Company's philosophy is to pay annual cash compensation which, if the Company's
annual goals are met, is moderately greater than the cash compensation paid by
competitors. The Company's non-cash benefit programs (including medical and
health insurance, life insurance, disability insurance, etc.) are designed to
be comparable to those offered by its competitors. See "Risk Factors--We may be
unable to hire and retain sufficient qualified personnel; the loss of any of
our key executive officers could adversely affect us."
The Company believes that the qualified candidates it seeks place particular
emphasis on equity-based long term incentive ("LTI") programs. The Company
currently has two complementary programs: (i) the equity-based "Shareworks"
program, which helps ensure that all employees have an ownership interest in
the Company and are encouraged to invest risk capital in the Company's stock;
and (ii) an innovative Outperform Stock Option ("OSO") program applicable to
the Company's employees. The Shareworks program currently enables employees to
contribute up to 7% of their compensation toward the purchase of restricted
common stock. If an employee remains employed by the Company for three years
from the date of purchase, the shares will vest and be matched by the Company
with a grant of an equal number of shares of its common stock. The Shareworks
program also provides that, subject to satisfactory Company performance, the
Company's employees will be eligible annually for grants by the Company of its
restricted common stock of up to 3% of the employees' compensation, which
shares will vest three years from the employee's initial grant date.
The Company has adopted the OSO program, which differs from LTI programs
generally adopted by the Company's competitors that make employees eligible for
conventional non-qualified stock options ("NQSOs"). While widely adopted, the
Company believes such NQSO programs reward employees when company stock price
performance is inferior to investments of similar risks, dilute public
stockholders in a manner not directly proportional to performance and fail to
provide a preferred return on stockholders' invested capital over the return to
option holders. The Company believes that the OSO program is superior to an
NQSO-based program with respect to these issues while, at the same time,
providing employees a success-based reward balancing the associated risk.
S-53
The OSO program was designed by the Company so that its stockholders receive
a market related return on their investment before OSO holders receive any
return on their options. The Company believes that the OSO program aligns
directly employees' and stockholders' interests by basing stock option value on
the Company's ability to outperform the market in general, as measured by the
S&P 500 Index. The value received for options under the OSO plan is based on a
formula involving a multiplier related to how much our common stock outperforms
the S&P 500 Index. Participants in the OSO program do not realize any value
from options unless our common stock price outperforms the S&P 500 Index. To
the extent that our common stock outperforms the S&P 500, the value of OSOs to
an option holder may exceed the value of NQSOs.
Subsequent to the split-off of the Construction Group from its other
businesses, the Company adopted the recognition provisions of SFAS No. 123.
Under SFAS No. 123, the fair value of an OSO (as computed in accordance with
accepted option valuation models) on the date of grant is amortized over the
vesting period of the OSO. The recognition provisions of SFAS No. 123 are
applied prospectively upon adoption. As a result, they are applied to all stock
awards granted in the year of adoption and are not applied to awards granted in
previous years unless those awards are modified or settled in cash after
adoption of the recognition provisions. The adoption of SFAS No. 123 resulted
in non-cash charges to operations of $126 million in 1999 and $39 million in
1998 and will continue to result in non-cash charges to operations for future
periods that the Company believes will also be material. The amount of the non-
cash charge will be dependent upon a number of factors, including the number of
options granted and the fair value estimated at the time of grant.
Competition
The communications and information services industry is highly competitive.
Many of the Company's existing and potential competitors in the communications
and information services industry have financial, personnel, marketing and
other resources significantly greater than those of the Company, as well as
other competitive advantages including existing customer bases. Increased
consolidation and strategic alliances in the industry resulting from the
Telecom Act, the opening of the U.S. market to foreign carriers, technological
advances and further deregulation could give rise to significant new
competitors to the Company.
In the special access and private line services market, the Company's
primary competitors are IXCs, ILECs and CLECs. Most of these competitors have a
significant base of customers for whom they are currently providing colocation
services. Due to the high costs to CLECs of switching colocation sites, the
Company may have a competitive disadvantage relative to these competitors. The
market for the colocation of web-servers is extremely competitive. In this
market, the Company competes with ISPs and many others, including Exodus,
GlobalCenter and Qwest.
For voice services, the Company will compete primarily with national and
regional network providers. AT&T, Sprint, MCI WorldCom and Qwest currently own
nationwide long distance fiber optic networks. Significant new competitors
could arise as a result of increased consolidation and strategic alliances in
the industry resulting from recent Congressional and FCC actions. MCI WorldCom
has entered into an agreement to acquire Sprint. In Europe, GTS, MCI WorldCom
and Viatel currently own intercity networks. Qwest's network as well as the
intercity networks being deployed by others, including Broadwing and Williams
Communications in the United States and KPNQwest, i-21 and Global Crossing in
Europe, use advanced technology similar to that of the Level 3 network and
offer significantly more capacity to the marketplace. Increased capacity may
cause significant decreases in the prices for services. The ability of the
Company to compete effectively in this market will depend upon its ability to
maintain high quality services at prices equal to or below those charged by its
competitors. Interexchange Carriers and certain CLECs with excess fiber optic
strands may be competitors in the dark fiber business. In the long distance
market, the Company's primary competitors will include AT&T, MCI WorldCom,
Sprint and Qwest, all of whom have extensive experience in the long distance
market. In addition, the Telecom Act will allow the RBOCs and others to enter
the long distance market. Bell Atlantic was recently authorized to conduct in-
region long distance service in New York. SBC has filed an application to
conduct such service in Texas. These providers are also competitors in the
provision of internet access. In local markets the Company will compete with
ILECs and CLECs, many of whom have extensive experience in the local market.
S-54
The communications and information services industry is subject to rapid and
significant changes in technology. For instance, recent technological advances
permit substantial increases in transmission capacity of both new and existing
fiber, and the introduction of new products or emergence of new technologies
may reduce the cost or increase the supply of certain services similar to those
which the Company plans on providing. Accordingly, in the future the Company's
most significant competitors may be new entrants to the communications and
information services industry, which are not burdened by an installed base of
outmoded equipment.
Regulation
The Company's communications and information services business will be
subject to varying degrees of federal, state, local and international
regulation.
Federal Regulation
The FCC regulates interstate and international telecommunications services.
The FCC imposes extensive regulations on common carriers such as ILECs that
have some degree of market power. The FCC imposes less regulation on common
carriers without market power, such as the Company. The FCC permits these
nondominant carriers to provide domestic interstate services (including long
distance and access services) without prior authorization; but it requires
carriers to receive an authorization to construct and operate
telecommunications facilities, and to provide or resell telecommunications
services, between the United States and international points. The Company has
recently obtained FCC approval to land its transatlantic cable in the U.S. The
Company has obtained FCC authorization to provide international services on a
facilities and resale basis. The Company has filed tariffs for its interstate
and international long distance services with the FCC.
Under the Telecom Act, any entity, including cable television companies, and
electric and gas utilities, may enter any telecommunications market, subject to
reasonable state regulation of safety, quality and consumer protection. Because
implementation of the Telecom Act is subject to numerous federal and state
policy rulemaking proceedings and judicial review, there is still uncertainty
as to what impact it will have on the Company. The Telecom Act is intended to
increase competition. The Telecom Act opens the local services market by
requiring ILECs to permit interconnection to their networks and establishing
ILEC obligations with respect to:
. Reciprocal Compensation. Requires all ILECs and CLECs to complete calls
originated by competing carriers under reciprocal arrangements at prices
based on a reasonable approximation of incremental cost or through
mutual exchange of traffic without explicit payment.
. Resale. Requires all ILECs and CLECs to permit resale of their
telecommunications services without unreasonable restrictions or
conditions. In addition, ILECs are required to offer wholesale versions
of all retail services to other telecommunications carriers for resale
at discounted rates, based on the costs avoided by the ILEC in the
wholesale offering.
. Interconnection. Requires all ILECs and CLECs to permit their
competitors to interconnect with their facilities. Requires all ILECs to
permit interconnection at any technically feasible point within their
networks, on nondiscriminatory terms and at prices based on cost (which
may include a reasonable profit). At the option of the carrier seeking
interconnection, colocation of the requesting carrier's equipment in an
ILEC's premises must be offered, except where the ILEC can demonstrate
space limitations or other technical impediments to colocation.
. Unbundled Access. Requires all ILECs to provide nondiscriminatory access
to specified unbundled network elements (including certain network
facilities, equipment, features, functions, and capabilities) at any
technically feasible point within their networks, on nondiscriminatory
terms and at prices based on cost (which may include a reasonable
profit).
S-55
. Number Portability. Requires all ILECs and CLECs to permit, to the
extent technically feasible, users of telecommunications services to
retain existing telephone numbers without impairment of quality,
reliability or convenience when switching from one telecommunications
carrier to another.
. Dialing Parity. Requires all ILECs and CLECs to provide "1+" equal
access to competing providers of telephone exchange service and toll
service, and to provide nondiscriminatory access to telephone numbers,
operator services, directory assistance, and directory listing, with no
unreasonable dialing delays.
. Access to Rights-of-Way. Requires all ILECs and CLECs to permit
competing carriers access to poles, ducts, conduits and rights-of-way at
regulated prices.
ILECs are required to negotiate in good faith with carriers requesting any
or all of the above arrangements. If the negotiating carriers cannot reach
agreement within a prescribed time, either carrier may request binding
arbitration of the disputed issues by the state regulatory commission. Even
when an agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunications regulatory
commissions.
In August 1996, the FCC released a decision (the "Interconnection Decision")
establishing rules implementing the above-listed requirements and providing
guidelines for review of interconnection agreements by state public utility
commissions. The United States Court of Appeals for the Eighth Circuit (the
"Eighth Circuit") vacated certain portions of the Interconnection Decision. On
January 25, 1999, the Supreme Court reversed the Eighth Circuit with respect to
the FCC's jurisdiction to issue regulations governing local interconnection
pricing (including regulations governing reciprocal compensation). The Supreme
Court also found that the FCC had authority to promulgate a "pick and choose"
rule and upheld most of the FCC's rules governing access to unbundled network
elements. The Supreme Court, however, remanded to the FCC the standard by which
the FCC identified the network elements that must be made available on an
unbundled basis.
On November 5, 1999, the FCC released an order largely retaining its list of
unbundled network elements but eliminating the requirement that ILECs provide
unbundled access to local switching for customers with four or more lines in
the densest portion of the top 50 Metropolitan Statistical Areas, and the
requirement to unbundle operator services and directory assistance.
The Eighth Circuit decisions and their recent reversal by the Supreme Court
continue to cause uncertainty about the rules governing the pricing, terms and
conditions of interconnection agreements. The Supreme Court's action in
particular may require or trigger the renegotiation of existing agreements.
Although state public utilities commissions have continued to conduct
arbitrations, and to implement and enforce interconnection agreements during
the pendency of the Eighth Circuit proceedings, the Supreme Court's recent
ruling and further proceedings on remand (either at the Eighth Circuit or the
FCC) may affect the scope of state commissions' authority to conduct such
proceedings or to implement or enforce interconnection agreements. They could
also result in new or additional rules being promulgated by the FCC. Given the
general uncertainty surrounding the effect of the Eighth Circuit decisions and
the recent decision of the Supreme Court reversing them, the Company may not be
able to continue to obtain or enforce interconnection terms that are acceptable
to it or that are consistent with its business plans.
The Telecom Act also codifies the ILECs' equal access and nondiscrimination
obligations and preempts inconsistent state regulation. The Telecom Act
contains special provisions that modify previous court decrees that prevented
RBOCs from providing long distance services and engaging in telecommunications
equipment manufacturing. These provisions permit a RBOC to enter the long
distance market in its traditional service area if it satisfies several
procedural and substantive requirements, including obtaining FCC approval upon
a showing that the RBOC has entered into interconnection agreements (or, under
some circumstances, has offered to enter into such agreements) in those states
in which it seeks long distance relief, the interconnection agreements satisfy
a 14-point "checklist" of competitive requirements, and the FCC is satisfied
that the RBOC's entry into long distance markets is in the public interest.
Recently, the FCC approved Bell Atlantic's
S-56
petition to offer long distance service in New York. SBC has filed an
application to conduct such service in Texas. The Telecom Act permitted the
RBOCs to enter the out-of-region long distance market immediately upon its
enactment.
In October 1996, the FCC adopted an order in which it eliminated the
requirement that non-dominant carriers such as the Company maintain tariffs on
file with the FCC for domestic interstate services. This order applies to all
non-dominant interstate carriers, including AT&T. The order does not apply to
the RBOCs or other local exchange providers. The FCC order was issued pursuant
to authority granted to the FCC in the Telecom Act to "forbear" from regulating
any telecommunications services provider if the FCC determines that the public
interest will be served. On February 13, 1997, the United States Court of
Appeals for the District of Columbia Circuit stayed the implementation of the
FCC order pending its review of the order on the merits. Currently, that
temporary stay remains in effect.
If the stay is lifted and the FCC order becomes effective,
telecommunications carriers such as the Company will no longer be able to rely
on the filing of tariffs with the FCC as a means of providing notice to
customers of prices, terms and conditions on which they offer their interstate
services. The obligation to provide non-discriminatory, just and reasonable
prices remains unchanged under the Communications Act of 1934. While tariffs
provided a means of providing notice of prices, terms and conditions, the
Company intends to rely primarily on its sales force and direct marketing to
provide such information to its customers.
The Company's costs of providing long distance services, as well as its
revenues from providing local services, will both be affected by changes in the
"access charge" rates imposed by ILECs on long distance carriers for
origination and termination of calls over local facilities. The FCC has made
major changes in the interstate access charge structure. In a December 24, 1996
order, the FCC removed restrictions on ILECs' ability to lower access prices
and relaxed the regulation of new switched access services in those markets
where there are other providers of access services. On August 5, 1999 the FCC
adopted an order granting price cap LECs additional pricing flexibility,
implementing certain access charge reforms and seeking comments on others. The
order provides certain immediate regulatory relief to price cap carriers and
sets a framework of "triggers" to provide those companies with greater pricing
flexibility to set interstate access rates as competition increases. The order
also initiated a rulemaking to determine whether the FCC should regulate the
access charges of CLECs. If this increased pricing flexibility is not
effectively monitored by federal regulators, it could have a material adverse
effect on the Company's ability to price its interstate access services
competitively. A May 16, 1997 order substantially increased the amounts that
ILECs subject to the FCC's price cap rules ("price cap LECs") recover through
monthly flat-rate charges and substantially decreased the amounts that these
LECs recover through traffic sensitive (per-minute) access charges. Several
parties appealed the May 16th order. On August 19, 1998, the Eighth Circuit
upheld the FCC's access charge reform rules.
Beginning in June 1997, every RBOC advised CLECs that they did not consider
calls in the same local calling area from their customers to CLEC customers,
who are ISPs, to be local calls under the interconnection agreements between
the RBOCs and the CLECs. The RBOCs claim that these calls are exchange access
calls for which exchange access charges would be owed. The RBOCs claimed,
however, that the FCC exempted these calls from access charges so that no
compensation is owed to the CLECs for transporting and terminating such calls.
As a result, the RBOCs threatened to withhold, and in many cases did withhold,
reciprocal compensation for the transport and termination of such calls. To
date, thirty-six state commissions have ruled on this issue in the context of
state commission arbitration proceedings or enforcement proceedings. In thirty-
three states, to date, the state commission has determined that reciprocal
compensation is owed for such calls. Several of these cases are presently on
appeal. Reviewing courts have upheld the state commissions in eight decisions
rendered to date on appeal. Appeals from these decisions are pending in the
Fourth and Fifth Circuits and the U.S. Circuit Court of Appeal for the District
of Columbia. The Seventh Circuit upheld the Illinois Commerce Commission
decision on June 18, 1999. On February 25, 1999, the FCC issued a Declaratory
Ruling on the issue of inter-carrier compensation for calls bound to ISPs. The
FCC ruled that the calls are largely jurisdictionally interstate calls, not
local calls. The FCC, however, determined that this issue was not dispositive
of whether inter-carrier compensation is owed. The FCC noted a number of
factors which would allow the state commissions to leave their decisions
requiring the payment of compensation undisturbed. The Company cannot predict
the effect of the FCC's ruling on existing state decisions, or the outcome of
pending
S-57
appeals or of additional pending cases. The Ninth Circuit dismissed an appeal
of a Washington decision on the ground that it constituted a collateral attack
on the FCC's ruling. The FCC also issued proposed rules to address inter-
carrier compensation in the future.
The Company recently entered into an agreement with Bell Atlantic which
establishes rates for transmission of local and Internet bound traffic.
The FCC has to date treated ISPs as "enhanced service providers," exempt
from federal and state regulations governing common carriers, including the
obligation to pay access charges and contribute to the universal service fund.
Nevertheless, regulations governing disclosure of confidential communications,
copyright, excise tax, and other requirements may apply to the Company's
provision of Internet access services. The Company cannot predict the
likelihood that state, federal or foreign governments will impose additional
regulation on the Company's Internet business, nor can it predict the impact
that future regulation will have on the Company's operations.
In December 1996, the FCC initiated a Notice of Inquiry regarding whether to
impose regulations or surcharges upon providers of Internet access and
information services (the "Internet NOI"). The Internet NOI sought public
comment upon whether to impose or continue to forebear from regulation of
Internet and other packet-switched network service providers. The Internet NOI
specifically identifies Internet telephony as a subject for FCC consideration.
On April 10, 1998, the FCC issued a Report to Congress on its implementation of
the universal service provisions of the Telecom Act. In that Report, the FCC
stated, among other things, that the provision of transmission capacity to ISPs
constitutes the provision of telecommunications and is, therefore, subject to
common carrier regulations. The FCC indicated that it would reexamine its
policy of not requiring an ISP to contribute to the universal service
mechanisms when the ISP provides its own transmission facilities and engages in
data transport over those facilities in order to provide an information
service. Any such contribution by a facilities based ISP would be related to
the ISP's provision of the underlying telecommunications services. In the
Report, the FCC also indicated that it would examine the question of whether
certain forms of "phone-to-phone Internet Protocol telephony" are information
services or telecommunications services. It noted that the FCC did not have an
adequate record on which to make any definitive pronouncements on that issue at
this time, but that the record the FCC had reviewed suggests that certain forms
of phone-to-phone Internet Protocol telephony appear to have similar
functionality to non-Internet Protocol telecommunications services and lack the
characteristics that would render them information services. If the FCC were to
determine that certain Internet Protocol telephony services are subject to FCC
regulations as telecommunications services, the FCC noted it may find it
reasonable that the ISPs pay access charges and make universal service
contributions similar to non-Internet Protocol based telecommunications service
providers. The FCC also noted that other forms of Internet Protocol telephony
appear to be information services. The Company cannot predict the outcome of
these proceedings or other FCC proceedings that may effect the Company's
operations or impose additional requirements, regulations or charges upon the
Company's provision of Internet access services.
On May 8, 1997, the FCC issued an order establishing a significantly
expanded federal universal service subsidy regime. For example, the FCC
established new universal service funds to support telecommunications and
information services provided to qualifying schools and libraries (with an
annual cap of $2.25 billion) and to rural health care providers (with an annual
cap of $400 million). The FCC also expanded the federal subsidies for local
exchange telephone services provided to low-income consumers and recently
doubled the size of the high cost fund for non-rural LECs. Providers of
interstate telecommunications service, such as the Company, as well as certain
other entities, must pay for these programs. The Company's contribution to
these universal service funds will be based on its telecommunications service
end-user revenues. The extent to which the Company's services are viewed as
telecommunications services or as information services will impact the amount
of the Company's contributions, if any. As indicated in the preceding
paragraph, that issue has not been resolved. Currently, the FCC assesses such
payments on the basis of a provider's revenue for the previous year. The
Company is currently unable to quantify the amount of subsidy payments that it
will be required to make and the effect that these required payments will have
on its financial condition because of uncertainties concerning the size of the
universal fund and uncertainties concerning the classification of its services.
The
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Fifth Circuit Court of Appeals recently upheld the FCC in most respects, but
rejected the FCC's effort to base contributions on intrastate revenues. The
FCC's universal service program may also be altered as a result of the agency's
reconsideration of its policies, or by future Congressional action.
The FCC recently adopted new rules designed to make it easier and less
expensive for CLECs to obtain colocation at ILEC central offices by, among
other things, restricting the ILEC's ability to prevent certain types of
equipment from being colocated and requiring ILECs to offer alternative
colocation arrangements which will be less costly.
On November 18, 1999, the FCC adopted a new order requiring ILECs to provide
line sharing, which will allow CLECs to offer data services over the same line
the consumer uses for voice services without the CLECs being required to offer
the voice services. State commissions have been authorized to establish the
prices to the CLECs for such services. The decision has been appealed.
State Regulation
The Telecom Act is intended to increase competition in the
telecommunications industry, especially in the local exchange market. With
respect to local services, ILECs are required to allow interconnection to their
networks and to provide unbundled access to network facilities, as well as a
number of other procompetitive measures. Because the implementation of the
Telecom Act is subject to numerous state rulemaking proceedings on these
issues, it is currently difficult to predict how quickly full competition for
local services, including local dial tone, will be introduced.
State regulatory agencies have jurisdiction when Company facilities and
services are used to provide intrastate services. A portion of the Company's
traffic may be classified as intrastate and therefore subject to state
regulation. The Company expects that it will offer more intrastate services
(including intrastate switched services) as its business and product lines
expand. To provide intrastate services, the Company generally must obtain a
certificate of public convenience and necessity from the state regulatory
agency and comply with state requirements for telecommunications utilities,
including state tariffing requirements. The Company currently is authorized to
provide telecommunications services in all fifty states and the District of
Columbia, other than Alaska.
The Company has a pending application for authority to provide
telecommunications services in Alaska. In addition, the Company has filed an
application with the California Public Utilities Commission to expand the
Company's network within that state. While approval of the application is
expected by mid-2000, the Company cannot predict how quickly the Commission
will act and whether any such delays will affect its ability to complete the
network.
States also often require prior approvals or notifications for certain
transfers of assets, customers or ownership of certificated carriers and for
issuances by certified carriers of equity or debt.
Local Regulation
The Company's networks will be subject to numerous local regulations such as
building codes and licensing. Such regulations vary on a city-by-city, county-
by-county and state-by-state basis. To install its own fiber optic transmission
facilities, the Company will need to obtain rights-of-way over privately and
publicly owned land. Rights-of-way that are not already secured may not be
available to the Company on economically reasonable or advantageous terms.
Canadian Regulation
The Canadian Radio-television and Telecommunications Commission (the "CRTC")
generally regulates long distance telecommunications services in Canada.
Regulatory developments over the past several years
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have terminated the historic monopolies of the regional telephone companies,
bringing significant competition to this industry for both domestic and
international long distance services, but also lessening regulation of domestic
long distance companies. Resellers, which, as well as facilities-based
carriers, now have interconnection rights, but which are not obligated to file
tariffs, may not only provide transborder services to the U.S. by reselling the
services provided by the regional companies and other entities but also may
resell the services of the former monopoly international carrier, Teleglobe
Canada ("Teleglobe"), including offering international switched services
provisioned over leased lines. Although the CRTC formerly restricted the
practice of "switched hubbing" over leased lines through intermediate countries
to or from a third country, the CRTC recently lifted this restriction. The
Teleglobe monopoly on international services and submarine cable landing rights
terminated as of October 1, 1998, although the provision of Canadian
international transmission facilities-based services remains restricted to
"Canadian carriers" with majority ownership by Canadians. Ownership of non-
international transmission facilities are limited to Canadian carriers but the
Company can own international submarine cables landing in Canada. The Company
cannot, under current or foreseen law, enter the Canadian market as a provider
of transmission facilities-based domestic services. Recent CRTC rulings address
issues such as the framework for international contribution charges payable to
the local exchange carriers to offset some of the capital and operating costs
of the provision of switched local access services of the incumbent regional
telephone companies, in their capacity as ILECs, and the new entrant CLECs.
While competition is permitted in virtually all other Canadian
telecommunications market segments, the Company believes that the regional
companies continue to retain a substantial majority of the local and calling
card markets. Beginning in May 1997, the CRTC released a number of decisions
opening to competition the Canadian local telecommunications services market,
which decisions were made applicable in the territories of all of the regional
telephone companies except SaskTel (although Saskatchewan has subsequently
allowed local service competition in that province). As a result, networks
operated by CLECs may now be interconnected with the networks of the ILECs.
Transmission facilities-based CLECs are subject to the same majority Canadian
ownership "Canadian carrier" requirements as transmission facilities-based long
distance carriers. CLECs have the same status as ILECs, but they do not have
universal service or customer tariff-filing obligations. CLECs are subject to
certain consumer protection safeguards and other CRTC regulatory oversight
requirements. CLECs must file interconnection tariffs for services to
interexchange service providers and wireless service providers. Certain ILEC
services must be provided to CLECs on an unbundled basis and subject to
mandatory pricing, including central office codes, subscriber listings, and
local loops in small urban and rural areas. For a five-year period, certain
other important CLEC services must be provided on an unbundled basis at
mandated prices, notably unbundled local loops in large, urban areas. ILECs,
which, unlike CLECs, remained fully regulated, will be subject to price cap
regulation in respect of their utility services for an initial four-year period
beginning May 1, 1997, and these services must not be priced below cost.
Interexchange contribution payments are now pooled and distributed among ILECs
and CLECs according to a formula based on their respective proportions of
residential lines, with no explicit contribution payable from local business
exchange or directory revenues. CLECs must pay an annual telecommunications fee
based on their proportion of total CLEC operating revenues. All bundled and
unbundled local services (including residential lines and other bulk services)
may now be resold, but ILECs need not provide these services to resellers at
wholesale prices. Transmission facilities-based local and long distance
carriers (but not resellers) are entitled to colocate equipment in ILEC central
offices pursuant to terms and conditions of tariffs and intercarrier
agreements. Certain local competition issues are still to be resolved. The CRTC
has ruled that resellers cannot be classified as CLECs, and thus are not
entitled to CLEC interconnection terms and conditions.
The Company's Other Businesses
The Company's other businesses include its investment in the C-TEC Companies
(as defined), coal mining, the SR91 Tollroad (as defined) and certain other
assets. In 1998, the Company completed the sale of its interests in United
Infrastructure Company, MidAmerican and Kiewit Investment Management Corp.
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C-TEC Companies
On September 30, 1997, C-TEC completed a tax-free restructuring, which
divided C-TEC into three public companies (the "C-TEC Companies"): C-TEC, which
changed its name to Commonwealth Telephone, RCN and Cable Michigan. The
Company's interests in the C-TEC Companies are held through a holding company
(the "C-TEC Holding Company"). The Company owns 90% of the common stock of the
C-TEC Holding Company, and preferred stock of the C-TEC Holding Company with a
liquidation value of approximately $499 million as of December 31, 1999. The
remaining 10% of the common stock of the C-TEC Holding Company is held by David
C. McCourt, a director of the Company who was formerly the Chairman of C-TEC.
In the event of a liquidation of the C-TEC Holding Company, the Company would
first receive the liquidation value of the preferred stock. Any excess of the
value of the C-TEC Holding Company above the liquidation value of the preferred
stock would be split according to the ownership of the common stock.
Commonwealth Telephone. Commonwealth Telephone is a Pennsylvania public
utility providing local telephone service to a 19-county, 5,191 square mile
service territory in Pennsylvania. Commonwealth Telephone services
approximately 291,000 main access lines. Commonwealth Telephone also provides
network access and long distance services to IXCs. Commonwealth Telephone's
business customer base is diverse in size as well as industry, with very little
concentration. A subsidiary, Commonwealth Communications Inc. provides
telecommunications engineering and technical services to large corporate
clients, hospitals and universities in the northeastern United States. Another
subsidiary, Commonwealth Long Distance operates principally in Pennsylvania,
providing switched services and resale of several types of services, using the
networks of several long distance providers on a wholesale basis. As of
December 31, 1999, the C-TEC Holding Company owned approximately 47.9% of the
outstanding common stock of Commonwealth Telephone.
On October 23, 1998, Commonwealth Telephone completed a rights offering of
3.7 million shares of its common stock. In the offering, Level 3 exercised all
rights it received and purchased approximately 1.8 million additional shares of
Commonwealth Telephone common stock for an aggregate subscription price of
$37.7 million.
RCN. RCN is a full service provider of local, long distance, Internet and
cable television services primarily to residential users in densely populated
areas in the Northeast. RCN operates as a competitive telecommunications
service provider in New York City and Boston. RCN also owns cable television
operations in New York, New Jersey and Pennsylvania; a 40% interest in
Megacable, S.A. de C.V., Mexico's second largest cable television operator; and
has long distance operations (other than the operations in certain areas of
Pennsylvania). RCN is developing advanced fiber optic networks to provide a
wide range of telecommunications services, including local and long distance
telephone, video programming and data services (including high speed Internet
access), primarily to residential customers in selected markets in the Boston
to Washington, D.C. and San Francisco to San Diego corridors. During the first
quarter of 1998, RCN acquired Ultranet Communications, Inc. and Erols Internet,
Inc., two ISPs with operations in the Boston to Washington, D.C. corridor. As
of December 31, 1999, the C-TEC Holding Company owned approximately 34.5% of
the outstanding common stock of RCN.
Cable Michigan. Cable Michigan was a cable television operator in the State
of Michigan which, as of December 31, 1997, served approximately 204,000
subscribers including approximately 39,400 subscribers served by Mercom.
Clustered primarily around the Michigan communities of Grand Rapids, Traverse
City, Lapeer and Monroe (Mercom), Cable Michigan's systems serve a total of
approximately 400 municipalities in suburban markets and small towns. On June
4, 1998, Cable Michigan announced that it had agreed to be acquired by Avalon
Cable. Level 3 received approximately $129 million in cash when the transaction
closed on November 6, 1998.
Coal Mining
The Company is engaged in coal mining through its subsidiary, KCP, Inc.
("KCP"). KCP has a 50% interest in three mines, which are operated by a
subsidiary of Peter Kiewit Sons', Inc. ("New PKS"). Decker
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Coal Company ("Decker") is a joint venture with Western Minerals, Inc., a
subsidiary of The RTZ Corporation PLC. Black Butte Coal Company ("Black Butte")
is a joint venture with Bitter Creek Coal Company, a subsidiary of Union
Pacific Resources Group Inc. Walnut Creek Mining Company ("Walnut Creek") is a
general partnership with Phillips Coal Company, a subsidiary of Phillips
Petroleum Company. The Decker mine is located in southeastern Montana, the
Black Butte mine is in southwestern Wyoming, and the Walnut Creek mine is in
east-central Texas. The coal mines use the surface mining method. For a
discussion of certain risks associated with the coal mining business, see "Risk
Factors--Environmental liabilities from our historical operations could be
material," "--Significant future declines in cash flow from coal operations"
and "--Potential liabilities and claims arising from our coal operations could
be significant."
The coal produced from the KCP mines is sold primarily to electric
utilities, which burn coal in order to produce steam to generate electricity.
Approximately 95% of sales are made under long-term contracts, and the
remainder are made on the spot market. Approximately 75%, 77% and 79% of KCP's
revenues in 1999, 1998 and 1997 respectively, were derived from long-term
contracts with Commonwealth Edison Company (with Decker and Black Butte) and
The Detroit Edison Company (with Decker). The primary customer of Walnut Creek
is the Texas-New Mexico Power Company ("TNP"). KCP also has other sales
commitments, including those with Sierra Pacific, Idaho Power, Solvay Minerals,
Pacific Power & Light, Minnesota Power, and Mississippi Power, that provide for
the delivery of approximately 13 million tons through 2005. The level of cash
flows generated in recent periods by the Company's coal operations will not
continue after the year 2000 because the delivery requirements under the
Company's current long-term contracts decline significantly.
Under a mine management agreement, KCP pays a subsidiary of New PKS an
annual fee equal to 30% of KCP's adjusted operating income. The fee for 1999
was $33 million.
The coal industry is highly competitive. KCP competes not only with other
domestic and foreign coal suppliers, some of whom are larger and have greater
capital resources than KCP, but also with alternative methods of generating
electricity and alternative energy sources. In 1997, KCP's production
represented 1.4% of total U.S. coal production. Demand for KCP's coal is
affected by economic, political and regulatory factors. For example, recent
"clean air" laws may stimulate demand for low sulfur coal. KCP's western coal
reserves generally have a low sulfur content (less than one percent) and are
currently useful principally as fuel for coal-fired, steam-electric generating
units.
KCP's sales of its western coal, like sales by other western coal producers,
typically provide for delivery to customers at the mine. A significant portion
of the customer's delivered cost of coal is attributable to transportation
costs. Most of the coal sold from KCP's western mines is currently shipped by
rail to utilities outside Montana and Wyoming. The Decker and Black Butte mines
are each served by a single railroad. Many of their western coal competitors
are served by two railroads and such competitors' customers often benefit from
lower transportation costs because of competition between railroads for coal
hauling business. Other western coal producers, particularly those in the
Powder River Basin of Wyoming, have lower stripping ratios (that is, the amount
of overburden that must be removed in proportion to the amount of minable coal)
than the Black Butte and Decker mines, often resulting in lower comparative
costs of production. As a result, KCP's production costs per ton of coal at the
Black Butte and Decker mines can be as much as four and five times greater than
production costs of certain competitors. KCP's production cost disadvantage has
contributed to its agreement to amend its long-term contract with Commonwealth
Edison Company to provide for delivery of coal from alternate source mines
rather than from Black Butte. Because of these cost disadvantages, KCP does not
expect that it will be able to enter into long-term coal purchase contracts for
Black Butte and Decker production as the current long-term contracts expire. In
addition, these cost disadvantages may adversely affect KCP's ability to
compete for spot sales in the future.
The Company is required to comply with various federal, state and local laws
and regulations concerning protection of the environment. KCP's share of land
reclamation expenses for the year ended December 31, 1999 was approximately $7
million. KCP's share of accrued estimated reclamation costs was $100 million at
December 31, 1999. The Company did not make significant capital expenditures
for environmental compliance
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with respect to the coal business in 1999. The Company believes its compliance
with environmental protection and land restoration laws will not affect its
competitive position since its competitors in the mining industry are similarly
affected by such laws. However, failure to comply with environmental protection
and land restoration laws, or actual reclamation costs in excess of the
Company's accruals, could have an adverse effect on the Company's business,
results of operations, and financial condition.
SR91 Tollroad
The Company has invested $12.9 million for a 65% equity interest and lent
$6.4 million to California Private Transportation Company L.P. ("CPTC"), which
developed, financed, and currently operates the 91 Express Lanes, a ten mile,
four-lane tollroad in Orange County, California (the "SR91 Tollroad"). The
fully automated highway uses an electronic toll collection system and variable
pricing to adjust tolls to demand. Capital costs at completion were $130
million, $110 million of which was funded with debt that was not guaranteed by
Level 3. However, certain defaults by Level 3 on its outstanding debt and
certain judgments against Level 3 can result in default under this debt of
CPTC. Revenue collected over the 35-year franchise period is used for operating
expenses, debt repayment, and profit distributions. The SR91 Tollroad opened in
December 1995 and achieved operating break-even in 1996. Approximately 93,900
customers have registered to use the tollroad as of December 31, 1999, and
weekday volumes typically exceed 21,600 vehicles per day during December 1999.
Legal Proceedings
In August 1999, the Company was named as a defendant in Schweizer vs. Level
3 Communications, Inc., et al., a purported national class action, filed in the
District Court, County of Boulder, State of Colorado which involves the
Company's right to install its fiber optic cable network in easements and
right-of-ways crossing the plaintiffs' land. In general, the Company obtained
the rights to construct its network from railroads, utilities, and others, and
is installing its network along the rights-of-way so granted. Plaintiffs in the
purported class action assert that they are the owners of lands over which the
Company's fiber optic cable network passes, and that the railroads, utilities,
and others who granted the Company the right to construct and maintain its
network did not have the legal ability to do so. The action purports to be on
behalf of a national class of owners of land over which the Company's network
passes or will pass. The complaint seeks damages on theories of trespass,
unjust enrichment and slander of title and property, as well as punitive
damages. Although the Company is not aware of any additional similar claims,
the Company may in the future receive claims and demands related to rights-of-
way issues similar to the issues in the Schweizer litigation that may be based
on similar or different legal theories. Although it is too early for the
Company to reach a conclusion as to the ultimate outcome of this litigation,
management believes that the Company has substantial defenses to the claims
asserted in the Schweizer action (and any similar claims which may be named in
the future), and intends to defend them vigorously.
The Company and its subsidiaries are parties to many other legal
proceedings. Management believes that any resulting liabilities for these legal
proceedings, beyond amounts reserved, will not materially affect the Company's
financial condition, future results of operations, or future cash flows.
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MANAGEMENT
Directors and Executive Officers
Set forth below is information as of February 1, 2000 about each director
and each executive officer of the Company. The executive officers of the
Company have been determined in accordance with the rules of the SEC.
Name Age Position
---- --- --------
Walter Scott, Jr........ 68 Chairman of the Board
James Q. Crowe.......... 50 President, Chief Executive Officer and Director
R. Douglas Bradbury..... 49 Executive Vice President, Chief Financial Officer and
Vice Chairman of the Board
Kevin J. O'Hara......... 39 Executive Vice President and Chief Operating Officer
Colin V.K. Williams..... 60 Executive Vice President
Stephen C. Liddell...... 38 Group Vice President
Kathleen A. Perone...... 46 Group Vice President
Gail P. Smith........... 40 Group Vice President
Philip B. Fletcher...... 66 Director
William L. Grewcock..... 74 Director
Richard R. Jaros........ 48 Director
Robert E. Julian........ 60 Director
David C. McCourt........ 43 Director
Kenneth E. Stinson...... 57 Director
Michael B. Yanney....... 66 Director
Other Management
Set forth below is information as of February 1, 2000, about the following
members of senior management of the Company.
Name Age Position
---- --- --------
Jimmy D. Byrd........... 39 President and Chief Executive Officer of PKSIS
Linda J. Adams.......... 43 Group Vice President
Daniel P. Caruso........ 36 Group Vice President
Sureel A. Choksi........ 27 Group Vice President and Treasurer
Donald H. Gips.......... 40 Group Vice President
Joseph M. Howell, III... 53 Group Vice President
Michael D. Jones........ 42 Group Vice President
Thomas C. Stortz........ 48 Group Vice President, General Counsel and Secretary
Ronald J. Vidal......... 39 Group Vice President
John F. Waters, Jr...... 34 Group Vice President
Walter Scott, Jr. has been the Chairman of the Board of the Company since
September 1979, and a director of the Company since April 1964. Mr. Scott has
been Chairman Emeritus of New PKS since the split-off. Mr. Scott is also a
director of New PKS, Berkshire Hathaway Inc., Burlington Resources Inc.,
MidAmerican, ConAgra, Inc., Commonwealth Telephone, RCN and Valmont Industries,
Inc.
James Q. Crowe has been the President and Chief Executive Officer of the
Company since August 1997, and a director of the Company since June 1993. Mr.
Crowe was President and Chief Executive Officer of MFS from June 1993 to June
1997. Mr. Crowe also served as Chairman of the Board of WorldCom from January
1997 until July 1997, and as Chairman of the Board of MFS from 1992 through
1996. Mr. Crowe is presently a director of New PKS, Commonwealth Telephone, RCN
and InaCom Communications, Inc.
R. Douglas Bradbury has been Vice Chairman of the Board since February 2000,
Executive Vice President and Chief Financial Officer of the Company since
August 1997, and a director of the Company since March 1998. Mr. Bradbury
served as Chief Financial Officer of MFS from 1992 to 1996, Senior Vice
President of MFS from 1992 to 1995, and Executive Vice President of MFS from
1995 to 1996.
Kevin J. O'Hara has been Executive Vice President of the Company since
August 1997, and Chief Operating Officer of the Company since March 1998. Prior
to that, Mr. O'Hara served as President and Chief
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Executive Officer of MFS Global Network Services, Inc. from 1995 to 1997, and
as Senior Vice President of MFS and President of MFS Development, Inc. from
October 1992 to August 1995. From 1990 to 1992, he was a Vice President of MFS
Telecom, Inc. ("MFS Telecom").
Colin V.K. Williams has been Executive Vice President of the Company since
July 1998 and President of Level 3 International, Inc. since July 1998. Prior
to joining the company, Mr. Williams was Chairman of WorldCom International,
Inc., where he was responsible for the international communications business
and the development and operation of WorldCom's fiber networks overseas. In
1993 Mr. Williams initiated and built the international operations of MFS.
Prior to joining MFS, Mr. Williams was Corporate Director, Business Development
at British Telecom from 1988 until 1992.
Stephen C. Liddell has been the Group Vice President of the Company since
February 1, 2000. Mr Liddell is responsible for the Company's Asian operations.
Prior to that, Mr. Liddell was Senior Vice President of the Company from May
1999 to February 1, 2000. Prior to that, Mr. Liddell was President, Asia-
Pacific Region at MCI-WorldCom from January 1996 to April 1999 and was Vice
President and General Manager, International Networks at MFS Communications
from July 1994 to January 1996. Mr. Liddell was Commercial Director and
Director of Planning and Business Development at Syncordia (British Telecom)
from November 1991 to July 1994 and Business Development Executive at British
Telecom from April 1989 to November 1991.
Kathleen A. Perone has been Group Vice President of the Company since
February 1, 2000. Ms. Perone is responsible for the Company's North American
operations. Prior to that, Ms. Perone was Vice President, Sales of the Company
from 1998 to February 1, 2000. Prior to that, Ms. Perone was President, Global
Services and Telecom East, of MFS/WorldCom, from 1990 to 1998 and Vice
President, National Accounts at Cable & Wireless from 1989 to 1990.
Gail P. Smith has been Group Vice President of the Company since February 1,
2000. Prior to that, Ms. Smith served as Senior Vice President, International
Sales and Marketing of the Company from December 1998 to February 1, 2000.
Prior to that, Ms. Smith was Vice President and General Manager of WorldCom
International Networks from November 1994 to July 1997 and European Marketing
Director during the start-up phase of MFS International.
Philip B. Fletcher has been a director of the Company since February 1999.
Mr. Fletcher was Chairman of the Board of ConAgra, Inc. from May 1993 until
September 1998. Mr. Fletcher was Chief Executive Officer of ConAgra, Inc. from
September 1992 to September 1997. Mr. Fletcher is a director of ConAgra, Inc.
and chairman of its executive committee.
William L. Grewcock has been a director of the Company since January 1968.
Prior to the split-off, Mr. Grewcock was Vice Chairman of the Company for more
than five years. He is presently a director of New PKS.
Richard R. Jaros has been a director of the Company since June 1993 and
served as President of the Company from 1996 to 1997. Mr. Jaros served as
Executive Vice President of the Company from 1993 to 1996 and Chief Financial
Officer of the Company from 1995 to 1996. He also served as President and Chief
Operating Officer of CalEnergy from 1992 to 1993, and is presently a director
of MidAmerican, Commonwealth Telephone, RCN and Homeservices.com, Inc.
Robert E. Julian has been a director of the Company since March 31, 1998.
Mr. Julian has also been Chairman of the Board of PKSIS since 1995. From 1992
to 1995 Mr. Julian served as Executive Vice President and Chief Financial
Officer of the Company.
David C. McCourt has been a director of the Company since March 31, 1998.
Mr. McCourt has also served as Chairman and Chief Executive Officer of
Commonwealth Telephone and RCN since October 1997. From 1993 to 1997 Mr.
McCourt served as Chairman of the Board and Chief Executive Officer of C-TEC.
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Kenneth E. Stinson has been a director of the Company since January 1987.
Mr. Stinson has been Chairman of the Board and Chief Executive Officer of New
PKS since the Split-Off. Prior to the Split-Off, Mr. Stinson was Executive Vice
President of the Company for more than the last five years. Mr. Stinson is also
a director of ConAgra, Inc. and Valmont Industries, Inc.
Michael B. Yanney has been a director of the Company since March 31, 1998.
He has served as Chairman of the Board, President and Chief Executive Officer
of America First Companies L.L.C. for more than the last five years. Mr. Yanney
is also a director of Burlington Northern Santa Fe Corporation, RCN, Forest Oil
Corporation and Mid-America Apartment Communities, Inc.
Jimmy D. Byrd has been the President and Chief Executive Officer of PKSIS
since March 1999. Mr. Byrd was President and General Manager of the New South
Wales Office of Corporate Express, Inc. and Chief Information Officer of
Corporate Express, Inc. Australia/New Zealand from 1997 to 1999. From 1993 to
1997 he was Vice President and CIO for Temple-Inland, Inc., was a National
Sales Manager for Visual Information Technologies from 1990 to 1993 and was an
Advisory Marketing Representative for IBM from 1982 to 1990.
Linda J. Adams has been Group Vice President Human Resources of the Company
since February 1, 2000. Prior to that, Ms. Adams was Vice President Human
Resources of the Company from November 1998 to February 1, 2000. Prior to that,
Ms. Adams was initially Vice President of Human Resources Rent-A-Center, a
subsidiary of Thorn Americas, Inc., and then Senior Vice President of Human
Resources for Thorn Americas, Inc. from August 1995 until August 1998. Prior to
that, Ms. Adams was Vice President of Worldwide Compensation & Benefits for
PepsiCo, Inc. from August 1994 to August 1995.
Daniel P. Caruso has been Group Vice President Global Customer Operations of
the Company since February 1, 2000. Prior to that, Mr. Caruso served as Senior
Vice President, Network Services of the Company from October 1997 to February
1, 2000. Prior to that, Mr. Caruso was Senior Vice President, Local Service
Delivery of WorldCom from December 1992 to September 1997 and was a member of
the senior management of Ameritech from June 1986 to November 1992.
Sureel A. Choksi has been Group Vice President Corporate Development and
Treasurer of the Company since February 1, 2000. Prior to that, Mr. Choksi
served as Vice President and Treasurer of the Company from January 1999 to
February 1, 2000. Prior to that, Mr. Choksi was a Director of Finance at the
Company from 1997 to 1998, an Associate at TeleSoft Management, LLC in 1997 and
an Analyst at Gleacher Natwest from 1995 to 1997.
Donald H. Gips has been Group Vice President Sales and Marketing of the
Company since February 1, 2000. Prior to that, Mr. Gips served as Senior Vice
President, Corporate Development of the Company from November 1998 to February
1, 2000. Prior to that, Mr. Gips served in the White House as Chief Domestic
Policy Advisor to Vice President Gore from April 1997 to April 1998. Before
working at the White House, Mr. Gips was at the Federal Communications
Commission as the International Bureau Chief and Director of Strategic Policy
from January 1994 to April 1997. Prior to his government service, Mr. Gips was
a management consultant at McKinsey and Company.
Joseph M. Howell, III has been Group Vice President Corporate Marketing of
the Company since February 1, 2000. Prior to that, Mr. Howell served as Senior
Vice President, Corporate Marketing of the Company from October 1997 to
February 1, 2000. Prior to that, Mr. Howell was Senior Vice President of
MFS/WorldCom from 1993 to 1997.
Michael D. Jones has served as Group Vice President and Chief Information
Officer of the Company since February 1, 2000. Prior to that, Mr. Jones served
as Senior Vice President and Chief Information Officer of the Company from
December 1998 to February 1, 2000. Prior to that, Mr. Jones was Vice President
and Chief Information Officer of Corporate Express, Inc. from May 1994 to May
1998.
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Thomas C. Stortz has been Group Vice President, General Counsel and
Secretary of the Company since February 1, 2000. Prior to that, Mr. Stortz
served as Senior Vice President, General Counsel and Secretary of the Company
from September 1998 to February 1, 2000. Prior to that, he served as Vice
President and General Counsel of Peter Kiewit Sons', Inc. and Kiewit
Construction Group, Inc. from April 1991 to September 1998. He has served as a
director of Peter Kiewit Sons', Inc., RCN, C-TEC, Kiewit Diversified Group Inc.
and CCL Industries, Inc.
Ronald J. Vidal has been Group Vice President New Ventures and Investor
Relations of the Company since February 1, 2000. Prior to that, Mr. Vidal
served as Senior Vice President, New Ventures of the Company from October 1997
to February 1, 2000. Prior to that, Mr. Vidal was a Vice President of
MFS/WorldCom from September 1992 to October 1997. Mr. Vidal joined the Company
in construction project management in July 1983.
John F. Waters, Jr. has been Group Vice President and Chief Technology
Officer of the Company since February 1, 2000. Prior to that, Mr. Waters was
Vice President, Engineering of the Company from November 1997 until February 1,
2000. Prior to that, Mr. Waters was an executive staff member of MCI
Communications from 1994 to November 1997.
The Board is divided into three classes, designated Class I, Class II and
Class III, each class consisting, as nearly as may be possible, of one-third of
the total number of directors constituting the Board. The Class I Directors
consist of Walter Scott, Jr., James Q. Crowe and Philip B. Fletcher; the Class
II Directors consist of William L. Grewcock, Richard R. Jaros, Robert E. Julian
and David C. McCourt; and the Class III Directors consist of R. Douglas
Bradbury, Kenneth E. Stinson and Michael B. Yanney. There is one vacancy among
the Class I Directors. The term of the Class I Directors will terminate on the
date of the 2001 annual meeting of stockholders; the term of the Class II
Directors will terminate on the date of the 2002 annual meeting of
stockholders; and the term of the Class III Directors will terminate on the
date of the 2000 annual meeting of stockholders. At each annual meeting of
stockholders, successors to the class of directors whose term expires at that
annual meeting will be elected for three-year terms. The Company's officers are
elected annually to serve until each successor is elected and qualified or
until his death, resignation or removal.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
beneficial ownership of our common stock, as of February 1, 2000 and as
adjusted to reflect the sale of shares in the common stock offering (without
giving effect to the underwriters' overallotment option), by the Company's
directors, executive officers, and directors and executive officers as a group,
and the only person known by the Company to beneficially own more than 5% of
the outstanding common stock.
Percent of common stock
beneficially owned
-------------------------
Before the After the
Number of shares of common stock common stock
Name common stock+ offering is offering is
- ---- ------------------- ------------ ------------
Walter Scott, Jr.(1)............ 33,333,958 9.8% 9.2%
James Q. Crowe(2)............... 11,006,382 3.2 3.0
R. Douglas Bradbury(3).......... 3,276,055 * *
Kevin J. O'Hara(4).............. 1,977,025 * *
Colin V.K. Williams............. 409,344 * *
Michael D. Jones (5)............ 259,311 * *
Philip B. Fletcher.............. 5,000 * *
William L. Grewcock(6).......... 11,530,166 3.4 3.2
Richard R. Jaros(7)............. 3,502,236 1.0 1.0
Robert E. Julian(8)............. 3,998,434 1.2 1.1
David C. McCourt(9)............. 119,738 * *
Kenneth E. Stinson(10).......... 729,231 * *
Michael B. Yanney(11)........... 105,314 * *
Directors and Executive Officers
as a Group (17 persons)(12).... 70,724,099 20.6 19.4
Donald L. Sturm(13)............. 18,373,750 5.4 5.1
- --------
* Less than 1%.
+ Included in this table are the number of shares of common stock issuable
upon exercise of Outperform Stock Options, which are exercisable within 60
days. The value of the Outperform Stock Options is dependent upon the extent
to which the Company's common stock has outperformed the results of the S&P
500. The number of shares of common stock issuable upon exercise of an
Outperform Stock Option has been calculated based upon the closing price of
the Company's common stock on February 1, 2000. The number of shares
issuable upon exercise of an Outperform Stock Option is therefore subject to
changes in the extent to which the Company's common stock has outperformed
the results of the S&P 500 and the Company's common stock closing price.
(1) Includes 99,700 shares of common stock held by the Suzanne Scott
Irrevocable Trust as to which Mr. Scott shares voting and investment powers
and 383,502 shares of common stock issuable upon conversion of $25 million
in principal amount of our 6% convertible subordinated notes that Mr. Scott
holds.
(2) In May 1999, Mr. Crowe announced that he had contributed 1,000,000 shares
of common stock to a trust of which he is the sole beneficiary and that,
beginning on May 10, 1999, the trust would sell 4,000 shares each trading
day until all the shares held by the trust were sold. The information in
the above table includes the remaining 292,000 shares of common stock held
by that trust. Includes 386,768 shares of common stock subject to vested
Outperform Stock Options.
(3) Includes 500,000 shares of common stock subject to vested non-qualified
stock options and 120,865 shares of common stock subject to vested
Outperform Stock Options.
(4) Includes 46,000 shares of common stock held by Kevin J. O'Hara Family LTD
Partnership. Includes 250,000 shares of common stock subject to vested non-
qualified stock options and 120,865 shares of common stock subject to
vested Outperform Stock Options.
(5) Includes 170,000 shares of common stock subject to vested non-qualified
stock options and 84,606 shares of common stock subject to vested
Outperform Stock Options.
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(6) Includes 1,154,640 shares of common stock held by Grewcock Family Limited
Partnership. Includes 351,230 shares of common stock held by the Bill &
Berniece Grewcock Foundation as to which Mr. Grewcock shares voting and
investment powers. Includes 4,738 shares of common stock subject to vested
Outperform Stock Options.
(7) Includes 370,000 shares of common stock held by the Jaros Family Limited
Partnership. Includes 4,738 shares of common stock subject to vested
Outperform Stock Options. Includes 1,351,500 shares of common stock subject
to vested non-qualified stock options held by Mr. Jaros and 648,500 shares
of common stock subject to vested non-qualified stock options held by a
grantor trust, of which Mr. Jaros is the residual beneficiary.
(8) Includes 4,854 shares of common stock subject to vested Outperform Stock
Options.
(9) Includes 4,738 shares of common stock subject to vested Outperform Stock
Options.
(10) Includes 4,738 shares of common stock subject to vested Outperform Stock
Options.
(11) Includes 4,854 shares of common stock subject to vested Outperform Stock
Options.
(12) Includes 771,971 shares of common stock subject to vested non-qualified
stock options and 661,100 shares of common stock subject to vested
Outperform Stock Options.
(13) Mr. Sturm's business address is 3033 East First Avenue, Denver, Colorado
80206. Based solely on Mr. Sturm's Schedule 13D dated May 5, 1998,
adjusted for a subsequent stock dividend, Mr. Sturm owns 15,610,310 shares
of common stock, and has voting and investment power with respect to
2,613,440 shares held by trusts and partnerships established for family
members and beneficially owns 150,000 shares as a member of the board of
directors of the University of Denver.
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CERTAIN TRANSACTIONS AND RELATIONSHIPS
Certain Relationships and Related Transactions
All share information has been adjusted to reflect the Company's 2-for-1
stock split, effected as a stock dividend in August 1998.
In connection with his retention as Chief Executive Officer of the Company,
Mr. Crowe entered into an engagement agreement (the "Engagement Agreement")
with the Company. Under the Engagement Agreement, the Company acquired from Mr.
Crowe, Mr. Bradbury and an additional individual, Broadband Capital Group,
L.L.C., a company formed to develop investment opportunities, for a purchase
price of $68,523, the owners' cash investment in that company. Pursuant to the
Engagement Agreement, the Company sold 10,000,000 shares of the Company's
former Class D Diversified Group Convertible Exchangeable Common Stock, par
value $.0625 per share (the "Class D Stock") to Mr. Crowe and 2,500,000 shares
of Class D Stock to Mr. Bradbury, in each case at $5.425 per share. The
Engagement Agreement also provided that the Company would make available for
sale, from time to time prior to the consummation of the Split-off, to certain
employees of the Company designated by Mr. Crowe in connection with the
implementation of the Business Plan, up to an aggregate of 10,500,000 shares of
Class D Stock.
During 1999, Mr. Crowe entered into an agreement for the period October 1999
to October 2000 to purchase personal use of the Company's aircraft. Mr. Crowe
has agreed that the Company will charge him the cost to operate the aircraft as
allowed by Part 91 of the U.S. Federal Aviation Administration regulations for
personal use of corporate aircraft. The Company expects that the amount to be
paid by Mr. Crowe for the one-year period will be approximately $100,000.
In October 1999, Mr. Crowe paid the Company an aggregate of $74,905 for
personal use of the Company's aircraft during the preceding 12 months. This
payment was calculated based upon the U.S. Federal Aviation Administration
regulations for this type of use as adjusted pursuant to Internal Revenue
Service regulations.
In January 1999, the Company repurchased a portion of the stock of the C-TEC
Holding Company held by David C. McCourt, a director of the Company, for a
total purchase price of approximately $5.6 million. Concurrently with this
repurchase, a portion of the Company's interest in the C-TEC Holding Company
was redeemed so that Mr. McCourt's percentage ownership of the outstanding C-
TEC Holding Company common stock remains at 10%. The C-TEC Holding Company is
Level 3's subsidiary, which holds Level 3's interests in both RCN and
Commonwealth Telephone.
On September 30, 1999, a subsidiary of the Company entered into an agreement
to purchase a 15% interest in a Falcon 900 aircraft from Elk Mountain Ventures,
Inc., a company owned by Walter Scott, Jr., the Company's Chairman. The
purchase price paid for the interest in the aircraft was $2.7 million.
On July 1, 1998, the Company issued 187,706 shares of its common stock to
Mr. Colin V.K. Williams, an Executive Vice President of the Company, in
connection with the Company's acquisition of UltraLine (Bermuda) Limited, a
company owned by Mr. Williams. The value of the transaction, based upon the
trading price of its common stock on that date, was approximately $5 million.
On June 18, 1998, Level 3 entered into a contract with Peter Kiewit Sons',
Inc. for the construction of Level 3's nearly 16,000 mile North American
intercity network. Construction of the North American intercity network is
currently expected to cost an estimated $3 billion and be completed by the end
of the year 2000. Level 3 has also entered into various other agreements with
PKS including for construction activities relating to its local networks,
gateway facilities and headquarters facility in Broomfield, Colorado. For the
year ended December 31, 1999, the Company incurred the following expenses under
these agreements to PKS: $918 million relating to construction of intercity and
local networks as well as gateway construction; $102 million for construction
of the Company's headquarters facility; and $4 million for miscellaneous
construction projects. PKS has the opportunity to earn a significant award fee
with respect to the construction of the intercity network, the amount of which
will be based on cost and speed of construction, quality, safety and program
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management. The award fee will be determined by Level 3's assessment of PKS'
performance in each of these areas. In 1999, the Company accrued approximately
$35 million toward the award fee, which is included in the $918 million
indicated above.
Level 3 and a subsidiary of PKS are parties to various aircraft operating
agreements pursuant to which the PKS subsidiary provides Level 3 with aircraft
maintenance, operations, management and related services. During 1999, Level 3
made payments under these aircraft agreements aggregating approximately $1.7
million.
In connection with the Split-off, Level 3 and PKS entered into various
agreements intended to implement the Split-off, including a separation
agreement and a tax-sharing agreement.
Separation Agreement. Level 3 and PKS entered into a separation agreement
(the "Separation Agreement") relating to the allocation of certain risks and
responsibilities between PKS and Level 3 after the Split-off and certain other
matters. The Separation Agreement provides that each of PKS and Level 3 will
indemnify the other with respect to the activities of its subsidiary business
groups, except as specifically provided under other agreements between the
companies. The cross-indemnities are intended to allocate financial
responsibility to PKS for liabilities arising out of the construction
businesses formerly conducted by Level 3, and to allocate to Level 3 financial
responsibility for liabilities arising out of the non-construction businesses
conducted by Level 3. The Separation Agreement also allocates between PKS and
Level 3 certain corporate-level risk exposures not readily allocable to either
the construction businesses or the non-construction businesses.
The Separation Agreement provides that each of Level 3 and PKS will be
granted access to certain records and information in the possession of the
other company, and requires that each of Level 3 and PKS retain all such
information in its possession for a period of ten years following the Split-
off. Under the Separation Agreement, each company is required to give the other
company prior notice of any intention to dispose of any such information.
The Separation Agreement provides that, except as otherwise set forth
therein or in any related agreement, costs and expenses in connection with the
Split-off will be paid 82.5% by Level 3 and 17.5% by PKS. On March 18, 1998,
Level 3 and PKS entered into an amendment to the Separation Agreement that
provides that PKS will bear substantially all of those expenses if the Level 3
Board determined to force conversion of all outstanding Class R Stock of Level
3 on or before July 15, 1998 (a "Forced Conversion Determination").
The Level 3 Board made such a determination and, accordingly, substantially
all of those expenses will be borne by PKS.
Tax Sharing Agreement. Level 3 and PKS have entered into a tax sharing
agreement (the "Tax Sharing Agreement") that defines each company's rights and
obligations with respect to deficiencies and refunds of federal, state and
other taxes relating to operations for tax years (or portions thereof) ending
prior to the Split-off and with respect to certain tax attributes of Level 3
and PKS after the Split-off. Under the Tax Sharing Agreement, with respect to
periods (or portions thereof) ending on or before the Split-off, Level 3 and
PKS generally will be responsible for paying the taxes relating to such returns
(including any subsequent adjustments resulting from the redetermination of
such tax liabilities by the applicable taxing authorities) that are allocable
to the non-construction business and the construction business, respectively.
The Tax Sharing Agreement also provides that Level 3 and PKS will indemnify
the other from certain taxes and expenses that would be assessed on PKS and
Level 3, respectively, if the Split-off were determined to be taxable, but
solely to the extent that such determination arose out of the breach by Level 3
or PKS, respectively, of certain representations made to the Internal Revenue
Service in connection with the private letter ruling issued with respect to the
Split-off. Under the Tax Sharing Agreement, if the Split-off were determined to
be taxable for any other reason, those taxes and certain other taxes associated
with the Split-off (together, "Split-off Taxes") would be allocated 82.5% to
Level 3 and 17.5% to PKS. The Tax Sharing
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Agreement, however, provides that Split-off Taxes will be allocated one-half to
each of Level 3 and PKS if a Forced Conversion Determination is made. As a
result of the Forced Conversion Determination, the Split-off Taxes would be so
allocated. Finally, the Tax Sharing Agreement provides, under certain
circumstances, for certain liquidated damage payments from Level 3 to PKS if
the Split-off were determined to be taxable, which are intended to compensate
stockholders of PKS indirectly for taxes assessed upon them in that event.
Those liquidated damage payments, however, are reduced because of the Forced
Conversion Determination.
Mine Management Agreement. In 1992, PKS and Level 3 entered into a mine
management agreement (the "Mine Management Agreement") pursuant to which a
subsidiary of PKS, Kiewit Mining Group Inc. ("KMG"), provides mine management
and related services for Level 3's coal mining properties. In consideration of
the provision of such services, KMG receives a fee equal to 30% of the adjusted
operating income of the coal mining properties. The term of the Mine Management
Agreement expires on January 1, 2016.
In connection with the Split-off, the Mine Management Agreement was amended
to provide KMG with a right of offer in the event that Level 3 were to
determine to sell any or all of its coal mining properties. Under the right of
offer, Level 3 would be required to offer to sell those properties to KMG at
the price that Level 3 would seek to sell the properties to a third party. If
KMG were to decline to purchase the properties at that price, Level 3 would be
free to sell them to a third party for an amount greater than or equal to that
price. If Level 3 were to sell the properties to a third party, thus
terminating the Mine Management Agreement, it would be required to pay KMG an
amount equal to the discounted present value to KMG of the Mine Management
Agreement, determined, if necessary, by an appraisal process.
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DESCRIPTION OF OTHER INDEBTEDNESS OF LEVEL 3
The following is a description of Level 3's material outstanding
indebtedness and the debt being offered in the other offerings. The following
summaries of the senior secured credit facility and Level 3's outstanding notes
are qualified in their entirety by reference to the credit agreement and the
indentures to which each issue of notes relates. Copies of these agreements are
available on request to Level 3.
Level 3 anticipates that the securities offered in the other debt offerings
will be substantially as described below. However, their final terms may differ
from the following description. No debt offering is conditioned on the closing
of any other.
Senior Secured Credit Facility
On September 30, 1999, Level 3 and certain Level 3 subsidiaries entered into
a $1.375 billion senior secured credit facility underwritten by a syndicate of
banks and other financial institutions led by Chase Securities, Inc., as sole
manager and lead arranger, Goldman Sachs Credit Partners L.P., J.P. Morgan
Securities Inc. and Salomon Smith Barney Inc., as co-syndication agents, and
The Chase Manhattan Bank, as administrative agent. These institutions are all
affiliated with our lead underwriters for, or our initial purchasers in, our
proposed offerings. The senior secured credit facility, which was amended on
November 24, 1999, consists of a $450 million tranche A term loan facility, a
$275 million tranche B term loan facility and a $650 million revolving credit
facility. As of December 31, 1999, we had $475 million outstanding under the
senior secured credit facility.
All obligations under the revolving credit facility are secured by
substantially all the assets of Level 3 and, subject to certain exceptions, its
wholly owned domestic subsidiaries (other than the borrower under the term loan
facilities). These assets also secure a portion of the term loan facilities in
an amount equal to $100 million plus, with certain exceptions, the undrawn
amount of the revolving credit facility. Additionally, all obligations under
the term loan facilities are secured by the equipment that is purchased, in
whole or in part, with the proceeds of the term loan facilities and the lease
rentals derived from the lease of such equipment to the Company's operating
subsidiaries. Level 3 and, subject to certain exceptions, all its domestic
subsidiaries (other than the borrower under the term loan facilities) have
guaranteed all obligations under the revolving credit facility. Level 3 and,
subject to certain exceptions, all its domestic subsidiaries have guaranteed
all obligations under the term loan facilities.
The revolving credit facility and the tranche A term loan facility mature on
September 30, 2007, and the tranche B term loan facility matures on January 15,
2008.
Amounts drawn under the revolving credit facility and the term loans bear
interest, at the option of the Company, at an alternate base rate or the London
Interbank Offered Rate (LIBOR) plus, in each case, applicable margins based
upon, in the case of the revolving credit facility and the tranche A term loan
facility, the ratings established by Moody's and S&P for the highest rated
senior unsecured long-term debt of Level 3. The applicable margins for the
revolving credit facility and the tranche A term loan facility range from 50 to
175 basis points over the alternate base rate and from 150 to 275 basis points
over LIBOR and are fixed for the tranche B term loan facility at 250 basis
points over the alternate base rate and 350 basis points over LIBOR.
Beginning on March 31, 2004, the revolving credit facility provides for
automatic and permanent quarterly reductions of the amount available for
borrowing under that facility, commencing at $17.25 million per quarter and
increasing to approximately $61 million per quarter. The tranche A term loan
facility amortizes in consecutive quarterly payments beginning on March 31,
2004, commencing at $9 million per quarter and increasing to $58.5 million per
quarter. The tranche B term loan facility amortizes with substantially all of
the scheduled payments due in equal amounts from March 31, 2007 to January 15,
2008.
The credit agreement requires that indebtedness outstanding under the term
loan facilities be paid with all of the net proceeds with respect to certain
asset sales and, beginning December 31, 2003, with 50% of excess cash flow for
each fiscal year.
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The credit agreement contains customary negative covenants restricting and
limiting the ability of Level 3, the borrowers and any other restricted
subsidiary to engage in certain activities, including but not limited to:
. limitations on indebtedness and the incurrence of liens;
. restrictions on sale leaseback transactions, consolidations, mergers,
sale of assets, transactions with affiliates and investments; and
. restrictions on issuance of preferred stock, dividends and distributions
on capital stock, and other similar distributions, including
distributions to Level 3 by its subsidiaries.
The credit agreement also requires Level 3 and the borrowers to comply with
specific financial and operational tests and maintain financial ratios,
including a:
. minimum intercity route miles completed test;
. minimum markets with fiber networks test;
. minimum telecom revenue test;
. maximum total debt to contributed capital ratio;
. maximum total debt to total telecommunications revenue ratio;
. maximum senior secured debt to gross property, plant and equipment
ratio; and
. beginning December 31, 2004, maximum total debt to EBITDA.
The credit agreement generally does not permit Level 3 or its subsidiaries
to make payments on any outstanding indebtedness, which will include the notes,
other than regularly scheduled interest and principal payments as and when due.
The senior secured credit facility contains customary events of default,
including an event of default upon certain changes of control of Level 3 and
certain defaults under other indebtedness having an outstanding principal
amount exceeding $25 million.
9 1/8% Senior Notes due 2008
On April 28, 1998, the Company issued $2 billion aggregate principal amount
of 9 1/8% senior notes due 2008 under an indenture between Level 3 and The Bank
of New York, as successor trustee to IBJ Whitehall Bank & Trust Company. The 9
1/8% senior notes are senior unsecured obligations of the Company. They rank
equally in right of payment with Level 3's 10 1/2% senior discount notes and
all other existing and future senior unsecured indebtedness of Level 3,
including the notes being issued in the other offerings. The notes bear
interest at a rate of 9 1/8% per annum, payable semiannually in arrears on May
1 and November 1.
Level 3 may redeem the 9 1/8% senior notes, in whole or in part, at any time
on or after May 1, 2003. If a redemption occurs before May 1, 2006, Level 3
will pay a premium on the principal amount of the 9 1/8% senior notes redeemed.
This premium decreases annually from approximately 4.5% for a redemption during
the twelve month period beginning on May 1, 2003 to approximately 1.5% for a
redemption during the twelve month period beginning on May 1, 2005.
In addition, at any time prior to May 1, 2001, Level 3 may redeem up to 35%
of the original aggregate principal amount of the 9 1/8% senior notes with the
net proceeds of specified public or private offerings of its common stock at a
redemption price equal to 109.125% of the principal amount of the notes
redeemed, plus accrued and unpaid interest, if any. At least 65% of the
aggregate principal amount of 9 1/8% senior notes must remain outstanding after
such a redemption.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 101% of the principal amount, plus
accrued and unpaid interest, if any.
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The indenture relating to the 9 1/8% senior notes places restrictions on the
ability of Level 3 and its restricted subsidiaries to:
. incur additional indebtedness;
. pay dividends or make other restricted payments and transfers;
. create liens;
. sell assets;
. issue or sell capital stock of some of its subsidiaries;
. enter into transactions, including transactions with affiliates; and
. in the case of Level 3, consolidate, merge or sell substantially all of
Level 3's assets.
The holders of the 9 1/8% senior notes may force Level 3 to immediately
repay the principal on the 9 1/8% senior notes, including interest to the
acceleration date, if certain defaults exist under other indebtedness having an
outstanding principal amount of at least $25 million.
10 1/2% Senior Discount Notes due 2008
On December 2, 1998, the Company issued $833.815 million aggregate principal
amount at maturity of 10 1/2% senior discount notes due 2008 under an indenture
between Level 3 and The Bank of New York, as successor trustee to IBJ Whitehall
Bank & Trust Company. The 10 1/2% senior discount notes are senior unsecured
obligations of the Company. They rank equally in right of payment with the 9
1/8% senior notes and all other existing and future senior unsecured
indebtedness of Level 3, including the notes being issued in the other
offerings.
The issue price of the 10 1/2% senior discount notes was approximately 60%
of the principal amount at maturity. The notes accrete at a rate of 10 1/2% per
year, compounded semiannually, to 100% of their principal amount by December 1,
2003. Cash interest will not begin to accrue on the 10 1/2% senior discount
notes until December 1, 2003, unless Level 3 elects to commence the accrual on
or after December 1, 2001. Beginning on December 1, 2003, cash interest will
accrue at a rate of 10 1/2% and will be payable semiannually on June 1 and
December 1, beginning June 1, 2004.
Level 3 may redeem the 10 1/2% senior discount notes, in whole or in part,
at any time on or after December 1, 2003. If a redemption occurs before
December 1, 2006, Level 3 will pay a premium on the accreted value of the 10
1/2% senior discount notes redeemed. This premium decreases annually from
approximately 5.25% for a redemption during the twelve month period beginning
on December 1, 2003 to approximately 1.75% for a redemption during the twelve
month period beginning on December 1, 2005.
In addition, at any time prior to December 1, 2001, Level 3 may redeem up to
35% of the original aggregate principal amount at maturity of the 10 1/2%
senior discount notes with the net proceeds of specified public or private
offerings of its common stock at a redemption price equal to 110.5% of the
accreted value of the notes redeemed, plus accrued and unpaid interest, if any.
At least 65% of the aggregate principal amount at maturity of the 10 1/2%
senior discount notes must remain outstanding after such a redemption.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 101% of the accreted value, plus
accrued and unpaid interest, if any.
The indenture relating to the 10 1/2% senior discount notes places certain
restrictions on the actions of Level 3 and some of its subsidiaries that are
substantially similar to those contained in the indenture relating to the 9
1/8% senior notes. The indenture also contains a provision relating to the
acceleration of the 10 1/2% senior discount notes that is substantially similar
to that contained in the indenture relating to the 9 1/8% senior notes.
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6% Convertible Subordinated Notes
On September 20, 1999, the Company issued $823 million aggregate principal
amount of 6% convertible subordinated notes due 2009 under an indenture between
Level 3 and The Bank of New York, as successor trustee to IBJ Whitehall Bank &
Trust Company. The 6% convertible notes are unsecured, subordinated obligations
of Level 3.
The 6% convertible notes are convertible into shares of common stock, at the
option of the holder, at any time prior to maturity, unless previously
repurchased or unless Level 3 has caused the conversion rights to expire. The
6% convertible notes may be converted at the initial rate of 15.3401 shares of
common stock per each $1,000 principal amount of notes, subject to adjustment
in certain circumstances. This is equivalent to a conversion price of
approximately $65.19 per share.
On or after September 15, 2002, the Company may cause the conversion rights
of the holders of 6% convertible notes to expire at any time prior to the
maturity date of the notes. The Company may exercise this option if the current
market price of the common stock exceeds 140% of the prevailing conversion
price then in effect, for at least 20 trading days within any 30-day period of
consecutive trading days, including the last trading day of such period.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 100% of the principal amount, plus
accrued and unpaid interest, if any. The Company will pay the repurchase price
in cash or, at the Company's option but subject to the satisfaction of certain
conditions, in shares of common stock.
In the event of a bankruptcy, liquidation or reorganization of Level 3, an
acceleration of the 6% convertible notes due to an event of default under the
indenture, and certain other events, the payment of the principal of, premium,
if any, and interest on the 6% convertible notes will be subordinated in right
of payment to the prior full and final payment in cash of all senior debt of
Level 3.
The indenture also contains a provision relating to the acceleration of the
6% convertible notes that is substantially similar to that contained in the
indenture relating to the 9 1/8% senior notes.
Dollar-Denominated Senior Note Offering
Concurrently with this offering, the Company is offering 11% senior notes
due 2008 (the "2008 senior notes"), 11 1/4% senior notes due 2010 (the "2010
senior notes") and 12 7/8% senior discount notes due 2010 (the "2010 senior
discount notes"), which are expected to generate aggregate gross proceeds of
approximately $1,410,000,000.
2008 Senior Notes
The Company is offering the 2008 senior notes under an indenture between
Level 3 and The Bank of New York, as trustee. The 2008 senior notes will be
senior unsecured obligations of the Company. They will rank equally in right of
payment with Level 3's other senior notes and senior discount notes and all
other existing and future senior unsecured indebtedness of Level 3. The notes
will bear interest at a rate of 11% per annum, payable semiannually in arrears
on March 15 and September 15.
The 2008 senior notes will not be redeemable at the option of the Company
prior to maturity.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 101% of the principal amount, plus
accrued and unpaid interest, if any.
The indenture relating to the 2008 senior notes will place certain
restrictions on the actions of Level 3 and some of its subsidiaries that are
substantially similar to those contained in the indenture relating to the 9
1/8%
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senior notes. The indenture also will contain a provision relating to the
acceleration of the 2008 senior notes that is substantially similar to that
contained in the indenture relating to the 9 1/8% senior notes.
2010 Senior Notes
The Company is offering the 2010 senior notes under an indenture between
Level 3 and The Bank of New York, as trustee. The 2010 senior notes will be
senior unsecured obligations of the Company. They will rank equally in right of
payment with Level 3's other senior notes and senior discount notes and all
other existing and future senior unsecured indebtedness of Level 3. The notes
will bear interest at a rate of 11 1/4% per annum, payable semiannually in
arrears on March 15 and September 15.
Level 3 may redeem the 2010 senior notes, in whole or in part, at any time
on or after March 15, 2005. If a redemption occurs before March 15, 2008, Level
3 will pay a premium on the principal amount of the 2010 senior notes redeemed.
This premium will decrease annually from approximately 5.625% for a redemption
during the twelve month period beginning on March 15, 2005 to approximately
1.875% for a redemption during the twelve month period beginning on March 15,
2007.
In addition, at any time prior to March 15, 2003, Level 3 may redeem up to
35% of the original aggregate principal amount of the 2010 senior notes with
the net proceeds of specified public or private offerings of its common stock
at a redemption price equal to 111.25% of the principal amount of the notes
redeemed, plus accrued and unpaid interest, if any. At least 65% of the
aggregate principal amount of 2010 senior notes must remain outstanding after
such a redemption.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 101% of the principal amount, plus
accrued and unpaid interest, if any.
The indenture relating to the 2010 senior notes will place certain
restrictions on the actions of Level 3 and some of its subsidiaries that are
substantially similar to those contained in the indenture relating to the 9
1/8% senior notes. The indenture also will contain a provision relating to the
acceleration of the 2010 senior notes that is substantially similar to that
contained in the indenture relating to the 9 1/8% senior notes.
2010 Senior Discount Notes
The Company is offering the 2010 senior discount notes under an indenture
between Level 3 and The Bank of New York, as trustee. The 2010 senior discount
notes are senior unsecured obligations of the Company. They rank equally in
right of payment with Level 3's other senior discount notes and senior notes
and all other existing and future senior unsecured indebtedness of Level 3.
The issue price of the 2010 senior discount notes will be approximately
53.308% of the principal amount at maturity. The notes will accrete at a rate
of 12 7/8% per year, compounded semiannually, to 100% of their principal amount
by March 15, 2005. Cash interest will not begin to accrue on the 2010 senior
discount notes until March 15, 2005, unless Level 3 elects to commence the
accrual on or after March 15, 2003. Beginning on March 15, 2005, interest will
accrue at a rate of 12 7/8% and will be payable semiannually on March 15 and
September 15, beginning September 15, 2005.
Level 3 may redeem the 2010 senior discount notes, in whole or in part, at
any time on or after March 15, 2005. If a redemption occurs before March 15,
2008, Level 3 will pay a premium on the accreted value of the 2010 senior
discount notes redeemed. This premium will decrease annually from approximately
6.438% for a redemption during the twelve month period beginning on March 15,
2005 to approximately 2.146% for a redemption during the twelve month period
beginning on March 15, 2007.
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In addition, at any time prior to March 15, 2003, Level 3 may redeem up to
35% of the original aggregate principal amount at maturity of the 2010 senior
discount notes with the net proceeds of specified public or private offerings
of its common stock at a redemption price equal to 112.875% of the accreted
value of the notes redeemed, plus accrued and unpaid interest, if any. At least
65% of the aggregate principal amount at maturity of the notes must remain
outstanding after a such redemption.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 101% of the accreted value, plus
accrued and unpaid interest, if any.
The indenture relating to the 2010 senior discount notes will place certain
restriction on the actions of Level 3 and some of its subsidiaries that are
substantially similar to those contained in the indenture relating to the 9
1/8% senior notes. The indenture also will contain a provision relating to the
acceleration of the 2010 senior discount notes that is substantially similar to
that contained in the indenture relating to the 9 1/8% senior notes.
Euro-Denominated Senior Note Offering
Concurrently with this offering, the Company is offering an aggregate
principal amount of (Euro)800,000,000 senior notes, consisting of an aggregate
principal amount of (Euro)500,000,000 10 3/4% senior notes due 2008 (the "2008
euro notes") and an aggregate principal amount of (Euro)300,000,000 11 1/4%
senior notes due 2010 (the "2010 euro notes").
2008 Euro Notes
The Company is offering the 2008 euro notes under an indenture between Level
3 and The Bank of New York, as trustee. The 2008 euro notes will be senior
unsecured obligations of the Company. They will rank equally in right of
payment with Level 3's other senior notes and senior discount notes and all
other existing and future senior unsecured indebtedness of Level 3. The notes
will bear interest at a rate of 10 3/4% per annum, payable semiannually in
arrears on March 15 and September 15.
The 2008 euro notes are not redeemable at the option of the Company prior to
maturity.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated, subject to certain conditions, to offer to purchase all of the
outstanding notes at a purchase price of 101% of the principal amount, plus
accrued and unpaid interest, if any.
The indenture relating to the 2008 euro notes will place certain
restrictions on the actions of Level 3 and some of its subsidiaries that are
substantially similar to those contained in the indenture relating to the 9
1/8% senior notes. The indenture also will contain a provision relating to the
acceleration of the 2008 euro notes that is substantially similar to that
contained in the indenture relating to the 9 1/8% senior notes.
2010 Euro Notes
The Company is offering the 2010 euro notes under an indenture between Level
3 and The Bank of New York, as trustee. The 2010 euro notes will be senior
unsecured obligations of the Company. They will rank equally in right of
payment with Level 3's other senior notes and senior discount notes and all
other existing and future senior unsecured indebtedness of Level 3. The notes
will bear interest at a rate of 11 1/4% per annum, payable semiannually in
arrears on March 15 and September 15.
Level 3 may redeem the 2010 euro notes, in whole or in part, at any time on
or after March 15, 2005. If a redemption occurs before March 15, 2008, Level 3
will pay a premium on the principal amount of the 2010
euro notes redeemed. This premium decreases annually from approximately 5.625%
for a redemption during
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the twelve month period beginning on March 15, 2005 to approximately 1.875% for
a redemption during the twelve month period beginning on March 15, 2007.
In addition, at any time prior to March 15, 2003, Level 3 may redeem up to
35% of the original aggregate principal amount of the 2010 euro notes with the
net proceeds of specified public or private offerings of its common stock at a
redemption price equal to 111.25% of the principal amount of the notes
redeemed, plus accrued and unpaid interest, if any. At least 65% of the
aggregate principal amount of the 2010 euro notes must remain outstanding after
such a redemption.
If an event treated as a change in control of Level 3 occurs, Level 3 will
be obligated to offer to purchase all of the outstanding notes at a purchase
price of 101% of the principal amount, plus accrued and unpaid interest, if
any.
The indenture relating to the 2010 euro notes will place certain
restrictions on the actions of Level 3 and some of its subsidiaries that are
substantially similar to those contained in the indenture relating to the 9
1/8% senior notes. The indenture also will contain a provision relating to the
acceleration of the 2010 euro notes that is substantially similar to that
contained in the indenture relating to the 9 1/8% senior notes.
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DESCRIPTION OF NOTES
The notes will be issued under an indenture to be dated as of September 20,
1999 between Level 3 and The Bank of New York as successor to IBJ Whitehall
Bank & Trust Company, as trustee, the form of which is filed as an exhibit to
the registration statement of which the accompanying prospectus is a part, and
a second supplemental indenture to be dated as of February 29, 2000, between
Level 3 and the trustee. Wherever particular defined terms of the notes
indenture (including the notes) are referred to, such defined terms are
incorporated herein by reference (the notes are referred to in the notes
indenture as "Securities"). The following summaries of certain provisions of
the notes indenture do not purport to be complete and are subject to, and are
qualified in their entirety by reference to, the detailed provisions of the
notes and the notes indenture, including the definitions therein of certain
terms.
General
The notes will be unsecured, direct, general, subordinated obligations of
Level 3, will be limited to $750 million aggregate principal amount (plus up to
an additional $112.5 million aggregate principal amount to cover sales of notes
in excess of $750 million aggregate principal amount) and will mature on March
15, 2010. Payment in full of the principal amount of the notes will be due on
March 15, 2010 at a price of 100% of the principal amount thereof.
The notes will bear interest at the rate per annum shown on the front cover
of this prospectus supplement from February 29, 2000 or from the most recent
Interest Payment Date to which interest has been paid or provided for, payable
semi-annually on March 15 and September 15 of each year, commencing September
15, 2000, until the principal thereof is paid or made available for payment, to
the person in whose name the note is registered at the close of business on the
preceding March 1 or September 1, as the case may be.
The notes will be convertible into shares of Level 3's common stock
initially at the conversion rate stated on the front cover of this prospectus
supplement, subject to adjustment upon the occurrence of certain events
described under "--Conversion Rights," at any time following the initial issue
date of the notes and before the close of business on the Business Day
immediately preceding March 15, 2010, unless previously redeemed or repurchased
or unless Level 3 has caused the conversion rights of holders of notes to
expire, as specified below under "--Repurchase at Option of Holders Upon a
Change of Control," "--Provisional Redemption" and "--Expiration of Conversion
Rights."
The notes are subject to repurchase by Level 3 at the option of the holders,
as described below under "--Repurchase at Option of Holders Upon a Change of
Control."
The principal of, premium, if any, and interest on the notes will be
payable, and the notes may be surrendered for registration of transfer,
exchange and conversion, at the office or agency of the trustee in the Borough
of Manhattan, The City of New York. In addition, payment of interest may, at
the option of Level 3, be made by check mailed to the address of the person
entitled thereto as it appears in the Security Register. See "--Payment and
Conversion." Payments, transfers, exchanges and conversions relating to
beneficial interests in notes issued in book-entry form will be subject to the
procedures applicable to global notes described below.
Level 3 initially will appoint the trustee at its Corporate Trust Office as
paying agent, transfer agent, registrar and conversion agent for the notes. In
such capacities, the trustee will be responsible for, among other things, (1)
maintaining a record of the aggregate holdings of notes represented by the
global note, as defined below, and accepting notes for exchange and
registration of transfer, (2) ensuring that payments of principal, premium, if
any, and interest received by the trustee from Level 3 in respect of the notes
are duly paid to DTC or its nominees, (3) transmitting to Level 3 any notices
from holders of the notes, (4) accepting conversion notices and related
documents and transmitting the relevant items to Level 3 and (5) delivering
certificates for common stock issued upon conversion of the notes.
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Level 3 will cause each transfer agent to act as a registrar and will cause
to be kept at the office of such transfer agent a register in which, subject to
such reasonable regulations as it may prescribe, Level 3 will provide for
registration of transfers of the notes. Level 3 may vary or terminate the
appointment of any paying agent, transfer agent or conversion agent, or appoint
additional or other such agents or approve any change in the office through
which any such agent acts, provided that there shall at all times be maintained
by Level 3, a paying agent, a transfer agent and a conversion agent in the
Borough of Manhattan, The City of New York. Level 3 will cause notice of any
resignation, termination or appointment of the trustee or any paying agent,
transfer agent or conversion agent, and of any change in the office through
which any such agent will act, to be provided to holders of the notes.
No service charge will be made for any registration of transfer or exchange
of notes, but Level 3 may require payment of a sum sufficient to cover any tax
or other governmental charge payable in connection therewith.
Form, Denomination, Transfer, Exchange and Book-Entry Procedures
Notes will be issued only in fully registered form, without interest
coupons, in minimum denominations of $1,000 and integral multiples in excess
thereof. Notes sold in the offering will be issued only against payment
therefor in immediately available funds.
The notes initially will be represented by one or more notes in registered,
global form, without interest coupons (collectively, the "global notes" or
"global note"). The global notes will be deposited upon issuance with the
trustee as custodian for DTC, in New York, New York, and registered in the name
of DTC or its nominee, in each case for credit to an account of a direct or
indirect participant in DTC as described below.
Transfers of beneficial interests in the global notes will be subject to the
applicable rules and procedures of DTC and its direct or indirect participants,
which may change from time to time.
Except as set forth below, the global notes may be transferred, in whole and
not in part, only to another nominee of DTC or to a successor of DTC or its
nominee. Beneficial interests in the global notes may not be exchanged for
notes in certificated form except in the limited circumstances described below
under "--Exchanges of Book-Entry Notes for Certificated Notes."
Exchanges of Book-Entry Notes for Certificated Notes
A beneficial interest in a global note may not be exchanged for a note in
certificated form unless (1) DTC (x) notifies Level 3 that it is unwilling or
unable to continue as Depositary for the global note or (y) has ceased to be a
clearing agency registered under the Exchange Act and in either case Level 3
thereupon fails to appoint a successor Depositary within 90 days, (2) Level 3,
at its option, notifies the trustee in writing that it elects to cause the
issuance of the notes in certificated form or (3) there shall have occurred and
be continuing an Event of Default or any event which after notice or lapse of
time or both would be an Event of Default with respect to the notes. In all
cases, certificated notes delivered in exchange for any global note or
beneficial interests therein will be registered in the names, and issued in any
approved denominations, requested by or on behalf of the Depositary, in
accordance with its customary procedures.
Certain Book-Entry Procedures for Global Notes
The descriptions of the operations and procedures of DTC that follow are
provided solely as a matter of convenience. These operations and procedures are
solely within the control of DTC and are subject to changes by them from time
to time. Level 3 takes no responsibility for these operations and procedures
and urges investors to contact DTC or its participants directly to discuss
these matters.
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DTC has advised Level 3 as follows: DTC is a limited purpose trust company
organized under the laws of the State of New York, a member of the Federal
Reserve System, a "clearing corporation" within the meaning of the Uniform
Commercial Code and a "Clearing Agency" registered pursuant to the provisions
of Section 17A of the Exchange Act. DTC was created to hold securities for its
participants ("participants") and facilitate the clearance and settlement of
securities transactions between participants through electronic book-entry
changes in accounts of its participants, thereby eliminating the need for
physical transfer and delivery of certificates. Participants include securities
brokers and dealers, banks, trust companies and clearing corporations and may
include certain other organizations. Certain of such participants, or their
representatives, together with other entities, own DTC. Indirect access to the
DTC system is available to other entities such as banks, brokers, dealers and
trust companies that clear through or maintain a custodial relationship with a
participant, either directly or indirectly ("indirect participants").
DTC has advised Level 3 that its current practice, upon the issuance of a
global note, is to credit, on its internal system, the respective principal
amount of the individual beneficial interests represented by such global note
to the accounts with DTC of the participants through which such interests are
to be held. Ownership of beneficial interests in the global note will be shown
on, and the transfer of that ownership will be effected only through, records
maintained by DTC or its nominees, with respect to interests of participants,
and the records of participants and indirect participants, with respect to
interests of persons other than participants.
As long as DTC, or its nominee, is the registered holder of a global note,
DTC or such nominee, as the case may be, will be considered the sole owner and
holder of the notes represented by such global note for all purposes under the
indenture and the notes. Except in the limited circumstances described above
under "--Exchanges of Book-Entry Notes for Certificated Notes," owners of
beneficial interests in a global note will not be entitled to have any portions
of such global note registered in their names, will not receive or be entitled
to receive physical delivery of notes in definitive form and will not be
considered the owners or holders of the global note, or any notes represented
thereby, under the notes indenture or the notes. Accordingly, each person
owning a beneficial interest in the global note must rely on the procedures of
DTC and, if such person is not a participant, those of the participant through
which such person owns its interest, in order to exercise any rights of a
holder under the indenture or such note.
Investors may hold their interests in the global note directly through DTC,
if they are participants in such system, or indirectly through organizations
that are participants in such system. All interests in a global note will be
subject to the procedures and requirements of DTC.
The laws of some states require that certain persons take physical delivery
in definitive form of securities that they own. Consequently, the ability to
transfer beneficial interests in a global note to such persons may be limited
to that extent. Because DTC can act only on behalf of its participants, which
in turn act on behalf of indirect participants and certain banks, the ability
of a person having beneficial interests in a global note to pledge such
interest to persons or entities that do not participate in the DTC system, or
otherwise take actions in respect of such interests, may be affected by the
lack of a physical certificate evidencing such interests.
Cash payment of the principal of, interest on, redemption proceeds from or
the repurchase of the global note will be made to DTC or its nominee, as the
case may be, as the registered owner of the global note by wire transfer of
immediately available funds on each relevant payment date. Neither Level 3, the
trustee nor any of their respective agents will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests in a global note including any delay by DTC
or any participant or indirect participant in identifying the beneficial
ownership interests, and Level 3 and the trustee may conclusively rely on, and
shall be protected in relying on, instructions from DTC for all purposes.
Level 3 expects that DTC or its nominee, upon receipt of any cash payment of
principal, interest, redemption proceeds or the repurchase price in respect of
a global note representing any notes held by it or its nominee, will
immediately credit participants' accounts with payments in amounts
proportionate to their
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respective beneficial interests in the principal amount of such global note for
such notes as shown on the records of DTC or its nominee (adjusted as necessary
so that such payments are made with respect of whole notes only), unless DTC
has reason to believe that it will not receive payment on such payment date.
Level 3 also expects that payments by participants to owners of beneficial
interests in such global note held through such participants will be governed
by standing instructions and customary practices, as is now the case with
securities held for the accounts of customers registered in "street name." Such
payments will be the responsibility of such participants.
Notice of the expiration of conversion rights will be sent to DTC or its
nominee.
Neither DTC nor its nominee will consent or vote with respect to the notes.
Under its usual procedures, DTC mails an omnibus proxy to the issuer as soon as
possible after the record date. The omnibus proxy assigns DTC's, or its
nominee's, consenting or voting rights to those participants to whose accounts
the notes are credited on the record date identified in a listing attached to
the omnibus proxy.
Interests in the global notes will trade in DTC's Same-Day Funds Settlement
System, and secondary market trading activity in such interests will therefore
settle in immediately available funds, subject in all cases to the rules and
procedures of DTC and its participants. Transfers between participants in DTC
will be effected in accordance with DTC's procedures, and will be settled in
same-day funds.
DTC has advised Level 3 that it will take any action permitted to be taken
by a holder of notes, including the presentation of notes for exchange as
described below and the conversion of notes, only at the direction of one or
more participants to whose account with DTC interests in the global notes are
credited and only in respect of such portion of the aggregate principal amount
of the notes as to which such participant or participants has or have given
such direction. However, if there is an Event of Default, as defined below,
under the notes, DTC reserves the right to exchange the global notes for notes
in certificated form, and to distribute such notes to its participants.
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of beneficial ownership interests in the global note among
participants, it is under no obligation to perform or continue to perform such
procedures, and such procedures may be discontinued at any time.
None of Level 3, the trustee nor any of their respective agents will have
any responsibility for the performance by DTC, its participants or indirect
participants of their respective obligations under the rules and procedures
governing its operations, including maintaining, supervising or reviewing the
records relating to, or payments made on account of, beneficial ownership
interests in global notes.
Payment and Conversion
The principal of the notes will be payable in U.S. dollars, against
surrender thereof at the Corporate Trust Office of the trustee in the Borough
of Manhattan, The City of New York, in U.S. currency by dollar check or by
transfer to a dollar account maintained by the holder with a bank in New York
City. Payment of interest on a note may be made by dollar check mailed to the
address of the person entitled thereto as such address shall appear in the
Security Register, or, upon written application by the holder to the Security
Registrar setting forth instructions not later than the relevant Record Date,
by transfer to a dollar account maintained by the holder with a bank in the
United States.
Payments in respect of the principal of, and premium, if any, and interest
on any global note registered in the name of DTC or its nominee will be payable
by the trustee to DTC or its nominee in its capacity as the registered holder
under the notes indenture. Under the terms of the notes indenture, Level 3 and
the trustee will treat the persons in whose names the notes, including the
global notes, are registered as the owners thereof for the purpose of receiving
such payments and for any and all other purposes whatsoever. Consequently,
neither Level 3, the trustee nor any agent of Level 3 or the trustee has or
will have any responsibility or liability for:
(1) any aspect of DTC's records or any participant's or indirect
participant's records relating to or payments made on account of beneficial
ownership interests in the global notes, or for maintaining, supervising or
reviewing any of DTC's records or any participant's or indirect participant's
records relating to the beneficial ownership interests in the global notes, or
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(2) any other matter relating to the actions and practices of DTC or any of
its participants or indirect participants.
Any payment on a note due on any day that is not a Business Day need not be
made on such day, but may be made on the next succeeding Business Day with the
same force and effect as if made on such due date, and no interest shall accrue
on such payment for the period from and after such date. "Business Day," when
used with respect to any place of payment, place of conversion or any other
place, as the case may be, means each Monday, Tuesday, Wednesday, Thursday and
Friday that is not a day on which banking institutions in such place of
payment, place of conversion or other place, as the case may be, are authorized
or obligated by law or executive order to close.
Notes may be surrendered for conversion at the Corporate Trust Office of the
trustee in the Borough of Manhattan, The City of New York. In the case of
global notes, conversion will be effected by DTC upon notice from the holder of
a beneficial interest in a global note in accordance with its rules and
procedures. Notes surrendered for conversion must be accompanied by a
conversion notice and any payments in respect of interest, as applicable, as
described below under "--Conversion Rights."
All moneys (1) deposited with the trustee or any paying agent or (2) then
held by Level 3 in trust for the payment of principal, premium, if any, or
interest on any notes which remain unclaimed at the end of two years after such
payment has become due and payable will be repaid to Level 3, and the holder of
such note will thereafter look only to Level 3 for payment thereof.
Conversion Rights
The holder of any note will have the right, at the holder's option, to
convert any portion of the principal amount of a note that is an integral
multiple of $1,000 into shares of common stock at any time following the
original issue date of the notes and prior to the close of business on the
Business Day immediately preceding the maturity date, unless previously
redeemed or repurchased or unless Level 3 has caused the conversion rights of
holders of notes to expire. See "--Provisional Redemption," "--Expiration of
Conversion Rights" and "--Repurchase at Option of Holders Upon a Change of
Control." The notes may be converted at a conversion rate equal to the number
of shares per $1,000 principal amount of notes shown on the front cover of this
prospectus supplement, subject to adjustment in certain events as described
below (the "Conversion Rate"). The right to convert a note will terminate (1)
with respect to any note delivered for repurchase, at the close of business on
the Business Day immediately preceding the Repurchase Date, as defined below,
for such note, unless Level 3 defaults in making the payment due upon
repurchase, (2) if Level 3 has exercised its right in accordance with the terms
of the notes indenture to cause the conversion right of holders to expire, on
the conversion expiration date and (3) if Level 3 has called the note for
redemption, at the close of business on the business day immediately preceding
the date fixed for redemption.
The right of conversion attaching to any note may be exercised by the holder
by delivering the note at the Corporate Trust Office of the trustee in the
Borough of Manhattan, The City of New York, accompanied by a duly signed and
completed notice of conversion, a copy of which may be obtained from the
trustee. The conversion date will be the date on which the note and the duly
signed and completed notice of conversion are so delivered. As promptly as
practicable on or after the conversion date, Level 3 will issue and deliver to
the trustee a certificate or certificates for the number of full shares of
common stock issuable upon conversion, together with payment in lieu of any
fraction of a share; such certificate will be sent by the trustee to the
Conversion Agent for delivery to the holder. Such shares of common stock
issuable upon conversion of the notes, in accordance with the provisions of the
notes indenture, will be fully paid and nonassessable and will also rank pari
passu with the other shares of the common stock outstanding from time to time.
Holders that surrender notes for conversion on a date that is not an
Interest Payment Date are not entitled to receive any interest for the period
from the next preceding Interest Payment Date to the date of conversion,
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except as described below. However, holders of notes on a Regular Record Date,
including notes surrendered for conversion after the Regular Record Date, will
receive the interest payable on such notes on the next succeeding Interest
Payment Date. Accordingly, any note surrendered for conversion during the
period from the close of business on a Regular Record Date to the opening of
business on the next succeeding Interest Payment Date must be accompanied by
payment of an amount equal to the interest payable on such Interest Payment
Date on the principal amount of notes being surrendered for conversion;
provided, however, that no such payment will be required upon the conversion of
any note, or portion thereof, that is eligible to be delivered for repurchase
or called for redemption if, as a result, the right to convert such note would
terminate during the period between such Regular Record Date and the close of
business on the next succeeding Interest Payment Date.
No other payment or adjustment for interest, or for any dividends in respect
of common stock, will be made upon conversion. Holders of common stock issued
upon conversion will not be entitled to receive any dividends payable to
holders of common stock as of any record date before the close of business on
the conversion date. No fractional shares will be issued upon conversion but,
in lieu thereof, an appropriate amount will be paid in cash by Level 3 based on
the market price of the common stock at the close of business on the date of
conversion.
A holder delivering a note for conversion will not be required to pay any
taxes or duties in respect of the issue or delivery of common stock on
conversion. However, Level 3 shall not be required to pay any tax or duty that
may be payable in respect of any transfer involved in the issue or delivery of
the common stock in a name other than that of the holder of the note.
Certificates representing shares of common stock will not be issued or
delivered unless the person requesting such issue has paid to Level 3 the
amount of any such tax or duty or has established to the satisfaction of Level
3 that such tax or duty has been paid.
The Conversion Rate is subject to adjustment in certain events, including
without duplication:
(a) dividends, and other distributions, payable in common stock on shares of
stock of Level 3,
(b) the issuance to all holders of common stock of rights, options or
warrants entitling them to subscribe for or purchase common stock (or
securities convertible into common stock) at less than the then Average Current
Market Price (determined as provided in the indenture) of such common stock as
of the record date for holders entitled to receive such rights, options or
warrants,
(c) subdivisions, combinations and reclassifications of common stock,
(d) distributions to all holders of common stock of evidences of
indebtedness of Level 3, shares of capital stock, cash or assets, including
securities, but excluding those dividends, rights, options, warrants and
distributions referred to in clauses (a) and (b) above, dividends and
distributions paid exclusively in cash and distributions upon mergers or
consolidations to which the next succeeding paragraph applies,
(e) distributions consisting exclusively of cash, excluding any cash portion
of distributions referred to in (d) above, or cash distributed upon a merger or
consolidation to which the next succeeding paragraph applies, to all holders of
common stock in an aggregate amount that, combined together with (1) other such
all-cash distributions made within the preceding 12 months in respect of which
no adjustment has been made and (2) any cash and the fair market value of other
consideration payable in respect of any tender offer by Level 3 or any of its
subsidiaries for common stock concluded within the preceding 12 months in
respect of which no adjustment has been made, exceeds 10% of Level 3's market
capitalization, being the product of the Average Current Market Price of the
common stock on the record date for such distribution and the number of shares
of common stock then outstanding, and
(f) the successful completion of a tender offer made by Level 3 or any of
its subsidiaries for common stock which involves an aggregate consideration
that, together with (1) any cash and other consideration payable in a tender
offer by Level 3 or any of its subsidiaries for common stock expiring within
the 12 months
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preceding the expiration of such tender offer in respect of which no adjustment
has been made and (2) the aggregate amount of any such all-cash distributions
referred to in (e) above to all holders of common stock within the 12 months
preceding the expiration of such tender offer in respect of which no
adjustments have been made, exceeds 10% of Level 3's market capitalization on
the expiration of such tender offer.
Level 3 reserves the right to make such increases in the Conversion Rate in
addition to those required in the foregoing provisions as it considers to be
advisable in order that any event treated for United States federal income tax
purposes as a dividend of stock or stock rights will not be taxable to the
recipients. No adjustment of the Conversion Rate will be required to be made
until the cumulative adjustments amount to 1% or more of the Conversion Rate.
Level 3 shall compute any adjustments to the Conversion Rate pursuant to this
paragraph and will give notice to the holders of any such adjustments.
In case of any consolidation or merger of Level 3 with or into another
person or any merger of another person into Level 3, other than a merger which
does not result in any reclassification, conversion, exchange or cancelation of
the common stock, or in the case of any sale or transfer of all or
substantially all of the assets of Level 3, each note then outstanding will,
without the consent of the holder of any note, become convertible only into the
kind and amount of securities, cash and other property receivable upon such
consolidation, merger, sale or transfer by a holder of the number of shares of
common stock into which such note was convertible immediately prior thereto,
assuming such holder of common stock failed to exercise any rights of election
and that such note was then convertible.
Level 3 from time to time may increase the Conversion Rate by any amount for
any period of at least 20 days (which increase is irrevocable during such
period), in which case Level 3 shall give at least 15 days' notice of such
increase, if the Board of Directors has made a determination that such increase
would be in the best interests of Level 3, which determination shall be
conclusive. No such increase shall be taken into account for purposes of
determining whether the Current Market Price of the common stock exceeds the
Conversion Price, as defined below, by 105% in connection with an event which
otherwise would be a Change of Control or for purposes of determining whether
the Current Market Price exceeds the triggering levels in connection with
either the Provisional Redemption or termination of conversion rights
provision. See "--Provisional Redemption" and "--Expiration of Conversion
Rights."
If at any time Level 3 makes a distribution of property to its shareholders
that would be taxable to such shareholders as a dividend for United States
federal income tax purposes, e.g., distributions of evidences of indebtedness
or assets of Level 3, but generally not stock dividends on common stock or
rights to subscribe for common stock, and, pursuant to the anti-dilution
provisions of the notes indenture, the number of shares into which notes are
convertible is increased, such increase may be deemed for United States federal
income tax purposes to be the payment of a taxable dividend to holders of
notes. See "Certain United States Federal Income Tax Considerations."
Subordination
The payment of the principal of, premium, if any, and interest on the notes,
including amounts payable on any redemption or repurchase of the notes, will be
subordinated in right of payment to the extent set forth in the notes indenture
to the prior full and final payment in cash of all Senior Debt of Level 3.
"Senior Debt" means the principal of, and premium, if any, and interest,
including all interest accruing subsequent to the commencement of any
bankruptcy or similar proceeding, whether or not a claim for post-petition
interest is allowable as a claim in any such proceeding, on, and all fees and
other amounts payable in connection with, the following, whether absolute or
contingent, secured or unsecured, due or to become due, outstanding on the date
of the notes indenture or thereafter created, incurred or assumed:
(a) indebtedness of Level 3 evidenced by a credit or loan agreement, note,
bond, debenture or other written obligation,
(b) all obligations of Level 3 for money borrowed,
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(c) all obligations of Level 3 evidenced by a note or similar instrument
given in connection with the acquisition of any businesses, properties or
assets of any kind,
(d) obligations of Level 3 (1) as lessee under leases required to be
capitalized on the balance sheet of the lessee under generally accepted
accounting principles and (2) as lessee under other leases for facilities,
capital equipment or related assets, whether or not capitalized, entered into
or leased for financing purposes,
(e) all obligations of Level 3 under interest rate and currency swaps, caps,
floors, collars, hedge agreements, forward contracts or similar agreements or
arrangements,
(f) all obligations of Level 3 with respect to letters of credit, bankers'
acceptances and similar facilities, including reimbursement obligations with
respect to the foregoing,
(g) all obligations of Level 3 issued or assumed as the deferred purchase
price of property or services, but excluding trade accounts payable and accrued
liabilities arising in the ordinary course of business,
(h) all obligations of the type referred to in clauses (a) through (g) above
of another person and all dividends of another person, the payment of which, in
either case, Level 3 has assumed or guaranteed, or for which Level 3 is
responsible or liable, directly or indirectly, jointly or severally, as
obligor, guarantor or otherwise, or which is secured by a lien on the property
of Level 3, and
(i) renewals, extensions, modifications, replacements, restatements and
refundings of, or any indebtedness or obligation issued in exchange for, any
such indebtedness or obligation described in clauses (a) through (h) of this
paragraph; provided, however, that Senior Debt shall not include the notes or
any such indebtedness or obligation if the terms of such indebtedness or
obligation, or the terms of the instrument under which, or pursuant to which it
is issued expressly provide that such indebtedness or obligation is not
superior in right of payment to the notes.
No payment in respect of the notes, whether on account of principal of or
premium, if any, or interest on, or redemption or repurchase of, the notes or
otherwise (other than with the money, securities or proceeds held under any
defeasance trust established in accordance with the notes indenture provided
that the establishment of such defeasance trust is permitted by the terms of
all Senior Debt) may be made by Level 3 if (1) a default in the payment of
principal, premium, if any, or interest, including a default under any
redemption or repurchase obligation, or other amounts with respect to Senior
Debt occurs or (2) any other default occurs and is continuing with respect to
Senior Debt that permits the holders thereof to accelerate (with notice, lapse
of time or both) the maturity thereof. Payments on the notes may and shall be
resumed (a) in the case of a payment default, upon the date on which such
default is cured or waived and (b) in the case of a nonpayment default, the
date on which such nonpayment default is cured or waived if the maturity of
such Senior Debt has not been accelerated.
In addition, upon any acceleration of the principal due on the notes as a
result of an Event of Default or payment or distribution of assets of Level 3
to creditors upon any dissolution, winding up, liquidation or reorganization,
whether voluntary or involuntary, marshaling of assets, assignment for the
benefit of creditors, or in bankruptcy, insolvency, receivership or other
similar proceedings, of Level 3, all principal, premium, if any, interest and
other amounts payable on all Senior Debt must be paid in full in cash before
the holders of the notes are entitled to receive any payment (other than with
the money, securities or proceeds held under any defeasance trust established
in accordance with the notes indenture provided that the establishment of such
defeasance trust is permitted by the terms of all Senior Debt). By reason of
such subordination, in the event of insolvency, creditors of Level 3 who are
holders of Senior Debt may recover more, ratably, than the holders of the
notes, and such subordination may result in a reduction or elimination of
payments to the holders of the notes. Assuming that on December 31, 1999 Level
3 had raised gross proceeds of $2.21 billion from the other debt offerings,
Level 3 would have had on that date approximately $5.244 billion of outstanding
senior debt, including $475 million of our subsidiaries' debt guaranteed by
Level 3, and Level 3's subsidiaries would have had $900 million in additional
borrowings available under the senior secured credit facility guaranteed by
Level 3 on a senior basis.
Substantially all of our operating assets are held directly by our
subsidiaries. Holders of any preferred stock of any of our subsidiaries and
creditors of any of our subsidiaries, including trade creditors, have and will
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have claims relating to the assets of that subsidiary that are senior to the
notes. As a result, the notes will be structurally subordinated to all
preferred stock, indebtedness and other liabilities, including trade payables
and lease obligations, of Level 3's subsidiaries and any right of Level 3 to
receive any assets of its subsidiaries upon their liquidation or
reorganization, and the consequent right of the holders of the notes to
participate in those assets, will be effectively subordinated to the claims of
that subsidiary's creditors, including trade creditors, except to the extent
that Level 3 itself is recognized as a creditor of such subsidiary, in which
case the claims of Level 3 would still be subordinate to any security interest
in the assets of such subsidiary and any indebtedness of such subsidiary senior
to that held by Level 3. Borrowings under Level 3's senior secured credit
facility are indebtedness of our subsidiaries, are structurally senior to the
notes, and are secured by substantially all of the Company's assets and,
subject to certain exceptions, the assets of the Company's wholly owned
domestic subsidiaries. In addition, the secured credit facility restricts the
ability of Level 3's subsidiaries to pay dividends and make loans and advances
to Level 3.
The notes indenture does not limit the ability of Level 3 or any of its
subsidiaries to incur indebtedness, including Senior Debt.
Provisional Redemption
At any time or from time to time prior to March 18, 2003, Level 3 may, at
its option, redeem the notes, in whole or in part (a "Provisional Redemption"),
at the following redemption prices, in each case plus accrued and unpaid
interest, if any, to the date of such redemption (the "Provisional Redemption
Date"), if the Current Market Price of the common stock equals or exceeds the
following trigger percentages of the prevailing Conversion Price then in effect
for at least 20 trading days in any consecutive 30-day trading period,
including the last day of such period, if called for redemption during the
periods beginning and ending as set forth below.
Trigger Redemption
Period Percentage Price
------ ---------- ----------
February 29, 2000 through March 14, 2001............... 170% 106.00%
March 15, 2001 through March 14, 2002.................. 160% 105.40%
March 15, 2002 through March 17, 2003.................. 150% 104.80%
The term "Conversion Price" means $1,000 divided by the Conversion Rate
(rounded to the nearest cent, with one-half cent being rounded upward).
Upon any Provisional Redemption, Level 3 will make an additional payment in
cash (the "Make-Whole Payment") with respect to the notes converted into common
stock between the date notice of redemption was given (the "Notice Date") and
the Provisional Redemption Date. The Make-Whole Payment will be equal to the
present value of the aggregate value of the interest payments that would
thereafter have been payable on the notes on each semi-annual interest payment
date from the Provisional Redemption Date through March 17, 2003. The present
value will be calculated using the bond equivalent yield on U.S. Treasury notes
or bills having a term nearest in length to that of the additional period as of
the day immediately preceding the Notice Date.
Selection and Notice
If less than all of the notes are to be redeemed at any time, selection of
notes for redemption will be made by the trustee in compliance with the
requirements of the principal national securities exchange, if any, on which
the notes are listed, or if the notes are not so listed, on a pro rata basis,
by lot or by such method as the trustee shall deem fair and appropriate,
provided that no notes of $1,000 in principal amount or less shall be redeemed
in part. A new note in principal amount equal to the unredeemed portion thereof
will be issued in the name of the holder thereof upon cancelation of the
original note. On and after the redemption date, interest ceases to accrue on
notes or portions of notes called for redemption.
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In order to redeem any or all of the notes, Level 3 must issue a press
release for publication on the Dow Jones News Service (or a comparable news
service) announcing the Provisional Redemption Date prior to the opening of
business on the second trading day after any period in which the condition
described above has been met. The press release shall announce the Provisional
Redemption Date and provide the current Conversion Price of the notes and the
Current Market Price of the common stock, in each case as of the close of
business on the trading day next preceding the date of the press release.
Notice of the Provisional Redemption will be given by Level 3 by first class
mail to the holders of the notes not more than four business days after Level 3
issued the press release. Such notice shall be irrevocable and will specify the
Provisional Redemption Date. The notes subject to the Provisional Redemption
will be redeemed at the close of business on the Provisional Redemption Date,
which will be a date selected by Level 3 not less than 30 nor more than 60 days
after the date on which Level 3 issues the press release announcing the
Provisional Redemption. If any note is to be redeemed in part only, the notice
of redemption that relates to such note shall state the portion of the
principal amount thereof to be redeemed.
The term "Current Market Price" of common stock for any day means the last
reported per share sale price, regular way on such day, or, if no sale takes
place on such day, the average of the reported closing per share bid and asked
prices on such day, regular way, in either case as reported on the Nasdaq
National Market or, if the common stock is not quoted or admitted to trading on
such quotation system, on the principal national securities exchange or
quotation system on which the common stock may be listed or admitted to trading
or quoted, or, if not listed or admitted to trading or quoted on any national
securities exchange or quotation system, the average of the closing per share
bid and asked prices of the common stock on the over-the-counter market on the
day in question as reported by the National Quotation Bureau Incorporated, or
similar generally accepted reporting service, or, if not so available in such
manner, as furnished by any Nasdaq member firm selected from time to time by
the board of directors of Level 3 for that purpose, or, if not so available in
such manner, as otherwise determined in good faith by the board of directors of
Level 3.
Expiration of Conversion Rights
On or after March 18, 2003, Level 3 may, at its option, cause the conversion
rights of holders of notes to expire. Level 3 may exercise this option only if
the Current Market Price of common stock exceeds 140% of the prevailing
Conversion Price then in effect for at least 20 trading days in any consecutive
30-day trading period, including the last trading day of such period. In order
to exercise its option to cause the conversion rights of holders of notes to
expire, Level 3 must issue a press release for publication on the Dow Jones
News Service (or a comparable news service) announcing the conversion
expiration date prior to the opening of business on the second trading day
after any period in which the condition in the preceding sentence has been met,
but in no event prior to March 18, 2003. The press release shall announce the
conversion expiration date and provide the current Conversion Price of the
notes and the Current Market Price of the common stock, in each case as of the
close of business on the trading day next preceding the date of the press
release.
Notice of the expiration of conversion rights will be given by Level 3 by
first class mail to the holders of the notes not more than four business days
after Level 3 issued the press release. Such notice shall be irrevocable and
will specify the conversion expiration date. Conversion rights will terminate
at the close of business on the conversion expiration date which will be a date
selected by Level 3 not less than 30 nor more than 60 days after the date on
which Level 3 issues the press release announcing its intention to terminate
conversion rights of the notes.
Repurchase at Option of Holders Upon a Change of Control
If a Change of Control, as defined below, occurs, each holder of notes shall
have the right, at the holder's option, to require Level 3 to repurchase all of
such holder's notes, or any portion of the principal amount thereof that is
equal to $5,000 or an integral multiple of $1,000 in excess thereof, on the
date (the "Repurchase
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Date") that is no earlier than 30 nor later than 60 days after the date of the
Company Notice, as defined below, at a price equal to 100% of the principal
amount of the notes to be repurchased, together with interest accrued to the
Repurchase Date (the "Repurchase Price"). Level 3's obligation to make or
consummate such a repurchase ceases upon defeasance of the indenture.
Level 3 may, at its option, in lieu of paying the Repurchase Price in cash,
pay the Repurchase Price in common stock valued at 95% of the average of the
closing sales prices of the common stock for the five trading days immediately
preceding and including the third day prior to the Repurchase Date; provided
that payment may not be made in common stock unless Level 3 satisfies certain
conditions with respect thereto prior to the Repurchase Date as provided in the
notes indenture.
Within 30 days after the occurrence of a Change of Control, Level 3 is
obligated to give to all holders of the notes notice, as provided in the notes
indenture (the "Company Notice"), of the occurrence of such Change of Control
and of the repurchase right arising as a result thereof. Level 3 must also
deliver a copy of the Company Notice to the trustee. To exercise the repurchase
right, a holder of notes must deliver on or before the 30th day after the date
of the Company Notice written notice to the trustee of the holder's exercise of
such right, together with the notes with respect to which the right is being
exercised.
A "Change of Control" at such time after the original issuance of the notes
means the occurrence of the following events:
(1) if any "person" or "group" (as such terms are used in Sections 13(d) and
14(d) of the Exchange Act or any successor provisions to either of the
foregoing), including any group acting for the purpose of acquiring, holding,
voting or disposing of securities within the meaning of Rule 13d-5(b)(1) under
the Exchange Act, other than any one or more of the Permitted Holders, as
defined below, becomes the "beneficial owner" (as defined in Rule 13d-3 under
the Exchange Act, except that a person will be deemed to have "beneficial
ownership" of all shares that any such person has the right to acquire, whether
such right is exercisable immediately or only after the passage of time),
directly or indirectly, of 35% or more of the total voting power of the Voting
Stock of Level 3; provided, however, that the Permitted Holders are the
"beneficial owners" (as defined in Rule 13d-3 under the Exchange Act, except
that a person will be deemed to have "beneficial ownership" of all shares that
any such person has the right to acquire, whether such right is exercisable
immediately or only after the passage of time), directly or indirectly, in the
aggregate of a lesser percentage of the total voting power of the Voting Stock
of Level 3 than such other person or group (for purposes of this clause (1),
such person or group shall be deemed to beneficially own any voting stock of a
corporation (the "specified corporation") held by any other corporation (the
"parent corporation") so long as such person or group beneficially owns,
directly or indirectly, in the aggregate a majority of the total voting power
of the Voting Stock of such parent corporation); or
(2) the sale, transfer, assignment, lease, conveyance or other disposition,
directly or indirectly, of all or substantially all the assets of Level 3 and
its subsidiaries, considered as a whole (other than a disposition of such
assets as an entirety or virtually as an entirety to a wholly owned subsidiary
or one or more Permitted Holders) shall have occurred; or
(3) during any period of two consecutive years, individuals who at the
beginning of such period constituted the board of directors of Level 3
(together with any new directors whose election or appointment by such board or
whose nomination for election by the stockholders of Level 3 was approved by a
vote of a majority of the directors then still in office who were either
directors at the beginning of such period or whose election or nomination for
election was previously so approved) cease for any reason to constitute a
majority of the board of directors of Level 3 then in office; or
(4) the stockholders of Level 3 shall have approved any plan of liquidation
or dissolution of Level 3; provided, however, that a Change of Control shall
not be deemed to have occurred if the Current Market Price of the common stock
for any five trading days within the period of 10 consecutive trading days
beginning immediately after the later of the Change of Control or the public
announcement of the Change of Control shall
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equal or exceed 105% of the Conversion Price of the notes in effect on each
such trading day; provided further that if the Change of Control results in the
reclassification, conversion, exchange of outstanding shares of common stock of
Level 3, such 10 consecutive trading day period shall be measured as ending
immediately before the Change of Control.
"Permitted Holders" means the members of Level 3's board of directors on
April 28, 1998 and their respective estates, spouses, ancestors, and lineal
descendants, the legal representatives of any of the foregoing and the trustees
of any bona fide trusts of which the foregoing are the sole beneficiaries or
the grantors, or any person of which the foregoing "beneficially owns" (as
defined in Rule 13d-3 under the Exchange Act) at least 66 2/3% of the total
voting power of the voting stock of such person.
"Voting Stock" of any person means Capital Stock of such person which
ordinarily has voting power for the election of directors (or persons
performing similar functions) of such person, whether at all times or only for
so long as no senior class of securities has such voting power by reason of any
contingency. "Capital Stock" of any person means any and all shares, interests,
participations or other equivalents (however designated) of corporate stock or
equity participations, including partnership interests, whether general or
limited, of such person and any rights (other than debt securities convertible
or exchangeable into any equity interest), warrants or options to acquire an
equity interest in such person.
Rule 13e-4 under the Exchange Act requires the dissemination of certain
information to security holders in the event of an issuer tender offer and may
apply in the event that the repurchase option becomes available to holders of
the notes. Level 3 will comply with this rule to the extent applicable at that
time.
Level 3 may, to the extent permitted by applicable law, at any time purchase
notes in the open market or by tender at any price or by private agreement. Any
note so purchased by Level 3 may, to the extent permitted by applicable law, be
reissued or resold or may, at Level 3's option, be surrendered to the trustee
for cancellation. Any notes surrendered as aforesaid may not be reissued or
resold and will be canceled promptly.
The foregoing provisions would not necessarily afford holders of the notes
protection in the event of highly leveraged or other transactions involving
Level 3 that may adversely affect holders.
Level 3's ability to repurchase notes upon the occurrence of a Change of
Control is subject to important limitations. The occurrence of a Change of
Control constitutes an event of default under its senior secured credit
facility. Moreover, the occurrence of a Change in Control could cause an event
of default under, or be prohibited or limited by, the terms of other Senior
Debt of Level 3. As a result, in each case, any repurchase of the notes would,
absent a waiver, be prohibited under the subordination provisions of the notes
indenture until the Senior Debt is paid in full. Level 3's obligation to
purchase the notes under this covenant will, unless consents are obtained,
require Level 3 to repay either prior to or concurrently with the note
repurchase all Senior Debt then outstanding that would by its terms prohibit
the note repurchase, including both series of Level 3's existing senior notes
and the senior secured credit facility.
Further, Level 3 may not have the financial resources and may not be able to
arrange financing, to pay the Repurchase Price for all the notes that might be
delivered by holders of notes seeking to exercise the repurchase right. Level
3's ability to repurchase notes with cash may also be limited by the terms of
its subsidiaries' borrowing arrangements due to dividend or other restrictions.
Level 3's senior secured credit facility restricts the ability of Level 3's
subsidiaries to pay dividends and make loans and advances to Level 3. Any
failure by Level 3 to repurchase the notes when required following a Change of
Control would result in an Event of Default under the notes indenture whether
or not such repurchase is permitted by the subordination provisions of the
notes indenture. Any such default may, in turn, cause a default under Senior
Debt of Level 3. See "--Subordination."
Mergers and Sales of Assets by Level 3
Level 3 may not consolidate with or merge into any other person or convey,
transfer, sell or lease its properties and assets substantially as an entirety
to any person, and Level 3 shall not permit any person to
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consolidate with or merge into Level 3 or convey, transfer, sell or lease such
person's properties and assets substantially as an entirety to Level 3, unless:
(a) the person formed by such consolidation or into or with which Level 3 is
merged or the person to which the properties and assets of Level 3 are so
conveyed, transferred, sold or leased, is a corporation, limited liability
company, partnership or trust organized and existing under the laws of the
United States, any State thereof or the District of Columbia and, if other than
Level 3, shall expressly assume the due and punctual payment of the principal
of and, premium, if any, and interest on the notes and the performance of the
other covenants of Level 3 under the notes indenture,
(b) immediately after giving effect to such transaction, no Event of
Default, and no event which, after notice or lapse of time or both, would
become an Event of Default, shall have occurred and be continuing, and
(c) an officer's certificate and legal opinion relating to the conditions
described in (a) and (b) above is delivered to the trustee.
Events of Default
The following will be Events of Default under the notes indenture:
(a) failure to pay principal of or premium, if any, on any note when due,
whether or not such payment is prohibited by the subordination provisions of
the notes indenture,
(b) failure to pay any interest on any note when due, continuing for 30
days, whether or not such payment is prohibited by the subordination provisions
of the notes indenture,
(c) failure to pay when due the Repurchase Price of any notes required to be
repurchased pursuant to the provisions described under "--Repurchase at Option
of Holders Upon Change of Control", whether or not a Company Notice is
prohibited by the subordination provisions of the notes indenture,
(d) failure to perform or comply with provisions described under "--Mergers
and Sales of Assets by Level 3,"
(e) failure to perform any other covenant of Level 3 in the notes indenture,
continuing for 60 days after written notice to Level 3 by the trustee or the
holders of at least 25% in aggregate principal amount of outstanding notes,
(f) failure to pay when due any indebtedness for money borrowed by Level 3
or any subsidiary that is a restricted subsidiary under the indentures
governing Level 3's outstanding senior notes totaling $25 million or more if
such failure shall have continued after the applicable grace period and shall
not have been cured or waived or the acceleration of any indebtedness for money
borrowed by Level 3 or any such restricted subsidiary totaling $25 million or
more,
(g) any judgment or judgments for the payment of money in an aggregate
amount in excess of $25 million that shall be rendered against Level 3 or any
such restricted subsidiary and that shall not be waived, satisfied or
discharged for any period of 45 consecutive days during which a stay of
enforcement shall not be in effect, and
(h) certain events of bankruptcy, insolvency or reorganization affecting
Level 3 or any Significant Subsidiary (as defined in the indenture).
Subject to the provisions of the notes indenture relating to the duties of
the trustee in case an Event of Default shall occur and be continuing, the
trustee will be under no obligation to exercise any of its rights or powers
under the notes indenture at the request or direction of any of the holders,
unless such holders shall have offered to the trustee reasonable indemnity.
Subject to such provisions for the indemnification of the trustee, the holders
of a majority in aggregate principal amount of the outstanding notes will have
the right to direct the time, method and place of conducting any proceeding for
any remedy available to the trustee or exercising any trust or power conferred
on the trustee.
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If an Event of Default, other than an Event of Default specified in clause
(h) above with respect to the Company, occurs and is continuing, either the
trustee or the holders of at least 25% in principal amount of the outstanding
notes may accelerate the maturity of all notes; provided, however, that after
such acceleration, but before a judgment or decree based on acceleration, the
holders of a majority in aggregate principal amount of outstanding notes may,
under certain circumstances as set forth in the notes indenture, rescind and
annul such acceleration if all Events of Default, other than the nonpayment of
principal of the notes which have become due solely by such declaration of
acceleration, have been cured or waived as provided in the notes indenture. If
an Event of Default specified in clause (h) occurs and is continuing with
respect to the Company, then the principal of, and accrued interest on, all of
the notes shall automatically become immediately due and payable without any
declaration or other act on the part of the holders of the notes or the
trustee. For information as to waiver of defaults, see "--Modification and
Waiver" below.
No holder of any note will have any right to institute any proceeding with
respect to the notes indenture or for any remedy thereunder, unless such
holder shall have previously given to the trustee written notice of a
continuing Event of Default and the holders of at least 25% in aggregate
principal amount of the outstanding notes shall have made written request, and
offered reasonable indemnity, to the trustee to institute such proceeding as
trustee, and the trustee shall not have received from the holders of a
majority in aggregate principal amount of the outstanding notes a direction
inconsistent with such request and shall have failed to institute such
proceeding within 60 days. However, such limitations do not apply to a suit
instituted by a holder of a note for the enforcement of payment of the
principal of or premium, if any, or interest on such note on or after the
respective due dates expressed in such note or of the right to convert such
note in accordance with the notes indenture.
Level 3 will be required to furnish to the trustee annually a statement as
to the performance by Level 3 of certain of its obligations under the notes
indenture and as to any default in such performance.
Modification and Waiver
Level 3 and the trustee may, at any time and from time to time, without
notice to or consent of any holders of notes, enter into one or more
indentures supplemental to the indenture:
(a) to evidence the succession of another person to Level 3 and the
assumption by such successor of the covenants of Level 3 in the indenture and
the notes,
(b) to add to the covenants of Level 3, for the benefit of the holders or
to surrender any right or power conferred upon Level 3 by the indenture,
(c) to add any additional Events of Default,
(d) to provide for uncertificated notes in addition to or in place of
certificated notes,
(e) to evidence and provide for the acceptance of appointment under the
indenture of a successor trustee,
(f) to secure the notes,
(g) to comply with the Trust Indenture Act or the Securities Act,
(h) to add guarantees with respect to the notes, or
(i) to cure any ambiguity in the indenture, to correct or supplement any
provision in the indenture which may be inconsistent with any other provision
therein or to add any other provision with respect to matters or questions
arising under the indenture; provided such actions shall not adversely affect
the interests of the holders in any material respect.
Other modifications and amendments of the notes indenture may be made, and
certain past defaults by Level 3 may be waived, with the consent of the
holders of not less than a majority in aggregate principal
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amount of the notes at the time outstanding. However, no such modification or
amendment may, without the consent of the holder of each outstanding note
affected thereby,
(a) change the stated maturity of the principal of, or any installment of
interest on, any note,
(b) reduce the principal amount of, or the premium, if any, or interest on,
any note,
(c) modify the provisions with respect to an expiration of conversion
rights in a manner adverse to the holders,
(d) at any time after a Change of Control has occurred, modify the
provisions with respect to the repurchase right of the holders in a manner
adverse to the holders,
(e) change the place or currency of payment of principal of, premium, if
any, or interest on, any note (including any payment of the Repurchase Price
in respect of such note),
(f) impair the right to institute suit for the enforcement of any payment
on or with respect to any note,
(g) except as otherwise permitted or contemplated by provisions concerning
consolidation, merger, conveyance, transfer, sale or lease of all or
substantially all of the property and assets of Level 3, adversely affect the
right of holders to convert any of the notes other than as provided in the
notes indenture,
(h) modify the conversion or subordination provisions in a manner adverse
to the holders of the notes,
(i) reduce the above-stated percentage of outstanding notes necessary to
modify or amend the notes indenture,
(j) reduce the percentage of aggregate principal amount of outstanding
notes necessary for waiver of compliance with certain provisions of the notes
indenture or for waiver of certain defaults,
(k) reduce the premium payable upon the redemption of any note nor change
the time at which any note may be redeemed, as described under "--Provisional
Redemption," or
(l) reduce the percentage in aggregate principal amount of outstanding
notes required for the adoption of a resolution or the quorum required at any
meeting of holders of notes at which a resolution is adopted. The quorum at
any meeting called to adopt a resolution will be persons holding or
representing a majority in aggregate principal amount of the notes at the time
outstanding and, at any reconvened meeting adjourned for lack of a quorum, 25%
of such aggregate principal amount.
The holders of a majority in aggregate principal amount of the outstanding
notes may waive compliance by Level 3 with certain restrictive provisions of
the notes indenture by written consent or by the adoption of a resolution at a
meeting. The holders of a majority in aggregate principal amount of the
outstanding notes also may waive any past default under the notes indenture,
except a default in the payment of principal, premium, if any, or interest, by
written consent.
The notes indenture contains provisions for convening meetings of holders
of notes.
Reports
Whether or not Level 3 is subject to Section 13(a) or 15(d) of the Exchange
Act, or any successor provision thereto, Level 3 shall file with the
Commission the annual reports, quarterly reports and other documents which
Level 3 would have been required to file with the Commission pursuant to such
Section 13(a) or 15(d) or any successor provision thereto if Level 3 were
subject thereto, such documents to be filed with the Commission on or prior to
the respective dates (the "Required Filing Dates") by which Level 3 would have
been required to file them. Level 3 shall also in any event (a) within 15 days
of each Required Filing Date (i) transmit by mail to all holders, as their
names and addresses appear in the Security Register, without cost to such
holders, and (ii) file with the trustee copies of the annual reports,
quarterly reports and other documents (without exhibits) which Level 3 would
have been required to file with the Commission pursuant to Section
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13(a) or 15(d) of the Exchange Act or any successor provisions thereto if Level
3 were subject thereto and (b) if filing such documents by Level 3 with the
Commission is not permitted under the Exchange Act, promptly upon written
request, supply copies of such documents (without exhibits) to any prospective
holder.
Notices
Notice to holders of the notes will be given by mail to the addresses of
such holders as they appear in the Security Register. Such notices will be
deemed to have been given on the date of mailing of the notice.
Replacement of Notes
Notes that become mutilated, destroyed, stolen or lost will be replaced by
Level 3 at the expense of the holder upon delivery to the trustee of the
mutilated notes or evidence of the loss, theft or destruction thereof
satisfactory to Level 3 and the trustee. In the case of a lost, stolen or
destroyed note, indemnity satisfactory to the trustee and Level 3 may be
required at the expense of the holder of such note before a replacement note
will be issued.
Payment of Stamp and Other Taxes
Level 3 shall pay all stamp and similar duties, if any, which may be imposed
by the United States or any political subdivision thereof or taxing authority
thereof or therein with respect to the issuance of the notes. Level 3 will not
be required to make any payment with respect to any payment with respect to any
other tax, assessment or governmental charge imposed by any government or any
political subdivision thereof or taxing authority thereof or therein.
Satisfaction and Discharge
The provisions in the indenture relating to defeasance will be applicable to
the notes. Level 3's obligation to make or consummate a repurchase of notes
upon the occurrence of a Change of Control ceases upon defeasance of the
indenture.
Governing Law
The notes indenture and the notes will be governed by and construed in
accordance with the laws of the State of New York.
The Trustee
The trustee for the holders of notes issued under the notes indenture will
be The Bank of New York, which is also the trustee with respect to the
indentures relating to Level 3's other senior notes, senior discount notes and
convertible subordinated notes. See "Description of Other Indebtedness of Level
3." In case an Event of Default shall occur, and shall not be cured, the
trustee will be required to use the degree of care of a prudent person in the
conduct of his own affairs in the exercise of its powers. Subject to such
provisions, the trustee will be under no obligation to exercise any of its
rights or powers under the notes indenture at the request of any of the holders
of notes, unless they shall have offered to the trustee reasonable security or
indemnity.
The notes indenture and the Trust Indenture Act contain limitations on the
rights of the trustee, should the trustee become a creditor of Level 3, to
obtain payments of claims in certain cases or to realize on certain property
received in respect of any such claim as security or otherwise. Subject to the
Trust Indenture Act, the trustee will be permitted to engage in other
transactions with Level 3 or any affiliate of Level 3; provided, however, that
if the trustee acquires any conflicting interest as described in the Trust
Indenture Act, it must eliminate such conflict or resign.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of certain United States federal income tax
considerations relating to the purchase, ownership and disposition of the
notes and of common stock into which notes may be converted. For purposes of
this summary, (1) the Internal Revenue Code of 1986, as amended, is referred
to as "the Code" and (2) the Internal Revenue Service is referred to as "the
IRS."
This summary:
. does not purport to be a complete analysis of all the potential tax
considerations that may be relevant to holders in light of their
particular circumstances;
. is based on laws, rulings and decisions now in effect, all of which are
subject to change, possibly on a retroactive basis;
. deals only with holders that will hold notes and common stock into which
notes may be converted as "capital assets" within the meaning of Section
1221 of the Internal Revenue Code of 1986, as amended;
. does not address tax considerations applicable to investors that may be
subject to special tax rules, such as partnerships, banks, tax-exempt
organizations, insurance companies, dealers in securities or currencies,
or persons that will hold notes as a position in a hedging transaction,
"straddle," or "conversion transaction" for tax purposes, or persons
deemed to sell notes or common stock under the constructive sale
provisions of the Code; and
. discusses only the tax considerations applicable to the initial
purchasers of the notes who purchase the notes at their "issue price" as
defined in Section 1273 of the Code and does not discuss the tax
considerations applicable to subsequent purchasers of the notes.
The Company has not sought any ruling from the IRS with respect to the
statements made and the conclusions reached in the following summary, and the
IRS may not agree with the statements and conclusions expressed in this
summary. In addition, the IRS is not precluded from adopting a contrary
position. This summary does not consider the effect of any applicable foreign,
state, local, or other tax laws.
Investors considering the purchase of notes should consult their own tax
advisors with respect to the application of the United States federal income
and estate tax laws to their particular situations, as well as any tax
consequences arising under the laws of any state, local or foreign taxing
jurisdiction or under any applicable tax treaty.
As used herein, the term "United States Holder" means a beneficial owner of
a note or common stock that is, for United States federal income tax purposes,
. a citizen or resident, as defined in Section 7701(b) of the Code, of the
United States,
. a corporation or other entity that is taxable as a corporation created
or organized under the laws of the United States or any political
subdivision thereof,
. an estate the income of which is subject to U.S. federal income taxation
regardless of its source, or
. in general, a trust subject to the primary supervision of a United
States court and the control of one or more United States persons.
A "Foreign Holder" is a beneficial owner of notes or common stock that is
not a United States Holder.
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United States Holders
Payment Of Interest
Interest on a note generally will be includable in the income of a United
States Holder as ordinary income at the time such interest is received or
accrued, in accordance with such United States Holder's regular method of
accounting for United States federal income tax purposes.
Sale, Exchange Or Redemption Of A Note
Upon the sale, exchange or redemption of a note, a United States Holder
generally will recognize capital gain or loss equal to the difference between
(1) the amount of cash proceeds and the fair market value of any property
received on the sale, exchange or redemption, except to the extent such amount
is attributable to accrued interest not previously included in income, which is
taxable as ordinary income, and (2) such United States Holder's adjusted tax
basis in the note. A United States Holder's adjusted tax basis in a note
generally will equal the cost of the note to such United States Holder plus the
amount, if any, included in income on an adjustment to the conversion rate of
the notes, as described in "--Adjustments to Conversion Rate" below. The
deductibility of capital losses is subject to limitations.
Adjustments to Conversion Rate
The conversion rate of the notes is subject to adjustment under certain
circumstances, as described under "Description of Notes--Conversion Rights."
Section 305 of the Code and the Treasury Regulations issued thereunder may
treat the holders of the notes as having received a constructive distribution,
resulting in dividend treatment (as described below) to the extent of the
Company's current and/or accumulated earnings and profits, if, and to the
extent that, certain adjustments in the conversion rate (or certain other
corporate transactions) increase the proportionate interest of a holder of
notes in the fully diluted common stock (particularly an adjustment to reflect
a taxable dividend to holders of common stock), whether or not such holder ever
exercises its conversion privilege. Moreover, if there is not a full adjustment
to the conversion rate of the notes to reflect a stock dividend or other event
increasing the proportionate interest of the holders of outstanding common
stock in the assets or earnings and profits of the Company, then such increase
in the proportionate interest of the holders of the common stock may be treated
as a distribution to such holders, taxable as a dividend (as described below)
to the extent of the Company's current and/or accumulated earnings and profits.
Conversion Of The Notes
A United States Holder generally will not recognize any income, gain or loss
upon conversion of a note into common stock except with respect to cash
received in lieu of a fractional share of common stock. A United States
Holder's tax basis in the common stock received on conversion of a note will be
the same as such United States Holder's adjusted tax basis in the note at the
time of conversion, reduced by any basis allocable to a fractional share
interest, and the holding period for the common stock received on conversion
will generally include the holding period of the note converted. However, to
the extent that any common stock received upon conversion is considered
attributable to accrued interest not previously included in income by the
United States Holder, it will be taxable as ordinary income. A United States
Holder's tax basis in shares of common stock considered attributable to accrued
interest generally will equal the amount of such accrued interest included in
income, and the holding period for such shares shall begin on the date of
conversion.
Cash received in lieu of a fractional share of common stock upon conversion
will be treated as a payment in exchange for the fractional share of common
stock. Accordingly, the receipt of cash in lieu of a fractional share of common
stock generally will result in capital gain or loss, measured by the difference
between the cash received for the fractional share and the United States
Holder's adjusted tax basis in the fractional share, and will be taxable as
described below under "--Sale of Common Stock."
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Dividends
Distributions, if any, paid or deemed paid on the common stock (or deemed
distributions on the notes as described above under "--Adjustments to
Conversion Rate") generally will be includable in the income of a United States
Holder as ordinary income to the extent of the Company's current or accumulated
earnings and profits as determined for U.S. federal income tax purposes.
Dividends paid to holders that are United States corporations may qualify for
the dividends received deduction. To the extent, if any, that a United States
Holder receives distributions on shares of common stock that would otherwise
constitute dividends for United States federal income tax purposes but that
exceed the current and accumulated earnings and profits of the Company, such
distributions will be treated first as a non-taxable return of capital,
reducing the holder's basis in the shares of common stock. Any such
distributions in excess of the holder's basis in the shares of common stock
generally will be treated as capital gains.
Sale Of Common Stock
Upon the sale or exchange of common stock, a United States Holder generally
will recognize capital gains or losses equal to the difference between (1) the
amount of cash and the fair market value of any property received upon the sale
or exchange and (2) such United States Holder's adjusted tax basis in the
common stock (as described above under "--Conversion of the Notes"). The
deductibility of capital losses is subject to limitations.
Foreign Holders
Stated Interest
Payments of interest on a note to a Foreign Holder will not be subject to
United States federal withholding tax provided that:
(1) the holder does not actually or constructively own 10% or more of the
total combined voting power of all classes of stock of the Company entitled to
vote (treating, for such purpose, notes held by a holder as having been
converted into common stock of the Company),
(2) the holder is not a controlled foreign corporation that is related to
the Company through stock ownership, and
(3) either (A) the beneficial owner of the note, under penalties of perjury,
provides the Company or its agent with its name and address and certifies that
it is not a United States person or (B) a securities clearing organization,
bank, or other financial institution that holds customers' securities in the
ordinary course of its trade or business (a "financial institution") certifies
to the Company or its agent, under penalties of perjury, that such a statement
has been received from the beneficial owner by it or another financial
institution and furnishes to the Company or its agent a copy thereof.
For purposes of this summary, we refer to this exemption from U.S. federal
withholding tax as the "Portfolio Interest Exemption." Under new United States
Treasury regulations that generally are effective for payments made after
December 31, 2000, subject to certain transition rules, the certification
described in clause (3) above may also be provided by a qualified intermediary
on behalf of one or more beneficial owners or other intermediaries, provided
that such intermediary has entered into a withholding agreement with the IRS
and certain other conditions are met.
The gross amount of payments to a Foreign Holder of interest that does not
qualify for the Portfolio Interest Exemption and that is not effectively
connected to a United States trade or business will be subject to United States
federal withholding tax at the rate of 30%, unless a United States income tax
treaty applies to reduce or eliminate withholding.
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A Foreign Holder will generally be subject to tax in the same manner as a
United States Holder with respect to payments of interest if such payments are
effectively connected with the conduct of a trade or business by the Foreign
Holder in the United States and, if an applicable tax treaty so provides, such
gain is attributable to an office or other fixed place of business maintained
in the United States by such holder. Such effectively connected income received
by a Foreign Holder which is a corporation may in certain circumstances be
subject to an additional "branch profits tax" at a 30% rate or, if applicable,
a lower treaty rate.
Foreign Holders should consult their own tax advisors regarding applicable
income tax treaties, which may provide different rules.
To claim the benefit of a tax treaty or to claim exemption from withholding
because the income is effectively connected with a U.S. trade or business, the
Foreign Holder must provide a properly executed Form 1001 or 4224, as
applicable, prior to the payment of interest. These forms must be periodically
updated. United States Treasury regulations, which generally are effective for
payments made after December 31, 2000, subject to certain transition rules,
require Foreign Holders or, under certain circumstances, a qualified
intermediary to file a withholding certificate with the Company's withholding
agent to obtain the benefit of an applicable tax treaty providing for a lower
rate of withholding tax. Such certificate must contain, among other
information, the name and address of the Foreign Holder.
Sale, Exchange Or Redemption Of A Note
A Foreign Holder generally will not be subject to United States federal
income tax or withholding tax on gain realized on the sale or exchange of notes
unless (1) the holder is an individual who was present in the United States for
183 days or more during the taxable year, and certain other conditions are met,
(2) the gain is effectively connected with the conduct of a trade or business
of the holder in the United States and, if an applicable tax treaty so
provides, such gain is attributable to an office or other fixed place of
business maintained in the United States by such holder or (3) the Company is
or has been a United States real property holding corporation ("USRPHC") at any
time during the shorter of the five-year period preceding the date of the
disposition or the holder's holding period (in which case the gain will be
treated as effectively connected income as described in (2)), unless (i) the
notes are considered to be "regularly traded" on an "established securities
market" under applicable Treasury Regulations and (ii) the holder at no time
during the shorter of the five-year period preceding the date of the
disposition or the holder's holding period owned (actually or constructively)
more than 5% of the total value of the notes. In the case of (2), such
effectively connected income received by a Foreign Holder which is a
corporation may in certain circumstances be subject to an additional "branch
profits tax" at a 30% rate or, if applicable, a lower treaty rate.
Additionally, in the case of (3), it is possible that a Foreign Holder that
initially owns 5% or less of the total value of the notes may subsequently be
considered to own more than 5% of the total value of the notes due to other
holders' conversion of notes into common stock. Regardless of whether a
disposition of any note is taxable to the seller pursuant to the rules
regarding USRPHCs, the withholding requirements of Section 1445 of the Code
generally will not be applicable to a purchaser of the notes or a financial
intermediary involved in any such transaction if the notes are considered to be
"regularly traded" on an "established securities market" under applicable
Treasury Regulations.
Conversion of a Note
In general, no United States federal income tax or withholding tax will be
imposed upon the conversion of a note into common stock by a Foreign Holder
except (1) to the extent the common stock is considered attributable to accrued
interest not previously included in income, which may be taxable under the
rules set forth in "--Stated Interest," (2) with respect to the receipt of cash
in lieu of fractional shares by Foreign Holders upon conversion of a note, in
each case where the conditions described in (1), (2) or (3) above under "--
Sale, Exchange or Redemption of a Note" is satisfied. Regardless of whether a
conversion of any note is taxable to the seller pursuant to the rules regarding
USRPHCs, the withholding requirements of Section 1445 of the Code generally
will not be applicable to the Company or a financial intermediary involved in
any such transaction if the notes are considered to be "regularly traded" on an
"established trading market" under applicable Treasury Regulations.
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Sale Or Exchange Of Common Stock
A Foreign Holder will generally not be subject to United States federal
income tax or withholding tax on the sale or exchange of common stock unless
either of the conditions described in (1) or (2) above under "--Sale, Exchange
or Redemption of a Note" is satisfied or the Company is or has been a USRPHC
for United States federal income tax purposes at any time within the shorter of
the five year period preceding such disposition or such Foreign Holder's
holding period. The Company believes that, based upon its current Business
Plan, it may be or it may become a USRPHC. In general, the Company will be
treated as a USRPHC if the fair market value of its U.S. real property
interests equals or exceeds 50% of the total fair market value of its U.S. and
non-U.S. real property and its other assets used or held in a trade or
business. If the Company is, or becomes, a USRPHC, so long as the common stock
continues to be regularly traded on an established securities market within the
meaning of Section 897(c)(3) of the Code, only a Foreign Holder who holds or
held directly, indirectly or constructively, at any time during the shorter of
the five-year period preceding the date of disposition or the holder's holding
period, more than 5% of the common stock will be subject to U.S. federal income
tax on the disposition of the common stock. For purposes of the ownership test
described above, a Foreign Holder of notes will be considered as constructively
owning the common stock into which such notes are convertible. Regardless of
whether a disposition of common stock is taxable to the seller pursuant to the
rules regarding USRPHCs, the withholding requirements of Section 1445 of the
Code generally will not be applicable to a purchaser of the common stock or a
financial intermediary involved in any such transaction.
Dividends
Distributions by the Company with respect to the common stock that are
treated as dividends paid or deemed paid (including a deemed distribution on
the notes or common stock as described above under "United States Holders--
Adjustments to Conversion Rate") to a Foreign Holder, excluding dividends that
are effectively connected with the conduct of a trade or business in the United
States by such holder, will be subject to United States federal withholding tax
at a 30% rate, or lower rate provided under any applicable income tax treaty.
Except to the extent that an applicable tax treaty otherwise provides, a
Foreign Holder will be subject to tax in the same manner as a United States
Holder on dividends paid or deemed paid that are effectively connected with the
conduct of a trade or business in the United States by the Foreign Holder. If
such Foreign Holder is a foreign corporation, it may in certain circumstances
also be subject to a United States "branch profits tax" on such effectively
connected income at a 30% rate or such lower rate as may be specified by an
applicable income tax treaty. Even though such effectively connected dividends
are subject to income tax, and may be subject to the branch profits tax, they
will not be subject to U.S. withholding tax if the Foreign Holder delivers IRS
Form 4224 to the payer.
Under current United States Treasury Regulations, dividends paid to an
address in a foreign country are presumed to be paid to a resident of that
country, unless the payer has knowledge to the contrary, for purposes of the
withholding discussed above, and, under the current interpretation of United
States Treasury Regulations, for purposes of determining the applicability of a
tax treaty rate. Under new United States Treasury Regulations that generally
are effective for payments made after December 31, 2000, subject to certain
transition rules, however, a Foreign Holder of common stock who wishes to claim
the benefit of an applicable treaty rate would be required to satisfy
applicable certification requirements. In addition, under current United States
Treasury Regulations, in the case of common stock held by a foreign
partnership, or other fiscally transparent entities, the certification
requirement would generally be applied to the partners of the partnership and
the partnership would be required to provide certain information, including a
United States taxpayer identification number. The Treasury Regulations also
provide look-through rules for tiered partnerships.
Death Of A Foreign Holder
A note held by an individual who is not a citizen or resident of the United
States at the time of death will not be includable in the decedent's gross
estate for United States estate tax purposes, provided that such holder or
beneficial owner did not at the time of death actually or constructively own
10% or more of the combined
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voting power of all classes of stock of the Company entitled to vote, and
provided that, at the time of death, payments with respect to such note would
not have been effectively connected with the conduct by such Foreign Holder of
a trade or business within the United States.
Common stock actually or beneficially held, other than through a foreign
corporation, by an individual who is not a citizen or resident of the United
States at the time of his or her death, or previously transferred subject to
certain retained rights or powers, will be subject to United States federal
estate tax unless otherwise provided by an applicable estate tax treaty.
Information Reporting And Backup Withholding
In general, information reporting requirements will apply to payments of
principal, premium, if any, and interest on a note, dividends on common stock,
and payments of the proceeds of the sale of a note or common stock to a United
States Holder, and a 31% backup withholding tax may apply to such payment if
the United States Holder (1) fails to establish properly that it is entitled to
an exemption, (2) fails to furnish or certify his correct taxpayer
identification number to the payer in the manner required, (3) is notified by
the IRS that he has failed to report payments of interest or dividends property
or (4) under certain circumstances, fails to certify that he has not been
notified by the IRS that he is subject to backup withholding for failure to
report interest or dividend payments.
Information reporting requirements will apply to payments of interest or
dividends to Foreign Holders where such interest or dividends are subject to
withholding or are exempt from United States withholding tax pursuant to a tax
treaty, or where such interest is exempt from United States tax under the
Portfolio Interest Exemption. Copies of these information returns may be made
available under the provisions of a specific treaty or agreement to the tax
authorities of the country in which the Foreign Holder resides.
Treasury Regulations provide that backup withholding and information
reporting will not apply to payments of principal on the notes by the Company
to a Foreign Holder if the Foreign Holder certifies as to its status as a
Foreign Holder under penalties of perjury or otherwise establishes an exemption
(provided that neither the Company nor its paying agent has actual knowledge
that the holder is a United States person or that the conditions of any other
exemption are not, in fact, satisfied).
The payment of the proceeds from the disposition of notes or common stock to
or through the United States office of any broker, United States or foreign,
will be subject to information reporting and possible backup withholding unless
the owner certifies as to its non-United States status under penalty of perjury
or otherwise establishes an exemption, provided that the broker does not have
actual knowledge that the holder is a United States person or that the
conditions of any other exemption are not, in fact, satisfied. The payment of
the proceeds from the disposition of a note or common stock to or through a
non-United States office of a non-United States broker that is not a United
States related person will not be subject to information reporting or backup
withholding. For this purpose, a "United States related person" is:
(1) a "controlled foreign corporation" for United States federal income tax
purposes or
(2) a foreign person 50% or more of whose gross income from all sources for
the three-year period ending with the close of its taxable year preceding the
payment, or for such part of the period that the broker has been in existence,
is derived from activities that are effectively connected with the conduct of a
United States trade or business.
In the case of the payment of proceeds from the disposition of notes or
common stock to or through a non-United States office of a broker that is
either a United States person or a United States related person, Treasury
Regulations require information reporting on the payment unless the broker has
documentary evidence in its files that the owner is a Foreign Holder and the
broker has no knowledge to the contrary.
Any amounts withheld under the backup withholding rules will be allowed as a
refund or a credit against such holder's United States federal income tax
liability provided the required information is furnished to the IRS.
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United States Treasury Regulations, which generally are effective for
payments made after December 31, 2000, subject to certain transition rules,
will generally expand the circumstances under which information reporting and
backup withholding may apply. Holders of notes should consult their tax
advisors regarding the application of the information and reporting and backup
withholding rules, including such Treasury regulations.
The preceding discussion of certain United States federal income tax
consequences is for general information only and is not tax advice.
Accordingly, holders of the notes should consult their own tax advisors as to
particular tax consequences to them or purchasing, holding and disposing of the
notes and the common stock, including the applicability and effect of any
state, local or foreign tax laws, and of any proposed changes in applicable
law.
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UNDERWRITING
Subject to the terms and conditions stated in the underwriting agreement
between Level 3 and the underwriters, each underwriter named below, for whom
Salomon Smith Barney Inc. is acting as the global coordinator and joint book-
running manager with Goldman, Sachs & Co., and, together with J.P. Morgan
Securities Inc., Morgan Stanley & Co. Incorporated and Credit Suisse First
Boston Corporation, as the representatives, has severally agreed to purchase,
and Level 3 has agreed to sell to each such underwriter, the principal amount
of notes set forth opposite the name of such underwriter.
Name Principal Amount
---- ----------------
Salomon Smith Barney Inc...................................... $300,000,000
Goldman, Sachs & Co........................................... 300,000,000
J.P. Morgan Securities Inc.................................... 60,000,000
Morgan Stanley & Co. Incorporated............................. 60,000,000
Credit Suisse First Boston Corporation........................ 30,000,000
------------
Total....................................................... $750,000,000
============
If the underwriters sell more notes than the total principal amount set
forth in the table above, the underwriters have an option to buy up to an
additional $112,500,000 principal amount of notes from Level 3 to cover such
sales. They may exercise that option for 30 days. If any notes are purchased
pursuant to this option, the underwriters will severally purchase notes in
approximately the same proportion as set forth in the table above.
The underwriting agreement provides that the obligations of the several
underwriters to purchase the notes included in this offering are subject to
approval of certain legal matters by counsel and to certain other conditions.
The underwriters are obligated to purchase all the notes if they purchase any
of the notes.
The underwriters propose to offer some of the notes directly to the public
at the public offering price set forth on the cover page of this prospectus
supplement and some of the notes to certain dealers at the public offering
price less a concession not in excess of 1.77% of the principal amount of the
notes. After the initial offering of the notes to the public, the public
offering price and such concessions may be changed by the representatives.
The following table shows the underwriting discounts and commissions
(expressed as a percentage of the principal amount of the notes) that we will
pay to the underwriters in connection with this offering. These amounts are
shown assuming both no exercise and full exercise of the underwriters' option
to purchase additional notes.
No Exercise Full Exercise
----------- -------------
Per note.............................................. 2.95% 2.95%
Total................................................ $22,125,000 $25,443,750
Level 3 has agreed that, for a period of 90 days from the date of this
prospectus supplement, it will not, without the prior written consent of
Salomon Smith Barney, offer, sell, contract to sell, issue, announce the
offering or issuance of, register, cause to be registered or announce the
registration or intended registration of, in any case for its own account, any
shares of common stock of Level 3, including any such shares beneficially or
indirectly owned or controlled by Level 3, or any securities convertible into
or exchangeable for common stock, except for: (1) up to 3,000,000 shares of
common stock issued in connection with acquisitions, provided that this limit
may be exceeded if the purchaser of such shares agrees to be bound for any
remaining portion of the 90-day "black-out" period, (2) common stock issued
pursuant to any employee benefit plan, stock
S-103
ownership or stock option plan or dividend reinvestment plan in effect on the
date hereof, or options granted pursuant to any such plan in effect on the date
hereof, provided that such options cannot be exercised for any remaining
portion of the 90-day "black-out" period, (3) common stock issued in connection
with the inclusion of Level 3's common stock in any major market index (as
defined in the underwriting agreement), (4) maintaining the effectiveness of
any registration statement in place on the date hereof or otherwise permitted
to be filed under this paragraph, (5) common stock issued in connection with
the exercise of warrants outstanding on the date hereof, (6) common stock
issued to prospective employees in connection with such employees being hired
by Level 3, (7) the notes and common stock issued upon the conversion of the
notes and the common stock concurrently being offered and upon conversion of
Level 3's existing 6% convertible notes due 2009 and (8) the filing, announcing
or amending of a shelf registration for up to $5 billion of securities,
provided that this clause (8) shall not permit the actual offering ("take
down") of any such securities during this 90-day period. Salomon Smith Barney,
in its sole discretion, may release any of the securities subject to these
"black-out" agreements at any time without notice.
In connection with the offering, Salomon Smith Barney, on behalf of the
underwriters, may purchase and sell notes in the open market. These
transactions may include over-allotment, syndicate covering transactions and
stabilizing transactions. Over-allotment involves syndicate sales of notes in
excess of the principal amount of notes to be purchased by the underwriters in
the offering, which creates a syndicate short position. Syndicate covering
transactions involve purchases of the notes in the open market after the
distribution has been completed in order to cover syndicate short positions.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the notes
while the offering is in progress.
The underwriters also may impose a penalty bid. Penalty bids permit the
underwriters to reclaim a selling concession from a syndicate member when
Salomon Smith Barney, in covering syndicate short positions or making
stabilizing purchases, repurchases notes originally sold by that syndicate
member.
Any of these activities may cause the price of the notes to be higher than
the price that otherwise would exist in the open market in the absence of such
transactions. These transactions may be effected in the over-the-counter market
or otherwise and, if commenced, may be discontinued at any time.
In addition, in connection with this offering, certain of the underwriters
(and selling group members) may engage in passive market-making transactions in
Level 3's common stock on the Nasdaq National Market, prior to the pricing and
completion of the offering. Passive market making consists of displaying bids
on the Nasdaq National Market no higher than the bid prices of independent
market makers and making purchases at prices no higher than those independent
bids and effective in response to order flow. Net purchases by a passive market
maker on each day are limited to a specified percentage of the passive market
maker's average daily trading volume in the common stock during a specified
period and must be discontinued when such limit is reached. Passive market
making may cause the price of Level 3's common stock to be higher than the
price that otherwise would exist in the open market in the absence of such
transactions. If passive market making is commenced, it may be discontinued at
any time.
Level 3 estimates that its total expense of this offering will be
approximately $440,000.
The representatives and the other underwriters have performed certain
investment banking and advisory services for Level 3 from time to time for
which they have received customary fees and expenses. The underwriters may,
from time to time, engage in transactions with and perform services for Level 3
in the ordinary course of their business. Some of the underwriters are acting
as lead underwriters for, and initial purchasers in, the other Level 3
offerings and are lenders under Level 3's credit facility. In addition, Salomon
Smith Barney Inc. will receive a financial advisory fee.
Level 3 has agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, or to
contribute to payments the underwriters may be required to make in respect of
any of those liabilities.
S-104
LEGAL MATTERS
The validity of the notes offered by this prospectus supplement will be
passed upon for the Company by Willkie Farr & Gallagher, New York, New York.
Certain legal matters relating to this offering will be passed upon for the
underwriters by Cravath, Swaine & Moore, New York, New York.
EXPERTS
The consolidated financial statements of Level 3 Communications, Inc. as of
December 31, 1999 and 1998 and for the years then ended, included in this
prospectus supplement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their report with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in
giving said report.
The consolidated statements of operations, cash flows, changes in
stockholders' equity and comprehensive income (loss) of Level 3 Communications,
Inc. for the year ended December 27, 1997 included in this prospectus
supplement, have been included herein in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
that firm as experts in accounting and auditing.
S-105
GLOSSARY OF TERMS
access...................... Telecommunications services that permit long distance
carriers to use local exchange facilities to originate
and/or terminate long distance service.
access charges.............. The fees paid by long distance carriers to LECs for
originating and terminating long distance calls on the
LECs' local networks.
backbone.................... A centralized high-speed network that interconnects
smaller, independent networks. It is the through-portion
of a transmission network, as opposed to spurs which
branch off the through-portions.
CAP......................... Competitive Access Provider. A company that provides its
customers with an alternative to the local exchange
company for local transport of private line and special
access telecommunications services.
capacity.................... The information carrying ability of a telecommunications
facility.
carrier..................... A provider of communications transmission services by
fiber, wire or radio.
Central Office.............. Telephone company facility where subscribers' lines are
joined to switching equipment for connecting other
subscribers to each other, locally and long distance.
CLEC........................ Competitive Local Exchange Carrier. A company that
competes with LECs in the local services market.
common carrier.............. A government-defined group of private companies offering
telecommunications services or facilities to the general
public on a non-discriminatory basis.
conduit..................... A pipe, usually made of metal, ceramic or plastic, that
protects buried cables.
dark fiber.................. Fiber optic strands that are not connected to
transmission equipment.
dedicated lines............. Telecommunications lines reserved for use by particular
customers.
dialing parity.............. The ability of a competing local or toll service provider
to provide telecommunications services in such a manner
that customers have the ability to route automatically,
without the use of any access code, their
telecommunications to the service provider of the
customers' designation.
equal access................ The basis upon which customers of interexchange carriers
are able to obtain access to their Primary Interexchange
Carriers' (PIC) long distance telephone network by
dialing "1", thus eliminating the need to dial additional
digits and an authorization code to obtain such access.
facilities based carriers... Carriers that own and operate their own network and
equipment.
fiber optics................ A technology in which light is used to transport
information from one point to another. Fiber optic cables
are thin filaments of glass through which light beams are
transmitted over long distances carrying enormous amounts
of data. Modulating light on thin strands of glass
produces major benefits including high bandwidth,
relatively low cost, low power consumption, small space
needs and total insensitivity to electromagnetic
interference.
S-106
Gbps........................ Gigabits per second. A transmission rate. One gigabit
equals 1.024 billion bits of information.
ILEC........................ Incumbent Local Exchange Carrier. A company historically
providing local telephone service. Often refers to one of
the Regional Bell Operating Companies (RBOCs). Often
referred to as "LEC" (Local Exchange Carrier).
interconnection............. Interconnection of facilities between or among local
exchange carriers, including potential physical
colocation of one carrier's equipment in the other
carrier's premises to facilitate such interconnection.
InterLATA................... Telecommunications services originating in a LATA and
terminating outside of that LATA.
Internet.................... A global collection of interconnected computer networks
which use a specific communications protocol.
IntraLATA................... Telecommunications services originating and terminating
in the same LATA.
ISDN........................ Integrated Services Digital Network. An information
transfer standard for transmitting digital voice and data
over telephone lines at speeds up to 128 Kbps.
ISPs........................ Internet Service Providers. Companies formed to provide
access to the Internet to consumers and business
customers via local networks.
IXC......................... Interexchange Carrier. A telecommunications company that
provides telecommunications services between local
exchanges on an interstate or intrastate basis.
Kbps........................ Kilobits per second. A transmission rate. One kilobit
equals 1,024 bits of information.
LATA........................ Local Access and Transport Area. A geographic area
composed of contiguous local exchanges, usually but not
always within a single state. There are approximately 200
LATAs in the United States.
leased line................. Telecommunications line dedicated to a particular
customer along predetermined routes.
LEC......................... Local Exchange Carrier. A telecommunications company that
provides telecommunications services in a geographic area
in which calls generally are transmitted without toll
charges. LECs include both ILECs and CLECs.
local exchange.............. A geographic area determined by the appropriate state
regulatory authority in which calls generally are
transmitted without toll charges to the calling or called
party.
local loop.................. A circuit that connects an end user to the LEC central
office within a LATA.
long distance carriers Long distance carriers provide services between local
(interexchange carriers)... exchanges on an interstate or intrastate basis. A long
distance carrier may offer services over its own or
another carrier's facilities.
Mbps........................ Megabits per second. A transmission rate. One megabit
equals 1.024 million bits of information.
S-107
multiplexing................ An electronic or optical process that combines a large
number of lower speed transmission lines into one high
speed line by splitting the total available bandwidth
into narrower bands (frequency division), or by allotting
a common channel to several different transmitting
devices, one at a time in sequence (time division).
NAP......................... Network Access Point. A location at which ISPs exchange
each other's traffic.
OC3......................... A data communications circuit consisting of three DS3s
capable of transmitting data at 155 Mbps.
OC48........................ A data communications circuit consisting of forty-eight
DS3s capable of transmitting data at approximately 2.45
Gbps.
peering..................... The commercial practice under which ISPs exchange each
other's traffic without the payment of settlement
charges. Peering occurs at both public and private
exchange points.
POP......................... Point of Presence. Telecommunications facility where a
communications provider locates network equipment used to
connect customers to its network backbone.
private line................ A dedicated telecommunications connection between end
user locations.
PSTN........................ Public Switched Telephone Network. That portion of a
local exchange company's network available to all users
generally on a shared basis (i.e., not dedicated to a
particular user). Traffic along the public switched
network is generally switched at the local exchange
company's central offices.
RBOCs....................... Regional Bell Operating Companies. Originally, the seven
local telephone companies (formerly part of AT&T)
established as a result of the AT&T Divestiture.
Currently consists of four local telephone companies as a
result of the mergers of Bell Atlantic with NYNEX and SBC
with Pacific Telesis and Ameritech.
reciprocal compensation..... The compensation of a CLEC for termination of a local
call by the ILEC on the CLEC's network, which is the same
as the compensation that the CLEC pays the ILEC for
termination of local calls on the ILEC's network.
resale...................... Resale by a provider of telecommunications services (such
as a LEC) of such services to other providers or carriers
on a wholesale or a retail basis.
router...................... Equipment placed between networks that relays data to
those networks based upon a destination address contained
in the data packets being routed.
SONET....................... Synchronous Optical Network. An electronics and network
architecture for variable bandwidth products which
enables transmission of voice, data and video
(multimedia) at very high speeds. SONET ring architecture
provides for virtually instantaneous restoration of
service in the event of a fiber cut by automatically
rerouting traffic in the opposite direction around the
ring.
S-108
special access services..... The lease of private, dedicated telecommunications lines
or "circuits" along the network of a local exchange
company or a CAP, which lines or circuits run to or from
the long distance carrier POPs. Examples of special
access services are telecommunications lines running
between POPs of a single long distance carrier, from one
long distance carrier POP to the POP of another long
distance carrier or from an end user to a long distance
carrier POP.
switch...................... A device that selects the paths or circuits to be used
for transmission of information and establishes a
connection. Switching is the process of interconnecting
circuits to form a transmission path between users and it
also captures information for billing purposes.
Tbps........................ Terabits per second. A transmission rate. One terabit
equals 1.024 trillion bits of information.
T1.......................... A data communications circuit capable of transmitting
data at 1.544 Mbps.
unbundled................... Services, programs, software and training sold separately
from the hardware.
unbundled access............ Access to unbundled elements of a telecommunications
services provider's network including network facilities,
equipment, features, functions and capabilities, at any
technically feasible point within such network.
web site.................... A server connected to the Internet from which Internet
users can obtain information.
wireless.................... A communications system that operates without wires.
Cellular service is an example.
world wide web or web....... A collection of computer systems supporting a
communications protocol that permits multimedia
presentation of information over the Internet.
xDSL........................ A term referring to a variety of new Digital Subscriber
Line technologies. Some of these new varieties are
asymmetric with different data rates in the downstream
and upstream directions. Others are symmetric. Downstream
speeds range from 384 Kbps (or "SDSL") to 1.5 to 8 Mbps
("ADSL").
S-109
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
(formerly, Peter Kiewit Sons', Inc.)
INDEX TO FINANCIAL STATEMENTS
Page
----
Financial Statements as of December 31, 1999 and December 31, 1998 and
for the three years ended December 31, 1999:
Reports of Independent Public Accountants.............................. F-2
Consolidated Statements of Operations.................................. F-4
Consolidated Balance Sheets............................................ F-5
Consolidated Statements of Cash Flows.................................. F-6
Consolidated Statements of Changes in Stockholders' Equity............. F-8
Consolidated Statements of Comprehensive Income (Loss)................. F-9
Notes to Consolidated Financial Statements............................. F-10
Schedules not indicated above have been omitted because of the absence of
the conditions under which they are required or because the information called
for is shown in the consolidated financial statements or in the notes thereto.
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Level 3 Communications, Inc.:
We have audited the consolidated balance sheets of Level 3 Communications,
Inc. and subsidiaries (a Delaware corporation) as of December 31, 1999 and 1998
and the related consolidated statements of operations, cash flows, changes in
stockholders' equity and comprehensive income (loss) for the years then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Level 3
Communications, Inc. and subsidiaries as of December 31, 1999 and 1998 and the
consolidated results of their operations and their cash flows for the years
then ended in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Denver, Colorado
February 2, 2000
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Level 3 Communications, Inc. and Subsidiaries
(formerly, Peter Kiewit Sons', Inc.)
We have audited the consolidated statements of operations, cash flows, changes
in stockholders' equity and comprehensive income (loss) of Level 3
Communications, Inc. and Subsidiaries (formerly, Peter Kiewit Sons', Inc.) for
the year ended December 27, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
Level 3 Communications, Inc. and Subsidiaries for the year ended December 27,
1997 in conformity with generally accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
Coopers & Lybrand LLP
Omaha, Nebraska
March 30, 1998
F-3
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three years ended December 31, 1999
1999 1998 1997
------- ----- -----
(dollars in
millions, except
per share data)
Revenue................................................. $ 515 $ 392 $ 332
Cost and Expenses:
Cost of revenue....................................... (360) (199) (163)
Depreciation and amortization......................... (228) (66) (20)
Selling, general and administrative................... (668) (332) (106)
Write-off of in-process research and development...... -- (30) --
------- ----- -----
Total costs and expenses............................ (1,256) (627) (289)
------- ----- -----
Earnings (Loss) from Operations......................... (741) (235) 43
Other Income (Expense):
Interest income....................................... 212 173 33
Interest expense, net................................. (174) (132) (15)
Equity in losses of unconsolidated subsidiaries, net.. (127) (132) (43)
Gain on equity investee stock transactions............ 118 62 --
Gain (loss) on sale of assets......................... (2) 107 10
Other, net............................................ 7 4 7
------- ----- -----
Total other income (expense)........................ 34 82 (8)
------- ----- -----
Earnings (Loss) Before Income Taxes and Discontinued
Operations............................................. (707) (153) 35
Income Tax Benefit...................................... 220 25 48
------- ----- -----
Earnings (Loss) from Continuing Operations.............. (487) (128) 83
Discontinued Operations:
Gain on Split-off of Construction Group............... -- 608 --
Construction operations, net of income tax expense of
($107)............................................... -- -- 155
Gain on disposition of energy business net of income
tax expense of ($175)................................ -- 324 --
Energy, net of income tax benefit of $1............... -- -- 10
------- ----- -----
Income from discontinued operations................... -- 932 165
------- ----- -----
Net Earnings (Loss)..................................... $ (487) $ 804 $ 248
======= ===== =====
Earnings (Loss) Per Share of Level 3 Common Stock
(Basic and Diluted):
Continuing operations................................. $ (1.46) $(.43) $ .33
======= ===== =====
Discontinued operations excluding construction
operations........................................... $ -- $3.09 $ .04
======= ===== =====
Net earnings (loss) excluding construction
operations........................................... $ (1.46) $2.66 $ .37
======= ===== =====
Net earnings (loss) excluding gain on Split-off of
Construction Group................................... $ (1.46) $ .64 $ .37
======= ===== =====
See accompanying notes to consolidated financial statements.
F-4
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
1999 1998
---------- ----------
(dollars in millions,
except per share
data)
Assets
Current Assets:
Cash and cash equivalents............................. $ 1,219 $ 842
Marketable securities................................. 2,227 2,863
Restricted securities................................. 46 32
Accounts receivable, less allowances of $9 and $5..... 148 57
Income taxes receivable............................... 241 54
Other................................................. 55 29
---------- ----------
Total Current Assets.................................... 3,936 3,877
Net Property, Plant and Equipment....................... 4,287 1,061
Investments............................................. 300 300
Other Assets, net....................................... 381 284
---------- ----------
$ 8,904 $ 5,522
========== ==========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable...................................... $ 830 $ 276
Current portion of long-term debt..................... 6 5
Accrued payroll and employee benefits................. 43 16
Accrued reclamation and other mining costs............ 13 16
Accrued interest...................................... 47 33
Deferred revenue...................................... 111 1
Other................................................. 75 23
---------- ----------
Total Current Liabilities............................... 1,125 370
Long-Term Debt, less current portion.................... 3,989 2,641
Deferred Income Taxes................................... 68 86
Accrued Reclamation Costs............................... 99 96
Other Liabilities....................................... 218 164
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, authorized 10,000,000
shares: no shares outstanding in 1999 and 1998........ -- --
Common stock:
Common stock, $.01 par value, authorized 1,500,000,000
shares: 341,396,727 outstanding in 1999 and
307,874,706 outstanding in 1998...................... 3 3
Class R, $.01 par value, authorized 8,500,000 shares:
no shares outstanding in 1999 and 1998............... -- --
Additional paid-in capital............................. 2,501 765
Accumulated other comprehensive income (loss).......... (5) 4
Retained earnings...................................... 906 1,393
---------- ----------
Total Stockholders' Equity.............................. 3,405 2,165
---------- ----------
$ 8,904 $ 5,522
========== ==========
See accompanying notes to consolidated financial statements.
F-5
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three years ended December 31, 1999
1999 1998 1997
------- ------- -----
(dollars in millions)
Cash Flows from Operating Activities:
Net Earnings (Loss)................................. $ (487) $ 804 $ 248
Less: Income from Discontinued Operations........... -- (932) (165)
------- ------- -----
Earnings (loss) from continuing operations.......... (487) (128) 83
Adjustments to reconcile earnings (loss) from
continuing operations to net cash provided by
continuing operations:
Write-off in process research and development... -- 30 --
Equity losses, net.............................. 127 132 43
Depreciation and amortization................... 228 66 20
Amortization of premiums (discounts) on
marketable securities.......................... 10 (24) --
Amortization of debt issuance costs............. 9 3 --
(Gain) loss on sale of property, plant and
equipment and other assets..................... 2 (17) (10)
Gain on equity investee stock transactions...... (118) (62) --
Gain on sale of Cable Michigan.................. -- (90) --
Compensation expense attributable to stock
awards......................................... 126 39 21
Federal income tax refunds...................... 81 46 146
Deferred income taxes........................... (56) (50) (103)
Deposits........................................ (64) -- --
Accrued interest on marketable securities....... 62 (39) --
Change in working capital items:
Receivables................................... (84) (1) (9)
Other current assets.......................... (170) (10) (1)
Payables...................................... 562 239 (3)
Other liabilities............................. 207 39 (5)
Other........................................... 3 (3) --
------- ------- -----
Net Cash Provided by Continuing Operations............ 438 170 182
Cash Flows from Investing Activities:
Proceeds from sales and maturities of marketable
securities......................................... 5,169 3,214 167
Purchases of marketable securities.................. (4,555) (5,334) (452)
Purchases of restricted securities.................. (11) (8) (2)
Capital expenditures................................ (3,436) (910) (26)
Investments and acquisitions, net of cash acquired.. (3) (67) (42)
Proceeds from sale of property, plant and equipment,
and other investments.............................. 12 27 1
Proceeds from sale of Cable Michigan................ -- 129 --
Other............................................... -- -- 3
------- ------- -----
Net Cash Used in Investing Activities................. $(2,824) $(2,949) $(351)
See accompanying notes to consolidated financial statements.
F-6
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued)
For the three years ended December 31, 1999
1999 1998 1997
------ ------ -----
(dollars in
millions)
Cash Flows from Financing Activities:
Long-term debt borrowings, net of issuance costs...... $1,249 $2,426 $ 17
Payments on long-term debt, including current
portion.............................................. (6) (12) (2)
Issuances of common stock............................. 1,498 21 117
Exchange of Class C Stock for Class D Stock, net...... -- 122 72
Stock options exercised............................... 22 11 21
Repurchases of common stock........................... -- (1) --
Dividends paid........................................ -- -- (12)
------ ------ -----
Net Cash Provided by Financing Activities............... 2,763 2,567 213
Cash Flows from Discontinued Operations:
Proceeds from sale of discontinued energy operations,
net of income tax payments of $192 million........... -- 967 --
Discontinued energy operations........................ -- -- 3
Investments in discontinued energy operations......... -- -- (31)
------ ------ -----
Net Cash Provided by (Used in) Discontinued Operations.. -- 967 (28)
Cash and Cash Equivalents of C-TEC at the Beginning of
1997................................................... -- -- (76)
------ ------ -----
Net Change in Cash and Cash Equivalents................. 377 755 (60)
Cash and Cash Equivalents at Beginning of Year.......... 842 87 147
------ ------ -----
Cash and Cash Equivalents at End of Year................ $1,219 $ 842 $ 87
====== ====== =====
Supplemental Disclosure of Cash Flow Information:
Income taxes paid..................................... $ 2 $ 246 $ 62
Interest paid......................................... 193 104 13
Noncash Investing and Financing Activities:
Issuances of stock for acquisitions:
Businessnet Ltd..................................... $ 8 $ -- $ --
XCOM Technologies, Inc.............................. -- 154 --
GeoNet Communications, Inc.......................... -- 19 --
Others.............................................. -- 10 --
The activities of the Construction Group have been removed from the
consolidated statements of cash flows. The Construction Group had cash flows of
($62) million and $59 million for the three months ended March 31, 1998, (the
date of the Split-off) and fiscal 1997, respectively.
See accompanying notes to consolidated financial statements.
F-7
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the three years ended December 31, 1999
Class Accumulated
B&C Additional Other
Common Common Paid-in Comprehensive Retained
Stock Stock Capital Income (Loss) Earnings Total
------ ------ ---------- ------------- -------- -------
(dollars in millions)
Balance at December 28,
1996................... $ 1 $ 1 $ 235 $16 $ 1,566 $ 1,819
Common Stock:
Issuances............. -- -- 117 -- -- 117
Stock options
exercised............ -- -- 21 -- -- 21
Stock dividend........ -- 7 (7) -- -- --
Stock plan grants..... -- -- 27 -- -- 27
Class C Stock:
Issuances............. -- -- 33 -- -- 33
Repurchases........... -- -- -- -- (2) (2)
Dividends (a)......... -- -- -- -- (13) (13)
Conversion of
debentures........... -- -- 1 -- -- 1
Net Earnings............ -- -- -- -- 248 248
Other Comprehensive
Loss................... -- -- -- (21) -- (21)
----- --- ------ --- ------- -------
Balance at December 27,
1997................... 1 8 427 (5) 1,799 2,230
Common Stock:
Issuances............. -- 1 203 -- -- 204
Stock options
exercised............ -- 1 10 -- (1) 10
Designation of par
value to $.01........ -- (8) 8 -- -- --
Stock dividend........ -- 1 (1) -- -- --
Stock plan grants..... -- -- 44 -- -- 44
Income tax benefit
from exercise of
options.............. -- -- 19 -- -- 19
Class R Stock:
Issuance and forced
conversion........... -- -- 164 -- (164) --
Class C Stock:
Repurchases........... -- -- (25) -- -- (25)
Conversion of
debentures........... -- -- 10 -- -- 10
Net Earnings............ -- -- -- -- 804 804
Other Comprehensive
Loss................... -- -- -- (6) -- (6)
Split-off of the
Construction & Mining
Group.................. (1) -- (94) 15 (1,045) (1,125)
----- --- ------ --- ------- -------
Balance at December 31,
1998................... -- 3 765 4 1,393 2,165
Common Stock:
Issuances, net of
offering costs....... -- -- 1,506 -- -- 1,506
Stock options
exercised............ -- -- 22 -- -- 22
Stock plan grants..... -- -- 130 -- -- 130
Income tax benefit
from exercise of
options.............. -- -- 78 -- -- 78
Net Loss................ -- -- -- -- (487) (487)
Other Comprehensive
Loss................... -- -- -- (9) -- (9)
----- --- ------ --- ------- -------
Balance at December 31,
1999................... $ -- $ 3 $2,501 $(5) $ 906 $ 3,405
===== === ====== === ======= =======
- --------
(a) Includes $.80 per share for dividends on Class C declared in 1997 but paid
in January 1998.
See accompanying notes to consolidated financial statements.
F-8
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the three years ended December 31, 1999
1999 1998 1997
----- ---- ----
(dollars in
millions)
Net Earnings (Loss).......................................... $(487) $804 $248
Other Comprehensive Income (Loss) Before Tax:
Foreign currency translation adjustments................... (10) 1 --
Unrealized holding losses arising during period............ (3) (2) (23)
Reclassification adjustment for gains included in net
earnings (loss)........................................... (1) (9) (9)
----- ---- ----
Other Comprehensive Loss, Before Tax......................... (14) (10) (32)
Income Tax Benefit Related to Items of Other Comprehensive
Loss........................................................ 5 4 11
----- ---- ----
Other Comprehensive Loss Net of Taxes........................ (9) (6) (21)
----- ---- ----
Comprehensive Income (Loss).................................. $(496) $798 $227
===== ==== ====
See accompanying notes to consolidated financial statements.
F-9
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated 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 and information services, and coal mining. Fifty-percent-owned
mining joint ventures are consolidated on a pro rata basis. Investments in
other companies in which the Company exercises significant influence over
operating and financial policies are accounted for by the equity method. All
significant intercompany accounts and transactions have been eliminated.
In 1997, the Company agreed to sell its energy assets to MidAmerican Energy
Holding Company, Inc. (f/k/a CalEnergy Company, Inc.) ("MidAmerican") and to
separate the construction operations ("Construction Group") from the Company.
Therefore, the results of operations of these businesses have been classified
as discontinued operations on the consolidated statements of operations and
cash flows. (See notes 2 and 3)
Communications and Information Services Revenue
Revenue for communications services, including private line, colocation,
Internet access, managed modem and voice, is recognized monthly as the services
are provided. Revenue attributable to leases of dark fiber pursuant to
indefeasible rights-of-use agreements ("IRU's") that qualify for sales-type
lease accounting and were entered into prior to June 30, 1999 are generally
recognized at the time of delivery and acceptance of the fiber by the lessee.
Dark fiber IRU's that do not meet the criteria for sales-type lease accounting
are accounted for as operating leases and revenue is recognized over the term
of the lease.
In June 1999, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 43, "Real Estate Sales, an interpretation of FASB Statement
No. 66" ("FIN 43"). Under FIN 43, dark fiber is considered integral equipment
and accordingly, a lease must include a provision allowing title to transfer to
the lessee in order for that lease to be accounted for as a sales-type lease.
FIN 43 applies to leases of integral equipment entered into after June 30,
1999.
Dark fiber agreements generally require the customer to make a down payment
due upon execution of the agreement with the balance due upon delivery and
acceptance of the fiber. Amounts billed or cash received in excess of revenue
earned are recorded as deferred revenue.
The Company is obliged under dark fiber agreements to maintain its network
in efficient working order and in accordance with industry standards. Customers
are obligated for the term of the agreement to pay for their allocable share of
the costs for operating and maintaining the network. The Company recognizes
this revenue monthly as services are provided.
The cost of revenue associated with the revenue recognized for dark fiber
agreements entered into prior to June 30, 1999, was determined based on an
allocation of the total estimated costs of the network to the dark fiber sold
to the customers. The allocation takes into account the service capacity of the
specific dark fiber sold to customers relative to the total expected capacity
of the network.
The Company is recognizing revenue in accordance with FIN 43 and the
Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." However, accounting practice and
guidance with respect to the accounting treatment of these transactions is
evolving. Any changes in the accounting treatment could affect the way the
Company accounts for revenue and expenses associated with these agreements in
the future.
F-10
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Information services revenue is primarily derived from the computer
outsourcing business and the systems integration business. Level 3 provides
outsourcing services, typically through contracts ranging from 3-5 years, to
firms that desire to focus their resources on their core businesses. Under
these contracts, Level 3 recognizes revenue in the month the service is
provided. The systems integration business helps customers define, develop and
implement cost-effective information systems. Revenue from these services is
recognized on a time and materials basis or percentage of completion basis
depending on the extent of the services provided.
Concentration of credit risk with respect to accounts receivable are limited
due to the dispersion of customer base among geographic areas and remedies
provided by terms of contracts and statutes.
Coal Sales Contracts
Level 3's coal is sold primarily under long-term contracts with electric
utilities, which burn coal in order to generate steam to produce electricity. A
substantial portion of Level 3's coal sales were made under long-term contracts
during 1999, 1998, and 1997. The remainder of Level 3's sales are made on the
spot market where prices are substantially lower than those in the long-term
contracts. As the long-term contracts expire, a higher proportion of Level 3's
sales will occur on the spot market.
The coal industry is highly competitive. Level 3 competes not only with
other domestic and foreign coal suppliers, some of whom are larger and have
greater capital resources than Level 3, but also with alternative methods of
generating electricity and alternative energy sources. Many of Level 3's
competitors are served by two railroads and, due to the competition, often
benefit from lower transportation costs than Level 3 which is served by a
single railroad. Additionally, many competitors have more favorable geological
conditions than Level 3, often resulting in lower comparative costs of
production.
Level 3 is also required to comply with various federal, state and local
laws concerning protection of the environment. Level 3 believes its compliance
with environmental protection and land restoration laws will not affect its
competitive position since its competitors are similarly affected by such laws.
Level 3 and its mining ventures have entered into various agreements with
its customers which stipulate delivery and payment terms on the sale of coal.
Prior to 1993, one of the primary customers deferred receipt of certain
commitments by purchasing undivided fractional interest in coal reserves of
Level 3 and the mining ventures. Under the agreements, revenue was recognized
when cash was received. The agreements with this customer were renegotiated in
1992. In accordance with the renegotiated agreements, there were no sales of
interest in coal reserves subsequent to January 1, 1993. Level 3 has delivered
and has the obligation to deliver the coal reserves to the customer in the
future if the customer exercises its option to take delivery of the coal. If
the option is exercised, Level 3 presently intends to deliver coal from
unaffiliated mines. In the opinion of the management, Level 3 has sufficient
coal reserves to cover the above sales commitments.
Level 3's coal sales contracts are with several electric utility and
industrial companies. In the event that these customers do not fulfill
contractual responsibilities, Level 3 would pursue the available legal
remedies.
F-11
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Depreciation and Amortization
Property, plant and equipment are recorded at cost. Depreciation and
amortization for the majority of the Company's property, plant and equipment
are computed on accelerated and straight-line methods based on the following
useful lives:
Facility and Leasehold Improvements......................... 20--40 years
Operating Equipment:........................................
Communications backbone.................................... 25 years
Transmission equipment and electronics..................... 3--7 years
Network Construction Equipment.............................. 5--7 years
Furniture and Office Equipment.............................. 3--7 years
Other....................................................... 2--10 years
Depletion of mineral properties is provided primarily on an units-of-
extraction basis determined in relation to coal committed under sales
contracts.
Software Development Costs
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). The
effective date of this pronouncement was for fiscal years beginning after
December 15, 1998, however, the Company elected to account for internal
software development costs incurred in developing its integrated business
support systems in accordance with SOP 98-1 in 1998. The Company recognized $27
million of expense for the development of operating support systems in 1998
that would have previously been capitalized prior to adoption of SOP 98-1.
Start-Up Costs
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-Up Activities", ("SOP 98-5"), which provides guidance on the
financial reporting for start-up and organization costs. It requires costs of
start-up activities and organization costs to be expensed as incurred. SOP 98-5
was effective for financial statements for fiscal years beginning after
December 15, 1998, however, the Company elected to adopt SOP 98-5 in 1998. The
adoption of SOP 98-5 did not result in a significant charge to earnings in
1998.
Subsidiary and Investee Stock Activity
The Company recognizes gains and losses from the sale, issuance and
repurchase of stock by its subsidiaries and equity method investees in the
statements of operations.
Earnings Per Share
Basic earnings per share have been computed using the weighted average
number of shares during each period. Diluted earnings per share is computed by
including the dilutive effect of common stock that would be issued assuming
conversion or exercise of outstanding convertible debt, stock options and other
dilutive securities.
Intangible Assets
Intangible assets primarily include amounts allocated upon acquisitions of
businesses, franchises and subscriber lists. These assets are amortized on a
straight-line basis over the expected period of benefit.
F-12
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For intangibles originating from communications or other information
services related acquisitions, the Company is amortizing these assets over a
five year period. Intangibles attributable to other acquisitions and
investments are amortized over periods which do not exceed 40 years.
Long Lived Assets
The Company reviews the carrying amount of long lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. Determination of any impairment would include a
comparison of estimated future operating cash flows anticipated to be generated
during the remaining life of the asset to the net carrying value of the asset.
Reserves for Reclamation
The Company follows the policy of providing an accrual for reclamation of
mined properties, based on the estimated total cost of restoration of such
properties to meet compliance with laws governing strip mining, by applying
per-ton reclamation rates to coal mined. These reclamation rates are determined
using the remaining estimated reclamation costs and tons of coal committed
under sales contracts. The Company reviews its reclamation cost estimates
annually and revises the reclamation rates on a prospective basis, as
necessary.
Income Taxes
Deferred income taxes are provided for the temporary differences between the
financial reporting and tax basis of the Company's assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse.
Comprehensive Income (Loss)
Comprehensive income (loss) includes net earnings (loss) and other changes
in equity not included in net earnings (loss), such as unrealized gains and
losses on marketable securities classified as available for sale and foreign
currency translation adjustments related to foreign subsidiaries.
Foreign Currencies
Generally, local currencies of foreign subsidiaries are the functional
currencies for financial reporting purposes. Assets and liabilities are
translated into U.S. dollars at year-end exchange rates. Revenue, expenses and
cash flows are translated using average exchange rates prevailing during the
year. Gains or losses resulting from currency translation are recorded as a
component of accumulated other comprehensive income (loss) in stockholders'
equity and in the statements of comprehensive income.
Stock Dividend
Effective August 10, 1998 the Company issued a dividend of one share, of
Level 3 Common Stock for each share of Level 3 Common Stock outstanding. All
share information and per share data have been restated to reflect the stock
dividend.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the
F-13
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Recently Issued Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 is effective
for fiscal years beginning after June 15, 2000 (January 1, 2001 for the
Company). SFAS No. 133 requires that all derivative instruments be recorded on
the balance sheet at the fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company currently makes
minimal use of derivative instruments as defined by SFAS No. 133. If the
Company does not increase the utilization of these derivative instruments by
the effective date of SFAS No. 133, the adoption of this standard is not
expected to have a significant effect on the Company's results of operations or
its financial position.
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 disclosure of
revenue in the financial statements. SAB 101 must be applied to the financial
statements no later than the first quarter of 2000. The Company does not
believe that the adoption of SAB 101 will have a material affect on the
Company's financial results.
Fiscal Year
In May 1998, the Company's Board of Directors changed Level 3's fiscal year
end from the last Saturday in December to a calendar year end. The results of
operations for the additional five days in the 1998 fiscal year are reflected
in the Company's Form 10-K for the period ended December 31, 1998 and were not
material to the overall results of operations and cash flows. There were 52
weeks in fiscal year 1997.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(2) Reorganization--Discontinued Construction Operations
Prior to March 31, 1998, the Company had a two-class capital structure. The
Company's Class C Stock reflected the performance of the construction
operations ("Construction Group") and the Class D Stock reflected the
performance of the other businesses, including communications, information
services and coal mining. In 1997 the Board of Directors of Level 3 approved a
proposal for the separation of the Construction Group from the other operations
of the Company through a split-off of the Construction Group (the "Split-off").
In December 1997, the Company's stockholders approved the Split-off and in
March 1998, the Company received a ruling from the Internal Revenue Service
that stated the Split-off would be tax-free to U.S. stockholders. The Split-off
was effected on March 31, 1998. As a result of the Split-off, the Company no
longer owns any interest in the Construction Group. Accordingly, the separate
financial statements and management's discussion and analysis of financial
condition and results of operations of Peter Kiewit Sons', Inc. should be
obtained to review the results of operations of the Construction Group for the
three and twelve months ended March 31, 1998 and December 27, 1997,
respectively.
F-14
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On March 31, 1998, the Company reflected the fair value of the Construction
Group as a distribution to the Class C stockholders because the distribution
was considered non-pro rata as compared to the Company's previous two-class
capital stock structure. The Company recognized a gain of $608 million within
discontinued operations, equal to the difference between the carrying value of
the Construction Group and its fair value in accordance with Financial
Accounting Standards Board Emerging Issues Task Force Issue 96-4, "Accounting
for Reorganizations Involving a Non-Pro Rata Split-off of Certain Nonmonetary
Assets to Owners." No taxes were provided on this gain due to the tax-free
nature of the Split-off.
In connection with the Split-off, the Class D Stock became the common stock
of Level 3 Communications, Inc. ("Common Stock"), and shortly thereafter, began
trading on the Nasdaq National Market under the symbol "LVLT".
The Company's certificate of incorporation gave stockholders the right to
exchange their Class C Stock for Class D Stock under a set conversion formula.
That right was eliminated as a result of the Split-off. To replace that
conversion right, Class C stockholders received 6.5 million shares of a new
Class R Stock in January 1998, which was convertible into Common Stock in
accordance with terms ratified by stockholders in December 1997. The Company
reflected in the equity accounts the exchange of the conversion right and
issuance of the Class R Stock at its fair value of $92 million at the date of
the Split-off.
On May 1, 1998, the Board of Directors of Level 3 Communications, Inc.
determined to force conversion of all shares of the Company's Class R Stock
into shares of Common Stock, effective May 15, 1998. The Class R Stock was
converted into Common Stock in accordance with the formula set forth in the
certificate of incorporation of the Company. Each holder of Class R Stock
ultimately received .7778 of a share of Common Stock for each share of Class R
Stock held. In total 6.5 million shares of Class R Stock were converted into
5.1 million shares of Common Stock. The value of the Class R Stock at the time
of the forced conversion was $164 million. The Company recognized the
additional $72 million of value upon conversion of the Class R Stock to Common
Stock in the equity accounts.
The following details the earnings per share calculations for Class C Stock:
Class C Stock 1997
------------- ------
Net Income Available to Common Shareholders (in millions)........... $ 155
Add: Interest Expense, Net of Tax Effect Associated with Convertible
Debentures......................................................... 1
------
Net Income for Diluted Shares....................................... $ 156
======
Total Number of Weighted Average Shares Outstanding Used to Compute
Basic Earnings per Share (in thousands)............................ 9,728
Additional Dilutive Shares Assuming Conversion of Convertible
Debentures......................................................... 441
------
Total Number of Shares Used to Compute Diluted Earnings per Share... 10,169
======
Net Income
Basic earnings per share.......................................... $15.99
======
Diluted earnings per share........................................ $15.35
======
The following is summarized financial information of the Construction Group:
Operations (in millions) 1997
------------------------ ------
Revenue............................................................. $2,764
Net Earnings........................................................ 155
F-15
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(3) Discontinued Energy Operations
On January 2, 1998, the Company completed the sale of its energy assets to
MidAmerican. These assets included approximately 20.2 million shares of
MidAmerican common stock (assuming the exercise of 1 million options held by
Level 3), Level 3's 30% interest in CE Electric and Level 3's investments in
international power projects in Indonesia and the Philippines. Level 3
recognized an after-tax gain on the disposition of $324 million and the after-
tax proceeds of approximately $967 million from the transaction are being used
in part to fund the Business Plan. Results of operations for the period through
January 2, 1998 were not considered significant and the gain on disposition was
calculated using the carrying amount of the energy assets as of December 27,
1997.
In order to fund the purchase of Level 3's energy assets, MidAmerican sold,
in 1997 approximately 19.1 million shares of its common stock at a price of
$37.875 per share. This sale reduced Level 3's ownership in MidAmerican to
approximately 24% but increased its proportionate share of MidAmerican's
equity. Level 3 recognized an after-tax gain of approximately $44 million from
MidAmerican transactions in 1997.
In 1997 the Labour Party in the United Kingdom implemented a "Windfall Tax"
against privatized British utilities. This one-time tax was 23% of the
difference between the value of Northern Electric, plc at the time of
privatization and the utility's current value based on profits over a period of
up to four years. CE Electric recorded an extraordinary charge of approximately
$194 million when the tax was enacted in 1997. The total impact to Level 3
directly through its investment in CE Electric and indirectly through its
interest in MidAmerican, was $63 million.
The following is summarized financial information for discontinued energy
operations for the fiscal year ended December 27, 1997:
Income from Discontinued Operations (in millions)
1997
----
Operations
Equity in:
MidAmerican earnings, net............................................... $16
CE Electric earnings, net............................................... 17
International energy projects earnings, net............................. 5
Income Tax Expense........................................................ (9)
---
Income from operations.................................................. 29
MidAmerican Stock Transactions
Gain on Investee Stock Activity........................................... 68
Income Tax Expense........................................................ (24)
---
Gain on MidAmerican stock activity...................................... 44
Extraordinary Loss--Windfall Tax
Level 3's Share from MidAmerican.......................................... (39)
Level 3's Share from CE Electric.......................................... (58)
Income Tax Benefits....................................................... 34
---
Extraordinary loss...................................................... (63)
---
Income from Discontinued Energy Operations................................ $10
===
F-16
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is summarized financial information of MidAmerican, CE
Electric, and the International energy projects:
Operations (in millions)
1997
------
Revenue:
MidAmerican.......................................................... $2,271
CE Electric.......................................................... 1,564
Net Earnings (Loss):
MidAmerican.......................................................... $ (84)
CE Electric.......................................................... (136)
International energy projects........................................ 2
(4) Earnings Per Share
The Company had a loss from continuing operations for the years ended
December 31, 1999 and 1998, therefore, the dilutive impact of the approximately
12 million shares attributable to the Convertible Subordinated Notes and the
approximately 21 million options and warrants outstanding at December 31, 1999
and approximately 23 million options and warrants outstanding at December 31,
1998, have not been included in the computation of diluted earnings (loss) per
share because the resulting computation would have been anti-dilutive. For the
year ended December 27, 1997, potentially dilutive stock options are calculated
in accordance with the treasury stock method which assumes that proceeds from
exercise of all options are used to repurchase common stock at the average
market value. The number of shares remaining after the assumed exercise
proceeds are exhausted represent the potentially dilutive effect of the
options.
F-17
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following details the earnings (loss) per share calculations for Level 3
Common Stock. A calculation of the earnings per share for the Class C Stock in
1997 can be found in Note 2 to the consolidated financial statements.
Year Ended
----------------------------
1999 1998 1997
-------- -------- --------
Earnings (Loss) from Continuing Operations (in
millions)......................................... $ (487) $ (128) $ 83
Discontinued Operations:
Earnings from discontinued energy operations..... -- 324 10
Gain on separation of construction operations.... -- 608 --
-------- -------- --------
Earnings from discontinued operations........... -- 932 10
-------- -------- --------
Net Earnings (Loss) Excluding Discontinued
Construction Operations........................... $ (487) $ 804 $ 93
======== ======== ========
Total Number of Weighted Average Shares Outstanding
used to Compute Basic Earnings Per Share (in
thousands)........................................ 334,348 301,976 249,293
Additional Dilutive Stock Options.................. -- -- 1,079
-------- -------- --------
Total Number of Shares used to Compute Dilutive
Earnings (Loss) Per Share......................... 334,348 301,976 250,372
======== ======== ========
Earnings (Loss) per Share (Basic and Diluted):
Continuing operations............................ $ (1.46) $ (.43) $ .33
======== ======== ========
Discontinued energy operations................... $ -- $ 1.07 $ .04
======== ======== ========
Gain on split-off of discontinued construction
operations...................................... $ -- $ 2.02 $ --
======== ======== ========
Net earnings (loss) excluding discontinued
construction operations......................... $ (1.46) $ 2.66 $ .37
======== ======== ========
Net earnings (loss) excluding gain on split-off
of construction operations...................... $ (1.46) $ .64 $ .37
======== ======== ========
(5) Acquisitions
On January 5, 1999, Level 3 acquired BusinessNet Ltd. ("BusinessNet"), a
leading London-based Internet service provider in a largely stock-for-stock
transaction valued at $12 million and accounted for as a purchase. After
completion of certain adjustments, the Company agreed to issue approximately
400,000 shares of Common Stock and paid $1 million in cash in exchange for all
of the issued and outstanding shares of BusinessNet's capital stock. Of the
approximately 400,000 shares Level 3 agreed to issue in connection with the
acquisition, approximately 150,000 shares of Level 3 Common Stock have been
pledged to Level 3 to secure certain indemnification obligations of the former
BusinessNet stockholders. In October 1999, Level 3 released approximately
42,000 shares pursuant to the acquisition agreement. The pledge of the
remaining shares will terminate in July 2000, unless otherwise extended
pursuant to the terms of the acquisition agreement. Liabilities exceeded assets
acquired, and goodwill of $16 million was recognized from the transaction and
is being amortized over five years.
In April 1998, the Company acquired XCOM Technologies, Inc. ("XCOM"), a
privately held company that has developed technology which provides certain key
components necessary for the Company to develop an interface between its
Internet protocol-based network and the existing public switched telephone
network. The Company issued approximately 5.3 million shares of Level 3 Common
Stock and 0.7 million options and warrants to purchase Level 3 Common Stock in
exchange for all the stock, options and warrants of XCOM.
F-18
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated to
in-process research and development and was taken as a nondeductible charge to
earnings in the second quarter of 1998. The purchase price exceeded the fair
value of the net assets acquired by $30 million which was recognized as
goodwill.
In October 1998, the SEC issued new guidelines for valuing acquired research
and development which were applied retroactively. The Company believes its
accounting for the acquisition was made in accordance with generally accepted
accounting principles and established appraisal practices at the time of the
acquisition. However, due to the significance of the charge relative to the
total value of the acquisition, the Company reduced the charge for in-process
research and development from $115 to $30 million, and increased the related
goodwill by $85 million. The goodwill associated with the XCOM transaction is
being amortized over a five-year period.
In September 1998, Level 3 acquired GeoNet Communications, Inc. ("GeoNet"),
a regional Internet service provider located in Northern California. The
Company issued approximately 0.6 million shares and options in exchange for
GeoNet's capital stock, which valued the transaction at approximately $19
million. Acquired liabilities exceeded assets, and goodwill of $21 million was
recognized from this transaction which is being amortized over five years.
The cumulative operating results of BusinessNet, XCOM and GeoNet and other
1998 acquisitions were not significant relative to the Company's 1999 and 1998
results.
For the Company's acquisitions, the excess purchase price over the fair
market value of the underlying assets was allocated to goodwill, other
intangible assets and property based upon preliminary estimates of fair value.
The final purchase price allocation for XCOM and GeoNet did not vary
significantly from preliminary estimates. The Company does not believe that the
final purchase price allocation for BusinessNet will vary significantly from
the preliminary estimates for BusinessNet.
(6) Disclosures about Fair Value of Financial Instruments
The following methods and assumptions were used to determine classification
and fair values of financial instruments:
Cash and Cash Equivalents
Cash equivalents generally consist of funds invested in highly liquid
instruments purchased with an original maturity of three months or less. The
securities are stated at cost, which approximates fair value.
Marketable and Restricted Securities
Level 3 has classified all marketable and restricted securities as
available-for-sale. Restricted securities include investments in mutual funds
that are restricted to fund certain reclamation liabilities of its coal mining
ventures and cash deposits to collateralize letters of credit. The amortized
cost of the securities used in computing unrealized and realized gains and
losses is determined by specific identification. Fair values are estimated
based on quoted market prices for the securities on hand or for similar
investments. Net unrealized holding gains and losses are included in
accumulated other comprehensive income (loss) within stockholders' equity, net
of tax.
F-19
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, 1999 and 1998 the amortized cost, unrealized holding gains
and losses, and estimated fair values of marketable and restricted securities
were as follows:
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
--------- ---------- ---------- ------
(dollars in millions)
1999
Marketable Securities:
U.S. Treasury securities.......... $2,231 $-- $ (4) $2,227
------ ---- ---- ------
$2,231 $-- $ (4) $2,227
====== ==== ==== ======
Restricted Securities:
Cash and cash equivalents......... $ 16 $-- $-- $ 16
Wilmington Trust:
Intermediate term bond fund..... 13 -- -- 13
Equity fund..................... 10 7 -- 17
------ ---- ---- ------
$ 39 $ 7 $-- $ 46
====== ==== ==== ======
1998
Marketable Securities:
U.S. Treasury securities.......... $2,147 $ 8 $-- $2,155
U.S. Government Agency
securities....................... 639 1 -- 640
Equity securities................. 54 -- (3) 51
Other securities.................. 20 -- (3) 17
------ ---- ---- ------
$2,860 $ 9 $ (6) $2,863
====== ==== ==== ======
Restricted Securities:
Cash and cash equivalents......... $ 6 $-- $-- $ 6
Wilmington Trust:
Intermediate term bond fund..... 13 -- -- 13
Equity fund..................... 10 3 -- 13
------ ---- ---- ------
$ 29 $ 3 $-- $ 32
====== ==== ==== ======
For debt securities, amortized costs do not vary significantly from
principal amounts. Realized gains and losses on sales of marketable and equity
securities were $17 million and $16 million in 1999, $10 million and $1
million in 1998, and $9 million and $- million in 1997, respectively.
At December 31, 1999, the contractual maturities of the debt securities are
as follows:
Amortized Fair
Cost Value
--------- ------
(dollars in
millions)
U.S. Treasury Securities:
Less than 1 year......................................... $2,231 $2,227
====== ======
Maturities for the restricted securities have not been presented as they do
not have a single maturity date.
F-20
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Long-Term Debt
The fair value of long-term debt was estimated using the December 31, 1999
and 1998 average of the bid and ask price for the publicly traded debt
instruments. The fair value of the outstanding amount under the Senior Secured
Credit Facility approximates its carrying value at December 31, 1999.
The carrying amount and estimated fair values of Level 3's financial
instruments are as follows:
1999 1998
--------------- --------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- -----
(dollars in millions)
Cash and Cash Equivalents................... $1,219 $1,219 $ 842 $ 842
Marketable Securities....................... 2,227 2,227 2,863 2,863
Restricted Securities....................... 46 46 32 32
Investments (Note 8)........................ 300 1,973 300 818
Long-term Debt including current portion
(Note 10).................................. 3,995 4,034 2,646 2,613
(7) Property, Plant and Equipment
Construction in Progress
The Company is currently constructing its communications network. Costs
associated directly with the uncompleted network and interest expense incurred
during construction are capitalized based on the weighted average accumulated
construction expenditures and the interest rates related to borrowings
associated with the construction (Note 10). Certain gateway facilities, local
networks and operating equipment have been placed in service during 1999. These
assets are being depreciated over their useful lives, primarily ranging from 3-
25 years. As other segments of the network are placed in service, the assets
will be depreciated over their useful lives.
The Company is currently developing business support systems required for
its Business Plan. The external direct costs of software, materials and
services, payroll and payroll related expenses for employees directly
associated with the project, and interest costs incurred when developing the
business support systems are capitalized. Upon completion of the projects, the
total cost of the business support systems are amortized over their useful
lives of 3 years.
For the year ended December 31, 1999, the Company invested $3,299 million in
its communications business, including $1,384 million on the U.S. intercity
network, $255 million on the Pan European network, $270 million on transoceanic
networks, $613 million on domestic gateway facilities and local networks, and
$221 million on European gateway facilities and local networks.
F-21
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Capitalized business support systems and network construction costs that
have not been placed in service have been classified as construction-in-
progress within Property, Plant & Equipment below.
Accumulated Book
Cost Depreciation Value
------ ------------ ------
(dollars in millions)
1999
Land and Mineral Properties......................... $ 56 $ (11) $ 45
Facility and Leasehold Improvements
Communications.................................... 400 (14) 386
Information Services.............................. 26 (3) 23
Coal Mining....................................... 18 (15) 3
CPTC.............................................. 92 (9) 83
Operating Equipment
Communications.................................... 686 (83) 603
Information Services.............................. 54 (37) 17
Coal Mining....................................... 176 (156) 20
CPTC.............................................. 17 (7) 10
Network Construction Equipment...................... 98 (10) 88
Furniture and Office Equipment...................... 150 (66) 84
Other............................................... 155 (28) 127
Construction-in-Progress............................ 2,798 -- 2,798
------ ----- ------
$4,726 $(439) $4,287
====== ===== ======
1998
Land and Mineral Properties......................... $ 32 $ (11) $ 21
Facility and Leasehold Improvements
Communications.................................... 80 (1) 79
Information Services.............................. 24 (2) 22
Coal Mining....................................... 18 (15) 3
CPTC.............................................. 91 (5) 86
Operating Equipment
Communications.................................... 245 (18) 227
Information Services.............................. 53 (30) 23
Coal Mining....................................... 180 (155) 25
CPTC.............................................. 17 (4) 13
Network Construction Equipment...................... 46 (1) 45
Furniture and Office Equipment...................... 67 (10) 57
Other............................................... 72 (2) 70
Construction-in-Progress............................ 390 -- 390
------ ----- ------
$1,315 $(254) $1,061
====== ===== ======
Depreciation expense was $192 million in 1999, $48 million in 1998 and $20
million in 1997. Depreciation expense attributable to the network construction
equipment is capitalized and included in Construction-in-Progress until such
time it is placed in service.
F-22
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(8) Investments
The Company holds significant equity positions in two publicly traded
companies; RCN Corporation ("RCN") and Commonwealth Telephone Enterprises, Inc.
("Commonwealth Telephone"). RCN is a facilities-based provider of
communications services to the residential market primarily in the northeastern
United States and California. RCN provides local and long distance phone, cable
television and Internet services in several markets; including Boston, New
York, Washington, D.C., and California's San Francisco to San Diego corridor.
Commonwealth Telephone holds Commonwealth Telephone Company, an incumbent
local exchange carrier operating in various rural Pennsylvania markets, and
CTSI, Inc., a competitive local exchange carrier which commenced operations in
1997.
On December 31, 1999, Level 3 owned approximately 35% and 48% of the
outstanding shares of RCN and Commonwealth Telephone, respectively, and
accounts for each entity using the equity method. The market value of the
Company's investment in RCN and Commonwealth Telephone was $1,292 million and
$574 million, respectively, on December 31, 1999.
The Company recognizes gains from the sale, issuance and repurchase of stock
by its subsidiaries and equity method investees in its statements of
operations. During 1999, RCN issued stock in a public offering and for certain
transactions which diluted the Company's ownership of RCN from 41% at December
31, 1998 to 35% at December 31, 1999. The increase in the Company's
proportionate share of RCN's net assets as a result of these transactions
resulted in a pre-tax gain of $117 million for the Company in 1999. The Company
also recognized a similar gain of $62 million in 1998. The Company's investment
in RCN, including goodwill, was $166 million and $184 million at December 31,
1999 and 1998, respectively.
On October 4, 1999, RCN announced that Vulcan Ventures, Inc. had agreed to
invest $1.65 billion in RCN. This transaction, expected to close during the
first quarter of 2000, is in the form of preferred stock convertible to 26.6
million shares of RCN common stock. The preferred shares must be converted to
common shares within a three to seven year period at $62 per share.
On December 13, 1999, RCN announced that it was acquiring 21st Century
Telecom Group, Inc. ("21st Century") in a transaction valued at approximately
$500 million, payable in RCN stock and assumed debt. RCN expects to issue 4.7
million shares for the outstanding stock of 21st Century and will offer to
exchange approximately $62 million worth of RCN stock for 21st Century's
outstanding preferred stock. This transaction is subject to the antitrust and
regulatory approvals and is expected to close in the first quarter of 2000.
Level 3, based on current market conditions, expects to recognize a
significant gain when Vulcan Ventures, Inc. converts its RCN preferred stock to
RCN common stock and the 21st Century transaction closes.
During 1999, Commonwealth Telephone issued stock for certain transactions
which slightly diluted the Company's ownership of Commonwealth Telephone. The
increase in the Company's proportionate share of Commonwealth Telephone's net
assets as a result of these transactions resulted in a pre-tax gain of $1
million for the Company in 1999. The Company's investment in Commonwealth
Telephone, including goodwill, was $126 million and $116 million at December
31, 1999 and 1998, respectively.
In September 1998, Commonwealth Telephone conducted a rights offering of 3.7
million shares of its common stock. Under the terms of the offering, each
stockholder received one right for every five shares of Commonwealth Telephone
Common Stock or Commonwealth Telephone Class B Common Stock held. The rights
enabled the holder to purchase Commonwealth Telephone Common Stock at a
subscription price of
F-23
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
$21.25 per share. Level 3, which owned approximately 48% of Commonwealth
Telephone prior to the rights offering, exercised its 1.8 million rights it
received with respect to the shares it held for $38 million. As a result of
subscriptions made by other stockholders, Level 3 maintained its 48% ownership
interest in Commonwealth Telephone after the rights offering.
In June 1998, Cable Michigan announced that its Board of Directors had
reached a definitive agreement to sell the company to Avalon Cable of Michigan,
Inc. for $40.50 per share in a cash-for-stock transaction. Level 3 received
approximately $129 million when the transaction closed in November 1998 and
recognized a pre-tax gain of approximately $90 million.
The following is summarized financial information of RCN for each of the
three years ended December 31, 1999 and as of December 31, 1999 and 1998 (in
millions):
Year Ended
-----------------
1999 1998 1997
----- ---- ----
Operations:
RCN Corporation:
Revenue................................................... $ 276 $211 $127
Net loss available to common shareholders................. (369) (205) (52)
Level 3's Share:
Net loss.................................................. (134) (91) (26)
Goodwill amortization..................................... (1) (1) --
----- ---- ----
$(135) $(92) $(26)
===== ==== ====
1999 1998
------ ------
Financial Position:
Current Assets................................................... $1,924 $1,092
Other Assets..................................................... 1,289 816
------ ------
Total assets................................................... 3,213 1,908
------ ------
Current Liabilities.............................................. 269 178
Other Liabilities................................................ 2,169 1,282
Minority Interest................................................ 130 77
Preferred Stock.................................................. 253 --
------ ------
Total liabilities and preferred stock.......................... 2,821 1,537
------ ------
Common equity................................................ $ 392 $ 371
====== ======
Level 3's Investment:
Equity in net assets........................................... $ 139 $ 150
Goodwill....................................................... 27 34
------ ------
$ 166 $ 184
====== ======
In July 1999, the Company and Data Return Corporation ("Data Return")
entered into an agreement whereby Data Return would purchase $5 million of
capacity from the Company by December 31, 2001. In lieu of cash, the Company
agreed to accept, at the time, approximately 1.9 million shares of Data Return
restricted common stock as payment for services to be provided. The Company
recorded the transaction as an investment and deferred revenue at the value of
the services to be provided. In October 1999, Data Return conducted an
F-24
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
initial public offering. The market value of the Company's investment in Data
Return at December 31, 1999 was approximately $104 million. The Company,
however, can not reflect the fair value of the Data Return investment in its
financial statements until it provides the services to Data Return or certain
restrictions expire.
(9) Other Assets
At December 31, 1999 and 1998 other assets consisted of the following:
1999 1998
---- ----
(in
millions)
Goodwill:
XCOM, net of accumulated amortization of $37 and $15............ $ 75 $100
GeoNet, net of accumulated amortization of $4 and $1............ 17 20
BusinessNet, net of accumulated amortization of $4 and $ --..... 12 --
Other, net of accumulated amortization of $8 and $1............. 14 21
Prepaid Network Assets............................................ 30 --
Deposits.......................................................... 64 --
Debt Issuance Costs, net.......................................... 101 67
Pavilion Towers Office Complex.................................... 23 23
CPTC Deferred Development and Financing Costs..................... 15 15
Unrecovered Mine Development Costs................................ 14 15
Other............................................................. 16 23
---- ----
Total other assets.............................................. $381 $284
==== ====
Goodwill amortization expense, excluding amortization expense attributable
to equity method investees, was $36 million in 1999, $17 in 1998 and $ -- in
1997.
(10) Long-Term Debt
At December 31, 1999 and 1998, long-term debt was as follows:
1999 1998
---------- ----------
(dollars in millions)
Senior Notes (9.125% due 2008)....................... $ 2,000 $ 2,000
Senior Discount Notes (10.5% due 2008)............... 559 504
Senior Secured Credit Facility:
Term Loan Facility
Tranche A (9.23% due 2007)......................... 200 --
Tranche B (9.98% due 2008)......................... 275 --
Convertible Subordinated Notes (6.0% due 2009)....... 823 --
CPTC Long-term Debt (with recourse only to CPTC):
(7.6%-9.5% due 2004 -2017)......................... 115 116
Other................................................ 23 26
---------- ----------
3,995 2,646
Less current portion................................. (6) (5)
---------- ----------
$ 3,989 $ 2,641
========== ==========
F-25
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9.125% Senior Notes
In April 1998, the Company received $1.94 billion of net proceeds from an
offering of $2 billion aggregate principal amount 9.125% Senior Notes Due 2008
("Senior Notes"). Interest on the notes accrues at 9.125% per year and is
payable on May 1 and November 1 each year in cash.
The Senior Notes are subject to redemption at the option of the Company, in
whole or in part, at any time or from time to time on or after May 1, 2003,
plus accrued and unpaid interest thereon to the redemption date, if redeemed
during the twelve months beginning May 1, of the years indicated below:
Redemption
Year Price
---- ----------
2003............................................................ 104.563%
2004............................................................ 103.042%
2005............................................................ 101.521%
2006 and thereafter............................................. 100.000%
In addition, at any time or from time to time prior to May 1, 2001, the
Company may redeem up to 35% of the original aggregate principal amount of the
Senior Notes at a redemption price equal to 109.125% of the principal amount of
the Senior Notes so redeemed, plus accrued and unpaid interest thereon to the
redemption date. The Senior Notes are senior, unsecured obligations of the
Company, ranking pari passu with all existing and future senior unsecured
indebtedness of the Company. The Senior Notes contain certain covenants, which
among other things, limit consolidated debt, dividend payments, and
transactions with affiliates. The Company used the net proceeds of the Senior
Notes offering in connection with the implementation of its Business Plan to
increase substantially its information services business and to expand the
range of services it offers by building an advanced, international, facilities-
based communications network based on IP technology.
Debt issuance costs of $65 million were capitalized and are being amortized
over the term of the Senior Notes.
10.5% Senior Discount Notes
In December 1998, the Company sold $834 million aggregate principal amount
at maturity of 10.5% Senior Discount Notes Due 2008 ("Senior Discount Notes").
The sales proceeds of $500 million, excluding debt issuance costs, were
recorded as long term debt. Interest on Senior Discount Notes accretes at a
rate of 10.5% per annum, compounded semiannually, to an aggregate principal
amount of $834 million by December 1, 2003. Cash interest will not accrue on
the Senior Discount Notes prior to December 1, 2003; however, the Company may
elect to commence the accrual of cash interest on all outstanding Senior
Discount Notes on or after December 1, 2001, in which case the outstanding
principal amount at maturity of each Senior Discount Note will on the elected
commencement date be reduced to the accreted value of the Senior Discount Note
as of that date and cash interest shall be payable on that Note on June 1 and
December 1 thereafter. Commencing June 1, 2004, interest on the Senior Discount
Notes will accrue at the rate of 10.5% per annum and will be payable in cash
semiannually in arrears. Accrued interest expense for the year ended
December 31, 1999 on the Senior Discount Notes of $55 million was added to
long-term debt.
F-26
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Senior Discount Notes will be subject to redemption at the option of the
Company, in whole or in part, at any time or from time to time on or after
December 1, 2003 at the following redemption prices (expressed as percentages
of accreted value) plus accrued and unpaid interest thereon to the redemption
date, if redeemed during the twelve months beginning December 1, of the years
indicated below:
Redemption
Year Price
---- ----------
2003............................................................ 105.25%
2004............................................................ 103.50%
2005............................................................ 101.75%
2006 and thereafter ............................................ 100.00%
In addition, at any time or from time to time prior to December 1, 2001, the
Company may redeem up to 35% of the original aggregate principal amount at
maturity of the Notes at a redemption price equal to 110.50% of the accreted
value of the notes so redeemed, plus accrued and unpaid interest thereon to the
redemption date. These notes are senior unsecured obligations of the Company,
ranking pari passu with all existing and future senior unsecured indebtedness
of the Company. The Senior Discount Notes contain certain covenants which,
among other things, restrict the Companys ability to incur additional debt,
make certain restricted payments, pay dividends, enter into sale and leaseback
transactions, enter into transactions with affiliates, and sell assets or merge
with another company.
The net proceeds of $486 million were used to accelerate the implementation
of its Business Plan, primarily the funding for the increase in committed
number of route miles of the Company's U.S. intercity network.
Debt issuance costs of $14 million have been capitalized and are being
amortized over the term of the Senior Discount Notes.
Senior Secured Credit Facility
On September 30, 1999, Level 3 and certain Level 3 subsidiaries entered into
a $1.375 billion secured credit facility ("Senior Secured Credit Facility").
The facility is comprised of a senior secured revolving credit facility in the
amount of $650 million and a two-tranche senior secured term loan facility
aggregating $725 million. The secured term loan facility consists of a $450
million tranche A and a $275 million tranche B term loan facility,
respectively. At December 31, 1999, Level 3 had borrowed $200 million and
$275 million under the tranche A and tranche B secured term loan facility,
respectively.
The obligations under the revolving credit facility are secured by
substantially all the assets of Level 3 and, subject to certain exceptions, its
wholly owned domestic subsidiaries (other than the borrower under the term loan
facility). Such assets will also secure a portion of the term loan facility.
Additionally, all obligations under the term loan facility will be secured by
the equipment that is purchased with the proceeds of the term loan facility.
Amounts drawn under the secured credit facility will bear interest, at the
option of the Company, at an alternate base rate or reserve-adjusted LIBOR plus
applicable margins. The applicable margins for the revolving credit facility
and tranche A term loan facility range from 50 to 175 basis points over the
alternate base rate and from 150 to 275 basis points over LIBOR and are fixed
for the tranche B term loan facility at 250 basis points over the alternate
base rate and 350 basis points over LIBOR. Interest and commitment fees on the
revolving credit facility and the term loan facilities are payable quarterly
with specific rates determined by actual borrowings under each facility.
F-27
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The revolving credit facility provides for automatic and permanent quarterly
reductions of the amount available for borrowing under that facility,
commencing at $17.25 million on March 31, 2004, and increasing to approximately
$61 million per quarter. The tranche A term loan facility amortizes in
consecutive quarterly payments beginning on March 31, 2004, commencing at $9
million per quarter and increasing to $58.5 million per quarter. The revolving
credit facility and tranche A term loan facility mature on September 30, 2007.
The tranche B term loan facility amortizes in consecutive quarterly payments
beginning on March 31, 2004, commencing at less than $1 million and increasing
to $67 million in 2007.
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 the borrowers must
also comply with specific financial and operational tests and maintain certain
financial ratios.
Debt issuance costs of $24 million were capitalized and will be amortized as
interest expense over the terms of Senior Secured Credit Facility.
6% Convertible Subordinated Notes
On September 14, 1999, the Company received $798 million of proceeds, after
transaction costs, from an offering of $823 million aggregate principal amount
of its 6% Convertible Subordinated Notes Due 2009 ("Subordinated Notes"). The
Subordinated Notes are unsecured and subordinated to all existing and future
senior indebtedness of the Company. Interest on the notes accrues at 6% per
year and is payable each year in cash on March 15 and September 15. The
principal amount of the notes will be due on September 15, 2009. The
Subordinated Notes may be converted into shares of common stock of the Company
at any time prior to maturity, unless the Company has caused the conversion
rights to expire. The conversion rate is 15.3401 shares per each $1,000
principal amount of Subordinated Notes, subject to adjustment in certain
circumstances. On or after September 15, 2002, Level 3, at its option, may
cause the conversion rights to expire. Level 3 may exercise this option only if
the current market price exceeds approximately $91.27 (which represents 140% of
the conversion price) for 20 trading days within any period of 30 consecutive
trading days including the last day of that period. At December 31, 1999, less
than $1 million of debt had been converted into shares of common stock.
Debt issuance costs of $25 million were capitalized and are being amortized
as interest expense over the term of the Subordinated Notes.
Level 3 currently is using the proceeds from the Senior Secured Credit
Facility and Subordinated Notes for working capital, capital expenditures and
other general corporate purposes in connection with the implementation of its
business plan, including the acquisition of telecommunications assets.
The Company capitalized $116 million and $15 million of interest expense and
amortized debt issuance costs related to network construction and business
systems development projects for the years ended December 31, 1999 and 1998,
respectively.
CPTC
California Private Transportation Company, LP's ("CPTC") long-term debt
consists of a term note with a consortium of banks. The liability under the
term note was $61 million and $64 million at December 31, 1999 and 1998,
respectively. The interest rate on the bank note is based on LIBOR plus a
varying rate with principal and interest payable quarterly. CPTC entered into
an interest rate swap agreement with the same parties. The swap agreement
expires in January 2004 and fixes the interest rate on the bank note from 9.21%
to 9.71% during the term of the swap agreement. In addition, CPTC's long-term
debt consists of a term loan held
F-28
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
by Connecticut General Life Insurance Company, a subsidiary of CIGNA
Corporation and Lincoln National Life Insurance Company. The liability under
the term loan was $35 million at December 31, 1999 and 1998. The remaining
long-term debt consists of $9 million of subordinated debt held by Orange
County Transportation Authority. The debt is due in varying amounts through
2004 and accrues interest at 9%. Lastly, CPTC had borrowed $10 million as of
December 31, 1999 and $8 million as of December 31, 1998 from it's partners.
The debt is generally subordinated to all other debt of CPTC. Interest on the
subordinated debt compounds annually at 9.3-9.5% and is payable only as CPTC
generates excess cash flows.
Future Debt Maturities:
Scheduled maturities of long-term debt are as follows (in millions): 2000--
$6; 2001--$7; 2002--$8; 2003--$9; 2004--$59 ; and $3,906 thereafter.
(11) Employee Benefit Plans
The Company adopted the recognition provisions of SFAS No. 123, "Accounting
for Stock Based Compensation" ("SFAS No. 123") in 1998. Under SFAS No. 123, the
fair value of an option or other stock-based compensation (as computed in
accordance with accepted option valuation models) on the date of grant is
amortized over the vesting periods of the options in accordance with FASB
Interpretation No. 28 "Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans"("FIN 28"). The recognition provisions of
SFAS No. 123 are applied prospectively upon adoption. As a result, the
recognition provisions are applied to all stock awards granted in the year of
adoption and are not applied to awards granted in previous years unless those
awards are modified or settled in cash after adoption of the recognition
provisions. 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 be settled in cash, but rather, generally are settled through
issuance of common stock.
The Company believes that the adoption of SFAS No. 123 will result in
material non-cash charges to operations in 2000 and thereafter. The amount of
the non-cash charge will be dependent upon a number of factors, including the
number of grants and the fair value of each grant estimated at the time of its
award. On a pro forma basis, adopting SFAS No. 123 would not have had a
material effect on the results of operations for the year ended December 27,
1997.
The Company recognized a total of $126 million and $39 million of non-cash
compensation in 1999 and 1998, respectively. In addition to the Company
capitalized $10 million and $5 million of non-cash compensation for those
employees directly involved in the construction of the network or development
of the business support systems.
Non-qualified Stock Options and Warrants
In December 1997, stockholders approved amendments to the 1995 Level 3 Stock
Plan ("the Plan"). The amended plan, among other things, increases the number
of shares reserved for issuance upon the exercise of stock based awards to
70,000,000; increases the maximum number of options granted to any one
participant to 10,000,000; provides for the acceleration of vesting in the
event of a change in control; allows for the grant of stock based awards to
directors of Level 3 and other persons providing services to Level 3; and
allows for the grant of nonqualified stock options ("NQSO") with an exercise
price less than the fair market value of Common Stock. In December 1997, Level
3 converted both option and stock appreciation rights plans of a subsidiary to
the Plan. This conversion resulted in the issuance of 7.4 million options to
purchase Common Stock at $4.50 per share. Level 3 recognized an expense and a
corresponding increase in equity as a result of
F-29
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the transaction. The increase in equity and the conversion of the stock
appreciation rights liability to equity are reflected as option activity in the
Statement of Changes in Stockholders' Equity. The options vest over three or
five years with a five or ten year life.
The Company granted 55,100 and 7,466,247 nonqualified stock options to
employees during the years ended December 31, 1999 and 1998, respectively. In
addition 1,898,036 warrants were granted to third parties in 1998 to acquire
shares of Common Stock at exercise prices ranging from $18.50--$20.00 per share
all of which were outstanding at December 31, 1999. The warrants vest quarterly
through June 30, 2001. The expense recognized for the year ended December 31,
1999 for NQSOs and warrants outstanding at December 31, 1999 in accordance with
SFAS No. 123 was $7 million. In addition to the expense recognized, the Company
capitalized $1 million of non-cash compensation costs for employees directly
involved in the construction of the Internet Protocol network and the
development of the business support systems. As of December 31, 1999, the
Company had not yet recognized $5 million of unamortized compensation costs for
NQSOs and warrants granted in 1998 and 1999.
The expense recognized in accordance with SFAS No. 123 for NQSOs and
warrants in 1998 was $6 million and $5 million, respectively. In addition to
the expense recognized, the Company capitalized $2 million of non-cash
compensation costs related to NQSOs for employees directly involved in the
construction of the IP network and the development of the business support
systems.
The fair value of NQSOs and warrants granted was calculated using the Black-
Scholes method with a risk free interest rate of 5.5% and expected life of 75%
of the total life of the NQSOs and warrants. The Company used an expected
volatility rate of 27.5%, except for when the minimum volatility of .001% was
used by the Company prior to becoming publicly traded in April 1998. The fair
value of the NQSOs and warrants granted in 1999, in accordance with SFAS No.
123 was $1 million.
In 1998, the Company exchanged approximately 700,000 options and 100,000
options, ranging in prices from $0.12 to $1.76 and primarily from $0.90 to
$1.79 for the XCOM and GeoNet acquisitions, respectively.
Transactions involving stock options granted under the NQSO plan are
summarized as follows:
Exercise Price Weighted Average
Shares Per Share Exercise Price
---------- -------------- ----------------
Balance December 28, 1996....... 4,440,000 $4.04--$4.95 $4.40
Options granted............... 14,990,930 4.50-- 5.42 4.96
Options cancelled............. (106,000) 4.95 4.95
Options exercised............. (4,636,930) 4.04-- 4.95 4.46
----------
Balance December 27, 1997....... 14,688,000 $4.04--$5.42 $4.95
============== ======
Options granted............... 7,466,247 $.12--$41.25 $8.67
Options cancelled............. (668,849) .12-- 34.69 5.52
Options exercised............. (2,506,079) .12-- 34.69 4.22
----------
Balance December 31, 1998....... 18,979,319 $.12--$41.25 $6.50
============== ======
Options granted............... 55,100 $41.44--$84.75 $58.61
Options cancelled............. (1,005,328) .12-- 41.25 10.84
Options exercised............. (3,950,528) .12-- 41.25 5.60
----------
Balance December 31, 1999....... 14,078,563 $.12--$84.75 $6.64
========== ============== ======
Options exercisable
December 27, 1997............. 2,590,538 $4.04--$ 4.95 $4.35
December 31, 1998............. 5,456,640 $ .12--$41.25 $4.67
December 31, 1999............. 6,291,624 $ .12--$41.25 $6.13
F-30
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The weighted average remaining contractual life for the 14,078,563 options
outstanding on December 31, 1999 is 7.43 years.
Options Outstanding Options Exercisable
----------------------------------- -----------------------
Weighted
Number Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise as of Life Exercise as of Exercise
Prices 12/31/99 (years) Price 12/31/99 Price
- -------------- ----------- --------- -------- ----------- --------
$ 0.12--$ 0.12 118,361 8.10 $ .12 68,381 $ .12
0.90-- 0.90 20,347 4.40 .90 14,782 .90
1.76-- 1.79 39,303 8.16 1.76 10,906 1.77
4.04-- 5.43 9,519,226 7.41 5.14 4,963,292 4.90
6.20-- 8.50 3,775,620 8.05 6.95 911,396 7.01
17.50-- 25.03 197,364 3.69 18.44 178,086 17.80
26.80-- 39.13 305,242 3.51 30.95 125,947 30.98
40.38-- 51.83 56,500 3.69 41.21 18,834 40.38
56.00-- 57.47 38,000 4.18 56.75 -- --
61.75-- 84.75 8,600 4.27 79.40 -- --
---------- ---------
14,078,563 7.43 $ 6.64 6,291,624 $ 6.13
========== ========= ======
Outperform Stock Option Plan
In April 1998, the Company adopted an outperform stock option ("OSO")
program that was designed so that the Company's stockholders would receive a
market return on their investment before OSO holders receive any return on
their options. The Company believes that the OSO program aligns directly
management's and stockholders' interests by basing stock option value on the
Company's ability to outperform the market in general, as measured by the
Standard & Poor's ("S&P") 500 Index. Participants in the OSO program do not
realize any value from awards unless the Common Stock price outperforms the S&P
500 Index. When the stock price gain is greater than the corresponding gain on
the S&P 500 Index, the value received for awards under the OSO plan is based on
a formula involving a multiplier related to the level by which the Common Stock
outperforms the S&P 500 Index. To the extent that the Common Stock outperforms
the S&P 500, the value of OSOs to a holder may exceed the value of non-
qualified stock options.
OSO grants are made quarterly to participants employed on the date of the
grant. Each award vests in equal quarterly installments over two years and has
a four-year life. Each award typically has a two-year moratorium on exercising
from the date of grant. As a result, once a participant is 100% vested in the
grant the two year moratorium expires. Therefore, each grant has an exercise
window of two years.
The fair value under SFAS No. 123 for the 3,241,599 OSOs granted to
employees for services performed for the year ended December 31, 1999 was $193
million. The Company recognized $111 million of compensation expense for the
year ended December 31, 1999 for OSOs granted in 1999 and 1998. In addition to
the expense recognized, $7 million of non-cash compensation was capitalized in
1999 for employees directly involved in the construction of the Internet
Protocol network and development of business support systems. As of December
31, 1999, the Company had not yet recognized $111 million of unamortized
compensation costs for OSOs granted in 1998 and 1999. The Company recognized
$24 million of compensation expense for the year ended December 31, 1998 for
OSOs outstanding at December 31, 1998. In addition to the expense recognized
the Company capitalized $3 million of non-cash compensation.
F-31
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of the options granted was calculated by applying the Black-
Scholes method with an S&P 500 expected dividend yield rate of 1.8% and an
expected life of 2.5 years. The Company used a blended volatility rate of 26%
between the S&P 500 expected volatility rate of 16% and the Level 3 Common
Stock expected volatility rate of 27.5%. The expected correlation factor of 0.4
was used to measure the movement of Level 3 stock relative to the S&P 500.
Transactions involving stock awards granted under the OSO plan are
summarized below:
Weighted
Average
Option Price Per Option
Shares Share Price
--------- ---------------- ---------
Balance December 27, 1997................ -- -- --
Options granted........................ 2,139,075 $ 29.78--$ 37.13 $34.85
Options cancelled...................... (46,562) 29.78-- 37.13 35.53
Options exercised...................... -- -- --
---------
Balance December 31, 1998................ 2,092,513 $ 29.78--$ 37.13 $34.85
Options granted........................ 3,241,599 56.00-- 78.50 66.58
Options cancelled...................... (157,623) 29.78-- 78.50 51.31
Options exercised...................... (37,500) 29.78-- 37.13 34.64
---------
Balance December 31, 1999................ 5,138,989 $ 29.78--$ 78.50 $54.15
========= ================ ======
Options vested but not exercisable as of
December 31, 1998...................... 234,305 $ 29.78--$ 37.13 $34.85
December 31, 1999...................... 2,098,337 $ 29.78--$ 78.50 44.69
Options Outstanding Options Exercisable
----------------------------------- -----------------------
Weighted
Number Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise as of Life Option as of Option
Prices 12/31/99 (years) Price 12/31/99 Price
- -------------- ----------- --------- -------- ----------- --------
$29.78--$34.50 1,115,214 2.80 $32.26 -- $ --
37.00-- 56.00 1,459,383 2.70 44.58 -- --
59.75-- 78.50 2,564,392 3.66 69.12 -- --
--------- ---
5,138,989 3.20 $54.15 -- $ --
========= === =====
Restricted Stock
In 1999 and 1998, 17,117 and 177,183 shares, respectively, of restricted
stock were granted to employees. The restricted stock shares were granted to
employees at no cost. The shares vest immediately; however, the employees are
restricted from selling these shares for 3 years. The fair value of restricted
stock granted in 1999 and 1998 of $1 million and $7 million, respectively, was
calculated using the value of the Common Stock the day prior to the grant. The
expense recognized in 1999 under SFAS No. 123 for restricted stock grants was
$4 million. The expense recognized in 1998 under SFAS No. 123 for Restricted
stock grants was $3 million.
As of December 31, 1999, the Company had not recognized $1 million of
compensation costs for Restricted Stock granted in 1998 and 1999.
F-32
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Shareworks
Level 3 has designed its compensation programs with particular emphasis on
equity-based, long-term incentive programs. The Company has developed two plans
under its Shareworks program: the Match Plan and the Grant Plan.
Match Plan--The Match Plan allows eligible employees to defer between 1% and
7% of their eligible compensation to purchase Common Stock at the average stock
price for the quarter. Any full time employee is considered eligible on the
first day of the calendar quarter after their hire. The Company matches the
shares purchased by the employee on a one-for-one basis. Stock purchased with
payroll deductions is fully vested. Stock purchased with the Company's matching
contributions vests three years after the end of the quarter in which it was
made.
The Company's quarterly matching contribution is amortized to compensation
expense over the vesting period of 36 months. In 1999, the Company's matching
contribution was $10 million under the Match Plan. The compensation expense
recognized in 1999 under this plan was $1 million. The non-cash compensation
expense recognized in 1998 for the Match Plan was less than $1 million.
Grant Plan--The Grant Plan enables the Company to grant shares of Common
Stock to eligible employees based upon a percentage of that employee's eligible
salary up to a maximum of 3%. Level 3 employees employed on December 31 of each
year, who are age 21 or older with a minimum of 1,000 hours credited service
are considered eligible. The shares granted are valued at the fair market value
as of the last business day of the calendar year. All prior and future grants
vest immediately upon the employees' third anniversary of joining the
Shareworks Plan.
The annual grant is expensed in the year of the grant. Compensation expense
recorded for the Shareworks Grant Plan for 1999 was approximately $3 million.
Approximately $1 million of compensation expense was recorded for the
Shareworks Grant Plan for 1998.
In addition to the compensation expense recognized, the Company capitalized
$2 million of non-cash compensation costs related to the Shareworks Plans for
employees directly involved in the construction of the IP network and the
development of the business support systems in 1999 and less than $1 million of
non-cash compensation costs in 1998.
401(k) Plan
The Company and its subsidiaries offer its qualified employees the
opportunity to participate in a defined contribution retirement plan qualifying
under the provisions of Section 401(k) of the Internal Revenue Code. Each
employee was eligible to contribute, on a tax deferred basis, a portion of
annual earnings not to exceed $10,000 in 1999. The Company does not match
employee contributions and therefore does not incur any expense related to the
401(k) plan.
F-33
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(12) Income Taxes
An analysis of the income tax (provision) benefit attributable to earnings
(loss) from continuing operations before income taxes for the three years ended
December 31, 1999 follows:
1999 1998 1997
---- ---- ----
(dollars in
millions)
Current:
U.S. federal................................................. $161 $(15) $(54)
State........................................................ 3 (10) (1)
---- ---- ----
164 (25) (55)
Deferred:
U.S. federal................................................. $ 56 50 103
State........................................................ -- -- --
---- ---- ----
56 50 103
---- ---- ----
$220 $ 25 $ 48
==== ==== ====
The United States and foreign components of earnings (loss) from continuing
operations before income taxes follows:
1999 1998 1997
----- ----- ----
(dollars in
millions)
United States................................................ $(578) $(142) $35
Foreign...................................................... (129) (11) --
----- ----- ---
$(707) $(153) $35
===== ===== ===
A reconciliation of the actual income tax (provision) benefit and the tax
computed by applying the U.S. federal rate (35%) to the earnings (loss) from
continuing operations, before income taxes for the three years ended December
31, 1999 follows:
1999 1998 1997
---- ---- ----
(dollars in
millions)
Computed Tax at Statutory Rate............................... $247 $ 53 $(12)
State Income Taxes........................................... 2 (7) (1)
Write-off of In Process Research & Development............... -- (11) --
Coal Depletion............................................... 2 2 3
Goodwill Amortization........................................ (12) (5) --
Tax Exempt Interest.......................................... -- -- 2
Prior Year Tax Adjustments................................... -- -- 62
Compensation Expense Attributable to Options................. -- -- (7)
Taxes on Unutilized Losses of Foreign Operations............. (9) (4) --
Foreign Tax Credits.......................................... (10) -- --
Other........................................................ -- (3) 1
---- ---- ----
$220 $ 25 $ 48
==== ==== ====
During the year ended December 27, 1997, the Company settled a number of
disputed tax issues related to prior years that have been included in prior
year tax adjustments.
F-34
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The components of the net deferred tax liabilities for the years ended
December 31, 1999 and 1998 were as follows:
1999 1998
---- ----
(dollars
in
millions)
Deferred Tax Liabilities:
Investments in securities.......................................... $ 2 $ 2
Investments in joint ventures...................................... 15 27
Asset bases--accumulated depreciation.............................. 122 83
Coal sales......................................................... 32 32
Other.............................................................. 3 20
---- ----
Total Deferred Tax Liabilities....................................... 174 164
Deferred Tax Assets:
Compensation--and related benefits................................. 76 35
Investment in subsidiaries......................................... 11 14
Provision for estimated expenses................................... 27 14
Other.............................................................. 12 13
---- ----
Total Deferred Tax Assets............................................ 126 76
---- ----
Net Deferred Tax Liabilities......................................... $ 48 $ 88
==== ====
(13) Stockholders' Equity
On March 9, 1999 the Company closed the sale of 28.75 million shares of its
Common Stock through an underwritten public offering. The net proceeds from the
offering of approximately $1.5 billion after underwriting discounts and
offering expenses are being used for working capital, capital expenditures,
acquisitions and other general corporate purposes in connection with the
implementation of the Company's Business Plan.
F-35
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Issuances of Common Stock, for sales, conversions, option exercises and
acquisitions, and repurchases of common shares for the three years ended
December 31, 1999 are shown below. Prior to the Split-off, the Company was
obligated to repurchase Class D shares from stockholders. The Level 3 Stock
Plan permits option holders to tender shares to the Company to cover income
taxes due on option exercises.
December 28, 1996.................................................. 231,802,430
Shares Issued.................................................... 21,589,100
Shares Repurchased............................................... (29,610)
Issuances for Class C Stock Conversions.......................... 13,035,430
Option Activity.................................................. 4,636,930
-----------
December 27, 1997.................................................. 271,034,280
Shares Issued.................................................... 2,240,467
Shares Repurchased............................................... (30,506)
Issuances for Class C Stock Conversions.......................... 20,934,244
Issuances for Class R Stock Conversions.......................... 5,084,568
Option Activity.................................................. 2,506,079
Shares Issued for Acquisition.................................... 6,105,574
-----------
December 31, 1998.................................................. 307,874,706
Shares Issued.................................................... 28,750,000
Option and Shareworks Activity................................... 4,371,578
Shares Issued for Acquisition.................................... 396,379
6% Convertible Notes Converted to Shares......................... 4,064
-----------
December 31, 1999.................................................. 341,396,727
===========
(14) Industry and Geographic Data
In 1998, the Company adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information". SFAS No. 131 establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports issued to stockholders. It also establishes standards for disclosures
about products and services and geographic areas. Operating segments are
components of an enterprise for which separate financial information is
available and which is evaluated regularly by the Company's chief operating
decision maker, or decision making group, in deciding how to allocate resources
and assess performance. Operating segments are managed separately and represent
strategic business units that offer different products and serve different
markets.
The Company's reportable segments include: communications and information
services (including communications, computer outsourcing and systems
integration segments), and coal mining. Other primarily includes CPTC, equity
investments, and other corporate assets and overhead not attributable to a
specific segment.
Industry and geographic data for the Company's discontinued construction and
energy operations are not included.
EBITDA, as defined by the Company, consists of earnings (loss) before
interest, income taxes, depreciation, amortization, non-cash operating expenses
(including stock-based compensation and in-process research and development
charges) and other non-operating income or expense. The Company excludes non-
cash compensation due to its adoption of the expense recognition provisions of
SFAS No. 123. EBITDA is commonly used in the communications industry to analyze
companies on the basis of operating performance. EBITDA is not intended to
represent cash flow for the periods presented.
F-36
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1999, 1998, and 1997 Commonwealth Edison Company, a coal mining customer,
accounted for 22%, 34%, and 43% of Level 3's revenues.
Industry segment financial information follows. Certain prior year
information has been reclassified to conform with the 1999 presentation.
Communications & Information Services
--------------------------------------
Computer Systems Coal
Communications Outsourcing Integration Mining Other Total
-------------- ----------- ----------- ------ ------ ------
(dollars in millions)
1999
Revenue................. $ 159 $67 $ 63 $207 $ 19 $ 515
EBITDA.................. (390) 19 (10) 81 (87) (387)
Identifiable Assets..... 5,001 61 30 345 3,467 8,904
Capital Expenditures.... 3,299 11 1 3 122 3,436
Depreciation and
Amortization........... 151 9 6 5 57 228
1998
Revenue................. $ 24 $63 $ 57 $228 $ 20 $ 392
EBITDA.................. (139) 14 (23) 92 (44) (100)
Identifiable Assets..... 1,072 59 42 362 3,987 5,522
Capital Expenditures.... 818 25 4 2 61 910
Depreciation and
Amortization........... 37 8 3 5 13 66
1997
Revenue................. $ -- $50 $ 45 $222 $ 15 $ 332
EBITDA.................. -- 13 1 88 (18) 84
Identifiable Assets..... -- 42 19 499 921 1,481
Capital Expenditures.... -- 9 5 3 9 26
Depreciation and
Amortization........... -- 6 2 5 7 20
F-37
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents a geographic breakout for revenue, EBITDA, and
identifiable assets:
Communications & Information Services
--------------------------------------
Computer Systems Coal
Communications Outsourcing Integration Mining Other Total
-------------- ----------- ----------- ------ ------ ------
(dollars in millions)
1999
Revenue:
United States......... $ 145 $ 67 $ 63 $207 $ 19 $ 501
Europe................ 14 -- -- -- -- 14
Other................. -- -- -- -- -- --
------ ---- ----- ---- ------ ------
$ 159 $ 67 $ 63 $207 $ 19 $ 515
====== ==== ===== ==== ====== ======
EBITDA:
United States......... $ (297) $ 19 $ (11) $ 81 $ (87) $ (295)
Europe................ (86) -- 1 -- -- (85)
Other................. (7) -- -- -- -- (7)
------ ---- ----- ---- ------ ------
$ (390) $ 19 $ (10) $ 81 $ (87) $ (387)
====== ==== ===== ==== ====== ======
Identifiable Assets:
United States......... $3,935 $ 61 $ 20 $345 $3,467 $7,828
Europe................ 723 -- 10 -- -- 733
Other................. 343 -- -- -- -- 343
------ ---- ----- ---- ------ ------
$5,001 $ 61 $ 30 $345 $3,467 $8,904
====== ==== ===== ==== ====== ======
1998
Revenue:
United States......... $ 23 $ 62 $ 56 $228 $ 20 $ 389
Europe................ 1 -- -- -- -- 1
Other................. -- 1 1 -- -- 2
------ ---- ----- ---- ------ ------
$ 24 $ 63 $ 57 $228 $ 20 $ 392
====== ==== ===== ==== ====== ======
EBITDA:
United States......... $ (128) $ 14 $ (23) $ 92 $ (44) $ (89)
Europe................ (9) -- -- -- -- (9)
Other................. (2) -- -- -- -- (2)
------ ---- ----- ---- ------ ------
$ (139) $ 14 $ (23) $ 92 $ (44) $ (100)
====== ==== ===== ==== ====== ======
Identifiable Assets:
United States......... $ 959 $ 59 $ 42 $362 $3,987 $5,409
Europe................ 60 -- -- -- -- 60
Other................. 53 -- -- -- -- 53
------ ---- ----- ---- ------ ------
$1,072 $ 59 $ 42 $362 $3,987 $5,522
====== ==== ===== ==== ====== ======
1997
Revenue:
United States......... $ -- $ 50 $ 45 $222 $ 15 $ 332
Europe................ -- -- -- -- -- --
Other................. -- -- -- -- -- --
------ ---- ----- ---- ------ ------
$ -- $ 50 $ 45 $222 $ 15 $ 332
====== ==== ===== ==== ====== ======
EBITDA:
United States......... $ -- $ 13 $ 1 $ 88 $ (18) $ 84
Europe................ -- -- -- -- -- --
Other................. -- -- -- -- -- --
------ ---- ----- ---- ------ ------
$ -- $ 13 $ 1 $ 88 $ (18) $ 84
====== ==== ===== ==== ====== ======
Identifiable Assets:
United States......... $ -- $ 42 $ 19 $499 $ 921 $1,481
Europe................ -- -- -- -- -- --
Other................. -- -- -- -- -- --
------ ---- ----- ---- ------ ------
$ -- $ 42 $ 19 $499 $ 921 $1,481
====== ==== ===== ==== ====== ======
F-38
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following information provides a reconciliation of EBITDA to earnings
(loss) from continuing operations for the three years ended December 31, 1999:
1999 1998 1997
----- ----- ----
(in millions)
EBITDA...................................................... $(387) $(100) $ 84
Depreciation and Amortization Expense....................... (228) (66) (20)
Non-Cash Compensation Expense............................... (126) (39) (21)
Write-off of In Process Research and Development............ -- (30) --
----- ----- ----
Earnings (Loss) from Operations........................... (741) (235) 43
Other Income (Expense)...................................... 34 82 (8)
Income Tax Benefit.......................................... 220 25 48
----- ----- ----
Earnings (Loss) from Continuing Operations.................. $(487) $(128) $ 83
===== ===== ====
(15) Commitments and Contingencies
On April 23, 1999, Level 3 announced that it had contracted with Tyco
Submarine Systems, Ltd. to design and build a transatlantic terabit cable
system from Long Island, New York to North Cornwall, UK. The cable system is
expected to be in service by September 2000 and is expected to cost between
$600 to $800 million. The total cost will depend on how the cable is upgraded
over time. Level 3 has prefunded the purchase of significant amounts of
undersea capacity as part of the Business Plan, but may require additional
funding depending on the cable's ultimate structure, pre-construction sales and
ownership.
Level 3 announced on April 29, 1999 that it had finalized contracts relating
to construction of Ring 1 of its European network in France, Belgium, the
Netherlands, Germany and the United Kingdom. Ring 1, which is approximately
1,800 miles, will connect Paris, Frankfurt, Amsterdam, Brussels and London. The
network is expected to be ready for service by September 2000. Ring 1 is part
of the approximately 4,750 mile intercity network. This European network will
be linked to the Level 3 North American intercity network by the Level 3
transatlantic terabit cable system currently under development, also expected
to be ready for service by September, 2000.
On July 26, 1999, the Company announced two important developments of its
European network build with agreements with Eurotunnel and Alcatel. Eurotunnel
will install and supply Level 3 with multiple cross-Channel cables between the
United Kingdom and France through the high-security service tunnel. The first
of these cables will be completed by the first quarter of 2000. Subsequent
cables will be installed to upgrade and expand the network as and when required
or when new fiber technology becomes available. Alcatel will design, develop,
and install an undersea cable to link the Level 3 network between the United
Kingdom and Belgium. The cable system is already under development and will be
completed by the end of the first half of 2000.
On May 4, 1999, Level 3 and COLT Telecom Group plc announced an agreement to
share costs for the construction of European networks. The agreement calls for
Level 3 to share construction costs of COLT's planned 1,600 mile intercity
German network linking Berlin, Cologne, Dusseldorf, Frankfurt, Hamburg, Munich
and Stuttgart. In return, COLT will share construction costs of Ring 1 of Level
3's planned European network.
On June 23, 1999, Level 3 announced a minimum four year, $250 million
strategic agreement with Lucent Techologies to purchase Lucent systems,
including new software switches or "softswitches." The minimum purchase
commitment is subject to certain conditions and has the potential to grow to $1
billion over five years.
F-39
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Under this nonexclusive agreement, Lucent will provide Level 3 its Lucent
Technologies Softswitch, a software switch for Internet Protocol networks that
is intended to combine the reliability and features that customers expect from
the public switched telephone network with the cost effectiveness and
flexibility of Internet Protocol technology. With the Lucent Softswitch, Level
3 expects to provide a full range of Internet Protocol based communications
services similar in quality and ease of use to services on traditional circuit
voice networks. In addition, the companies also agreed to collaborate on future
enhancements of softswitches and gateway products to support next-generation
broadband services for business and consumers that will combine high-quality
voice and video communications with Internet-style web data services.
Operating Leases
The Company is leasing rights of way, communications capacity and premises
under various operating leases which, in addition to rental payments, require
payments for insurance, maintenance, property taxes and other executory costs
related to the lease. Certain leases provide for adjustments in lease cost
based upon adjustments in the consumer price index and increases in the
landlord's management costs. The lease agreements have various expiration dates
through 2019.
In addition to the items described above, future minimum payments for the
next five years, under the non-cancelable operating leases with initial or
remaining terms of one year or more, consist of the following at December 31,
1999 (in millions):
2000................................................................ $ 67
2001................................................................ 43
2002................................................................ 36
2003................................................................ 35
2004................................................................ 35
Thereafter.......................................................... 211
Rent expense under lease agreements was $41 million in 1999, $18 million in
1998 and $1 million in 1997.
(16) Related Party Transactions
Peter Kiewit Sons', Inc. ("Kiewit") acted as the general contractor on
several significant projects for the Company in 1999 and 1998. These projects
include the U.S. intercity network, certain local loops and certain gateway
sites, the Company's new corporate headquarters in Colorado and a new data
center in Tempe, Arizona. Kiewit provided approximately $1,024 million and $130
million of construction services related to these projects in 1999 and 1998,
respectively.
Level 3 also receives certain mine management services from Kiewit. The
expense for these services was $33 million for 1999, $34 million for 1998, and
$32 million for 1997, and is recorded in selling, general and administrative
expenses. The revenue earned by Peter Kiewit Sons', Inc. in 1997 is included in
discontinued operations.
(17) 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 plaintiffs' land. In general, the Company obtained
the rights to construct its network from railroads, utilities, and others, and
is installing its network along the rights-of-way so granted. Plaintiffs in the
purported
F-40
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 construction and maintain its
network did not have the legal ability to do so. The action purports to be on
behalf of a national class of owners of land over which the Company's network
passes or will pass. The complaint seeks damages on theories of trespass,
unjust enrichment and slander of title and property, as well as punitive
damages. Although the Company is not aware of any additional similar claims,
the Company may in the future receive claims and demands related to the rights
of way issues similar to the issues in the Schweizer litigation that may be
based on similar or different legal theories. Although it is too early for the
Company to reach a conclusion as to the ultimate outcome of this litigation,
management believes that the Company has substantial defenses to the claims
asserted in the Schweizer action (and any similar claims which may be named in
the future), and intends to defend them vigorously.
The Company is involved in various other lawsuits, claims and regulatory
proceedings incidental to its business. Management believes that any resulting
liability for legal proceedings beyond that provided should not materially
affect the Company's financial position, future results of operations or future
cash flows.
It is customary in Level 3's industries to use various financial instruments
in the normal course of business. These instruments include items such as
letters of credit. Letters of credit are conditional commitments issued on
behalf of Level 3 in accordance with specified terms and conditions. As of
December 31, 1999, Level 3 had outstanding letters of credit of approximately
$35 million. The Company does not believe it is practicable to estimate the
fair value of the letters of credit and does not believe exposure to loss is
likely.
Level 3 filed with the Securities and Exchange Commission a "universal"
shelf registration statement covering up to $3.5 billion of common stock,
preferred stock, debt securities and depositary shares that became effective
February 17, 1999. On March 9, 1999 the Company received approximately $1.5
billion from the sale of 28.75 million shares of Common Stock and on September
14, 1999 the Company sold $823 million aggregate principal amount of its 6%
Convertible Subordinated Notes under the "universal" shelf registration
statement.
On December 10, 1999, Level 3 filed with the SEC a second "universal" shelf
registration covering up to $2.375 billion of common stock, preferred stock,
debt securities and depositary shares. Combined with remaining availability
under the initial universal shelf registration statement, Level 3 may offer an
aggregate of up to $3.5 billion of securities.
Prior to the Split-off, as of January 1 of each year, holders of Class C
Stock had the right to convert Class C Stock into Class D Stock, subject to
certain conditions. In January 1998, holders of Class C Stock converted 2.3
million shares, with a redemption value of $122 million, into 21 million shares
of Class D Stock (now known as Common Stock).
(18) Subsequent Events
On January 24, 2000, Level 3 announced the expansion of its business plan to
increase the amount of gateway space it intends to secure to approximately 6.5
million square feet. Level 3 currently has secured approximately 3.4 million
square feet of gateway space. The Company has completed the buildout of
approximately 1.3 million square feet of space.
Also on January 24, 2000, Level 3 announced plans to construct a high speed,
broadband undersea cable system connecting Hong Kong and Tokyo. The 2.56
terabit system is expected to be completed in the second quarter of 2001. The
Hong Kong-Tokyo cable is intended to be the first stage in the Company's
construction of an undersea network in the region. The Company plans to share
construction and operating expenses of the Northern Asia cable loop with one or
more industry partners.
F-41
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On February 2, 2000, Level 3 announced a series of separate securities
offerings. As of the date of the initial filing of the Company's Annual Report
on Form 10-K for the year ended December 31, 1999, the Company is offering 15
million shares of common stock and $500 million of convertible subordinated
notes in separate registered offerings pursuant to an effective registration
statement. It is also offering senior notes and senior discount notes that will
generate aggregate gross proceeds of $1 billion, and 400 million of euro-
denominated (approximately $391 million) senior notes. The dollar-denominated
and euro-denominated senior notes will not be registered under the Securities
Act of 1933 and may not be sold in the United States absent registration or an
applicable exemption from the registration requirements. Each of the offerings
is being made pursuant to a separate prospectus supplement or offering
memorandum. No offering is conditioned on the closing of any other. The Company
may not complete any of the offerings. In addition, the size of each offering
is subject to change. The Company will use the proceeds from these offerings
for working capital, capital expenditures, acquisitions and other general
corporate purposes in connection with the implementation of the Company's
Business Plan.
(19) Unaudited Quarterly Financial Data
March June September December
------------ ------------ ------------ ------------
1999 1998 1999 1998 1999 1998 1999 1998
----- ----- ----- ----- ----- ----- ----- -----
(in millions except per share data)
Revenue................. $ 102 $ 87 $ 106 $ 103 $ 134 $ 106 $ 173 $ 96
Loss from Operations.... (126) (9) (183) (41) (207) (52) (225) (133)
Net Earnings (Loss)..... (105) 926 (44) (34) (147) (49) (191) (39)
Earnings (Loss) per
Share (Basic and
Diluted):
Continuing
Operations........... $(.33) $(.02) $(.13) $(.11) $(.43) $(.16) $(.56) $(.13)
Discontinued
Operations Excluding
Construction
Operations........... -- 3.19 -- -- -- -- -- --
Net Earnings Excluding
Construction
Operations............. (.33) 3.17 (.13) (.11) (.43) (.16) (.56) (.13)
Net Earnings Excluding
Gain On Split-Off of
Construction Group..... (.33) 1.09 (.13) (.11) (.43) (.16) (.56) (.13)
Earnings (loss) per share was calculated for each three-month period on a
stand-alone basis. As a result of all the stock transactions, the sum of the
earnings (loss) per share for the four quarters of each year may not equal the
earnings (loss) per share for the twelve month periods.
The earnings (loss) per share amounts above are those of Level 3 Common
Stock.
On January 2, 1998 the Company completed the sale of its energy assets to
MidAmerican, as discussed in Note 3, and recognized an after-tax gain on the
disposition of $324 million.
The Company recognized $111 million of gains related to RCN stock
transactions in the second quarter of 1999.
On March 31, 1998, as a result of the Split-off as discussed in Note 2, the
Company recognized a gain of $608 million equal to the difference between the
carrying value of the Construction Group and its fair value in accordance with
Financial Accounting Standards Board Emerging Issues Task Force Issue 96-4. No
taxes were provided on this gain due to the tax-free nature of the Split-off.
The Company reflected the fair value of the Construction Group as a
distribution to the Class C stockholders.
F-42
Prospectus
- ----------
Level 3 Communications, Inc.
Debt Securities
Preferred Stock
Depositary Shares
Common Stock
------------
We will provide specific terms of these securities and their offering prices
in supplements to this prospectus.
In the case of debt securities, these terms will include, as applicable, the
specific designation, aggregate principal amount, maturity, rate or formula of
interest, premium, terms for redemption. In the case of shares of preferred
stock, these terms will include, as applicable, the specific title and stated
value, any dividend, liquidation, redemption, conversion, voting and other
rights. In the case of depositary shares, these terms will include the
fractional share of preferred stock represented by each depositary share. In
the case of common stock, these terms will include the aggregate number of
shares offered.
We may sell any combination of these securities in one or more offerings up
to a total dollar amount of $3,500,000,000.
Our common stock is quoted on the Nasdaq National Market under the symbol
LVLT. The closing price of our common stock on the Nasdaq National Market was
$67.063 per share on December 9, 1999. None of the other securities are
currently publicly traded.
You should read this prospectus and any prospectus supplement carefully
before you invest.
See "Risk Factors" on page 1 for a discussion of matters that you should
consider before investing in these securities.
------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
The date of this prospectus is December 10, 1999.
Table of Contents
Page
----
About This Prospectus...................................................... 1
Where You Can Find More Information........................................ 1
Risk Factors............................................................... 1
The Company................................................................ 2
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends........... 2
Application of Proceeds.................................................... 2
Description of Debt Securities............................................. 3
General terms of debt securities......................................... 3
Certificated securities.................................................. 4
Book-entry debt securities............................................... 4
Merger................................................................... 5
Events of default, notice and waiver..................................... 6
Modification of the indentures........................................... 7
Defeasance and covenant defeasance....................................... 9
Senior debt securities................................................... 10
Subordination of subordinated securities................................. 10
Definition of senior indebtedness........................................ 11
Convertible debt securities.............................................. 11
Description of Preferred Stock............................................. 12
General.................................................................. 12
Dividends................................................................ 13
Redemption............................................................... 14
Conversion or exchange rights............................................ 15
Rights upon liquidation.................................................. 15
Voting rights............................................................ 16
Description of Depositary Shares........................................... 17
General.................................................................. 17
Dividends and other distributions........................................ 17
Withdrawal of stock...................................................... 17
Redemption of depositary shares.......................................... 17
Voting the preferred stock............................................... 18
Exchange of preferred stock.............................................. 18
Conversion of preferred stock............................................ 18
Amendment and termination of the deposit agreement....................... 19
Charges of preferred stock depositary.................................... 19
Resignation and removal of depositary.................................... 19
Miscellaneous............................................................ 19
Description of Common Stock................................................ 20
Description of Outstanding Capital Stock................................... 20
Common stock............................................................. 20
Preferred stock.......................................................... 21
Anti-takeover provisions................................................. 21
Plan of Distribution....................................................... 21
By agents................................................................ 21
By underwriters.......................................................... 22
To dealers............................................................... 22
Direct sales............................................................. 22
Delayed delivery contracts............................................... 22
General information...................................................... 22
Legal Matters.............................................................. 23
Experts.................................................................... 23
About This Prospectus
This prospectus is part of two registration statements that we filed with
the SEC utilizing a shelf registration process. Under this shelf process, we
may, over the next two years, sell any combination of the securities described
in this prospectus in one or more offerings up to a total dollar amount of
$3,500,000,000 or the equivalent denominated in foreign currencies or units of
two or more foreign currencies. This prospectus provides you with a general
description of the securities we may offer. Each time we sell securities, we
will provide a prospectus supplement that will contain specific information
about the terms of that offering. The prospectus supplement may also add,
update or change information contained in this prospectus. You should read
both this prospectus and any prospectus supplement together with additional
information described under the heading "Where You Can Find More Information."
Where You Can Find More Information
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's web site at http://www.sec.gov. You may also read and
copy any document we file at the SEC's public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330
for further information on the public reference room. Our SEC filings are also
available at the offices of the Nasdaq National Market, in Washington, D.C.
The SEC allows us to incorporate by reference the information we file with
them, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
an important part of this prospectus, and information that we file later with
the SEC will automatically update and supersede this information. We
incorporate by reference our documents listed below and any future filings we
make with the SEC under Sections 13(a), 13(c), 14, or 15(d) of the Securities
Exchange Act until we sell all of the securities.
. Annual report on Form 10-K for the fiscal year ended December 31, 1998
. Quarterly reports on Form 10-Q for the quarters ended March 31, 1999,
June 30, 1999 and September 30, 1999
. Current reports on Form 8-K, filed February 24, 1999, March 5, 1999, May
18, 1999, June 3, 1999 and September 20, 1999 and on Form 8-K/A filed
February 17, 1999 and November 9, 1999
. Registration statements on Forms 8-A/A filed March 31, 1998 and June 10,
1998
You may request a copy of these filings at no cost, by writing or
telephoning us at the following address:
Vice President, Investor Relations
Level 3 Communications, Inc.
1025 Eldorado Boulevard
Broomfield, Colorado 80021
(720) 888-1000
You should rely only on the information incorporated by reference or
provided in this prospectus or any prospectus supplement. We have not
authorized anyone else to provide you with different information. We are not
making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information in this prospectus or
any prospectus supplement is accurate as of any date other than the date on
the front of those documents.
Risk Factors
Before you invest in our securities, you should carefully consider the
risks involved. These risks include, but are not limited to:
. the risks described in our current report on Form 8-K/A filed with the
SEC on November 9, 1999, which is incorporated by reference in this
prospectus; and
. any risks that may be described in other filings we make with the SEC or
in the prospectus supplements relating to specific offerings of
securities.
1
The Company
We engage in the communications, information services and coal mining
businesses through ownership of operating subsidiaries and substantial equity
positions in public companies. In late 1997, we announced a business plan to
increase substantially our information services business and to expand the
range of services we offer. We are implementing our business plan by building
an advanced communications network based on internet protocol technology.
Since late 1997, we have substantially increased the emphasis we place on
and the resources devoted to our communications and information services
business. Since that time we have become a facilities-based provider of a broad
range of integrated communications services. A facilities-based provider is one
that owns or leases a substantial portion of the plant, property and equipment
necessary to provide its services. We have expanded substantially the business
of our subsidiary, PKS Information Services, Inc. and are creating, through a
combination of construction, purchase and leasing of facilities and other
assets, an advanced, international facilities based communications network. We
designed our network based on internet protocol technology in order to leverage
the efficiencies of this technology to provide lower cost communications
services.
Our network will combine both local and long distance networks and will
connect customers end-to-end across the U.S. and in Europe and Asia. We expect
to complete the U.S. intercity portion of the network during the first quarter
of 2001. In the meantime, we have leased a national network over which we began
to offer services in the third quarter of 1998. We intend to provide a full
range of communications services--including local, long distance, international
and internet services.
Our principal executive offices are located at 1025 Eldorado Boulevard,
Broomfield, Colorado 80021 and our telephone number is (720) 888-1000.
Ratio of Earnings to Fixed Charges and Preferred Stock Dividends
The ratio of earnings to fixed charges for each of the periods indicated is
as follows:
Nine Months Ended
September 30, Fiscal Year Ended
----------------- ------------------------
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
-- -- -- 5.73 3.87 -- --
For this ratio, earnings consist of earnings (loss) before income taxes,
minority interest and discontinued operations plus fixed charges excluding
capitalized interest. Fixed charges consist of interest expensed and
capitalized, plus the portion of rent expense under operating leases deemed by
us to be representative of the interest factor, plus, prior to September 30,
1995, preferred stock dividends on preferred stock of its former subsidiary,
MFS Communications Company, Inc. We had deficiencies of earnings to fixed
charges of $421 million for the nine months ended September 30, 1999, $106
million for the nine months ended September 30, 1998, $36 million for 1998, $32
million for 1995 and $42 million for 1994.
Application of Proceeds
Unless the applicable prospectus supplement states otherwise, the net
proceeds from the sale of the offered securities will be used for working
capital, capital expenditures, acquisitions and other general corporate
purposes. Until we use the net proceeds in this manner, we may temporarily use
them to make short-term investments or reduce short-term borrowings.
2
Description of Debt Securities
This section describes the general terms and provisions of the debt
securities. The applicable prospectus supplement will describe the specific
terms of the debt securities offered through that prospectus supplement as well
as any general terms described in this section that will not apply to those
debt securities.
The debt securities will be our direct unsecured general obligations and may
include debentures, notes, bonds and/or other evidences of indebtedness. The
debt securities will be either senior debt securities or subordinated debt
securities. The debt securities will be issued under one or more separate
indentures between us and IBJ Whitehall Bank & Trust Company, as trustee.
Senior debt securities will be issued under a senior indenture, and
subordinated debt securities will be issued under a subordinated indenture.
Together, the senior indentures and the subordinated indentures are called
indentures.
We have summarized selected provisions of the indentures below. The summary
is not complete. We have also filed the forms of the indentures as exhibits to
the registration statement. You should read the indentures for provisions that
may be important to you before you buy any debt securities.
General terms of debt securities
The debt securities issued under each indenture may be issued without limit
as to aggregate principal amount, in one or more series. Each indenture
provides that there may be more than one trustee under the indenture, each with
respect to one or more series of debt securities. Any trustee under either
indenture may resign or be removed with respect to one or more series of debt
securities issued under that indenture, and a successor trustee may be
appointed to act with respect to that series.
If two or more persons are acting as trustee with respect to different
series of debt securities issued under the same indenture, each of those
trustees will be a trustee of a trust under that indenture separate and apart
from the trust administered by any other trustee. In that case, except as
otherwise indicated in this prospectus, any action described in this prospectus
to be taken by the trustee may be taken by each of those trustees only with
respect to the one or more series of debt securities for which it is trustee.
A prospectus supplement relating to a series of debt securities being
offered will include specific terms relating to the offering and that series.
These terms will contain some or all of the following:
. the title of the debt securities;
. any limit on the aggregate principal amount of the debt securities;
. the purchase price of the debt securities, expressed as a percentage of
the principal amount;
. the date or dates on which the principal of and any premium on the debt
securities will be payable or the method for determining the date or
dates;
. if the debt securities will bear interest, the interest rate or rates or
the method by which the rate or rates will be determined;
. if the debt securities will bear interest, the date or dates from which
any interest will accrue, the interest payment dates on which any
interest will be payable, the record dates for those interest payment
dates and the basis upon which interest shall be calculated if other
than that of a 360 day year of twelve 30-day months;
. the place or places where payments on the debt securities will be made
and the debt securities may be surrendered for registration of transfer
or exchange;
3
. if we will have the option to redeem all or any portion of the debt
securities, the terms and conditions upon which the debt securities may
be redeemed;
. the terms and conditions of any sinking fund or other similar provisions
obligating us or permitting a holder to require us to redeem or purchase
all or any portion of the debt securities prior to final maturity;
. the currency or currencies in which the debt securities are denominated
and payable if other than U.S. dollars;
. whether the amount of any payments on the debt securities may be
determined with reference to an index, formula or other method and the
manner in which such amounts are to be determined;
. any additions or changes to the events of default in the respective
indentures;
. any additions or changes with respect to the other covenants in the
respective indentures;
. the terms and conditions, if any, upon which the debt securities may be
convertible into common stock or preferred stock;
. whether the debt securities will be issued in certificated or book-entry
form;
. whether the debt securities will be in registered or bearer form and, if
in registered form, the denominations of the debt securities if other
than $1,000 and multiples of $1,000;
. the applicability of the defeasance and covenant defeasance provisions
of the applicable indenture; and
. any other terms of the debt securities consistent with the provisions of
the applicable indenture.
Debt securities may be issued under the indentures as original issue
discount securities to be offered and sold at a substantial discount from their
stated principal amount. Special U.S. federal income tax, accounting and other
considerations applicable to original issue discount securities will be
described in the applicable prospectus supplement.
Unless otherwise provided with respect to a series of debt securities, the
debt securities will be issued only in registered form, without coupons, in
denominations of $1,000 and multiples of $1,000.
Certificated securities
Except as otherwise stated in the applicable prospectus supplement, debt
securities will not be issued in certificated form. If, however, debt
securities are to be issued in certificated form, no service charge will be
made for any transfer or exchange of any of those debt securities. We may
require payment of a sum sufficient to cover any tax or other governmental
charge payable in connection with the transfer or exchange of those debt
securities.
Book-entry debt securities
The debt securities of a series may be issued in whole or in part in the
form of one or more global securities that will be deposited with the
depositary identified in the applicable prospectus supplement. Unless it is
exchanged in whole or in part for debt securities in definitive form, a global
security may not be transferred. However, transfers of the whole security
between the depositary for that global security and its nominee or their
respective successors are permitted.
4
Unless otherwise stated, The Depository Trust Company, New York, New York
will act as depositary for each series of global securities. Beneficial
interests in global securities will be shown on, and transfers of global
securities will be effected only through, records maintained by DTC and its
participants.
DTC has provided the following information to us. DTC is a:
. limited-purpose trust company organized under the New York Banking Law;
. a banking organization within the meaning of the New York Banking Law;
. a member of the U.S. Federal Reserve System;
. a clearing corporation within the meaning of the New York Uniform
Commercial Code; and
. a clearing agency registered under the provisions of Section 17A of the
Securities Exchange Act.
DTC holds securities that its direct participants deposit with DTC. DTC also
facilitates the settlement among direct participants of securities
transactions, in deposited securities through electronic computerized book-
entry changes in the direct participant's accounts. This eliminates the need
for physical movement of securities certificates. Direct participants include
securities brokers and dealers, banks, trust companies, clearing corporations
and certain other organizations. DTC is owned by a number of its direct
participants and by the New York Stock Exchange, Inc., the American Stock
Exchange, Inc. and the National Association of Securities Dealers, Inc. Access
to DTC's book-entry system is also available to indirect participants such as
securities brokers and dealers, banks and trust companies that clear through or
maintain a custodial relationship with a direct participant. The rules
applicable to DTC and its direct and indirect participants are on file with the
SEC.
Principal and interest payments on global securities registered in the name
of DTC's nominee will be made in immediately available funds to DTC's nominee
as the registered owner of the global securities. We and the trustee will treat
DTC's nominee as the owner of the global securities for all other purposes as
well. Accordingly, we, the trustee and any paying agent will have no direct
responsibility or liability to pay amounts due on the global securities to
owners of beneficial interests in the global securities. It is DTC's current
practice, upon receipt of any payment of principal or interest, to credit
direct participants' accounts on the payment date according to their respective
holdings of beneficial interests in the global securities. These payments will
be the responsibility of the direct and indirect participants and not of DTC,
the trustee or us.
Debt securities represented by a global security will be exchangeable for
debt securities in definitive form of like amount and terms in authorized
denominations only if:
. DTC notifies us that it is unwilling or unable to continue as
depositary;
. DTC ceases to be a registered clearing agency and a successor depositary
is not appointed by us within 90 days; or
. we determine not to require all of the debt securities of a series to be
represented by a global security and notify the trustee of our decision.
Merger
We generally may consolidate with, or sell, lease or convey all or
substantially all of our assets to, or merge with or into, any other
corporation if:
. we are the continuing corporation; or
. we are not the continuing corporation, the successor corporation,
expressly assumes all payments on all the debt securities and the
performance and observance of all the covenants and conditions of the
applicable indenture; and
5
. neither we nor the successor corporation is in default immediately after
the transaction under the applicable indenture.
Events of default, notice and waiver
Senior indenture. The senior indenture provides that the following are
events of default with respect to any series of senior debt securities:
. default for 30 days in the payment of any interest on any debt security
of that series;
. default in the payment of the principal of or premium, if any, on any
debt security of that series at its maturity;
. default in making a sinking fund payment required for any debt security
of that series;
. default in the performance of any of our other covenants in the senior
indenture that continues for 60 days after written notice, other than
default in a covenant included in the senior indenture solely for the
benefit of another series of senior debt securities;
. the acceleration of the maturity of more than $25,000,000 in the
aggregate of any of our other indebtedness, where that indebtedness is
not discharged or that acceleration is not rescinded or annulled;
. certain events of bankruptcy, insolvency or reorganization of us or our
property; and
. any other event of default provided with respect to a particular series
of debt securities.
The senior trustee generally may withhold notice to the holders of any
series of debt securities of any default with respect to that series if it
considers the withholding to be in the interest of those holders. However, the
senior trustee may not withhold notice of any default in the payment of the
principal of, or premium, if any, or interest on any debt security of that
series or in the payment of any sinking fund installment in respect of any debt
security of that series.
If an event of default with respect to any series of senior debt securities
occurs and is continuing, the senior trustee or the holders of not less than
25% in principal amount of the outstanding debt securities of that series may
declare the principal amount of all of the debt securities of that series
immediately due and payable. Subject to certain conditions, the holders of a
majority in principal amount of outstanding debt securities of that series may
rescind and annul that acceleration. However, they may only do so if all events
of default, other than the non-payment of accelerated principal or specified
portion of accelerated principal, with respect to debt securities of that
series have been cured or waived.
Holders of a majority in principal amount of any series of outstanding
senior debt securities may, subject to some limitations, waive any past default
with respect to that series and the consequences of the default. The prospectus
supplement relating to any series of senior debt securities which are original
issue discount securities will describe the particular provisions relating to
acceleration of a portion of the principal amount of those original issue
discount securities upon the occurrence and continuation of an event of
default. Within 120 days after the close of each fiscal year, we must file with
the senior trustee a statement, signed by specified of our officers, stating
whether those officers have knowledge of any default under the senior
indenture.
Except with respect to its duties in case of default, the senior trustee is
not obligated to exercise any of its rights or powers at the request or
direction of any holders of any series of outstanding senior debt securities,
unless those holders have offered the senior trustee reasonable security or
indemnity. Subject to those indemnification provisions and limitations
contained in the senior indenture, the holders of a majority in principal
amount of any series of the outstanding debt securities issued thereunder may
direct any proceeding for any remedy available to the senior trustee, or the
exercising of any of the senior trustee's trusts or powers.
6
Subordinated indenture. The subordinated indenture provides that the
following are events of default with respect to any series of subordinated debt
securities:
. default for 30 days in the payment of any interest on any debt security
of that series;
. default in the payment of the principal of or premium, if any, on any
debt security of that series at its maturity;
. default in making a sinking fund payment required for any debt security
of that series;
. any default in the performance of any of our other covenants in the
subordinated indenture that continues for 60 days after written notice,
other than default in a covenant included in the subordinated indenture
solely for the benefit of another series of subordinated debt
securities;
. the acceleration of more than $25,000,000, where that indebtedness is
not discharged or that acceleration is not rescinded or annulled;
. certain events relating to the bankruptcy, insolvency or reorganization
of us or our property; and
. any other event of default provided with respect to a particular series
of debt securities.
The subordinated trustee generally may withhold notice to the holders of any
series of subordinated debt securities of any default with respect to that
series if it considers the withholding to be in the interest of the holders.
However, the subordinated trustee may not withhold notice of any default in the
payment of the principal of or premium, if any or interest on any debt security
of that series or in the payment of any sinking fund installment in respect of
any debt security of that series.
If an event of default with respect to any series of subordinated debt
securities occurs and is continuing, the subordinated trustee or the holders of
not less than 25% in principal amount of the outstanding debt securities of
that series may declare the principal amount of all of the debt securities of
that series immediately due and payable. Subject to certain conditions, the
holders of a majority in principal amount of outstanding debt securities of
that series may rescind and annul that acceleration. However, they may only do
so if all events of default with respect to debt securities of that series have
been cured or waived. Holders of a majority in principal amount of any series
of the outstanding subordinated debt securities may, subject to some
limitations, waive any past default with respect to that series and the
consequences of the default. The prospectus supplement relating to any series
of subordinated debt securities which are original issue discount securities
will describe the particular provisions relating to acceleration of a portion
of the principal amount of those original issue discount securities upon the
occurrence and continuation of an event of default. Within 120 days after the
close of each fiscal year, we must file with the subordinated trustee a
statement, signed by specified officers of us, stating whether such officers
have knowledge of any default under the subordinated indenture.
Except with respect to its duties in case of default, the subordinated
trustee is not obligated to exercise any of its rights or powers at the request
or direction of any holders of any series of outstanding subordinated debt
securities, unless those holders have offered the subordinated trustee
reasonable security or indemnity. Subject to those indemnification provisions
and limitations contained in the subordinated indenture, the holders of a
majority in principal amount of any series of the outstanding subordinated debt
securities may direct any proceeding for any remedy available to the
subordinated trustee, or the exercising of any of the subordinated trustee's
trusts or powers.
Modification of the indentures
Senior indenture. Modifications and amendments of the senior indenture may
be made only, subject to some exceptions, with the consent of the holders of a
majority in aggregate principal amount of all outstanding debt securities under
the senior indenture which are affected by the modification or amendment.
However, the
7
holder of each affected senior debt security must consent to any modification
or amendment of the senior indenture that:
. changes the stated maturity of the principal of, or the premium, if any,
or any installment of interest on, that debt security;
. reduces the principal amount of, or the rate or amount of interest on,
or any premium payable on redemption of, that debt security;
. reduces the amount of principal of an original issue discount security
that would be due and payable upon declaration of acceleration of its
maturity or would be provable in bankruptcy;
. adversely affects any right of repayment of the holder of that debt
security;
. changes the place of payment where, or the currency in which, any
payment on that debt security is payable;
. impairs the right to institute suit to enforce any payment on or with
respect to that debt security; or
. reduces the percentage of outstanding debt securities of any series
necessary to modify or amend the senior indenture or to waive compliance
with some of its provisions or defaults and their consequences.
We and the senior trustee may amend the senior indenture without the consent
of the holders of any senior debt securities in certain limited circumstances,
such as:
. to evidence the succession of another entity to us and the assumption by
the successor of our covenants contained in the senior indenture;
. to secure the securities; and
. to cure any ambiguity, to correct or supplement any provision in the
senior indenture which may be inconsistent with any other provision of
the senior indenture.
Subordinated indenture. Modifications and amendments to the subordinated
indenture may be made only, subject to some exceptions, with the consent of the
holders of a majority in aggregate principal amount of all outstanding debt
securities under the subordinated indenture which are affected by the
modification or amendment. However, the holder of each affected subordinated
debt security must consent to any modification or amendment of the subordinated
indenture that:
. changes the stated maturity of the principal of, or the premium, if any,
or any installment of interest on, that debt security;
. reduces the principal amount of, or the rate or amount of interest on,
or any premium payable on redemption of, that debt security;
. reduces the amount of principal of an original issue discount security
that would be due and payable upon declaration of acceleration of its
maturity or would be provable in bankruptcy;
. adversely affects any right of the repayment of the holder of that debt
security;
. changes the place of payment where, or the currency in which, any
payment on that debt security is payable;
. impairs the right to institute suit to enforce any payment on or with
respect to that debt security;
. reduces the percentage of outstanding debt securities of any series
necessary to modify or amend the subordinated indenture or to waive
compliance with some of its provisions or defaults and their
consequences; or
. subordinates the indebtedness evidenced by that debt security to any of
our indebtedness other than senior indebtedness.
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We and the subordinated trustee also may amend the subordinated indenture
without the consent of the holders of any subordinated securities in certain
limited circumstances, such as:
. to evidence the succession of another entity to us and the assumption by
the successor of our covenants contained in the subordinated indenture;
. to secure the securities; and
. to cure any ambiguity, to correct or supplement any provision in the
subordinated indenture which may be inconsistent with any other
provision of the subordinated indenture.
Defeasance and covenant defeasance
When we establish a series of debt securities, we may provide that that
series is subject to the defeasance and discharge provisions of the applicable
indenture. If those provisions are made applicable, we may elect either:
. to defease and be discharged from, subject to some limitations, all of
our obligations with respect to those debt securities; or
. to be released from our obligations to comply with specified covenants
relating to those debt securities as described in the applicable
prospectus supplement.
To effect that defeasance or covenant defeasance, we must irrevocably
deposit in trust with the relevant trustee an amount in any combination of
funds or government obligations, which, through the payment of principal and
interest in accordance with their terms, will provide money sufficient to make
payments on those debt securities and any mandatory sinking fund or analogous
payments on those debt securities.
On such a defeasance, we will not be released from obligations:
. to pay additional amounts, if any, upon the occurrence of some events;
. to register the transfer or exchange of those debt securities;
. to replace some of those debt securities;
. to maintain an office relating to those debt securities;
. to hold moneys for payment in trust will not be discharged.
To establish such a trust we must, among other things, deliver to the
relevant trustee an opinion of counsel to the effect that the holders of those
debt securities:
. will not recognize income, gain or loss for U.S. federal income tax
purposes as a result of the defeasance or covenant defeasance; and
. will be subject to U.S. federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if the
defeasance or covenant defeasance had not occurred. In the case of
defeasance, the opinion of counsel must be based upon a ruling of the
IRS or a change in applicable U.S. federal income tax law occurring
after the date of the applicable indenture.
Government obligations mean generally securities which are:
. direct obligations of the U.S. or of the government which issued the
foreign currency in which the debt securities of a particular series are
payable, in each case, where the issuer has pledged its full faith and
credit to pay the obligations; or
. obligations of an agency or instrumentality of the U.S. or of the
government which issued the foreign currency in which the debt
securities of that series are payable, the payment of which is
unconditionally guaranteed as a full faith and credit obligation by the
U.S. or that other government.
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In any case, the issuer of government obligations cannot have the option
to call or redeem the obligations. In addition, government obligations
include, subject to certain qualifications, a depository receipt issued
by a bank or trust company as custodian with respect to any government
obligation or a specific payment of interest on or principal of any such
government obligation held by the custodian for the account of a
depository receipt holder.
If we effect covenant defeasance with respect to any debt securities, the
amount on deposit with the relevant trustee will be sufficient to pay amounts
due on the debt securities at the time of their stated maturity. However,
those debt securities may become due and payable prior to their stated
maturity if there is an event of default with respect to a covenant from which
we have not been released. In that event, the amount on deposit may not be
sufficient to pay all amounts due on the debt securities at the time of the
acceleration.
The applicable prospectus supplement may further describe the provisions,
if any, permitting defeasance or covenant defeasance, including any
modifications to the provisions described above.
Senior debt securities
Senior debt securities are to be issued under the senior indenture. Each
series of senior debt securities will constitute senior indebtedness and will
rank equally with each other series of senior debt securities and other senior
indebtedness. All subordinated debt, including, but not limited to, all
subordinated securities, will be subordinated to the senior debt securities
and other senior indebtedness.
Subordination of subordinated securities
Subordinated indenture. Payments on the subordinated securities will be
subordinated to our senior indebtedness, whether outstanding on the date of
the subordinated indenture or incurred after that date. At September 30, 1999,
our aggregate senior indebtedness was approximately $3.019 billion. The
applicable prospectus supplement for each issuance of subordinated securities
will specify the aggregate amount of our outstanding indebtedness as of the
most recent practicable date that would rank senior to and equally with the
offered subordinated securities.
Ranking. No class of subordinated securities is subordinated to any other
class of subordinated debt securities. See "Subordination provisions" below.
Subordination provisions. If any of certain specified events occur, the
holders of senior indebtedness must receive payment of the full amount due on
the senior indebtedness, or that payment must be duly provided for, before we
may make payments on the subordinated securities. These events are:
. any distribution of our assets upon our liquidation, reorganization or
other similar transaction except for a distribution in connection with a
merger or other transaction complying with the covenant described above
under "Merger";
. the occurrence and continuation of a payment default on any senior
indebtedness; or
. a declaration of the principal of any series of the subordinated
securities, or, in the case of original issue discount securities, the
portion of the principal amount specified under their terms, as due and
payable, that has not been rescinded and annulled.
However, if the event is the acceleration of any series of subordinated
securities, only the holders of senior indebtedness outstanding at the time of
the acceleration of those subordinated securities, or, in the case of
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original issue discount securities, that portion of the principal amount
specified under their terms, must receive payment of the full amount due on
that senior indebtedness, or such payment must be duly provided for, before we
make payments on the subordinated securities.
As a result of the subordination provisions, some of our general creditors,
including holders of senior indebtedness, may recover more, ratably, than the
holders of the subordinated securities in the event of insolvency.
Definition of senior indebtedness
Senior indebtedness means the following indebtedness or obligations:
. the principal of and premium, if any, and unpaid interest on
indebtedness for money borrowed;
. purchase money and similar obligations;
. obligations under capital leases;
. guarantees, assumptions or purchase commitments relating to, or other
transactions as a result of which we are responsible for the payment of,
the indebtedness of others;
. renewals, extensions and refunding of that indebtedness;
. interest or obligations in respect of the indebtedness accruing after
the commencement of any insolvency or bankruptcy proceedings; and
. obligations associated with derivative products.
However, indebtedness or obligations are not senior indebtedness if the
instrument by which we become obligated for that indebtedness or those
obligations expressly provides that that indebtedness or those obligations are
junior in right of payment to any other of our indebtedness or obligations.
Convertible debt securities
Unless otherwise provided in the applicable prospectus supplement, the
following provisions will apply to debt securities that will be convertible
into common stock or preferred stock.
Conversion. The holder of unredeemed convertible debt securities may, at any
time during the period specified in the applicable prospectus supplement,
convert those convertible debt securities into shares of common stock or
preferred stock. The conversion price or rate for each $1,000 principal amount
of convertible debt securities will be specified in the applicable prospectus
supplement. The holder of a convertible debt security may convert a portion of
the convertible debt security which is $1,000 principal amount or any multiple
of $1,000. In the case of convertible debt securities called for redemption,
conversion rights will expire at the close of business on the date fixed for
the redemption. However, in the case of repayment at the option of the
applicable holder, conversion rights will terminate upon receipt of written
notice of the holder's exercise of that option.
In certain events, the conversion price or rate will be subject to
adjustment as specified in the applicable indenture. For debt securities
convertible into common stock, those events include:
. the issuance of shares of common stock as a dividend;
. subdivisions and combinations of common stock;
. the issuance to all holders of common stock of rights or warrants
entitling such holders for a period not exceeding 45 days to subscribe
for or purchase shares of common stock at a price per share less than
its current per share market price; and
11
. the distribution to all holders of common stock of:
(1) shares of our capital stock, other than common stock;
(2) evidences of our indebtedness or assets excluding cash dividends or
distributions paid from our retained earnings; or
(3) subscription rights or warrants other than those referred to above.
No adjustment of the conversion price or rate will be required in any of
these cases unless an adjustment would require a cumulative increase or
decrease of at least 1% in that price or rate. Fractional shares of common
stock will not be issued upon conversion. In place of fractional shares, we
will pay a cash adjustment. Unless otherwise specified in the applicable
prospectus supplement, convertible debt securities convertible into common
stock surrendered for conversion between any record date for an interest
payment and the related interest payment date must be accompanied by payment of
an amount equal to the interest payment on the surrendered convertible debt
security. However, that payment does not have to accompany convertible debt
securities surrendered for conversion if those convertible debt securities have
been called for redemption during that period.
The adjustment provisions for debt securities convertible into shares of
preferred stock will be determined at the time of an issuance of debt
securities and will be described in the applicable prospectus supplement.
Description of Preferred Stock
This section describes the general terms and provisions of our preferred
stock. The applicable prospectus supplement will describe the specific terms of
the preferred stock offered through that prospectus supplement as well as any
general terms described in this section that will not apply to those shares of
preferred stock.
We have summarized certain selected terms of the preferred stock in this
section. The summary is not complete. You should read our restated certificate
of incorporation that is an exhibit to our annual report on Form 10-K and the
certificate of designation relating to the applicable series of the preferred
stock that we will file with the SEC for additional information before you buy
any preferred stock.
General
Our restated certificate of incorporation and Delaware General Corporation
Law give our board of directors the authority, without further stockholder
action, to issue a maximum of 10,000,000 shares of preferred stock. The board
of directors has the authority to fix the following terms with respect to
shares of any series of preferred stock:
. the designation of the series;
. the number of shares to comprise the series;
. the dividend rate or rates payable with respect to the shares of the
series;
. the redemption price or prices, if any, and the terms and conditions of
any redemption;
. the voting rights;
. any sinking fund provisions for the redemption or purchase of the shares
of the series;
. the terms and conditions upon which the shares are convertible or
exchangeable, if they are convertible or exchangeable; and
. any other relative rights, preferences and limitations pertaining to the
series.
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The preferred stock will have the rights described in this section unless
the applicable prospectus supplement provides otherwise. You should read the
prospectus supplement relating to the particular series of the preferred stock
it offers for specific terms, including:
. the designation, stated value and liquidation preference of that series
of the preferred stock and the number of shares offered;
. the initial public offering price at which the shares will be issued;
. the dividend rate or rates or method of calculation of dividends, the
dividend periods, the date or dates on which dividends will be payable
and whether such dividends will be cumulative or noncumulative and, if
cumulative, the dates from which dividends shall commence to cumulate;
. any redemption or sinking fund provisions;
. any conversion or exchange provisions;
. the procedures for any auction and remarketing, if any, of that series
of preferred stock;
. whether interests in that series of preferred stock will be represented
by our depositary shares; and
. any additional dividend, liquidation, redemption, sinking fund and other
rights, preferences, privileges, limitations and restrictions of that
series of preferred stock.
When we issue shares of preferred stock against payment for the shares, they
will be fully paid and nonassessable. This means that the full purchase price
for those shares will have been paid and the holders of those shares will not
be assessed any additional monies for those shares. Holders of preferred stock
will have no preemptive rights to subscribe for any additional securities that
we may issue.
Because we are a holding company, our rights and the rights of holders of
our securities, including the holders of preferred stock, to participate in the
distribution of assets of any subsidiary of ours upon its liquidation or
recapitalization will be subject to the prior claims of its creditors and
preferred stockholders. We will not be structurally subordinated to the extent
we are a creditor with recognized claims against the subsidiary or are a holder
of preferred stock of the subsidiary.
Dividends
The holders of the preferred stock will be entitled to receive dividends, if
declared by our board of directors out of our assets that we can legally use to
pay dividends. The prospectus supplement relating to a particular series of
preferred stock will describe the dividend rates and dates on which dividends
will be payable. The rates may be fixed or variable or both. If the dividend
rate is variable, the applicable prospectus supplement will describe the
formula used for determining the dividend rate for each dividend period. We
will pay dividends to the holders of record as they appear on our stock books
on the record dates fixed by our board of directors. The applicable prospectus
supplement will specify whether dividends will be paid in the form of cash,
preferred stock or common stock.
The applicable prospectus supplement will also state whether dividends on
any series of preferred stock are cumulative or noncumulative. If our board of
directors does not declare a dividend payable on a dividend payment date on any
noncumulative series of preferred stock, then the holders of that series will
not be entitled to receive a dividend for that dividend period. In those
circumstances, we will not be obligated to pay the dividend accrued for that
period, whether or not dividends on such preferred stock are declared or paid
on any future dividend payment dates.
Our board of directors may not declare and pay a dividend on any of our
stock ranking, as to dividends, equal with or junior to any series of preferred
stock unless full dividends on that series have been declared and
13
paid, or declared and sufficient money is set aside for payment. Until either
full dividends are paid, or are declared and payment is set aside, on preferred
stock ranking equal as to dividends, then:
. we will declare any dividends pro rata among the preferred stock of each
series and any preferred stock ranking equal to the preferred stock as
to dividends; in other words, the dividends we declare per share on each
series of such preferred stock will bear the same relationship to each
other that the full accrued dividends per share on each such series of
the preferred stock bear to each other;
. other than such pro rata dividends, we will not declare or pay any
dividends or declare or make any distributions upon any security ranking
junior to or equal with the preferred stock as to dividends or upon
liquidation, except dividends or distributions paid for with securities
ranking junior to the preferred stock as to dividends and upon
liquidation; and
. we will not redeem, purchase or otherwise acquire or set aside money for
a sinking fund for any securities ranking junior to or equal with the
preferred stock as to dividends or upon liquidation except by conversion
into or exchange for stock junior to the preferred stock as to dividends
and upon liquidation.
We will not owe any interest, or any money in lieu of interest, on any
dividend payment(s) on any series of the preferred stock which may be past due.
Redemption
Preferred stock may be redeemable, in whole or in part, at our option, and
may be subject to mandatory redemption through a sinking fund or otherwise, as
described in the applicable prospectus supplement. Redeemed preferred stock
will become authorized but unissued shares of preferred stock that we may issue
in the future.
If a series of preferred stock is subject to mandatory redemption, the
applicable prospectus supplement will specify the number of shares that we will
redeem each year and the redemption price. If preferred stock is redeemed, we
will pay all accrued and unpaid dividends on those shares to, but excluding,
the redemption date. In the case of any noncumulative series of preferred
stock, accrued and unpaid dividends will not include any accumulation of
dividends for prior dividend periods. The applicable prospectus supplement will
also specify whether we will pay the redemption price in cash or other
property. If the redemption price for preferred stock of any series is payable
only from the net proceeds of the issuance of our capital stock, the terms of
that preferred stock may provide for its automatic conversion upon the
occurrence of certain events. These events include if no capital stock has been
issued or if the net proceeds from any issuance are insufficient to pay in full
the aggregate redemption price then due.
If fewer than all of the outstanding shares of any series of the preferred
stock are to be redeemed, our board of directors will determine the number of
shares to be redeemed. We may redeem the shares pro rata from the holders of
record in proportion to the number of shares held by them, with adjustments to
avoid redemption of fractional shares, or by lot in a manner determined by our
board of directors.
Even though the terms of a series of preferred stock may permit redemption
of shares of preferred stock in whole or in part, if any dividends, including
accumulated dividends, on that series are past due:
. we will not redeem any preferred stock of that series unless we
simultaneously redeem all outstanding shares of preferred stock of that
series; and
. we will not purchase or otherwise acquire any preferred stock of that
series.
The prohibition discussed in the prior sentence will not prohibit us from
purchasing or acquiring preferred stock of that series through a purchase or
exchange offer if we make the offer on the same terms to all holders of that
series.
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Unless the applicable prospectus supplement specifies otherwise, we will
give notice of a redemption by mailing a notice to each record holder of the
shares to be redeemed, between 30 to 60 days prior to the date fixed for
redemption. We will mail the notices to the holders' addresses as they appear
on our stock records. Each notice will state:
. the redemption date;
. the number of shares and the series of the preferred stock to be
redeemed;
. the redemption price;
. the place or places where holders can surrender the certificates for the
preferred stock for payment of the redemption price;
. that dividends on the shares to be redeemed will cease to accrue on the
redemption date; and
. the date when the holders' conversion rights, if any, will terminate.
If we redeem fewer than all shares of any series of the preferred stock held
by any holder, we will also specify the number of shares to be redeemed from
the holder in the notice.
If we have given notice of the redemption and have provided the funds for
the payment of the redemption price, then beginning on the redemption date:
. the dividends on the preferred stock called for redemption will no
longer accrue;
. such shares will no longer be considered outstanding; and
. the holders will no longer have any rights as stockholders except to
receive the redemption price.
When the holders of these shares surrender the certificates representing
these shares, in accordance with the notice, the redemption price described
above will be paid out of the funds we provide. If fewer than all the shares
represented by any certificate are redeemed, a new certificate will be issued
representing the unredeemed shares without cost to the holder of those shares.
Conversion or exchange rights
The prospectus supplement relating to a series of preferred stock that is
convertible or exchangeable will state the terms on which shares of that series
are convertible or exchangeable into common stock, another series of preferred
stock or debt securities.
Rights upon liquidation
Unless the applicable prospectus supplement states otherwise, if we
liquidate, dissolve or wind up our business, the holders of shares of each
series of the preferred stock will be entitled to receive:
. liquidation distributions in the amount stated in the applicable
prospectus supplement; and
. all accrued and unpaid dividends whether or not earned or declared.
We will pay these amounts to the holders of shares of each series of the
preferred stock, and all amounts owing on any preferred stock ranking equally
with that series of preferred stock as to liquidating distributions, out of our
assets available for distribution to stockholders. These payments will be made
before any distribution is made to holders of any securities ranking junior to
the series of preferred stock upon liquidation.
If we liquidate, dissolve or wind up our business and the assets available
for distribution to the holders of the preferred stock of any series and any
other shares of our stock ranking equal with that series as to liquidating
distributions are insufficient to pay all amounts to which the holders are
entitled, then we will only
15
make pro rata distributions to the holders of all shares ranking equal as to
liquidating distributions. This means that the distributions we pay to these
holders will bear the same relationship to each other that the full
distributable amounts for which these holders are respectively entitled upon
liquidation of our business bear to each other.
After we pay the full amount of the liquidation distribution to which the
holders of a series of the preferred stock are entitled, those holders will
have no right or claim to any of our remaining assets.
Voting rights
Except as indicated below or in the applicable prospectus supplement, or
except as expressly required by applicable law, the holders of preferred stock
will not be entitled to vote.
If we fail to pay dividends on any shares of preferred stock for six
consecutive quarterly periods, the holders of those shares of preferred stock,
voting separately as a class with all other series of preferred stock upon
which the same voting rights have been conferred and are exercisable, will be
entitled to vote for the election of two additional directors to the board of
directors. This may be done at a special meeting called by the holders of
record of at least 10% of those shares of preferred stock or the next annual
meeting of stockholders and at each subsequent meeting until:
. in the case of a series of preferred stock with cumulative dividends,
all dividends accumulated on that series of preferred stock for the past
dividend periods and the then current dividend period have been fully
paid or declared and a sum sufficient for the payment of these dividends
has been set aside for payment; or
. in the case of a series of noncumulative preferred stock, four
consecutive quarterly dividends on that series of noncumulative
preferred stock have been fully paid or declared and a sum sufficient
for the payment of these dividends has been set aside for payment.
In this case, the entire board of directors will be increased by two
directors.
So long as any shares of preferred stock remain outstanding, unless we
receive the consent of the holders of any outstanding series of preferred stock
as specified below, we will not:
. authorize, issue or increase the authorized amount of, any capital stock
ranking prior to the outstanding series of preferred stock as to
dividends or liquidating distributions;
. reclassify any capital stock into any shares with this kind of prior
ranking;
. authorize or issue any obligation or security that represents the right
to purchase any capital stock with this kind of prior ranking; or
. amend or alter the provisions of our restated certificate of
incorporation, so as to materially and adversely affect any right,
preference, privilege or voting power of that series of preferred stock
or the holders of that series of preferred stock.
This consent must be given by the holders of at least two-thirds of each
series of all outstanding preferred stock described in the preceding sentence,
voting separately as a class. We will not be required to obtain this consent
with respect to the actions relating to changes to our restated certificate of
incorporation, however, if we only:
. increase the amount of the authorized preferred stock or any outstanding
series of preferred stock or any of our other capital stock; or
. create and issue another series of preferred stock or any other capital
stock; and
. in either case, this preferred stock ranks equal with or junior to the
outstanding preferred stock as to dividends and liquidating
distributions.
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Description of Depositary Shares
This section describes the general terms and provisions of shares of
preferred stock represented by depositary shares. The applicable prospectus
supplement will describe the specific terms of the depositary shares offered
through that prospectus supplement and any general terms outlined in this
section that will not apply to those depositary shares.
We have summarized in this section certain terms and provisions of the
deposit agreement, the depositary shares and the receipts representing
depositary shares. The summary is not complete. You should read the forms of
deposit agreement and depositary receipt that we have filed with the SEC for
additional information before you buy any depositary shares that represent
preferred stock of that series.
General
We may issue depositary receipts evidencing the depositary shares. Each
depositary share will represent a fraction of a share of preferred stock.
Shares of preferred stock of each class or series represented by depositary
shares will be deposited under a separate deposit agreement among us, the
preferred stock depositary and the holders of the depositary receipts. Subject
to the terms of the deposit agreement, each owner of a depositary receipt will
be entitled, in proportion to the fraction of a share of preferred stock
represented by the depositary shares evidenced by that depositary receipt, to
all the rights and preferences of the preferred stock represented by those
depositary shares. Those rights include any dividend, voting, conversion,
redemption and liquidation rights. Immediately following our issuance and
delivery of the preferred stock to the preferred stock depositary, we will
cause the preferred stock depositary to issue the depositary receipts on our
behalf.
Dividends and other distributions
The preferred stock depositary will distribute all dividends or other cash
distributions received in respect of the preferred stock to the record holders
of depositary receipts in proportion to the number of depositary receipts owned
by those holders.
If there is a distribution other than in cash, the preferred stock
depositary will distribute property it receives to the entitled record holders
of depositary receipts. However, if the preferred stock depositary determines
that it is not feasible to make that distribution, the preferred stock
depositary may, with our approval, sell the property and distribute the net
proceeds from this sale to the holders of depositary shares.
Withdrawal of stock
If a holder of depositary receipts surrenders the depositary receipts at the
corporate trust office of the preferred stock depositary, the holder will be
entitled to receive the number of shares of the preferred stock and any money
or other property represented by those depositary shares. However, the holder
will not be entitled to receive these shares and related assets if the related
depositary shares have previously been called for redemption or converted or
exchanged into other securities of our company. Holders of depositary receipts
will be entitled to receive whole or fractional shares of the preferred stock
on the basis of the proportion of preferred stock represented by each
depositary share specified in the applicable prospectus supplement. Holders of
shares of preferred stock received in exchange for depositary shares will no
longer be entitled to receive depositary shares in exchange for shares of
preferred stock. If the holder delivers depositary receipts evidencing a number
of depositary shares that is more than the number of depositary shares
representing the number of shares of preferred stock to be withdrawn, the
preferred stock depositary will issue the holder a new depositary receipt
evidencing this excess number of depositary shares at the same time.
Redemption of depositary shares
Whenever we redeem shares of preferred stock held by the preferred stock
depositary, the preferred stock depositary will redeem as of that redemption
date the number of depositary shares representing shares of the
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preferred stock so redeemed. However, we must have paid in full the redemption
price of the preferred stock to be redeemed plus any accrued and unpaid
dividends on the preferred stock to the preferred stock depositary.
The redemption price per depositary share will be equal to the redemption
price and any other amounts per share payable with respect to the preferred
stock. If fewer than all the depositary shares are to be redeemed, the
depositary shares to be redeemed will be selected by the preferred stock
depositary pro rata or by lot or another equitable method. In each case, we
will determine the method for selecting the depositary shares.
After the date fixed for redemption, the depositary shares called for
redemption will no longer be outstanding. When the depositary shares are no
longer outstanding, all rights of the holders of the related depositary
receipts will cease, except the right to receive money or other property that
the holders of the depositary receipts were entitled to receive upon such
redemption. These payments will be made when the holders surrender their
depositary receipts to the preferred stock depositary.
Voting the preferred stock
Upon receipt of notice of any meeting at which the holders of the preferred
stock are entitled to vote, the preferred stock depositary will mail
information about the meeting contained in the notice to the record holders of
the depositary shares representing such preferred stock. Each record holder of
depositary shares on the record date will be entitled to instruct the preferred
stock depositary as to how the preferred stock underlying the holder's
depositary shares will be voted. The record date for the depositary shares will
be the same as the record date for the preferred stock.
The preferred stock depositary will vote the amount of preferred stock
represented by the depositary shares according to these instructions. We will
agree to take all reasonable action deemed necessary by the preferred stock
depositary in order to enable the preferred stock depositary to vote the
preferred stock in that manner. The preferred stock depositary will not vote
shares of preferred stock for which it does not receive specific instructions
from the holders of depositary shares representing that preferred stock. The
preferred stock depositary will not be responsible for any failure to carry out
any voting instruction, or for the manner or effect of any vote, as long as its
action or inaction is in good faith and does not result from its negligence or
willful misconduct.
Exchange of preferred stock
Whenever we exchange all of the shares of preferred stock held by the
preferred stock depositary for debt securities or common stock, the preferred
stock depositary will exchange as of that exchange date all depositary shares
representing all of the shares of the preferred stock exchanged for debt
securities or common stock. However, we must have issued and deposited with the
preferred stock depositary debt securities or common stock for all of the
shares of the preferred stock to be exchanged.
The exchange rate per depositary share will be equal to the exchange rate
per share of preferred stock, multiplied by the fraction of a share of
preferred stock represented by one depositary share, plus all money and other
property, if any, represented by such depositary shares, including all accrued
and unpaid dividends on the shares of preferred stock.
Conversion of preferred stock
The depositary shares, as such, are not convertible or exchangeable into
common stock or any of our other securities or property. Nevertheless, the
prospectus supplement relating to an offering of depositary shares may provide
that the holders of depositary receipts may surrender their depositary receipts
to the preferred stock depositary with written instructions to the preferred
stock depositary to instruct us to cause the conversion or exchange of the
preferred stock represented by these depositary shares. We have agreed that
upon receipt of
18
these instructions and any related amounts payable we will cause the requested
conversion or exchange. If the depositary shares are to be converted or
exchanged in part only, a new depositary receipt or receipts will be issued for
any depositary shares not to be converted or exchanged.
Amendment and termination of the deposit agreement
The form of depositary receipt evidencing the depositary shares and any
provision of the deposit agreement may be amended by agreement between us and
the preferred stock depositary. However, any amendment that materially and
adversely alters the rights of the holders of depositary shares or that would
be materially and adversely inconsistent with the rights granted to the holders
of the related preferred stock requires the approval of the holders of at least
two thirds of the depositary shares then outstanding.
We may terminate the deposit agreement upon not less than 60 days' notice if
holders of a majority of the depository shares then outstanding consent. If we
terminate the deposit agreement, the preferred stock depositary will deliver or
make available to each holder of depositary receipts that surrenders the
depositary receipts it holds, the number of whole or fractional shares of
preferred stock represented by the depositary shares evidenced by these
depositary receipts.
In addition, the deposit agreement will automatically terminate if:
. all outstanding depositary shares are redeemed, converted or exchanged;
or
. there is a final distribution in respect of the related preferred stock
in connection with any liquidation of our business and the distribution
has been distributed to the holders of the related depositary receipts.
Charges of preferred stock depositary
We will pay all transfer and other taxes and governmental charges arising
solely from the existence of the deposit agreement. In addition, we will pay
the fees and expenses of the preferred stock depositary in connection with the
performance of its duties under the deposit agreement. Holders of depositary
receipts will pay transfer and other taxes and governmental charges and any
other charges that are stated to be their responsibility in the deposit
agreement.
Resignation and removal of depositary
The preferred stock depositary may resign at any time by delivering notice
to us. We also may remove the preferred stock depositary at any time.
Resignations or removals will take effect upon the appointment of a successor
preferred stock depositary. This successor must be appointed within 60 days
after delivery of the notice of resignation or removal and must be a bank or
trust company having its principal office in the United States and having a
combined capital and surplus of at least $50,000,000.
Miscellaneous
The preferred stock depositary will forward to holders of depositary
receipts any reports and communications that we send to the preferred stock
depositary with respect to the related preferred stock.
Neither we nor the preferred stock depositary will be liable if it is
prevented or delayed, by law or any circumstances beyond its control in
performing its obligations under the deposit agreement. Our obligations and the
preferred stock depositary's obligations under the deposit agreement will be
limited to performance in good faith and without negligence or willful
misconduct of the duties described in the deposit agreement. Neither we nor the
preferred stock depositary will be obligated to prosecute or defend any legal
proceeding relating to any depositary receipts, depositary shares or shares of
preferred stock unless satisfactory indemnity is furnished. We and the
preferred stock depositary may rely on written advice of counsel or
accountants, or information
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provided by persons presenting shares of preferred stock for deposit, holders
of depositary receipts or other persons believed to be competent and authorized
to this information and on documents believed to be genuine.
If the preferred stock depositary receives conflicting claims, requests or
instructions from any holders of depositary receipts, on the one hand, and us,
on the other hand, the preferred stock depositary will be entitled to act on
the claims, requests or instructions received from us.
Description of Common Stock
We may issue, either separately or together with other securities, shares of
our common stock. Under our restated certificate of incorporation, we are
authorized to issue up to 1,500,000,000 shares of our common stock. A
prospectus supplement relating to an offering of common stock, or other
securities convertible or exchangeable for, or exercisable into, common stock,
will describe the relevant terms, including the number of shares offered, any
initial offering price, and market price and dividend information, as well as,
if applicable, information on other related securities. See "Description of
Outstanding Capital Stock" below.
Description of Outstanding Capital Stock
We have summarized some of the terms and provisions of our outstanding
capital stock in this section. The summary is not complete. We have also filed
our restated certificate of incorporation, our by-laws and the certificate of
designation relating to the Series A preferred stock as exhibits to our annual
report on Form 10-K. You should read our restated certificate of incorporation
and our by-laws and the certificate of designation relating to the Series A
preferred stock for additional information before you purchase any of our
capital stock.
As of October 29, 1999, our authorized capital stock was 1,518,500,000
shares. Those shares consisted of:
. 1,500,000,000 shares of common stock, par value $.01 per share;
. 10,000,000 shares of preferred stock, par value $.01 per share; and
. 8,500,000 shares of Class R convertible common stock, par value
$.01 per share.
As of October 29, 1999 there were 341,076,021 shares of common stock, no shares
of preferred stock and no shares of Class R convertible common stock
outstanding.
Common stock
Subject to the senior rights of preferred stock which may from time to time
be outstanding, holders of common stock are entitled to receive dividends
declared by the board of directors out of funds legally available for their
payment. Upon dissolution and liquidation of our business, holders of common
stock are entitled to a ratable share of our net assets remaining after payment
to the holders of the preferred stock of the full preferential amounts they are
entitled to. All outstanding shares of common stock are fully paid and
nonassessable.
The holders of common stock are entitled to one vote per share for the
election of directors and on all other matters submitted to a vote of
stockholders. Holders of common stock are not entitled to cumulative voting
for the election of directors. They are not entitled to preemptive rights.
The transfer agent and registrar for the common stock is Norwest Bank
Minnesota, N.A.
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Preferred stock
The preferred stock has priority over the common stock with respect to
dividends and to other distributions, including the distribution of assets upon
liquidation. The board of directors is authorized to fix and determine the
terms, limitations and relative rights and preferences of the preferred stock,
to establish series of preferred stock and to fix and determine the variations
as among series. The board of directors without stockholder approval could
issue preferred stock with voting and conversion rights which could adversely
affect the voting power of the holders of common stock. The board of directors
has designated 500,000 shares of Series A junior participating preferred stock.
Series A junior participating preferred stock will be issued in units
consisting of one one-thousandth of a share of Series A junior participating
preferred stock. Series A junior participating preferred stock is on a parity
with the common stock with respect to dividends and to other distributions,
including the distribution of assets on liquidation. Quarterly dividends per
unit equal the amount of the quarterly dividend paid per share of common stock,
when, as and if declared by the board of directors. The holders of units are
entitled to one vote per unit, voting together with the common stock on all
matters submitted to the stockholders. As of the date of this prospectus, there
are no outstanding shares of preferred stock.
Anti-takeover provisions
We currently have provisions in our restated certificate of incorporation
and by-laws that could have an anti-takeover effect. The provisions in the
restated certificate of incorporation include:
. a classified board of directors;
. a prohibition on our stockholders taking action by written consent;
. the requirement that special meetings of stockholders be called only by
the board of directors or the chairman of the board; and
. the requirement of the affirmative vote of at least 66-2/3% of our
outstanding shares of stock entitled to vote thereon to adopt, repeal,
alter, amend or rescind our by-laws.
The by-laws contain specific procedural requirements for the nomination of
directors and the introduction of business by a stockholder of record at an
annual meeting of stockholders where such business is not specified in the
notice of meeting or brought by or at the discretion of the board of directors.
In addition to these provisions, the board of directors has adopted a
stockholder's rights plan, under which rights were distributed in a dividend.
These rights entitle the holder to acquire units of Series A junior
participating preferred stock, which is exercisable upon the occurrence of
certain events, including the acquisition by a person or group of a specified
percentage of the common stock.
Plan of Distribution
We may sell the offered securities as follows:
. through agents;
. through underwriters;
. to dealers; or
. directly to one or more purchasers.
By agents
Offered securities may be sold through agents designated by us. Unless
otherwise indicated in a prospectus supplement, the agents will use their best
efforts to solicit purchases for the period of their appointment.
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By underwriters
If underwriters are used in the sale, the offered securities will be
acquired by the underwriters for their own account. The underwriters may
resell the securities in one or more transactions, including negotiated
transactions, at a fixed public offering price or at varying prices determined
at the time of sale. The obligations of the underwriters to purchase the
securities will be subject to certain conditions. The underwriters will be
obligated to purchase all the securities of the series offered if any of the
securities are purchased. Any initial public offering price and any discounts
or concessions allowed or re-allowed or paid to dealers may be changed from
time to time.
To dealers
If a dealer is used in the sale, we will sell the offered securities to the
dealer, as principal. The dealer may then resell those securities to the
public at varying prices to be determined by the dealer at the time of resale.
Direct sales
We may also sell offered securities directly to institutional investors or
others. These sales may include ones made under arrangements with the
investors under which we have the right to require the investors to purchase
the offered securities from us from time to time at prices tied to the market
price for those securities.
Delayed delivery contracts
We may authorize underwriters, dealers and agents to solicit offers by
certain institutional investors to purchase offered securities under contracts
providing for payment and delivery on a future date specified in the
prospectus supplement. The prospectus supplement will also describe the public
offering price for the securities and the commission payable for solicitation
of these delayed delivery contracts. Delayed delivery contracts will contain
definite fixed price and quantity terms. The obligations of a purchaser under
these delayed delivery contracts will be subject to only two conditions:
. that the institution's purchase of the securities at the time of
delivery of the securities is not prohibited under the law of any
jurisdiction to which the institution is subject; and
. that we shall have sold to the underwriters the total principal amount
of the offered securities, less the principal amount covered by the
delayed delivery contracts.
General information
Underwriters, dealers, agents and direct purchasers that participate in the
distribution of the offered securities may be underwriters as defined in the
Securities Act and any discounts or commissions they receive from us and any
profit on the resale of the offered securities by them may be treated as
underwriting discounts and commissions under the Securities Act. Any
underwriters, dealers or agents will be identified and their compensation
described in a prospectus supplement.
We may have agreements with the underwriters, dealers and agents to
indemnify them against certain civil liabilities, including liabilities under
the Securities Act, or to contribute with respect to payments which the
underwriters, dealers or agents may be required to make.
Underwriters, dealers and agents may engage in transactions with, or
perform services for, us or our subsidiaries in the ordinary course of their
businesses.
The place, time of delivery and other terms of the sale of the offered
securities will be described in the prospectus supplement.
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Legal Matters
Willkie Farr & Gallagher will issue an opinion for us about the legality of
the offered securities. Any underwriters will be advised about other issues
relating to any offering by their own legal counsel.
Experts
The consolidated financial statements of Level 3 Communications, Inc. as of
December 31, 1998 and for the year then ended, incorporated by reference in
this registration statement have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and have been incorporated herein in reliance upon the authority of
said firm as experts in giving said report.
The consolidated balance sheet of Level 3 Communications, Inc. as of
December 27, 1997, and the related statements of earnings, cash flows,
comprehensive income, and changes in stockholders' equity for each of the two
years in the period ended December 27, 1997, as well as the consolidated
balance sheets of RCN Corporation and Subsidiaries as of December 31, 1997 and
1998 and the related statements of operations, cash flows, comprehensive
income, and changes in stockholders' equity, for each of the three years in the
period ended December 31, 1998, incorporated by reference in this registration
statement, have been incorporated herein in reliance on the reports of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
that firm as experts in accounting and auditing.
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[ARTWORK APPEARING ON INSIDE BACK COVER OF PROSPECTUS SUPPLEMENT]
LEVEL 3 NETWORK
Level 3 Communications is building the first international end-to-end
communications network based entirely on Internet Protocol (IP) technology. To
implement this new technology, Level 3 plans to offer services in 56 markets
across the United States and 21 European and Pacific Rim markets, all
connected by intercity networks.
[MAP SHOWING LEVEL 3 NETWORK PLANNED OR IN DEVELOPMENT]
UPGRADEABLE NETWORK
[PICTURES SHOWING INSTALLATION OF CONDUITS]
[DIAGRAM SHOWING MULTIPLE CONDUITS IN PLACE]
Level 3 is installing multiple conduits 42" below ground in its continuously
upgradeable network. Ten to twelve 1 1/4" conduits are grouped together. Fiber
will initially be drawn through only one of the conduits, leaving the others for
future expansion as technology changes, to meet customer demand and to provide
Level 3 the flexibility to offer conduit to others.
[LOGO OF LEVEL 3]
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$750,000,000
Level 3 Communications, Inc.
6% Convertible Subordinated Notes due 2010
[LOGO OF LEVEL 3]
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PROSPECTUS SUPPLEMENT
February 23, 2000
(Including Prospectus dated December 10, 1999)
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Goldman, Sachs & Co.
Salomon Smith Barney
J.P. Morgan & Co.
Morgan Stanley Dean Witter
Credit Suisse First Boston
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