FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 orOR 15(d) of the Securities Exchange Act ofOF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission File
December 27, 1997
Numberfile number: 0-15658
PETER KIEWIT SONS', INC.Level 3 Communications, Inc.
(Exact name of registrantRegistrant as specified in its charter)
Delaware 47-0210602
(State or other jurisdiction of Incorporation) (I.R.S. Employer)Employer
incorporation or organization) Identification No.)
1000 Kiewit Plaza,3555 Farnam Street, Omaha, Nebraska 68131
(Address of principal executive offices) (Zip Code)
(402) 342-2052code)
402-536-3677
(Registrant's telephone number including area code)
Securities registered pursuant to Section
12(b) of the Act:
None.None
Securities registered pursuant to Sectionsection 12(g) of the Act:
Class C Common Stock, par value $.0625
Class D Common$.01 per share
Rights to Purchase Series A Junior Participating Preferred Stock,
par value $.0625$.01 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]X No [ ]____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The registrant's Class C stock is not publicly traded, and
therefore there is no ascertainable aggregate market valueX
(Cover continued on next page)
(Cover continued from prior page)
Indicate the number of voting stock held by nonaffiliates. The registrant's Class D
stock has been trading on the Nasdaq OTC Bulletin Board. The
aggregate market valueshares outstanding of each of the Class Dregistrant's
classes of common stock, held by nonaffiliatesas of the latest practicable date.
Title Outstanding
Common Stock, par value $.01 per share 337,845,001 as of March 14, 1998 was $7.3 billion.
As of March 15, 1998,9, 1999
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the number of outstanding shares of
each classfollowing documents if incorporated by reference and the Part
of the Company's common stock was:
Class C - 7,681,020
Class D - 146,943,752Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980).
Portions of the Company's definitiveDefinitive Proxy Statement for the 19981999
Annual Meeting of Stockholders are incorporated by reference into Part
III of this Form 10-K.
TABLE OF CONTENTS
Page
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission10-K
(End of Matters to a Vote of Security Holders
Executive Officers of the Registrant
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Index to Financial Statements and Financial Statement Schedules of Registrant
PART Icover)
ITEM 1. BUSINESS
Level 3 Communications, Inc. ("Level 3" or the "Company") engages in the
information services, communications and coal mining businesses through
ownership of operating subsidiaries and substantial equity positions in public
companies. In late 1997, the Company announced a business plan (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 IP technology. For definitions
of certain terms used in this description of Level 3's business, please see "--
Glossary" below.
History
The Company was incorporated as Peter Kiewit Sons', Inc. ("PKS" or the "Company") is one of
the largest construction contractors in North America and also
owns information services, telecommunications and coal mining
businesses. The Company pursues these activities through two
subsidiaries, Kiewit Construction Group Inc. ("KCG") and Level 3
Communications, Inc., formerly known as Kiewit Diversified Group
Inc. ("Level 3"). The organizational structure is shown by the
following chart.
Class C Stock
Peter Kiewit Sons', Inc.
Kiewit Construction Group Inc.
Materials Operations
Construction Operations
Class D Stock
Level 3 Communications, Inc.
PKS Information Services, Inc.
Level 3 Communications, LLC
Kiewit Energy Group Inc.
Kiewit Coal Properties Inc.
Cable Michigan, Inc. 48.5%
Commonwealth Telephone Enterprises, Inc. 48.4%
RCN Corporation 46.1%
The Company has two principal classes of common stock, Class
C Construction & Mining Group Restricted Redeemable Convertible
Exchangeable Common Stock, par value $.0625 per share (the "Class
C stock") and Class D Diversified Group Convertible Exchangeable
Common Stock par value $.0625 per share (the Class D stock").
The value of Class C stock is linked to the Company's
construction and materials operations (the "Construction Group").
The value of Class D stock is linked to the operations of Level 3
(the "Diversified Group"), under the terms of the Company's
charter (see Item 5 below). All Class C shares and historically
most Class D shares have been owned by current and former
employees of the Company and their family members. The Company
was incorporated 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, and the telecommunications business
in 1988. In 1995, the Company distributed to its Class
D stockholders all of its shares(consisting of MFS Communications Company, Inc. ("MFS") (which was later acquired by WorldCom, Inc.and, more recently, an
investment in C-TEC Corporation and its successors RCN Corporation ("RCN").
Through subsidiaries, the Company owns 48.5% of the common stock
of Cable Michigan, Inc., 48.4% of
Commonwealth Telephone Enterprises, Inc., formerly known as C-TEC Corporation ("C-TEC"Commonwealth Telephone") and 46.1% of RCN Corporation (collectively, the "C-TEC
Companies"), the three companies that resulted from the
restructuring of C-TEC, which was completed in September 1997.
RCN Corporation, Cable
Michigan, Inc. and Commonwealth Telephone
Enterprises, Inc. are publicly traded companies and more detailed("Cable Michigan") in 1988, the information about each of them is containedservices business in
their separate
Annual Reports on Form 10-K. Prior to January 2, 1998, the
Company was also engaged in1990 and the alternative energy business, through its ownership of 24% of the voting stock ofMidAmerican Energy Holdings
Company (f/k/a CalEnergy Company, Inc.) ("CalEnergy"MidAmerican"), in 1991. Level 3 also
has made investments in several development-stage ventures.
In the last three years, the Company has distributed to its stockholders a
portion of its telecommunications business, split off its construction business
and certain international development
projectssold its investments in conjunction with CalEnergy.
Onthe alternative energy sector.
In December 8, 1997, the Company's stockholders ratified the decision of the
Company's Board of Directors (the "PKS Board""Board") to effect a transaction to separate the
Company's construction business conducted byfrom the Construction Group and the
business conducted by the Diversified Group (collectively, the
"Business Groups") into two independent companies. In connection
with the consummation of this transaction, the PKS Board declared
a dividend of eight-tenths of one sharediversified portion of the Company's
newly
created Class R Convertible Common Stock, par value $.01 per
share ("Class R stock"business (the "Split-off") with respect to each outstanding share. As a result of Class C stock. The Class R stock is convertible in shares of
Class D stock pursuant to a defined formula. In addition, the Company has announced that effectiveSplit-off, which was completed on
March 31, 1998, the Company through a resolutionno longer owns any interest in the construction
portion of the PKS Board, shall cause each
outstanding share of Class C stock to be mandatorily exchangedits former business (the "Share Exchange") pursuant to provisions of the PKS Restated
Certificate of Incorporation (the "PKS Certificate") for one
outstanding share of Common Stock, par value $.01 per share, of
PKS Holdings, Inc. ("PKS Holdings"), a recently formed, direct,
wholly owned subsidiary of PKS, to which the eight-tenths of one
share of Class R Stock would attach (collectively, the
"Transaction""Construction Group"). In connectionconjunction with
the consummation of the
Transaction,Split-off, the Company will changechanged its name to Level"Level 3 Communications, Inc.,"
and PKS Holdings, Inc. will changethe Construction Group changed its name to Peter"Peter Kiewit Sons', Inc." See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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 has announced thatreceived proceeds of approximately $1.16 billion from
this sale, and as a result recognized an after-tax gain of approximately $324
million in 1998.
On November 6, 1998, Avalon Cable of Michigan, Inc. acquired all the
PKS Board has approvedoutstanding stock of Cable Michigan. Level 3 received approximately $129 million
in principlecash for its interest in Cable Michigan and recognized a planpre-tax gain of
approximately $90 million.
Industry Background
History and Industry Development
Telecommunications Industry. Prior to force conversion of
all 6,538,231 shares of Class R Stock outstanding. Dueits court-ordered breakup in 1984
(the "Divestiture"), AT&T Corp. ("AT&T") largely monopolized the
telecommunications services in the United States even though technological
developments had begun to certain provisionsmake it economically possible for companies (primarily
entrepreneurial enterprises) to compete for segments of the Class R stock, conversion will not be
forced priorcommunications
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 May 1998, andoffer services in geographically defined areas
called LATAs. The RBOCs were separated from the final decision to force
conversion would be made at that time. The decision may be made
not to force conversion if it were decided that conversion is notlong distance provider, AT&T,
resulting in the best interestcreation of two distinct market segments: local exchange and
long distance. The Divestiture provided for direct, open competition in the then stockholderslong
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 Company.
The Transaction is intendedILECs to separateupgrade their
networks; and (iv) the Business Groups
into two independent companies. The PKS Board believessignificant fees, called "access charges," that separation oflong
distance carriers were required to pay to the Business Groups will (i) permit Level 3 to
attract and retain the senior management and employees needed to
implement and develop Level 3's expansion plan (which is
discussed below), (ii) enable Level 3ILECs to access the capital
marketsILECs'
networks.
The first competitors in orderthe 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 fund its expansion plan on more advantageous
terms than would be availablelong distance carriers and
large businesses. These connections allowed high-volume users to Level 3 asavoid the
relatively high prices charged by ILECs for dedicated, unswitched connections.
As CAPs proliferated during the latter part of the Company,
(iii) enable Level 31980s, certain federal
and state regulators issued rulings which favored competition and promised to
pursue strategic investments and
acquisitions, as partopen local markets to new entrants. These rulings allowed CAPs to offer a number
of the expansion plan, which could be
foreclosed to Level 3 as part of the Company and (iv) allow the
directors and management of each Business Group to focus their
attention and financial resources on that Business Group's
business. Except for the anticipated effect of the Transaction
on the management of the construction business, the PKS Board
does not believe that the Transaction will have any other
significant effect on the construction business.
For purposes of this filing, the Company has filed as
exhibits to this Form 10-K, Financial Statements and Other
Information for each of the Construction Group (Exhibit 99.A) and
the Diversified Group or Level 3 (Exhibit 99.B). These exhibits
generally follow the format of Form 10-K and consist of separate
financial statements for each Group and excerpts of other
information from this Form 10-K pertaining to each Business
Group.
For 1997 results, the Company reports financial information
for four business segments: construction; information services;
telecommunications; and coal mining. Additional financial
information about these segments,new services, including, revenue, operating
earnings, equity earnings, identifiable assets, capital
expenditures, and depreciation, depletion and amortization, as
well as foreign operations information, is contained in Note 13
to the Company's consolidated financial statements.
KIEWIT CONSTRUCTION GROUP
CONSTRUCTION OPERATIONS
The construction business is conducted by operating
subsidiaries of Kiewit Construction Group Inc. (collectively,
"KCG"). KCG and its joint ventures perform construction services
forcertain states, a broad range of publiclocal exchange
services, including local switched services. Companies providing a combination
of CAP and private customers primarily inswitched 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 and Canada. New contract awards during 1997
were distributed amongStates.
Over the following construction markets:
transportation (including highways, bridges, airports, railroads,
and mass transit) -- 62%, power, heat, cooling -- 18%, commercial
buildings -- 8%, water supply -- 2%, mining -- 2%, sewage and
waste disposal -- 1% and other markets -- 7%.
KCG primarily performs its services as a general contractor.
As a general contractor, KCG is responsible for the overall
direction and management of construction projects and for
completion of each contract in accordance with terms, plans, and
specifications. KCG plans and schedules the projects, procures
materials, hires workers as needed, and awards subcontracts. KCG
generally requires performance and payment bonds or other
assurances of operational capability and financial capacity from
its subcontractors.
Contract Types. KCG performs its construction work under
various types of contracts, including fixed unit or lump-sum
price, guaranteed maximum price, and cost-reimbursable contracts.
Contracts are either competitively bid and awarded or negotiated.
KCG's public contracts generally provide for the payment of a
fixed price for the work performed. Profit on a fixed-price
contract is realized on the difference between the contract price
and the actual cost of construction, and the contractor bears the
risk that it may not be able to perform all the work for the
specified amount. Construction contracts generally provide for
progress payments as work is completed, with a retainage to be
paid when performance is substantially complete. Construction
contracts frequently contain penalties or liquidated damages for
late completion and infrequently provide bonuses for early
completion.
Government Contracts. Public contracts accounted for 74%last three years, several significant transactions have been
announced representing consolidation of the combined pricesU.S. telecom industry. Among the
ILECs, Bell Atlantic Corporation and NYNEX Corporation merged in August 1997,
Pacific Telesis Group and SBC Communications Inc. merged in April 1997, SBC
Communications Inc. and Ameritech Corporation have proposed a merger and GTE
Corporation and Bell Atlantic Corporation have proposed a merger. Major long
distance providers have sought to enhance their positions in local markets,
through transactions such as AT&T's acquisition of contracts awardedTeleport Communications Group
and Tele-Communications, Inc. and WorldCom, Inc.'s mergers with MFS
Communications Company, Inc. ("MFS") and Brooks Fiber Properties. They have also
sought to KCG during 1997.
Most of these contracts were awarded by government and
quasi-government units under fixed price contracts afterotherwise improve their competitive bidding. Most public contracts are subject to
termination at the election of the government. In the event of
termination, the contractor is entitled to receive the contract
price on completed work and payment of termination related costs.
Backlog. At the end of 1997, KCG had backlog (anticipated
revenue from uncompleted contracts) of $3.9 billion, an increase
from $2.3 billion at the end of 1996. Of current backlog,
approximately $1.0 billion is not expected to be completed during
1998. In 1997 KCG was low bidder on 226 jobspositions, through transactions
such as WorldCom's merger with total contract
prices of $3.5 billion, an average price of $15.3 million per
job. There were 19 new projects with contract prices over $25
million, accounting for 76% of the successful bid volume.
Competition. A contractor's competitive position is based
primarily on its prices for construction services and its
reputation for quality, timeliness, experience, and financial
strength. The construction industry is highly competitive and
lacks firms with dominant market power. In 1997 Engineering News
Record, a construction trade publication, ranked KCG as the 9th
largest U.S. contractor in terms of 1996 revenue and 12th largest
in terms of 1996 new contract awards. It ranked KCG 1st in the
transportation market in terms of 1996 revenue.
Joint Ventures. KCG frequently enters into joint ventures
to efficiently allocate expertise and resources among the
venturers and to spread risks associated with particular
projects. In most joint ventures, if one venturer is financially
unable to bear its share of expenses, the other venturers may be
required to pay those costs. KCG prefers to act as the sponsor
of its joint ventures. The sponsor generally provides the
project manager, the majority of venturer-provided personnel, and
accounting and other administrative support services. The joint
venture generally reimburses the sponsor for such personnel and
services on a negotiated basis. The sponsor is generally
allocated a majority of the venture's profits and losses and
usually has a controlling vote in joint venture decision making.
In 1997 KCG derived 70% of its joint venture revenue from
sponsored joint ventures and 30% from non-sponsored joint
ventures. KCG's share of joint venture revenue accounted for 28%
of its 1997 total revenue.
Demand. The volume and profitability of KCG's construction
work depends to a significant extent upon the general state of
the economiesMCI.
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 Canada,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.
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 IP, 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 IP-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.
IP 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. In addition, there are concerns about the adequacy
of the security and reliability of packet-switch based systems as currently
implemented.
Initiatives are under way to develop technology to address these
disadvantages of packet-switch based systems. The Company believes that the
evolving IP standard, which is a market based standard broadly adopted in the
Internet and elsewhere, will remain a primary focus of these development
efforts. The Company expects the benefits of these efforts to be improved
communications throughout, reduced latency and declining networking hardware
costs.
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. In 1997, it is estimated that
local exchange services accounted for revenues of $92.4 billion, long distance
services generated revenues of $104.6 billion and Internet services revenues
totaled $6.3 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.
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 does
provide the local portion of most long distance calls.
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 IP 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.
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. In 1997, it is estimated that local exchange services
accounted for revenues of $116.6 billion, long distance services generated
revenues of $193.7 billion and Internet services revenues totaled $4.8 billion.
IP Network and Interconnection. The Company is designing the Level 3
network to be optimized for IP-based communications, rather than circuit-switch
based communications such as that utilized by the PSTN. The network is being
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 IP 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 IP services generally require either customized
end-user equipment or the dialing of "access codes" or the following of other
special procedures to initiate a call. There are also concerns about the
reliability and security of existing IP-voice networks.
The Company is developing its IP-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 are developing soft-switch
technology to enable the transmission of traffic seamlessly between a
router-based IP network and the volume of
work availablecircuit-based PSTN. This technology is expected
to contractors. Fluctuating demand cycles are
typicalprovide the Level 3 network with the same ubiquity of the industry,PSTN. Specifically,
the Company's technology is expected to 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 such cycles determine(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 large
extentleast-cost routing
criteria). When this capability is fully developed, based in part on acquired
software, Level 3 expects to be able to obtain the degreebenefits of competitionpacket-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 available projects. KCG's
construction operations could be adversely affectedrouting the call to the Level 3 network. Level 3
believes that by labor
stoppages or shortages, adverse weather conditions, shortages of
supplies, or governmental action. The volume of available
government work is affected by budgetarybuilding its own network with significant excess capacity,
expandability and political
considerations. A significant decreasethe latest technological advances in network design and
equipment and having the ability to route calls over the PSTN in the amountevent of
new
government contracts, for whatever reasons, would have a material
adverse effect on KCG.
Locations. KCG structuresservice disruptions, the other significant issues associated with IP-voice
transmission (quality, latency, reliability and security) should be
satisfactorily addressed. The Company plans to begin commercially testing its
construction operations
around 20 principal operating offices located throughout the U.S.
and Canada, with headquartersIP-voice transmission services in Omaha, Nebraska. Through its
decentralized system of management, KCG has been able to quickly
respond to changesselected markets in the local markets. Atsecond quarter of
1999.
On November 16, 1998, Level 3 and Bell Communications Research Inc.
announced the endmerger of 1997, KCG
hadtheir respective specifications for a new protocol
designed to bridge between the current projectscircuit-based PSTN and emerging IP
technology based networks.
The merged specification, called the Media Gateway Control Protocol, or
MGCP, represents a combination of the Internet Protocol Device Control, or IPDC
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 Inc. and Cisco Systems, Inc.
The MGCP specification is available without a fee to service providers and
hardware and software vendors interested in 33 statesimplementing it in their networks
and 6 Canadian provinces. KCG
also participatesequipment.
The significance of MGCP is that when implemented it will provide customers
with a seamless interconnection between traditional PSTN and the newer IP
technology networks. Level 3 believes that this integration will enable
customers to benefit from the lower cost of IP 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 constructiondevelopment of geothermal power plants
inits own network.
Business Plan
Since late 1997, the PhilippinesCompany has substantially increased the emphasis it
places on and Indonesia.
Properties. KCGthe resources devoted to its communications and information
services business. Since that time, the Company has 20 district offices, of which 16 are in
owned facilities and 4 are leased. KCGbecome a facilities-based
provider (that is, a provider that owns or leases numerous
shops,a substantial portion of the
plant, property and equipment yards, storage facilities, warehouses, and
construction material quarries. Since construction projects are
inherently temporary and location-specific, KCG owns
approximately 950 portable offices, shops, and transport
trailers. KCGnecessary to provide its services) of a broad
range of integrated communications services. The Company has a large equipment fleet, including
approximately 4,500 trucks, pickups, and automobiles, and 2,000
heavy construction vehicles, such as graders, scrapers, backhoes,
and cranes.
MATERIALS OPERATIONS
Several KCG subsidiaries, primarily in Arizona and Oregon,
produce construction materials, including ready-mix concrete,
asphalt, sand and gravel. KCG also has quarrying operations in
New Mexico and Wyoming, which produce landscaping materials and
railroad ballast. Kiewit Mining Group Inc. ("KMG"), aexpanded
substantially the business of its subsidiary
of KCG, provides mine management services to Kiewit Coal
Properties Inc., a subsidiary of PKS. KMG also owns a 48%
interest in an underground coal mine near Pelham, Alabama.
LEVEL 3 COMMUNICATIONS, INC.
Level 3 engages in the information services,
telecommunications, coal mining and energy businesses, through
ownership of operating subsidiaries, joint venture investments
and ownership of substantial positions in public companies.
Level 3 also holds smaller positions in a number of development
stage or startup ventures.
INFORMATION SERVICES PKS Information Services, Inc.
("PKSIS") and is creating, through a fullcombination of construction, purchase and
leasing of facilities and other assets, an international, end-to-end,
facilities-based communications network. The Company is designing the Level 3
network based on IP technology in order to leverage the efficiencies of this
technology to provide lower cost communications services.
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 IP technology.
These services will include traditional voice services and fax transmission, 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:
o Efficiency. As a packet-switched technology, IP technology generally uses
network capacity more efficiently than the traditional circuit-switched
PSTN. Therefore, certain services can be provided for lower cost over a
network using IP technology, particularly those services which are not
timing sensitive, such as e-mail and file transfer.
o Flexibility. IP technology is an open protocol (a non-proprietary,
published standard) which allows for market driven development of new uses
and applications for IP 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.
o Improving Technologies. The Company believes that IP's market based
protocol will likely lead to technological advances that will address the
problems currently associated with IP-based applications, including the
difficulty achieving seamless interconnection with the PSTN, latency (delay
through the network which can negatively affect timing sensitive
communications such as voice and fax), quality and concerns about adequate
security and reliability.
o Standardized Interface. Web browsers were developed for the public Internet
and are usable with many IP networks. Web browsers can provide a
standardized interface to data and applications on an IP network.
Standardized interfaces make it easier for end users to access and use
these resources.
Level 3's Strategy. The Company is seeking to capitalize on the benefits of
IP technology by pursuing the Business Plan. Key elements of the Company's
strategy include:
o Become the Low Cost Provider of Communications Services. Level 3 is
designing its network to provide high quality communications services at a
lower cost and to incorporate more readily future technological
improvements relative to older, less adaptable networks. 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.
o Offer a Comprehensive Range of Communications Services. As the Business
Plan is implemented, the Company intends to provide a comprehensive range
of communications services over the Level 3 network, including private
line, colocation, Internet access, managed modem and voice and fax
transmission service. The Company is currently offering all of these
services other than voice and fax transmission services.
o Provide Seamless Interconnection to the PSTN. The Company and other
technology providers are developing technology to allow seamless
interconnection of the Level 3 network with the PSTN. A seamless
interconnection will allow customers to use the Level 3 network, including
voice and fax, without modifying existing telephone and fax equipment or
existing dialing procedures (that is, without the need to dial access codes
or follow other similar special procedures).
o 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 has begun offering services in 17 U.S. cities and in
London and Frankfurt over leased local and intercity facilities. Over time,
these leased networks will be displaced by networks that the Company is
constructing.
o Expand Target Market Opportunities. The Company has a direct sales force
that targets large businesses. In addition, the Company has developed
alternative distribution channels to gain access to a substantially larger
base of potential customers than the Company could otherwise initially
address through its direct sales force. Through the combination of a direct
sales force and alternative distribution channels, the Company believes
that it will be able to rapidly increase revenue-producing traffic on its
network.
o 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 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 its business support
system.
o 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 IP networks and web browser access.
o 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:
o 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 telecommunication products and in designing, constructing and managing
intercity, metropolitan and international networks.
o Opportunity to Create a More Readily Upgradable Network Infrastructure.
Level 3's network design strategy seeks to take 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 development and innovation.
o 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 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.
o 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 international, end-to-end network optimized for IP 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
three to five years, the Company's network is expected to encompass:
o an intercity network covering nearly 16,000 miles in North America;
o backbone facilities in 40 North American markets;
o leased backbone facilities in 10 additional North American markets;
o an intercity network covering approximately 3,500 miles across Europe;
o leased or owned backbone facilities in 13 European and 8 Pacific Rim
markets; and
o transoceanic capacity.
Intercity Networks. The Company's nearly 16,000 mile fiber optic intercity
network in North America will consist of the following:
o Rights-of-way ("ROW") from a number of third parties including railroads,
highway commissions and utilities. The Company is procuring these rights
from sources which maximize the security and quality of the Company's
installed network. As of February 2, 1999, the Company had use of
approximately 14,400 miles of ROW which will satisfy approximately 93% of
the ROW requirements for the North American intercity network. It has
obtained these rights pursuant to agreements with Union Pacific Railroad
Company, Burlington Northern & Santa Fe Railroad Company, Canadian Pacific
Railway Co., Norfolk Southern Corporation and others.
o Multiple conduits connecting local city networks in approximately 200 North
American cities, in 50 of which the Company expects to have city networks.
In general, Level 3 will install groups of 10 conduits in its intercity
network, but will install groups of up to 12 conduits in areas where it
expects network demand to be stronger. 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.
o 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.
o High speed SONET transmission equipment employing self-healing protection
switching and designed for high quality and reliable transmission.
o 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.
To support the launch of its services in the third quarter of 1998, the
Company has leased intercity capacity from two providers, connecting the first
15 Level 3 North American markets. 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.
The following diagram depicts the currently planned North American intercity
network when fully constructed:
[Map depicting the Company's U.S. intercity network at completion.]
The North American intercity network is expected to be completed during the
first quarter of 2001. 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,
1998, the Company has completed 410 route miles of the intercity network and has
an additional 850 route miles under construction.
In Europe, the Company is deploying an approximately 3,500 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 line and dark fiber network that will be displaced over
time by the intercity network owned by the Company. The Company has recently
begun development of the first approximately 1,750 mile portion of the European
intercity network, with completion expected by the end of the third quarter of
2000. 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 1998, the Company entered into transoceanic capacity agreements for
three systems which 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 mid-year 2000. The remaining two agreements were entered into by the
Company for trans-Atlantic capacity.
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 has secured approximately 1.25 million square feet of space for
its gateway facilities as of January 1999 and has completed the buildout of
approximately 825,000 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 IP 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 has
gateway facilities, which vary in size, in New York City, Washington, D.C.,
Philadelphia, Atlanta, Boston, Dallas, Houston, Chicago, Detroit, Denver,
Seattle, San Francisco, San Jose, Los Angeles, San Diego, Manchester, New
Hampshire and Providence, Rhode Island. The Company is offering a limited set of
services (including private line, colocation services, Internet access and
managed modem) at its gateway sites in these cities. The availability of these
services varies by location.
Construction of initial local fiber loops in eight cities is expected to be
completed by the end of the second quarter of 1999.
As of February 1, 1999, the Company had 107 approved ILEC colocation
applications in 27 cities and completed construction in 38 of these central
offices. As of February 1, 1999, the Company had entered into interconnection
agreements with RBOCs covering 22 cities.
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.
The Company launched its international gateway in London in January 1999. The
75,000 square foot office and operations facility will be the hub of European
operations and will house the operational center and network equipment, along
with additional space for expansion and colocation services. The Company plans
to offer services in and between Paris, Amsterdam and Frankfurt in 1999 and one
additional European city, also in 1999.
Communication 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 technology company that providesservices business. The Company intends to build
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.
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. Utilizing all
computing environments from mainframes to client/server
platforms, PKSIS offers custom-tailored computer outsourcing
services. PKSIS also provides network andThe Company's systems integration services help
customers define, develop and network management services for various computer platforms.
In addition, PKSIS develops, implements and supports applications
software. Through its subsidiary NET Twenty-One, Inc., PKSIS'
strategy is to focus on assisting its customers in "Web-enabling"
legacy software applications, that is, migrating computer
applications from closed computing and networking environments to
network platforms using Transmission Control Protocol/Internet
Protocol ("TCP/IP") technology that are then accessed using Web
browsers.implement cost-effective information services. The
computer outsourcing services offered by PKSIS through
its subsidiary PKS Computer Services, Inc.the Company include networking and
computing services necessary both for older mainframe-based systems and newer
client/server-based systems. PKSISThe Company provides its outsourcing services to
clients that desirewant to focus their resources on core businesses, rather than
expendingexpend capital and incurringincur overhead costs to operate their own computing
environment. PKSISenvironments. Level 3 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
customer itself,customers themselves, while at the same time reducing the customer'scustomers' cost for
such services. This service is particularly useful for those customers moving
from older computing platforms to more modern client/server networks.
PKSIS' systems integration services help customers define,
develop and implement cost-effective information services. In
addition, through PKS Systems Integration, Inc., PKSISThe Company 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 Hypertext
Markup Language (HTML)-basedweb browsers ("Web browsers") over the Internet or over private or
limited access TCP/IP networks. PKSIS, throughThrough its Suite 2000-SM2000SM line of services, the
Company provides customers with a multi-phased service for converting programs
and applicationapplications so that date-related information is accurately processed and
stored before and after the year 2000. Through the
process of converting a customer's legacy software for year 2000
compliance, PKSIS is able to provide additional insight and
advice to further stream-line and improve the customer's
information systems.
PKSIS has established a software engineering facility at the
National Technology Park in Limerick, Ireland, to undertake:
large scale development projects; system conversions; and code
restructuring and software re-engineering. PKSIS hasThe Company also
established relationships with domestic and international
partners to provide such activities as well as establishing
recently a joint venture in India.
PKSIS' subsidiary, LexiBridge Corporation of Shelton,
Connecticut, provides customers with
a combination of workbench tools and methodologymethodologies that provide a complete
strategy for converting mainframe-based application systems to client/server
architecture, while at the same time ensuring yearYear 2000 compliance.
In 1997, 93% of PKSIS' revenue was from external customers
andAs the remainder was from affiliates.
Level 3 recently has determinedBusiness Plan is being implemented, the Company is beginning to
increase substantially
the emphasis it places on and the resources devoted to its
information services business, withoffer a view to becoming a
facilities-based provider (that is, a provider of information
services that owns or leases a substantial portion of the plant,
property and equipment necessary to provide those services) of a
broad range of integrated information services to business (the
"Expansion Plan"). Pursuant to the Expansion Plan, Level 3
intends to expand substantially its current information services
business, through both the expansion of the business of PKSIS and
the creation, through a combination of construction, purchase and
leasing of facilities and other assets, of a substantial,
facilities-based communications network that utilizes Internet
Protocol or IP technology.
In order to grow and expand substantially the information
services it provides, Level 3 has developed a comprehensive plan
to construct, purchase and lease local and backbone facilities
necessary to provide a wide range of communications services, overincluding the following:
o Private Line and Special Access. Private line and special access services
are established as a network that uses Internet Protocol based technology. Thesepermanent physical connection between locations for
the exclusive use of the customer. The Company is offering the following
types of special access and private line services:
o Private Line. This type of link is a dedicated line connecting two end-user
locations for voice and data applications, including ISPs.
o Carrier-to-Carrier Special Access. This type of link connects carriers
(long distance providers, wireless providers, ILECs and CLECs) to other
carriers.
o 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 local special access and private line
services include:
A number of business-oriented communicationswith available transmission speeds from T1 to OC3 and OC48 and its long
distance services using
a combination of network facilities Level 3 would
construct, purchase and lease from third parties, which
services may include fax services that are transmitted in
part over an Internet Protocol network and arewill be offered at speeds from T1 to OC3 and OC48. The Company
is initially marketing its special access and private line services to ISPs,
resellers and medium to large corporate customers.
o 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 lower price than public circuit-switched telephone
network- based fax servicesafe and voice message storingsecure 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 forwarding that are transmitted in part overoperations. At its operational colocation sites, the same
Internet Protocol technology based network; and
After construction, purchase and lease of local and
backbone facilities, a range of Internet access services at
varying capacity levels and, as technology development
allows, at specified levels of quality of serviceCompany is
offering customers AC/DC power, optional UPS power, emergency back-up
generator power, HVAC, fire protection and security. Level 3 believesis 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 ("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 and is also
offering IP services such as e-mail, news feeds and Domain Name Services.
o Internet Access. The Company is beginning to offer Internet access to
business customers, other carriers and ISPs. These services include
high-capacity Internet connections ranging from T1 to OC3 transmission
speeds. The Company has peering arrangements with approximately 60 ISPs and
is currently purchasing transit from two major ISPs.
o 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 over time,may include
access to the public Internet ("Managed Modem"). While ISPs are provided a
substantial numberfully 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 businesses will convert existing computer application systemslocal
network coverage, dedicated local telephone numbers (which run on standalonethe Managed
Modem customer distributes to its customers in the case of an ISP or networked computing platforms
utilizingto its
employees in the case of a wide varietycorporate customer), racks and modems as well as
dedicated connectivity from the customers location to the Level 3 gateway
facility. Level 3 also provides monitoring of operating systems, applications and
data repositories) to computer systems that communicate using
Internet Protocol and are accessed by users employing Web
browsers.this infrastructure 24 hours
a day, seven days a week. By providing a turn-key infrastructure modem
solution, Level 3 believes that suchthis product allows its customers to save
both capital and operating costs.
o Voice and Fax. The Company seeks to offer voice and fax services, including
both real-time voice and fax transmission services, which are accessed
using existing telephone and fax equipment and existing dialing procedures.
The Company expects that these services will be offered at a conversion will occurquality level
equal to that of the PSTN.
o Special Services. The Company is offering dark fiber and conduit along its
local and intercity networks on a long term lease basis. Dark fiber is the
term that is used to describe fiber optic strands that are not connected to
transmission equipment. A customer can obtain dark fiber and/or 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 the
following reasons:
Internet Protocolplacement of their transmission electronics. Although Level 3 will not be
responsible for the management of the customer's transmission electronics,
Level 3 is contemplating providing installation and maintenance services
for this equipment on a fee for service basis.
Distribution Strategy
The Company's distribution strategy is to utilize a direct sales force as
well as alternative distribution channels. Through the combination of a direct
sales force and alternative distribution channels, the Company believes that it
will be able to more rapidly access markets and increase revenue-producing
traffic on its network. To implement its distribution strategy, the Company is
developing an in-house direct sales force and several alternative distribution
channels.
The Company uses its direct sales force to market its available products
and services directly to large communications-intensive businesses. In addition,
the direct sales force targets national and international accounts. These
communications-intensive customers would typically be connected directly to the
Level 3 leased network using unswitched, dedicated facilities.
As part of its distribution strategy, the Company is developing several
alternative distribution channels. These include agents, resellers and
wholesalers.
o Agents are independent organizations that sell Level 3's products and
services under the Level 3 brand name to end-users in exchange for revenue
based commissions. The Company's agents generally focus on specific market
segments (such as small and medium sized businesses) and have existing
customer bases. Sales through this alternative distribution channel require
Level 3 to provide the same type of services that would be provided in the
case of sales through its own direct sales force such as order fulfillment,
billing and collections, customer care and direct sales management.
o Resellers are independent companies that purchase Level 3's products and
services and then "repackage" these services for sale to their customers
under their own brand name. Resellers generally require access to certain
of the Company's business operating systems in connection with the sale of
the Company's services to the resellers' customers. Sales through this
distribution channel generally do not require Level 3 to provide order
fulfillment, billing and collection and customer care.
o Wholesalers are independent companies that purchase from the Company
unbundled network and service capabilities in large quantities in order to
market their own products and services under a brand name other than Level
3. Wholesalers have minimal dependence on the Company's business support
systems in connection with the sale of services to their customers.
The Company anticipates that participants in its alternative distribution
channels will sell services directly to medium and small businesses and
consumers. The Company expects these medium and small businesses and consumers
to access the Level 3 network by using local switched services that are provided
by CLECs or ILECs or by utilizing newly emerging alternatives including various
DSL modem technologies, cable modems and wireless access technologies.
Business Support System
In order to pursue its direct sales and alternative 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 becomethe opportunity to develop a de facto networking standard
supportedcompetitive 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.
Key design aspects of the business support system development program are:
o integrated modular applications to allow the Company to upgrade specific
applications as new products are available;
o a scalable architecture that allows certain functions that would otherwise
have to be performed by numerous hardwareLevel 3 employees to be performed by the Company's
alternative distribution channel participants;
o phased completion of software releases designed to allow the Company to
test functionality on an incremental basis;
o "web-enabled" applications so that on-line access to all order entry,
network operations, billing, and software vendorscustomer care functions is available to
all authorized users, including Level 3's customers and as
such, providesresellers;
o use of a common protocol for connecting computers
utilizing a wide variety of operating systems;
Web browsers can provide a standardized interfacethree-tiered, client/server architecture that is designed to
separate data and applications, and thusis expected to enable continued
improvement of software functionality at minimum cost; and
o maximum use of pre-developed or "shrink wrapped" applications, which will
interface to Level 3's enterprise resource planning suites.
The first three releases of the business support system have been delivered
and contain functionality necessary to support the set of services presently
offered. See "--Communication 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 minimize costsoffer local switched
services. See "--Regulation."
As of training personnelFebruary 1, 1999, the Company had entered into interconnection
agreements covering 22 cities. 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.
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 60 ISPs and is
currently purchasing transit from two major ISPs. The basis on which the large
national ISPs make peering available or impose settlement charges is evolving as
the provision of Internet access and userelated 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 resources;more restrictive criteria.
Employee Recruiting and Retention
As of December 31, 1998, Level 3 had 1,225 employees in the communications
portion of its business and PKSIS had approximately 959 employees, for a packet-switched technology,total
of 2,184 employees. The Company believes that its ability to implement the
Business Plan will depend in many instances,
Internet Protocol utilizes network capacity more
efficientlylarge 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 announced relocation
to new facilities, currently being constructed 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 circuit-switched public telephone
network. Consequently, certain services provided over an
Internet Protocol network maycash 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 less costly than the same
services provided over public switched telephone network.
Level 3 furthercomparable to those offered by its
competitors.
The Company believes that businessesthe 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.
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 prefervest 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 contractsatisfactory Company performance, the Company's employees will
be eligible annually for assistancegrants by the Company of its restricted common stock of
up to 3% of the employees' compensation, which shares will vest three years from
the 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 eligible employees when company stock
price performance is inferior to investments of similar risks, dilute public
stockholders in making this conversion with those
vendors ablea manner not directly proportional to performance and fail to
provide a full range of services from initial
consultingpreferred return on stockholders' invested capital over the return to
Internet access with requisite quality and security
levels.
Pursuant to the Expansion Plan, Level 3's strategy will be
to attempt to meet this customer need by: (i) growing and
expanding its existing capabilities in computer network systems,
consulting, outsourcing, and software reengineering, with
particular emphasis on conversion of legacy software systems to
systems that are compatible with Internet Protocol networks and
Web browsers access; and (ii) creating a national end-to-end
Internet Protocol based network through a combination of
construction, purchase and leasing of assets. Level 3 intends to
optimize its international network to provide Internet based
communications services to businesses at low cost and high
quality, and to design its network, to the extent possible, to
more readily include future technological upgrades than older,
less flexible networks owned by competitors.
To implement its strategy, Level 3 has formulated a long
term business plan that provides for the development of an end-to-
end network optimized for the Internet Protocol. Initially,
Level 3 will offer its services over facilities, both local and
national, that are in part leased from third parties to allow for
the offering of services during the construction of its own
facilities. Over time, it is anticipated that the portion of
Level 3's network that includes leased facilities will decrease
and the portion of facilities that have been constructed, and are
owned, by Level 3 will increase. Over the next 4 to 6 years, it
is anticipated that the Level 3 network will encompass local
facilities in approximately 40 North American markets, leased
backbone facilities in approximately 10 additional North American
markets, a national or inter-city network covering approximately
15,000 miles, the establishment of local facilities in
approximately 10 European and 4 Asian markets and an inter-city
network covering approximately 2,000 miles across Europe. Level
3 intends to design and construct its inter-city network using
multiple conduits. Level 3option holders. The Company believes that the spare conduitsOSO program is superior to an
NQSO-based program with respect to these issues while, at the same time,
providing eligible employees a success-based reward balancing the associated
risk.
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 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
S&P 500 Index. The value received for awards 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
OSOs 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.
The Company adopted the recognition provisions of SFAS No. 123 in 1998.
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. While the Company has not yet determined
the total effect of adopting the recognition provisions of SFAS No. 123, the
adoption resulted in non-cash charges to operations in 1998 of approximately $39
million and will allow itresult in OSO program non-cash charges to deployoperations 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 awards 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 innovationsadvances
and expand
capacity without incurringfurther deregulation could give rise to significant overbuild costs.new competitors to the
Company.
In the special access and private line services market, the Company's
primary competitors will be IXCs, ILECs and CLECs. In the market for the
colocation of CLECs, the Company will compete with 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 foregoing descriptionmarket for the colocation of web-servers is
extremely competitive. In this market, the Company competes with ISPs and many
others, including IXCs, companies that provide only web hosting/IP colocation
services and a number of companies in the computer industry.
For voice and fax services, the Company will compete primarily with
national and regional network providers. There are currently three principal
facilities- based long distance fiber optic networks (AT&T, Sprint and MCI
WorldCom, Inc. ("MCI WorldCom")), as well as numerous ILEC and CLEC networks.
Others, including Qwest, IXC and Williams, are building additional networks that
employ advanced technology similar to that of the Level 3 networkNetwork and offer
significantly more capacity to the marketplace. The additional capacity that is
expected to become available in the next several years 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. IXCs 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 and Sprint, 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. 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. While the Company believes that IP technology will prove to be a
viable technology for the transmission of voice and fax services, technology is
not yet in place that will enable the Company to provide voice and fax services
at an acceptable level of quality. There can be no assurance that the Company
can develop or acquire such technology.
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 Expansion
Plan constitutesintroduction 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 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 obtained FCC authorization to provide
international services on a forward-looking statement.facilities and resale basis. The actual
configurationCompany will be
required to file tariffs for its interstate and international long distance
services with the FCC before commencing operations.
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:
o 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.
o 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.
o 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, 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.
o Unbundled Access. Requires all ILECs to provide nondiscriminatory access to
unbundled network elements (including network facilities, equipment,
features, functions, and capabilities) at any technically feasible point
within their networks, on nondiscriminatory terms, at prices based on cost
(which may include a reasonable profit).
o Number Portability. Requires all ILECs and CLECs to permit users of
telecommunications services to retain existing telephone numbers without
impairment of quality, reliability or convenience when switching from one
telecommunications carrier to another.
o 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.
o 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. Where an
agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunication 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.
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, there can be no assurance
that the Company will 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. To date,
several petitions by RBOCs for such entry have been denied by the FCC, and none
have been granted. 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. In two orders released on
December 24, 1996, and May 16, 1997, the FCC made major changes in the
interstate access charge structure. In the December 24th 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. 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. The May
16th 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. In the May 16th order, the FCC also
announced its plan to bring interstate access rate levels more in line with
cost. The plan will include rules that are expected to be established sometime
in 1999 that may grant price cap LECs increased pricing flexibility upon
demonstrations of increased competition (or potential competition) in relevant
markets. The manner in which the FCC implements this approach to lowering access
charge levels could have a material effect on the Company's revenues and costs.
Several parties have appealed the May 16th order. Those appeals were
consolidated and transferred to the Eighth Circuit. 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,
twenty-nine state commissions have ruled on this issue in the context of state
commission arbitration proceedings or enforcement proceedings. In every state,
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 the four decisions rendered to date
on appeal. Appeals from these decisions are pending in the Fifth, Seventh and
Ninth U.S. Circuit Courts of Appeal. 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 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 appeals
or of additional pending cases. The FCC also issued proposed rules to address
inter- carrier compensation in the future. If no compensation is provided for
these calls, it could have an adverse effect on the Company.
Since the FCC issued its order, each RBOC, including BellAtlantic from
which the Company has been receiving reciprocal compensation, has filed
petitions in selected states seeking relief from its obligations to pay
reciprocal compensation for ISP traffic. Where appropriate, the Company has
taken an active role in opposing these petitions.
The FCC has to date treated ISPs as "enhanced service providers," exempt
from federal and state regulations governing common carriers, including the
numberobligation to pay access charges and contribute to the universal service fund.
Nevertheless, regulations governing disclosure of markets
servedconfidential 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 IP 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 IP telephony
appear to have similar functionality to non-IP telecommunications services and
lack the characteristics that would render them information services. If the FCC
were to determine that certain IP 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-IP-based telecommunications service providers. The
FCC also noted that other forms of IP 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, or 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. 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. Since the Company had
no significant telecommunications service revenues in 1997, it was not liable
for subsidy payments in any material amount during 1998. With respect to
subsequent years, however, the Company is currently unable to quantify the
amount of subsidy payments that it will be required to make and the expanseeffect that
these required payments will have on its financial condition because of
uncertainties concerning the size of the inter-city networksuniversal fund and uncertainties
concerning the classification of its services. In the May 8th order, the FCC
also announced that it will depend on
a varietysoon revise its rules for subsidizing service
provided to consumers in high cost areas, which may result in further
substantial increases in the overall cost of factors including Level 3's ability to: access
markets; design fiber optic network backbone routes; attractthe subsidy program. Several
parties have appealed the May 8th order. Such appeals have been consolidated and
retain qualified personnel; design, develop and deploy enterprise
support systems that will allow Level 3transferred to build and operate a
packet switched network that interconnects with the public
switched network, install fiber optic cable and facilities;
obtain rights-of-way, building access rights, unbundled loops and
required government authorizations, franchises and permits; and
to negotiate interconnection and peering agreements.Fifth Circuit Court of Appeals where they are currently
pending. The operations toFCC's universal service program may also be conductedaltered as a result of
the Expansion
Planagency's reconsideration of its policies, or by future Congressional action.
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 and state regulations are modified to allow increased local services
competition. 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 Arkansas (facilities-based IXC), California,
Colorado, Connecticut, Delaware, the District of Columbia, Florida, Georgia,
Idaho, Illinois, Indiana, Kentucky, Maryland, Massachusetts, Michigan, Missouri,
Montana, Nebraska, Nevada, New Hampshire, New Jersey, New York, Ohio, Oregon,
Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Virginia,
Washington, and Wyoming.
The Company has pending applications for authority to provide
telecommunications service in Alabama, Arizona, Iowa, Kansas, Louisiana, Maine,
Minnesota, Mississippi, New Mexico, North Carolina, North Dakota, Oklahoma,
South Dakota, Vermont, West Virginia, Wisconsin, and Utah.
Local Regulation
The Company's networks will be subject to extensive federalnumerous local regulations such
as building codes and state regulation.
Federal lawslicensing. Such regulations vary on a city-by-city,
county- by-county and Federal Communicationsstate-by-state basis. To install its own fiber optic
transmission facilities, the Company will need to obtain rights-of-way over
private and publicly owned land. There can be no assurance that rights-of-way
that are not already secured will be available to the Company on economically
reasonable or advantageous terms.
Canadian Regulation
The Canadian Radio-Television and Telecommunications Commission regulations
apply to interstate(the
"CRTC") generally regulates long distance telecommunications while state regulatory
authorities exercise jurisdictionservices in Canada.
Regulatory developments over telecommunications both
originating and terminating within a state. Generally,
implementationthe past several years have terminated the historic
monopolies of the Expansion Plan will require obtainingregional telephone companies, bringing significant competition
to this industry for both domestic and maintaining certificatesinternational long distance services, but
also lessening regulation of authority from regulatory bodies in
most states wheredomestic 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 are to be offered.
With respect to
the Expansion Plan, Level 3 is devoting
substantially more management timeU.S. by reselling the services provided by the regional companies and capital resources to its
informationother
entities but also may resell the services business with a view to making the
information services business, over time, the principal business
of Level 3. In that respect, the management of Level 3 has been
conducting a comprehensive review of the existing Level 3
businessesmonopoly 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 determine how those businesses will complement
Level 3's focusa third country, the CRTC recently lifted this restriction. The
Teleglobe monopoly on informationinternational services businessesand submarine cable landing rights
terminated as of October 1, 1998, although the provision of Canadian
international facilities-based services remains restricted to "Canadian
carriers" with majority ownership by Canadians. Ownership of non-international
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 resultprovider of
facilities-based domestic services. Pending proceedings address issues such as
the scope of contribution charges payable to the telephone companies to offset
some of the Expansion Plan. For example,capital and operating costs of interconnection as well as
deregulation of the managementlong distance services of Level 3
negotiated the sale of its energy interests (see "- CalEnergy"
below) because it believedincumbent regional telephone
companies.
While competition is now emerging in other Canadian telecommunications
market segments, the Company believes that the ongoing ownership by Level 3
of an interest in an energy businesses was not compatible with
its focus on the information services business, and because sale
of those assets providedregional companies continue to
retain a substantial portionmajority of the money
necessary to fundlocal and calling card markets. Beginning
in May 1997, the early stages of the Expansion Plan.
In addition, the Construction Group and Level 3 are
currently discussing a restructuring of the current mine
management arrangement between the two Business Groups. Level 3
also is reviewing its involvement inCRTC released a number of start-updecisions opening to competition the
Canadian local telecommunications services market, which decisions were made
applicable in the territories of all Stentor member 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. Facilities-based ILECs are
subject to the same majority Canadian ownership "Canadian carrier" requirements
as 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 development stageother 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. ILECs, which, unlike CLECs, remained fully regulated,
will not be subject to rate of return regulation for an initial four-year period
beginning May 1, 1997, but their 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. The Company recently completed the sale of its interestinterests in United
Infrastructure Company, ("UIC"). Level 3
is also currently discussing with the Construction Group the sale
ofMidAmerican and Kiewit Investment Management Corp.
to the Construction Group.
Level 3 has no current intention, however, to sell, dispose or
otherwise alter its ownership interest in the C-TEC Companies.
C-TEC COMPANIESCompanies
On September 30, 1997, C-TEC completed a tax-free restructuring, which
divided C-TEC into three public companies: C-
TEC,companies (the "C-TEC Companies"): C-TEC, which
changed its name to Commonwealth Telephone, Enterprises, Inc. ("Commonwealth Telephone"), RCN Corporation
("RCN") and Cable Michigan, Inc. ("Cable Michigan"Michigan. The
Company's interests in the C-TEC Companies are held through a holding company
(the "C-TEC Holding Company"). BusinessesThe Company owns 90% of the common stock of the
C-TEC Companies.Holding Company, and preferred stock of the C-TEC Holding Company with a
liquidation value of approximately $467 million as of December 31, 1998. 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 owns the following businesses:is a Pennsylvania public
utility providing local telephone service to a 19-county, 5,191 square mile
service territory in Pennsylvania. Commonwealth Telephone Company
(the rural local exchange carrier business);services approximately
259,000 main access lines. Commonwealth Communications (the communications engineering business); the
Pennsylvania competitive local exchange carrier business;Telephone also provides network access
and long distance operationsservices to IXCs. Commonwealth Telephone's business customer
base is diverse in certainsize 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, 1998, the C-TEC
Holding Company owned approximately 48% 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 $38
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 of Pennsylvania.in the Northeast. RCN owns the following businesses: itsoperates as a competitive telecommunications services operationsservice
provider in New York City and Boston; itsBoston. RCN also owns cable television operations
in New York, New Jersey and Pennsylvania; itsa 40% interest in Megacable, S.A. de
C.V., Mexico's second largest cable television operator; and itshas long distance
operations (other than the operations in certain areas of Pennsylvania). Cable Michigan owns and operates cable television
systems in the State of Michigan and owns a 62% interest in
Mercom, Inc., a publicly held Michigan cable television operator.
Ownership of the C-TEC Companies. In connection with the
restructuring and as a result of the conversion of certain shares
of C-TEC held by Level 3, Level 3 now holds 13,320,485 shares of
RCN common stock, 3,330,119 shares of Cable Michigan common
stock, and 8,880,322 shares of Commonwealth Telephone common
stock. Such ownership represents 48.5% of the outstanding common
stock of Cable Michigan, 48.4% of the outstanding common stock of
Commonwealth Telephone and 46.1% of the outstanding common stock
of RCN.
Each of the shares of RCN common stock, Cable Michigan
common stock and Commonwealth Telephone Common Stock is traded on
the National Association of Securities Dealers, Inc.'s National
Market (the "Nasdaq National Market").
In its filings with the Securities and Exchange Commission,
the board of directors of C-TEC concluded that the distributions
were in the best interests of the shareholders because the
distributions will, among other things, (i) permit C-TEC to raise
financing to fund the development of the RCN business on more
advantageous economic terms than the other alternatives
available, (ii) facilitate possible future acquisitions and joint
venture investments by RCN and Cable Michigan and possible future
offerings by RCN, (iii) allow the management of each company to
focus attention and financial resources on its respective
business and permit each company to offer employees incentives
that are more directly linked to the performance of its
respective business, (iv) facilitate the ability of each company
to grow in both size and profitability, and (v) permit investors
and the financial markets to better understand and evaluate C-
TEC's various businesses.
Accounting Method. Since the ownership by Level 3 of the
equity and voting rights of each of RCN, Cable Michigan and
Commonwealth Telephone at the end of 1997 was less than 50%,
under generally accepted accounting principles, Level 3 uses the
equity method to account for its investments in each of these
companies. Under the equity method, Level 3 reports its
proportionate share of each of Commonwealth Telephone's, RCN's
and Cable Michigan's earnings, even though it has received no
dividends from those companies. Level 3 keeps track of the
carrying value of its investment in each of the C-TEC Companies.
"Carrying value" is the purchase price of the investment, plus
the investor's proportionate share of the investee's earnings,
less the amortized portion of goodwill, less any dividends paid.
Level 3 purchased its C-TEC Companies shares at a premium over
the book value of the underlying net assets. This premium is
being amortized over a period of between 30 to 40 years. At
December 27, 1997 the carrying value of Level 3's Commonwealth
Telephone shares was $75 million, RCN shares was $214 million and
Cable Michigan shares was $46 million.
Description of the C-TEC Companies. 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.
corridor. 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, 1998, the C-TEC Holding
Company owned approximately 41% of the outstanding common stock of RCN.
Cable Michigan. Cable Michigan is a cable television operator in the State
of Michigan which, as of December 31, 1997, served approximately 204,000
subscribers. These figures include thesubscribers including approximately 42,00039,400 subscribers served by Mercom, a 62% owned subsidiary of
Cable Michigan.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. Commonwealth Telephone Company is a Pennsylvania public utility
providing local telephone service to a 19 county, 5,067 square
mile service territory in Pennsylvania. The telephone company
services approximately 259,000 main access lines. The company
also provides network access, long distance, and billing and
collection services to interexchange carriers. The telephone
company's business customer base is diverse in size as well as
industry, with very little concentration. 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.
Commonwealth Communications Inc. provides telecommunications
engineering and facilities management services to large corporate
clients, hospitals and universities throughout the Northeastern
United States and sells, installs and maintains PBX systems in
Pennsylvania and New Jersey. In January 1995, C-TEC purchased a
40% equity position in Megacable, Mexico's second largest cable
television operator, serving approximately 174,000 subscribers in
12 cities.
For more information on the business of each of RCN,On June 4,
1998, Cable Michigan and Commonwealth Telephone, please seeannounced that it had agreed to be acquired by Avalon
Cable. Level 3 received approximately $129 million in cash when the individual
filings of Annual Reportstransaction
closed on Form 10-K for each of such companies
as filed with the Securities and Exchange Commission.
COAL MINING
Level 3November 6, 1998.
Coal Mining
The Company is engaged in coal mining through its subsidiary, Kiewit Coal PropertiesKCP Inc.
("KCP"). KCP has a 50% interest in three mines, which are operated by KCP.a
subsidiary of Peter Kiewit Sons', Inc. ("New PKS"). Decker 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. Production and Distribution. The coal mines use
the surface mining method. During surface mining operations, topsoil is
removed and stored for later use in land reclamation. After
removal of topsoil, overburden in varying thicknesses is stripped
from above coal seams. Stripping operations are usually conducted
by means of large, earth-moving machines called draglines, or by
fleets of trucks, scrapers and power shovels. The exposed coal
is fractured by blasting and is loaded into haul trucks or onto
overland conveyors for transportation to processing and loading
facilities. Coal delivered by rail from Decker originates on the
Burlington Northern Railroad. Coal delivered by rail from Black
Butte originates on the Union Pacific Railroad. Coal is also
hauled by trucks from Black Butte to the nearby Jim Bridger Power
Plant. Coal is delivered by trucks from Walnut Creek to the
adjacent facilities of the Texas-New Mexico Power Company.
Customers.
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 89% of sales are made under long-term contracts, and the remainder
are made on the spot market. Approximately 79%77%, 80%79% and 80% of KCP's revenues in
1998, 1997 1996 and 1995,1996, 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.
Contracts. Customers enter into long-term contracts for
coal primarily to secure a reliable source of supply at a
predictable price. KCP's major long-term contracts have
remaining terms ranging from 1 to 30 years. A majority of KCP's
long-term contracts provide for periodic price adjustments. The
price is typically adjusted through the use of various indices
for items such as materials, supplies, and labor. Other portions
of the price are adjusted for changes in production taxes,
royalties, and changes in cost due to new legislation or
regulation. In most cases, these cost items are directly passed
through to the customer as incurred. In most cases the price is
also adjusted based on the heating content of the coal.
Decker has a sales contract with Detroit Edison Company that
provides for the delivery of a minimum of 36 million tons of low
sulphur coal during the period 1998 through 2005, with annual
shipments ranging from 5.2 million tons in 1998 to 1.7 million
tons in 2005.
KCP and its mining ventures have entered into various
agreements with Commonwealth Edison Company ("Commonwealth"TNP"),
which stipulate delivery and payment terms for the sale of coal.
The agreements as amended provide for delivery of 88 million tons
during the period 1998 through 2014, with annual shipments
ranging from 1.8 million tons to 13.1 million tons. These
deliveries include 15 million tons of coal reserves previously
sold to Commonwealth. Since 1993, the amended contract between
Commonwealth and Black Butte provides that Commonwealth's
delivery commitments will be satisfied, not with coal produced
from the Black Butte mine, but with coal purchased from three
unaffiliated mines in the Powder River Basin of Wyoming. The
contract amendment allows Black Butte to purchase alternate
source coal at a price below its production costs, and to pass
the cost savings through to Commonwealth while maintaining the
profit margins available under the original contract.
The contract between Walnut Creek and Texas-New Mexico Power
Company provides for delivery of between 42 and 90 million tons
of coal during the period 1989 through 2027. The actual tons
provided will depend on the number of power units constructed and
operated by TNP. The maximum amount KCP is expecting to ship in
any one year is between 1.6 and 3.2 million tons.. 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. Coal Production. Coal production began atThe level of cash flows generated in
recent periods by the Decker, Black
Butte, and Walnut Creek mines in 1972, 1979, and 1989,
respectively. KCP's share ofCompany's coal mined in 1997 atoperations will not continue after the Decker,
Black Butte, and Walnut Creek mines was 5.9, 1.0, and .9 million
tons, respectively.
Revenue. KCP's total revenue in 1997 was $222 million.
Revenue attributable toyear
2000 because the Decker, Black Butte, and Walnut Creek
entities was $114 million, $89 million, and $17 million,
respectively.delivery requirements under the Company's current long-term
contracts decline significantly.
Under a 1992 mine management agreement, KCP pays a KCG
subsidiary of New PKS an
annual fee equal to 30% of KCP's adjusted operating income. The fee in 19971998 was
$32$34 million.
Backlog. At the end of 1997, the backlog of coal to be sold
under KCP's long-term contracts was approximately $1.4 billion,
based on December 1997 market prices. Of this amount, $213
million is expected to be sold in 1998.
Reserves. At the end of 1997, KCP's share of assigned coal
reserves at Decker, Black Butte, and Walnut Creek was 111, 39,
and 31 million tons, respectively. Of these amounts, KCP's share
of the committed reserves of Decker, Black Butte, and Walnut
Creek was 46, 2, and 23 million tons, respectively. Assigned
reserves represent coal that can be mined using KCP's current
mining practices. Committed reserves (excluding alternate source
coal) represent KCP's maximum contractual amounts. These coal
reserve estimates represent total proved and probable reserves.
Leases. The coal reserves and deposits of the mines are
held pursuant to leases with the federal government through the
Bureau of Land Management, with two state governments (Montana
and Wyoming), and with numerous private parties.
Competition.
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 1996,1997, KCP's production
represented 1.5%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 sulphursulfur coal. KCP's western coal
reserves generally have a low sulphursulfur 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.
Environmental Regulation.
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 in 19971998 was $3.6approximately $4 million. KCP's share of
accrued estimated reclamation costs was $100$96 million at the end of 1997.1998. The
Company doesdid not expect to make significant capital expenditures for environmental
compliance with respect to the coal business in 1998. 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. CALENERGY COMPANY, INC.
CalEnergy develops, owns,However, failure to comply with environmental
protection and operates electric power
production facilities, particularly those using geothermal
resources,land restoration laws, or actual reclamation costs in excess of
the United States, the Philippines, and Indonesia.
In December 1996, CalEnergy and Level 3 acquired Northern
Electric plc,Company's accruals, could have an English electric utility company. CalEnergy is
a Delaware corporation formed in 1971 and has its headquarters in
Omaha, Nebraska. CalEnergy common stock is tradedadverse effect on the New
York, Pacific, and London Stock Exchanges. In 1997, CalEnergy
had revenueCompany's business,
results of $2.3 billion and a net loss of $84 million. At the
end of 1997, CalEnergy had total assets of $7.5 billion, debt of
$3.5 billion, and stockholders' equity of $1.4 billion.
At the end of 1997, Level 3 owned approximately 24% of the
common stock of CalEnergy. Under generally accepted accounting
principles, an investor owning between 20% and 50% of a company's
equity, generally uses the equity method. Under the equity
method, Level 3 reports its proportionate share of CalEnergy's
earnings, even though it has received no dividends from
CalEnergy. Level 3 keeps track of the carrying value of its
CalEnergy investment. "Carrying value" is the purchase price of
the investment, plus the investor's proportionate share of the
investee's earnings, less the amortized portion of goodwill, less
any dividends paid. At December 27, 1997 the carrying value of
Level 3's CalEnergy shares was $337 million. On January 2, 1998,
Level 3 sold its entire interest in CalEnergy along with its
interests in several development projects and Northern Electric
plc. to CalEnergy for approximately $1.16 billion.
OTHER BUSINESSESoperations, or financial condition.
SR91 Tollroad. Level 3Tollroad
The Company has invested $12 million for a 65% equity interest and $4.3lent
$5.1 million loan to California Private Transportation Company L.P. ("CPTC"), which
developed, financed, and currently operates the 91 Express Lanes, a ten mile,
four lanefour-lane tollroad in Orange County, California.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 limited
recourse debt.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 tollroadSR91 Tollroad opened in December 1995
and achieved operating break-even in 1996. Approximately 100,00091,500 customers have
registered to use the tollroad as of December 1998, and weekday volumes
typically exceed 29,00027,000 vehicles per day.
United Infrastructure Company. UIC wasday during December 1998.
Glossary
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 equal partnership
between Kiewit Infrastructure Corp.,alternative to the local
exchange for local transport of private line and
special access telecommunications services.
capacity The information carrying ability of a
wholly owned subsidiarytelecommunications facility.
carrier A provider of Level 3,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 Bechtel Infrastructure Enterprises, Inc.
("Bechtel"). UIC was formedlong distance.
CLEC Competitive Local Exchange Carrier. A company that
competes with LECs in 1993the local services market.
colocation Colocation refers to develop North American
infrastructure projects. During 1996, UIC beganthe physical location of a
telecommunication carrier's equipment in ILEC or CLEC
premises to focus
primarilyfacilitate the interconnection of their
respective switching/routing equipment.
common carrier A government-defined group of private
companies offering telecommunications services or
facilities to the general public on water infrastructure projects, principally through
U.S. Water, a
partnership formed with United Utilities PLC,non-discriminatory basis.
conduit A pipe, usually made of metal, ceramic or plastic,
that protects buried cables.
dedicated lines Telecommunications lines reserved for use by
particular customers.
dialing parity The ability of a U.K. company. As partcompeting 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 strategic decision to concentrate
on its information services business and the Expansion Plan, on
December 31, 1997 Level 3 sold its entire interest in UIC to
Bechtel for $10 million.
Kiewit Mutual Fund. Kiewit Mutual Fund, a Delaware business
trust and a registered investment company, was formed in 1994.
Initially formed to manage the Company's internal investments,
shares in Kiewit Mutual Fund are now available for purchase by
the general public.customers' designation.
equal access The Fund's investors currently include
individuals and unrelated companies, as well as
Company-affiliated joint ventures, pension plans, and
subsidiaries. Kiewit Mutual Fund has six series: Money Market
Portfolio, Government Money Market Portfolio, Short-Term
Government Portfolio, Intermediate-Term Bond Portfolio,
Tax-Exempt Portfolio, and the Equity Portfolio. In February
1997, the Fund adopted a master- feeder structure. Eachbasis upon which customers of
the
Portfolios invests in a corresponding series of the Kiewit
Investment Trust, which now manages the underlying securities
holdings. The structure will allow smaller mutual funds and
institutional investors to pool their assets with Kiewit
Investment Trust, providing lower expense ratios for all
participants. The registered investment adviser of Kiewit
Investment Trust is Kiewit Investment Management Corp., a
subsidiary of Level 3 (60%) and KCG (40%). At the end of 1997,
Kiewit Mutual Fund had net assets of $1.3 billion. As part of
the strategic decision to concentrate on its information services
business and the Expansion Plan, it is anticipated that Level 3
will sell its interest in Kiewit Investment Management Corp. to
the Construction Group.
Other. In February 1997, Level 3 purchased an office
building in Aurora, Colorado for $21 million. By investing in
real estate, Level 3 defers taxes on a portion of the $40 million
of taxable gain otherwise recognizable with respect to the
Whitney Benefits litigation settlement in 1995. Level 3 may make
additional real estate investments in 1998 with a view toward
deferring the balance of that taxable gain. Level 3 has also
made investments in several development-stage companies, but does
not expect earnings from these companies in 1998.
GENERAL INFORMATION
Year 2000. The Company. The Company has conducted a review
of its computer systems to identify those systems that could be
affected by the "Year 2000" computer issue, and has developed and
is implementing a plan to resolve the issue. The Year 2000 issue
results from computer programs written with date fields of two
digits, rather than four digits, thus resulting in the inability
of the computer programs to distinguish between the year 1900 and
2000.
The Company expects that its Year 2000 compliance project
will be completed before the Year 2000 date change. During the
execution of this project, the Company has and will continue to
incur internal staff costs as well as consulting and other
expenses. These costs will be expensed, as incurred, in
compliance with GAAP. The expenses associated with this project,
as well as the related potential effect on the Company's earnings
is not expected to have a material effect on its future operating
results or financial condition. There can be no assurance,
however, that the Year 2000 problem will not adversely affect the
Company and its business.
PKSIS. PKS Computer Services, Inc., the computer
outsourcing subsidiary of PKSIS, has developed a comprehensive
approach to address the potential operational risks associated
with the Year 2000, and began to implement remediation plans in
1997. As part of its plans PKS Computer Services is: working
with its key suppliers to verify their operational viability
through the Year 2000; reviewing building infrastructure
components that may be affected by the Year 2000 issue, which
components include fire alarms systems, security systems, and
automated building controls; identifying hardware inventories
that are affected by date logic that is not Year 2000 compliant,
which hardware includes mainframe computers, mid-range computers,
micro-computers, and network hardware. To the extent that
vendors identify items that are not Year 2000 compliant, PKS
Computer Services will work with the hardware vendor to develop a
plan that will enable continuous operations through the Year
2000.
PKS Computer Services is responsible for providing an
operating environment in which its customers applications are
run. As a result, PKS Computer Services will confirm the system
software inventories that it is responsible for managing. PKS
Computer Services will then develop a plan with each of its
customers that indicate that they intend to be customers in the
year 2000 to provide for Year 2000 compliance.
PKS Computer Services believes that many of the required
changes for hardware and operating environments will be included
in the costs that are incurred for annual maintenance.
PKS Systems Integration LLC provides a wide variety of
information technology services to its customers. In fiscal year
1997 approximately 80% of the revenue generated by PKSIS related
to projects involving Year 2000 assessment and renovation
services performed by PKS Systems Integration for its customers.
These contracts generally require PKS Systems Integration to
identify date affected fields in certain application software of
its customers and, in many cases, PKS Systems Integration
undertakes efforts to remediate those date-affected fields so
that the applicable applicationsinterexchange carriers are able to process date-relatedobtain 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 occurringfrom 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 or before the Year 2000. Thus, Year
2000 issues affect manythin strands of glass produces major
benefits including high bandwidth, relatively low
cost, low power consumption, small space needs and
total insensitivity to electromagnetic interference.
Gbps 1000 Mbps.
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 PKS Systems Integrationoriginating 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.
IP Internet Protocol. Network protocols that allow
computers with different architectures and operating
system software to communicate with other computers
on the Internet.
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.
A transmission rate. One kilobit equals 1,024 bits of
information.
Kbps Kilobits per second. A transmission rate. One kilobit
equals 1,024 bits of information.
LATA Local Access and Transport Area. A geographic area
composed of contiguous local exchanges, usually but
not always within a single state. There are
approximately 200 LATAs in the United States.
leased line Telecommunications line dedicated to a particular
customer along predetermined routes.
LEC Local Exchange Carrier. A telecommunications company
that provides telecommunications services in a
geographic area in which calls generally are
transmitted without toll charges. LECs include both
ILECs and CLECs.
local exchange A geographic area determined by the
appropriate state regulatory authority in which calls
generally are transmitted without toll charges to the
calling or called party.
local loop A circuit that connects an end user to the LEC
central office within a LATA.
long distance carriers (interexchange carriers) Long distance carriers
provide services between local exchanges on an
interstate or intrastate basis. A long distance
carrier may offer services over its own or another
carrier's facilities.
Mbps Megabits per second. A transmission rate. One megabit
equals 1,024 kilobits.
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 customers. This exposes PKS Systems Integrationnetwork 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 potential risks that may include problems with services
provided by PKS Systems Integrationall
users generally on a shared basis (i.e., not
dedicated to its customers anda particular user). Traffic along the
potential for claims arising under PKS Systems Integration
customer contracts. PKS Systems Integration attempts to
contractually limit its exposure to liability for Year 2000
compliance issues. However, there can be no assurance as topublic switched network is generally switched at the
effectivenesslocal exchange company's central offices.
RBOCs Regional Bell Operating Companies. Originally, the
seven local telephone companies (formerly part of
such contractual limitations.
The expenses associated with this project by PKSIS, as well
as the related potential effect on PKSIS's earnings is not
expected to have a material effect on its future operating
results or financial condition. There can be no assurance,
however, that the Year 2000 problem, and any loss incurred by any
customers of PKSISAT&T)established as a result of the Year 2000 problem will not
materiallyAT&T Divestiture.
Currently consists of five local telephone companies
as a result of the mergers of Bell Atlantic with
NYNEX and adversely affect PKSISSBC with Pacific Telesis.
reciprocal compensation The compensation of a new competitive local exchange
carrier for termination of a local call by the
local exchange carrier on the new carrier's
network, which is the same as the compensation
that the new carrier pays the local exchange
carrier for termination of local calls on the local
exchange carrier 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
its business.
Environmental Protection. Compliance with federal, state,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.
special access services The lease of private, dedicated telecommunications
lines or "circuits" along the network of a local
provisions regulatingexchange company or a CAP, which lines or circuits
run to or from the dischargelong distance carrier POPs.
Examples of materials into
the environment, or otherwise relatingspecial access services are
telecommunications lines running between POPs of a
single long distance carrier, from one long distance
carrier POP to the protectionPOP 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.
TI 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 area symmetric 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").
Directors and Executive Officers
Set forth below is information as of March 23, 1999 about each director and
each executive officer of the environment, has not and is not expected to have a material
effect upon the capital expenditures, earnings, or competitive
positionCompany. The executive officers of the Company
have been determined in accordance with the rules of the SEC.
Name Age Position
Walter Scott, Jr. 67 Chairman of the Board
James Q. Crowe 49 President, Chief Executive Officer and its subsidiaries.
Employees. AtDirector
R. Douglas Bradbury 48 Executive Vice President, Chief Financial Officer
and Director
Kevin J. O'Hara 38 Executive Vice President and Chief Operating
Officer
Colin V.K. Williams 59 Executive Vice President
Mark L. Gershien 48 Senior Vice President
Michael D. Jones 41 Senior Vice President
Thomas C. Stortz 47 Senior Vice President, General Counsel and
Secretary
Philip B. Fletcher 66 Director
William L. Grewcock 73 Director
Richard R. Jaros 47 Director
Robert E. Julian 59 Director
David C. McCourt 42 Director
Kenneth E. Stinson 56 Director
Michael B. Yanney 65 Director
Other Management
Set forth below is information as of March 23, 1999 about the endfollowing
members of 1997,senior management of the Company.
Name Age Position
Daniel P. Caruso 35 Senior Vice President
Donald H. Gips 39 Senior Vice President
Joseph M. Howell, III 52 Senior Vice President
Gail P. Smith 39 Senior Vice President
Thomas Sweeney 38 Senior Vice President
Ronald J. Vidal 38 Senior Vice President
Sureel A. Choksi 26 Vice President and Treasurer
Walter Scott, Jr. has been the Chairman of the Board of the Company since
September 1979, and a director of the Company since April 1964. Mr. Scott has
been Chairman Emeritus of New PKS since the Split-off. Mr. Scott is also a
director of New PKS, Berkshire Hathaway Inc., Burlington Resources Inc.,
MidAmerican, ConAgra, Inc., Commonwealth Telephone, RCN, U.S. Bancorp and
Valmont Industries, Inc.
James Q. Crowe has been the President and Chief Executive Officer of the
Company since August 1997, and a director of the Company since June 1993. Mr.
Crowe was President and Chief Executive Officer of MFS from June 1993 to June
1997. Mr. Crowe also served as Chairman of the Board of MFS/WorldCom from
January 1997 until July 1997, and as Chairman of the Board of MFS from 1992
through 1996. Mr. Crowe is presently a director of New PKS, Commonwealth
Telephone, RCN and InaCom Communications, Inc.
R. Douglas Bradbury has been Executive Vice President and Chief Financial
Officer of the Company since August 1997, and a director of the Company since
March 1998. Mr. Bradbury served as Chief Financial Officer of MFS from 1992 to
1996, Senior Vice President of MFS from 1992 to 1995, and Executive Vice
President of MFS from 1995 to 1996.
Kevin J. O'Hara has been Executive Vice President of the Company since
August 1997, and Chief Operating Officer of the Company since March 1998. Prior
to that, Mr. O'Hara served as President and Chief 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.
Mark L. Gershien has been Senior Vice President, Sales of the Company since
January 1998. Prior to that, Mr. Gershien was Vice President/General Manager of
MFS during 1993, Division President of MFS from 1993 to 1995, Chief Operating
Officer of MFS Telecom from May 1995 to July 1996, President of MFS Telecom from
1996 to 1997, and Senior Vice President, National Accounts of MFS/WorldCom from
1997 to 1998.
Michael D. Jones has been the Acting Chief Executive Officer of PKSIS since
December 1998. Mr. Jones also has served as Senior Vice President and Chief
Information Officer of the Company since December 1998. Prior to that, Mr. Jones
was Vice President and Chief Information Officer of Corporate Express, Inc. from
May 1994 to May 1998.
Thomas C. Stortz has been Senior Vice President, General Counsel and
Secretary of the Company since September 1998. 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.
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 majority-owned subsidiaries employed approximately 17,700 people
- - 16,200executive 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 MidAmerican from 1992 to 1993, and is presently a director
of MidAmerican, Commonwealth Telephone and RCN.
Robert E. Julian has been a director of the Company since March 31, 1998.
Mr. Julian has also been Chairman of the Board of PKSIS since 1995. From 1992 to
1995 Mr. Julian served as Executive Vice President and Chief Financial Officer
of the Company.
David C. McCourt has been a director of the Company since March 31, 1998.
Mr. McCourt has also served as Chairman and Chief Executive Officer of
Commonwealth Telephone and RCN since October 1997. From 1993 to 1997 Mr. McCourt
served as Chairman of the Board and Chief Executive Officer of C-TEC.
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.
Daniel P. Caruso has been Senior Vice President, Network Services of the
Company since October 1997. 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.
Donald H. Gips has been Senior Vice President, Corporate Development of the
Company since November 1998. 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 Senior Vice President, Corporate Marketing
of the Company since October 1997. Prior to that, Mr. Howell was Senior Vice
President of MFS/WorldCom from 1993 to 1997. Prior to joining MFS, Mr. Howell
was President and CEO of Carl Byoir & Associates, Inc., an international
marketing company, from 1991 to 1993.
Gail P. Smith has been Senior Vice President, International Sales and
Marketing of the Company since December 1998. 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.
Thomas P. Sweeney has been Senior Vice President, Marketing of the Company
since December 1997. Prior to that, Mr. Sweeney was Vice President, Sales
Operations of MFS Intelenet, Inc. ("MFS Intelenet") from 1995 to 1996, Senior
Vice President, Marketing of MFS Intelenet from 1996 to 1997 and Senior Vice
President, Business Development of MFS/WorldCom during 1997.
Ronald J. Vidal has been Senior Vice President, New Ventures of the Company
since October 1997. 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.
Sureel A. Choksi has been Vice President and materials operations, 500 by coal
mining companies, 800Treasurer of the Company since
January 1999. Prior to that, Mr. Choksi was a Director of Finance at PKSIS,the Company
from 1997 to 1998, an Associate at TeleSoft Management, LLC in 1997 and 200 in corporatean
Analyst at Gleacher Natwest from 1995 to 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
currently consist of Walter Scott, Jr., James Q. Crowe and Philip B. Fletcher,
with one vacancy; 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. The
term of the initial Class I Directors will terminate on the date of the 2001
annual meeting of stockholders; the term of the initial Class II Directors will
terminate on the date of the 1999 annual meeting of stockholders; and the term
of the initial 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.
Employees
As of December 31, 1998, Level 3 positions. This does not includehad 1,225 employees in the communications
portion of its business and PKSIS had approximately 959 employees, for a total
of the C-TEC
Companies.2,184 employees.
ITEM 2. PROPERTIES.PROPERTIES
The properties used in the construction segment are
described under a separate heading in Item 1 above. Properties
relating to the Company's coal mining segment are described as
part of the general business description of the coal mining
business. Level 3Company has announced that it has acquired 46 acres in the Northwest
corner of the Interlocken office park within the City of Broomfield, Colorado,
and within Boulder County, Colorado limits and will build a campus facility that
is expected to encompass eventually encompass over 500,000 square feet of office space.
Interlocken is located
within the City of Broomfield, Colorado,Construction has begun on this facility, and within Boulder
County, Colorado. Itit is anticipated that the first
phase of this facility will be constructedcompleted by the endsummer of June 1999. In addition, Level 3the
Company has leased approximately 50,000250,000 square feet of temporary office space
in Louisville, Colorado to allow for the relocation of the majority of its
employees (other than those of PKSIS) while its permanent facilities are under
construction. Properties relating to the Company's coal mining segment are
described under "--The Company's Other Businesses" above. In connection with
certain existing and historical operations, the Company is subject to
environmental risks.
The Company considers its properties to be adequatehas approximately 1.25 million square feet of space for its
presentgateway facilities. The Company's gateway facilities are being designed to house
local sales staff, operational staff, the Company's transmission and foreseeable requirements.IP
routing/switching facilities and technical space to accommodate colocation of
equipment by high-volume Level 3 customers.
PKSIS maintains its corporate headquarters in Omaha, Nebraska and leases
approximately 35,000 square feet of office space in Omaha. The computer
outsourcing business of PKSIS is located at an 89,000 square foot office space
in Omaha and at a 60,000 square foot computer center in Tempe, Arizona. PKSIS
maintains additional office space in Phoenix, Atlanta, Omaha and Parsippany for
its systems integration business.
ITEM 3. LEGAL PROCEEDINGS.
General.PROCEEDINGS
The Company and its subsidiaries are parties to many pending legal
proceedings. Management believes that any resulting liabilities for legal
proceedings, beyond amounts reserved, will not materially affect the Company's
financial condition, future results of operations or future cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At a special meeting of stockholders held on December 8,
1997, the followingHOLDERS
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote.
1. Ratificationvote of the decision of the PKS Board to
separate the construction business of PKS and the diversified
business of PKS into two independent companiessecurity holders, through the declarationsolicitation
of a dividend of eight-tenths of one share of newly
created Class R Convertible Common Stock, par value $.01 per
share ("Class R stock"), of PKS with respect to each outstanding
share of Class C Construction & Mining Group Restricted
Redeemable Convertible Exchangeable Common Stock, par value
$.0625 per share ("Class C stock"), of PKS, and mandatory
exchange of each outstanding share of Class C stock for one
outstanding share of Common Stock, par value $.01 per share, of
PKS Holdings, Inc. (collectively, the "Transaction").
Class C stock Class D stock
Affirmative votes: 9,031,714 21,673,495
Negative votes: 30,926 185,412
Abstentions: 11,020 64,227
2. Approval of amendments to the PKS Certificate (the
"Initial Certificate Amendments"), to: (i) create the Class R
Stock to be distributed in the Transaction; (ii) increase from
50,000,000 to 500,000,000 the number of shares of Class D
Diversified Group Convertible Exchangeable Common Stock, par
value $.0625 per share ("Class D stock"), which PKS is authorized
to issue; (iii) designate 10 shares of Class D stock as "Class D
Stock, Non-Redeemable Series"; and (iv) eliminate the requirement
that the Certificate of Incorporation of PKS Holdings as in
effect at the time of the Share Exchange be substantially similar
to the PKS Certificate.
Class C stock Class D stock
Affirmative votes: 9,030,927 21,735,628
Negative votes: 28,676 147,676
Abstentions: 14,057 39,830
3. Approval of amendments to the PKS Certificate to be
effected only if the Transaction is consummated, to: (i)
redesignate Class D stock as "Common Stock, par value $.01 per
share", and Class D Stock, Non-Redeemable Series as "Common
Stock, Non-Redeemable Series"; (ii) authorize the issuance of
series of preferred stock, the terms of which are to be
determined by the board of directors; (iii) modify the repurchase
rights to which the holders of Class D stock are entitled; (iv)
delete the provisions regarding Class C stock; (v) classify the
board of directors; (vi) prohibit stockholder action by written
consent; (vii) empower the board of directors, exclusively, to
call special meetings of the stockholders; (viii) require a
supermajority vote of stockholders to amend the by-laws; and (ix)
make certain other non-substantive changes consistent with the
implementation of the foregoing.
Class C stock Class D stock
Affirmative votes: 9,011,554 21,472,115
Negative votes: 30,696 381,726
Abstentions: 31,410 69,293
4. Approval of the amendment and restatement of the Peter
Kiewit Sons', Inc. 1995 Class D stock Plan.
Class C stock Class D stock
Affirmative votes: 8,958,084 21,268,757
Negative votes: 70,566 536,914
Abstentions: 45,010 117,463
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below shows information as of March 15, 1998 about
each director and executive officer of the Company, including his
business experience during the past five years. The Company's
directors and officers are elected annually and each was elected
on June 7, 1997 to serve until his successor is elected and
qualifiedproxies or until his death, resignation or removal.
Name Business Experience Age PKS Director Since
Walter Scott, Jr.* Chairman of the Board and 66 09/27/79- Chairman
President, PKS (for more 04/22/64- Director
than the past five years);
also a director of Berkshire
Hathaway, Inc., Burlington
Resources, Inc., CalEnergy,
ConAgra, Inc., Commonwealth
Telephone Enterprises, Inc.,
RCN Corporation, U.S. Bancorp
and Valmont Industries, Inc.
Peter Kiewit, Jr. Attorney, of counsel to the 71 01/13/66
law firm of Gallagher &
Kennedy of Phoenix, Arizona
(for more than the past five
years)
William L. Grewcock* Vice Chairman, PKS (for more 72 01/11/68
than the past five years)
Robert B. Daugherty Director (and formerly 75 01/08/86
Chairman of the Board and
Chief Executive Officer)
Valmont Industries, Inc.
(for more than the past
five years)
Charles M. Harper Former Chairman of the 69 01/08/86
Board and Chief Executive
Officer of RJR Nabisco
Holdings Corp. Currently
a director (and formerly
Chairman of the Board and
Chief Executive Officer)
of ConAgra, Inc. and also
a director of E.I. DuPont
de Nemours and Company,
Norwest Corp. and Valmont
Industries, Inc.
Kenneth E. Stinson* Executive Vice President, 55 01/07/87
PKS (for more than the
past five years); Chairman
since 1993) and CEO (since
1992), KCG; also a director
of ConAgra, Inc. and Valmont
Industries, Inc.
Richard Geary* Executive Vice President, 62 04/29/88
KCG; President of Kiewit
Pacific Co., a KCG
construction subsidiary
(for more than the past five years)
George B. Toll, Jr.* Executive Vice President, 61 06/05/93
KCG (since 1994); Vice
President, Kiewit
Pacific Co., a KCG
construction subsidiary
(1992-1994)
James Q. Crowe* President and Chief 48 06/05/93
Executive Officer,
Level 3 (since August 1,
1997); Chairman of the
Board, WorldCom, Inc., an
International
telecommunications company
(January 1997-July 1997);
Chairman of the Board, MFS
Communications Company, Inc.,
an international
telecommunications company
(1992-1996) (MFS was a
Diversified Group subsidiary
until 1995); also a director
of Commonwealth Telephone
Enterprises, Inc., RCN
Corporation, and InaCom
Communications, Inc.
Richard R. Jaros Executive Vice President 46 06/05/93
(1993-1997) and Chief
Financial Officer (1995-1997),
PKS; President of Level 3
(1996-1997); President and
COO of CalEnergy (1992-1993);
also a director of CalEnergy,
Commonwealth Telephone
Enterprises, Inc., RCN
Corporation and WorldCom, Inc.
Richard W. Colf* Vice President, Kiewit 54 06/03/95
Pacific Co., a KCG
construction subsidiary
(for more than the past
five years)
Bruce E. Grewcock* Executive Vice President, 44 06/04/94
KCG (since 1996); Chairman
(since 1996), President
(1992-1996) and Sr. Vice
President (1992) of Kiewit
Mining Group Inc.; also a
director of Kinross Gold
Corporation
Tait P. Johnson* President, Gilbert 48 06/03/95
Industrial Corporation, a
KCG construction subsidiary
(for more than the past five
years); President (1992-1996),
Gilbert Southern Corp., a KCG
construction subsidiary
Allan K. Kirkwood* Senior Vice President, 54 06/07/97
Kiewit Pacific Co., a KCG
construction subsidiary
(for more than the past
five years)
Identified by asterisks are the ten persons currently
serving as executive officers of PKS. Executive officers are
those directors who are employed by PKS or its subsidiaries.
Bruce E. Grewcock is the son of William L. Grewcock.
The PKS Board has an Audit Committee, a Compensation
Committee and an Executive Committee.
The Audit Committee members are Messrs. Johnson, Kirkwood
and Kiewit. The functions of the Audit Committee are to
recommend the selection of the independent auditors; review the
results of the annual audit; inquire into important internal
control, accounting and financial matters; and report and make
recommendations to the full PKS Board. The Audit Committee had
four meetings in 1997.
The Compensation Committee members are Messrs. Daugherty,
Harper, and Kiewit, none of whom are employees of PKS. This
committee reviews the compensation of the executive officers of
PKS. This committee has also assumed the functions of the former
Management Compensation Committee, the purpose of which was to
review the compensation, securities ownership, and benefits of
the employees of PKS other than its executive officers. The
Compensation Committee had one formal meeting in 1997.
The Executive Committee members are Messrs. Scott
(Chairman), William Grewcock, Stinson, and Crowe. This committee
exercises the powers of the PKS Board between meetings of the PKS
Board, except powers assigned to other committees. During 1997,
the Executive Committee had no formal meetings, acted by written
consent action in lieu of a meeting on two occasions, and had
several informal meetings.
PKS does not have a nominating committee. The PKS
Certificate provides that the incumbent directors elected by
holders of Class C Stock may nominate a slate of Class C
directors to be elected by holders of Class C Stock and the
incumbent directors elected by holders of Class D Stock may
nominate a slate of directors to be elected by holders of Class D
Stock, for election at the annual meeting of stockholders.
The PKS Board had six formal meetings in 1997 and acted by
written consent action on six occasions. In 1997, no director
attended less than 75% of the meetings of the PKS Board and the
committees of which he was a member.
Directors who are employees of PKS or its subsidiaries do
not receive directors' fees. Non-employee directors are paid
annual directors' fees of $30,000, plus $1,200 for attending each
meeting of the PKS Board, and $1,200 for attending each meeting
of a committee of the PKS Board.
PART IIotherwise.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.MATTERS
Market Information. The Company's common stock is traded on the Nasdaq
National Market under the symbol "LVLT." As of December 27, 1997,March 23, 1999, there were
approximately 3,000 holders of record of the Company's common stock, is not listed on any national securities exchange or
the Nasdaq National Market. However, the Class D stock is
currently quoted on the National Association of Securities
Dealers, Inc.'s OTC Bulletin Board. During the fourth quarter of
1997, the only quarter during which this trading occurred, the
range of the high and low bid information for the Class D stock
was $24.60 to $29.00.par value
$.01 per share. The Company has announced that the common
stock of Level 3 Communications, Inc. (renamed from Peter Kiewit
Sons', Inc. in connection with the Transaction) will beginCommon Stock began trading on the Nasdaq National Market on
April 1, 1998, the day following the Split-off. 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.
Year Ended December 31, 1998 High Low
Second Quarter (from April 1, 1998).........$37.1300 $24.0000
Third Quarter................................42.1300 29.7800
Fourth Quarter...............................43.1300 24.0000
Dividend Policy. The Company's current dividend policy, in effect since
April 1, 1998, is to retain future earnings for use in the Company's business.
As a result, management does not anticipate paying any cash dividends on shares
of Common Stock in the foreseeable future. In addition, the Company is
effectively restricted under certain debt covenants from paying cash dividends
on shares of its Common Stock.
Information For Periods Prior to April 1, 1998.
The following information relates to the equity securities of the Company
for periods prior to April 1, 1998. As part of the Split-off, an amended and
restated certificate of incorporation for the Company was filed in the State of
Delaware to provide for only one class of common stock, par value $.01 per
share. The information that follows is for historical purposes only and is
required to be presented by the rules of the Securities and Exchange Commission.
Company Repurchase Duty. Pursuant to the current terms of the PKSCompany's Certificate
of Incorporation prior to April 1, 1998 (the "Pre-April 1998 Certificate"), the
Company iswas generally required to repurchase shares at a formula price upon
demand. Under the PKSPre-April 1998 Certificate effective January 1992, the Company
hashad three classes of common stock: Class B Construction & Mining Group Nonvoting
Restricted Redeemable Convertible Exchangeable Common Stock ("Class B"), Class C
stock,Construction & Mining Group Restricted Redeemable Convertible Exchangeable
Common Stock, par value $.0625 per share (the "Class C Stock"), and Class D
stock. There are no
outstanding Class B stock; the last Class B stock were converted
into ClassDiversified Group Convertible Exchangeable Common Stock, par value $.0625 per
share (the "Class D stock on JanuaryStock"). Prior to April 1, 1997.1998, Class C stock can beStock was issued
only to Company employees and cancould only be resold only to the Company at a formula
price based on the year-end book value of the Construction Group. The Company
iswas generally required to repurchase Class C stockStock for cash upon stockholdera stockholder's
demand. Class D stock hasStock had a formula price based on the year-end book value of
the Diversified Group. The Company mustwas generally required to repurchase Class D
stockStock for cash upon stockholdera stockholder's demand at the formula price, unless the
Class D stockStock become publicly traded.
Formula values. The formula price of the Class D stock isStock was based on the
book value of Level 3the Diversified Group and its subsidiaries, plus one-half of the
book value, on a stand-alone basis, of the parent company, PKS.company. The formula price of
the Class C stock isStock was based on the book value of the Construction Group and its
subsidiaries, plus one-half of the book value of the unconsolidated parent
company. A significant element of the Class C formula price iswas the subtraction
of the book value of property, plant, and equipment used in construction
activities ($122 million in 1997).activities.
Conversion. Under the PKSPre-April 1998 Certificate, Class C stock isStock was
convertible into Class D stockStock at the end of each year. Between October 15 and
December 15 of each year a Class C stockholder mayStockholder was able to elect to convert some
or all of his or her shares. Conversion occursoccurred on the following January 1. The
conversion ratio iswas the relative formula prices of Class C and Class D stockStock
determined as of the last Saturday in December, that is, the last day in the
Company's fiscal year.December. Class D stock may be convertedStock was convertible
into Class C stockStock only as part of an annual offering of Class C stockStock to
employees. Instead of purchasing the offered shares for cash, an employee owning
Class D stock mayStock was able to convert such shares into Class C stockStock at the
applicable conversion ratio.
Restrictions. Ownership of Class C stock isStock was generally restricted to active
Company employees. Upon retirement, termination of employment, or death, Class C
stock mustStock was required to be resold to the Company at the applicable formula price,
but may be converted into Class D stockStock if the terminating event occurs during
the annual conversion period. Class D stock isStock was not subject to ownership or
transfer restrictions.
Dividends and Prices. During 1996 and 1997 the Company declared or paid the
following dividends on its common stock.shares of Class C Stock and Class D Stock. The table also
shows the stock price after each dividend payment or other valuation event.
Dividend Dividend
Declared Dividend
Date Date Paid Per ShareAmount Class Date Price Adjusted Stock Price
Oct. 27, 1995 Jan. 5, 1996 $0.60 C Dec. 30, 1995 $32.40
Apr. 26, 1996 May 1, 1996 0.60 C May 1, 1996 31.80
Oct. 25, 1996 Jan. 4, 1997 0.70 C Dec. 28, 1996 40.7040.700
Apr. 23, 1997 May 1, 1997 0.70 C May 1, 1997 40.0040.000
Oct. 22, 1997 Jan. 5, 1998 0.80 C Dec. 27, 1997 51.2051.200
Oct. 27, 1995 Jan. 5, 1996 0.500.05 D Dec. 30, 1995 9.90*4.950*
Oct. 25, 1996 Jan. 4, 1997 0.500.05 D Dec. 28, 1996 10.85*5.425*
D Dec. 27, 1997 11.65*5.825*
* All stock prices and dividends for the Class D stockStock reflect a dividend of
four shares of Class D stock for each outstanding share of Class
D stock that was effective on December 26, 1997.
The Company's current dividend policy is to pay a regular
dividend on Class C stock of about 15% to 20% of the prior year's
ordinary earnings of the Construction Group, with any special
dividends to be based on extraordinary earnings. Although the
PKS Board announced in August 1993 that the Company did not
intend to pay regular dividends on Class D stock for the
foreseeable future, the PKS Board declared a special dividend of
$0.50 per share of Class D stock in both October 1995 and 1996.
A dividend of 4 shares of Class D Stock for each share of
Class D Stock was effected on December 26, 1997.
Stockholders. On March 15, 1998, and after giving effect to
a dividend of 4 shares of Class D Stock for each outstanding share of Class D stock effected onStock
that was effective December 26, 1997 the Company
had the following numbersand a dividend of stockholders and outstanding sharesone share of Common Stock
(formerly Class D Stock) for each classoutstanding share of its common stock:
Class ofCommon Stock
Stockholders Shares Outstanding
B - -
C 996 7,681,020
D 2,121 146,943,752
Recent Sales of Unregistered Securities. On April 1, 1997,
the Company sold 10,000 shares of Class D stock to Charles Harper
and Robert Daugherty and 8,000 shares of Class D stock to Peter
Kiewit Jr. at a sale price of $49.50 per share. Each of Messrs
Harper, Daugherty and Kiewit are members of the PKS Board of
Directors. The sale was effected pursuant to an exemption from
registration under the Securities Act of 1933 contained in
Section 4(2) of such Act.effective August 1998.
ITEM 6. SELECTED FINANCIAL DATA.
PETER KIEWIT SONS', INC.
SELECTED CONSOLIDATED FINANCIAL DATA
The Selected Financial Data of Peter Kiewit Sons', Inc., the
Kiewit Construction & Mining Group ("C Stock") and the
Diversified Group ("D Stock") appear below and on the next two
pages. The consolidated data of PKS are presented below with the
exception of per common share data which is presented in the
Selected Financial Data of the respective Groups.
(dollars in millions, Fiscal Year Ended
except per share amounts) 1997 1996 1995 1994 1993
Results of Operations:
Revenue (1) $ 332 $ 652 $ 580 $ 537 $ 267
Earnings from continuing
operations 83 104 126 28 174
Net earnings (2) 248 221 244 110 261
Financial Position:
Total assets (1) 2,779 3,066 2,945 4,048 3,236
Current portion of
long-term debt (1) 3 57 40 30 11
Long-term debt, less
current portion (1) 137 320 361 899 452
Stockholders' equity (3) 2,230 1,819 1,607 1,736 1,671
(1) In October 1993, the Company acquired 35% of the outstanding
shares of C-TEC Corporation that had 57% of the available
voting rights. On December 28, 1996 the Company owned 48%
of the outstanding shares and 62% of the voting rights.
As a result of the C-TEC restructuring, the Company owns less
than 50% of the outstanding shares and voting rights of the
three entities, and therefore accounted for each entity using
the equity method in 1997. The Company consolidated C-TEC
from 1993 through 1996.
The financial position and results of operations of Kiewit
Construction & Mining Group have been classified as
discontinued operations due to the pending spin-off from
Peter Kiewit Sons', Inc.
In September 1995, the Company dividended its investment in
MFS to Class D shareholders. MFS' results of operations have
been classified as a single line item on the statements of
earnings. MFS is consolidated in the 1993 and 1994 balance
sheets.
In January 1994, MFS, issued $500 million of 9.375% Senior
Discount Notes.
In September 1997, Level 3 agreed to sell its energy segment to
CalEnergy Company,Communications, Inc. The transaction closed on January 2,
1998.
(2) In 1993, through two public offerings, the Company sold 29%
of its subsidiary, MFS, resulting in a $137 million after-tax
gain. In 1995 and 1994, additional MFS stock transactions
resulted in $2 million and $35 million after-tax gains to the
Company and reduced its ownership in MFS to 66% and 67%.
(3) The aggregate redemption value of common stock at December
27, 1997 was $2.1 billion.
KIEWIT CONSTRUCTION & MINING GROUP
SELECTED FINANCIAL DATA
The following selected financial data for each of the years in
the period 1993 to 1997 have been derived from audited financial
statements. The historical financial information for the Kiewit
Construction & Mining and Diversified Groups supplements the
consolidated financial information of PKS and, taken together,
includes all accounts which comprise the corresponding
consolidated financial information of PKS.
(dollars in millions, Fiscal Year Ended
except per share amounts) 1997 1996 1995 1994 1993
Results of Operations:
Revenue $ 2,764 $ 2,303 $ 2,330 $ 2,175 $ 1,783
Net earnings 155 108 104 77 80
Per Common Share:
Net earnings
Basic 15.99 10.13 7.78 4.92 4.63
Diluted 15.35 9.76 7.62 4.86 4.59
Dividends (1) 1.50 1.30 1.05 0.90 0.70
Stock price (2) 51.20 40.70 32.40 25.55 22.35
Book value 64.38 51.02 42.90 31.39 27.43
Financial Position:
Total assets 1,341 1,038 976 967 889
Current portion of
long-term debt 5 - 2 3 4
Long-term debt, less
current portion 22 12 9 9 10
Stockholders' equity (3) 652 562 467 505 480
(1) The 1997, 1996, 1995, 1994 and 1993 dividends include $.80,
$.70, $.60, $.45 and $.40 for dividends declared in 1997,
1996, 1995, 1994 and 1993, respectively, but paid in
January of the subsequent year.
(2) Pursuant to the Certificate of Incorporation, the stock
price calculation is computed annually at the end of the
fiscal year.
(3) Ownership of the Class C Stock is restricted to certain
employees conditioned upon the execution of repurchase
agreements which restrict the employees from transferring
the stock. PKS is generally committed to purchase all
Class C Stock at the amount computed, when put to PKS by a
stockholder, pursuant to the Certificate of Incorporation.
The aggregate redemption value of the Class C Stock at
December 27, 1997 was $527 million.
DIVERSIFIED GROUP
SELECTED FINANCIAL DATA
The following selected financial data for each of the years in
the period 1993 to 1997 have been derived from audited financial
statements. The historical financial information for the
Diversified Group and Kiewit Construction & Mining Group
supplements the consolidated financial information of PKS and,
taken together, includes all accounts which comprise the
corresponding consolidated financial information of PKS.
(dollars in millions, Fiscal Year Ended
except per share amounts) 1997 1996 1995 1994 1993
Results of Operations:
Revenue (1) $ 332 $ 652 $ 580 $ 537 $ 267
Earnings from continuing operations 83 104 126 28 174
Net earnings (2) 93 113 140 33 181
Per Common Share:
Earnings from continuing operations
Basic .66 .90 1.17 .27 1.74
Diluted .66 .90 1.17 .27 1.74
Net earnings
Basic .74 .97 1.29 1.32 1.82
Diluted .74 .97 1.29 1.32 1.81
Dividends (3) - .10 .10 - .10
Stock price (4) 11.65 10.85 9.90 12.05 11.88
Book value 11.65 10.85 9.90 12.07 11.90
Financial Position:
Total assets (1) 2,127 2,504 2,478 3,543 2,756
Current portion of long-term debt (1) 3 57 40 30 11
Long-term debt,less current portion (1) 137 320 361 899 452
Stockholders' equity (5) 1,578 1,257 1,140 1,231 1,191
(1) In October 1993, the Group acquired 35% of the outstanding
shares of C-TEC Corporation that had 57% of the available
voting rights. At December 28, 1996, the Group owned 48% of
the outstanding shares and 62% of the voting rights.
As a result of the C-TEC restructuring, the Group owns less
than 50% of the outstanding shares and voting rights of each
of the three entities, and therefore accounted for each
entity using the equity method in 1997. The Company
consolidated C-TEC from 1993 to 1996.
In September 1995, the Group dividended its investment in MFS to
Class D shareholders. MFS' results of operations have been
classified as a single line item on the statements of
earnings. MFS is consolidated in the 1993 and 1994 balance
sheets.
In January 1994, MFS issued $500 million of 9.375% Senior
Discount Notes.
In September 1997, the Group agreed to sell its energy segment
to CalEnergy Company, Inc. The transaction closed on January
2, 1998.
(2) In 1993, through two public offerings, the Group sold 29% of
MFS, resulting in a $137 million after-tax gain. In 1995 and
1994, additional MFS stock transactions resulted in $2
million and $35 million after-tax gains to the Group and
reduced its ownership in MFS to 66% and 67%.
(3) The 1996, 1995 and 1993 dividends include $.10 for
dividends declared in 1996, 1995 and 1993 but paid in
January of the subsequent year.
(4) Pursuant to the Certificate of Incorporation, the stock price
calculation is computed annually at the end of the fiscal
year.
(5) Unless Class D Stock becomes publicly traded, PKS is
generally committed to purchase all Class D Stock at the
amount computed, in accordance with the Certificate of
Incorporation, when put to PKS by a stockholder. The
aggregate redemption value of the Class D Stock at December
27, 1997 was $1,578 million.Subsidiaries
appears below.
Fiscal Year Ended (1)
(dollars in millions, -----------------------------------------------------------------
except per share amounts) 1998 1997 1996 1995 1994
- - ------------------------------------------------------------------------------------------------------------------
Results of Operations:
Revenue $ 392 $ 332 $ 652 $ 580 $ 537
Income (loss) from continuing
operations (2) (128) 83 104 126 28
Net earnings (3) 804 248 221 244 110
Per Common Share:
Earnings (loss)from continuing operations (0.43) 0.33 0.45 0.58 0.23
Dividends (4) - - 0.05 0.05 -
Financial Position:
Total assets 5,525 2,779 3,066 2,945 4,048
Current portion of
long-term debt 5 3 57 40 30
Long-term debt, less
current portion (5) 2,641 137 320 361 899
Stockholders' equity 2,165 2,230 1,819 1,607 1,736
(1) In October 1993, Level 3 acquired 35% of the outstanding shares of C-TEC
Corporation ("C-TEC"), which shares entitled Level 3 to 57% of the
available voting rights of 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 owns 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 in 1997 and 1998. Level 3 consolidated C-TEC
in its financial statements from 1994 to 1996.
The financial position and results of operations of the construction and
mining management businesses ("Construction Group") of Level 3 have been
classified as discontinued operations due to the March 31, 1998 split-off
of Level 3's Construction Group from its other businesses.
In 1995, Level 3 dividended its investment in its former subsidiary, MFS
Communications Company, Inc. ("MFS") to the holders of the Class D Stock.
MFS' results of operations have been classified as a single line item on
the statements of earnings for 1994 and 1995. MFS was consolidated in the
1994 balance sheet of Level 3. In 1994, MFS received net proceeds of
approximately $500 million from the sale of 9.375% Senior Discount Notes.
Level 3 sold its energy segment to MidAmerican Energy Holdings Company
(f/k/a CalEnergy Company, Inc.) ("MidAmerican") in 1998 and classified it
as discontinued operations within the financial statements.
(2) Level 3 incurred significant expenses in conjunction with the expansion of
its communications and information services businesses in 1998.
In 1998, Level 3 acquired XCOM Technologies, Inc. ("XCOM") and its
developing telephone-to-IP network bridge technology. Level 3 originally
recorded a $115 million nondeductible charge against earnings for the
write-off of in-process research and development acquired in the
transaction.
In October 1998, the Securities and Exchange Commission ("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 the corresponding amount. The
goodwill associated with the XCOM transaction is being amortized over a
five year period.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guidelines and methodologies.
However, no assurances can be given that the SEC will not require
additional adjustments.
(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.
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 the fourth quarter of 1998.
Level 3 also recognized in 1998 an after-tax gain of $324 million on the
sale of its energy segment to MidAmerican.
(4) The 1996 and 1995 dividends include $.05 for dividends declared in 1996
and 1995 but paid in January of the subsequent year.
The Company's current dividend policy, in effect since April 1, 1998, is to
retain future earnings for use in the Company's business. As a result,
management does not anticipate paying any cash dividends on shares of
Common Stock in the foreseeable future. In addition, the Company is
effectively restricted under certain covenants from paying cash dividends
on shares of its Common Stock.
(5) In 1998, Level 3 issued $2 billion of 9.125% Senior Notes due 2008 and $834
million principal amount at maturity of 10.5% Senior Discount Notes due
2008.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALLYSISANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This item contains information about Peter Kiewit Sons', Inc.
(the "Company") as a whole. Separate reports containing
management's discussion and analysis of financial condition and
results of operations for the Kiewit Construction & Mining Group
and Diversified Group have been filed as Exhibits 99.A
and 99.B to this Form 10-K. A copy of Exhibit 99.A will be
furnished without charge upon the written request of a
stockholder addressed to: Stock Registrar, Peter Kiewit Sons',
Inc., 1000 Kiewit Plaza, Omaha, Nebraska 68131. Exhibit 99.B
can be obtained by contacting Investor Relations, Level 3 Communications,
Inc., 3555 Farnam Street, Omaha, Nebraska 68131.
The following discussion of Results of Operations should be
read in conjunction with the segment information contained in
Note 13 of the Consolidated Financial Statements.OPERATION
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 Level 3 Communications, Inc. and its
subsidiaries ("Level 3" or the Company."Company"). When used in this document, the words
"anticipate", "believe", "estimate" and "expect" and similar expressions, as
they relate to the Company or its management, are intended to identify
forward-looking statements. Such statements reflect the current views of the
Company with respect to future events and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those described in this document.
Recent Developments
Split-off
In October 1996, the Board of Directors of the Company (the "Board")
directed management of the Company to pursue a listing of the Company's Class D
Diversified Group Convertible Exchangeable Common Stock, par value $.0625 per
share (the "Class D Stock"), as a way to address certain issues created by the
Company's then two-class capital stock structure and the need to attract and
retain the best management for the Company's businesses. During the course of
its examination of the consequences of a listing of the Class D Stock,
management concluded that a listing of the Class D Stock would not adequately
address these issues, and instead began to study a separation of the
construction operations ("Construction Group") from the other businesses of the
Company (the "Diversified Group"), thereby forming two independent companies. At
the time, the performance of the Diversified Group was reflected by the Class D
Stock. The performance of the Construction Group was reflected by the Company's
Class C Construction & Mining Group Restricted Redeemable Convertible
Exchangeable Common Stock, par value $.0625 per share (the "Class C Stock"). At
the regular meeting of the Board on July 23, 1997, management submitted to the
Board for consideration a proposal for the separation of the Construction Group
and the Diversified Group through a split-off of the Construction Group (the
"Split-off"). At a special meeting on August 14, 1997, the Board approved the
Split-off.
The separation of the Construction Group and the Diversified Group was
contingent upon a number of conditions, including the favorable ratification by
a majority of the holders of both the Company's Class C Stock and the Class D
Stock, and the receipt by the Company of an Internal Revenue Service ruling or
other assurance acceptable to the Board that the separation would be tax-free to
U.S. stockholders. On December 8, 1997, the holders of Class C Stock and Class D
Stock approved the Split-off and on March 5, 1998, the Company received a
favorable private letter ruling from the Internal Revenue Service. The Split-off
was effected on March 31, 1998. In connection with the Split-off, (i) the
Company exchanged each outstanding share of Class C Stock for one share of
Common Stock of PKS Holdings, Inc. ("New PKS"), the Company formed to hold the
Construction Group, to which eight-tenths of a share of the Company's Class R
Convertible Common Stock, par value $.01 per share (the "Class R Stock"), was
attached to replace certain conversion features in the Class C Stock which would
terminate upon the Split-off (ii) New PKS was renamed "Peter Kiewit Sons', Inc."
(iii) the Company was renamed "Level 3 Communications, Inc.", and (iv) the Class
D Stock was designated as common stock, par value $.01 per share (the "Common
Stock"). As a result of the Split-off, the Company no longer owns any interest
in New PKS or the Construction Group. Accordingly, the separate financial
statements and management's discussion and analysis of financial condition and
results of operations of Peter Kiewit Sons', Inc. should be obtained to review
the financial position of the Construction Group as of December 27, 1997, and
the results of operations for the two years ended December 27, 1997.
On March 31, 1998, the Company reflected the fair value of the Construction
Group as a distribution to the Class C stockholders because the distribution was
considered non-pro rata as compared to the Company's previous two-class capital
stock structure. The Company recognized a gain of $608 million within
discontinued operations, equal to the difference between the carrying value of
the Construction Group and its fair value in accordance with Financial
Accounting Standards Board Emerging Issues Task Force Issue 96-4, "Accounting
for Reorganizations Involving a Non-Pro Rata Split-off of Certain Nonmonetary
Assets to Owners". No taxes were provided on this gain due to the tax-free
nature of the Split-off.
Conversion of Class R Stock
On May 1, 1998, the Board of the Company determined to force conversion of
all shares of the Company's Class R Stock into shares of Common Stock, effective
May 15, 1998. The Class R Stock was converted into the Company's Common Stock in
accordance with the formula set forth in the Company's Certificate of
Incorporation. The formula provided for a conversion ratio equal to $25, divided
by the average of the midpoints between the high and low sales prices for the
Company's Common Stock on each of the fifteen trading days during the period
beginning April 9, 1998 and ending April 30, 1998. The average for that period
was $32.14, adjusted for the stock dividend issued August 10, 1998. Accordingly,
each holder of Class R Stock received .7778 of a share of Common Stock for each
share of Class R Stock held. In total, the 6.5 million shares of Class R Stock
were converted into 5.1 million shares of Common Stock on May 15, 1998. As a
result of the forced conversion, certain adjustments were made to the cost
sharing and risk allocation provisions of the Separation Agreement and Tax
Sharing Agreement between the Company and Peter Kiewit Sons', Inc. that were
executed in connection with the Split-off. The effect of these adjustments was
to reduce certain Split-off costs and risks allocated to the Company.
Conversion of Class C Stock in January 1998
Prior to the Split-off, as of January 1 of each year, holders of Class C
Stock had the right to convert Class C Stock into Class D Stock, subject to
certain conditions. In January 1998, holders of Class C Stock converted 2.3
million shares, with a redemption value of $122 million into 21 million shares
of Class D Stock (now known as Common Stock).
MidAmerican Transaction
In January 1998, the Company and MidAmerican Energy Holding Co. (f/k/a as
CalEnergy Company, Inc.) ("MidAmerican") closed the sale of the Company's energy
assets to MidAmerican (the "MidAmerican Transaction"). The Company received
proceeds of approximately $1.16 billion and recognized an after-tax gain of $324
million in the first quarter of 1998. The after-tax proceeds from this
transaction of approximately $967 million are being used to fund in part the
Company's expansion of its information services business and the development of
an advanced, international, facilities-based communications network based on
Internet Protocol ("IP") technology.
Stock Options
The Company adopted the recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123") in 1998. Under SFAS No. 123, the fair value of an option (as computed
in accordance with accepted option valuation models) on the date of grant is
amortized over the vesting period of the option. 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.
In April 1998, the company adopted an outperform stock option ("OSO")
program that was designed by the Company 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 options 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 options 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 an option holder may exceed the value of
non-qualified stock options.
The Company believes that the fair value method of accounting more
appropriately reflects the substance of the transaction between an entity that
issues stock options, or other stock-based instruments, and its employees and
consultants; that is, an entity has granted something of value to an employee
and consultants (the stock option or other instrument) generally in return for
their continued employment and services. The Company believes that the value of
the instrument granted to employees and consultants should be recognized in
financial statements because nonrecognition implies that either the instruments
have no value or that they are free to employees and consultants, neither of
which is an accurate reflection of the substance of the transaction. Although
the recognition of the value of the instruments results in compensation and
professional expenses in an entity's financial statements, the expense differs
from other compensation and professional expenses in that these charges will not
be settled in cash, but rather, generally, through issuance of common stock.
The Company believes that the adoption of SFAS No. 123 will result in
material non-cash charges to operations in 1999 and thereafter. The amount of
the non-cash charge will be dependent upon a number of factors, including the
number of options granted and the fair value of each option estimated at the
time of its grant. The expense recognized for options granted to employees and
consultants for services performed for the year ended December 31, 1998, was $39
million. In addition to the expense recognized, the Company capitalized $5
million of non-cash compensation costs for employees directly involved in the
construction of the IP network and the development of the business support
systems.
Frontier Agreement
On March 23, 1998, the Company and Frontier Communications International,
Inc. ("Frontier") entered into an agreement ("Frontier Agreement") enabling the
Company to lease approximately 8,300 miles of network capacity on Frontier's new
13,000 mile SONET fiber optic, IP-capable network, currently under construction
for a period of up to five years. The leased network will initially connect 15
of the larger cities across the United States. While requiring an aggregate
minimum payment of $165 million over its five-year term, the Frontier Agreement
does not impose monthly minimum consumption requirements on the Company,
allowing the Company to order, alter or terminate circuits as it deems
appropriate. The Company recognized $4 million of costs in 1998 for leased
capacity on Frontier's network.
Union Pacific Rights-of-Way
On April 2, 1998, the Company announced it had reached a definitive
agreement with Union Pacific Railroad Company (the "Union Pacific Agreement")
granting the Company the use of approximately 7,800 miles of rights-of-way along
Union Pacific's rail routes for construction of the Company's North American
intercity network. The Company expects that the Union Pacific Agreement will
satisfy substantially all of its anticipated right-of-way requirements west of
the Mississippi River and approximately 50% of the right-of-way requirements for
its North American intercity network. The agreement provides for initial fixed
payments of up to $8 million to Union Pacific upon execution of the agreement
and throughout the construction period, recurring payments in the form of cash,
communications capacity, and other communications services based on the number
of conduits that are operational and certain construction obligations of the
Company to provide fiber or conduit connections for Union Pacific at the
Company's incremental cost of construction. In 1998, the Company recorded $9
million of payments made under this agreement in network
construction-in-progress.
XCOM Technologies, Inc. Acquisition
On April 23, 1998, the Company acquired XCOM Technologies, Inc. ("XCOM"), a
privately held company that has developed technology which the Company believes
will provide certain key components necessary for the Company to develop an
interface between its IP-based network and the existing public switched
telephone network. The Company issued approximately 5.3 million shares of Level
3 Common Stock and 0.7 million options and warrants to purchase Level 3 Common
Stock in exchange for all the stock, options and warrants of XCOM.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally
allocated to in-process research and development, and was taken as a
nondeductible charge to earnings in the second quarter. The purchase price
exceeded the fair value of the net assets acquired by $30 million which was
recognized as goodwill and is being amortized over five years.
In October 1998, the Securities and Exchange Commission ("SEC") issued new
guidelines for valuing acquired research and development which are applied
retroactively. The Company believes its accounting for the acquisition was made
in accordance with generally accepted accounting principles and established
appraisal practices at the time of the acquisition. However, due to the
significance of the charge relative to the total value of the acquisition, the
Company reviewed the facts and assumptions with the SEC. Consequently, using
the revised guidelines and assumptions, the Company reduced the charge for
in-process research and development from $115 to $30 million and increased
related goodwill by $85 million. The goodwill associated with the XCOM
transaction is being amortized over a five year period.
XCOM's in-process research and development value is comprised primarily
of one project to develop an interface between an IP-based network and the
existing public switched telecommunications network. Remaining development
efforts for this project include various phases of design, development and
testing. The anticipated completion date for this project in progress is
expected to be over the next 12 months, at which time the Company expects to
begin generating the full economic benefit from the technology. Funding for
this project is expected to be obtained from internally generated
sources.
The value of the in-process research and development represents the
estimated fair value based on risk-adjusted cash flows related to the incomplete
project. At the date of acquisition, the development of the project had not
yet reached technological feasibility and the research and development ("R&D")
in progress had no alternative future uses. Accordingly, these costs were
expensed as of the acquisition date.
The Company used an independent third-party appraiser to assess and
allocate a value to the in-process research and development. The value assigned
to the asset was determined, using the income approach, by identifying
significant research projects for which technological feasibility had not been
established.
The nature of the efforts to develop the acquired in-process technology
into commercially viable products and services principally relate to the
completion of all planning, designing, prototyping, high-volume verification,
and testing activities that are necessary to establish that the proposed
technologies meet their design specifications including functional, technical,
and economic performance requirements.
The value assigned to purchased in-process technology was determined by
estimating the contribution of the purchased in-process technology to developing
a commercially viable product, estimating the resulting net cash flows from the
expected product sales over a 15 year period, and discounting the net cash flows
to their present value using a risk-adjusted discount rate of 30%, and
adjusting it for the estimated stage of completion.
The Company believes that the foregoing assumptions used in the forecast
were reasonable at the time of the acquisition. No assurance can be given,
however, that the underlying assumptions used to estimate expected project
sales, development costs or profitability, or the events associated with this
project, will transpire as estimated. For these reasons, actual results may vary
from the projected results.
Management expects to continue their support of this effort and believes
the Company has a reasonable chance of successfully completing the R&D program.
However, there is risk associated with the completion of the project and there
is no assurance that it will meet with either technological or commercial
success. If the XCOM project is not successful, the Company would not realize
its investment in XCOM and would be required to modify its business plan to
utilize alternative technologies which may increase the cost of its network.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guideline and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
9.125% Senior Notes
On April 28, 1998, the Company received $1.94 billion of net proceeds from
an offering of $2 billion aggregate principal amount 9.125% Senior Notes Due
2008 (the "Senior Notes"). The Senior Notes are senior, unsecured obligations of
the Company, ranking pari passu with all existing and future senior unsecured
indebtedness of the Company. The Senior Notes contain certain covenants, which
among others, limit consolidated debt, dividend payments and transactions with
affiliates. The Company is using the net proceeds of the Senior Notes offering
in connection with the implementation of its Business Plan.
Debt issuances costs of $65 million have been capitalized and are being
amortized over the term of the Senior Notes.
Network Construction Contract
On June 18, 1998, Level 3 selected Peter Kiewit Sons', Inc. ("Kiewit") to
build a majority of its nearly 16,000 mile U.S. intercity communications
network. The overall cost of the project is estimated at $2 billion.
Construction of the network began in the third quarter of 1998 and is expected
to be completed during the first quarter of 2001. The contract provides that
Kiewit will be reimbursed for its costs relating to all direct and indirect
project level costs. In addition, Kiewit will have the opportunity to earn an
award fee that will be based on cost and speed of construction, quality, safety
and program management. The award fee will be determined by Level 3's assessment
of Kiewit's performance in each of these areas.
Burlington Northern Santa Fe Rights-of-Way
On June 23, 1998, the Company signed a master easement agreement with
Burlington Northern and Santa Fe Railroad Company ("BNSF"). The agreement grants
Level 3 right-of-way access to BNSF rail routes in as many as 28 states over
which to build its network. Under the easement agreement, Level 3 will make
annual payments to BNSF and provide communications capacity to BNSF for its
internal requirements. The amount of the annual payments is dependent upon the
number of conduits installed, the number of conduits with fiber, and the number
of miles of conduit installed along BNSF's route.
INTERNEXT Agreement
On July 20, 1998, Level 3 entered into a network construction cost-sharing
agreement with INTERNEXT, LLC, a subsidiary of NEXTLINK Communications, Inc.
valued at $700 million. The agreement provides for INTERNEXT to acquire the
right to use conduit, fibers and certain associated facilities along the entire
route of Level 3's nearly 16,000 mile intercity fiber optic network in the
United States. INTERNEXT paid $26 million in 1998 which was deferred and
included in other liabilities at December 31, 1998 and will pay the remaining
amounts as segments of the intercity network are completed and accepted. The
Company will recognize income as the segments of the network are completed and
accepted.
The agreement does not include the necessary electronics that allow the
fiber to carry communications transmissions. INTERNEXT will be restricted from
selling or leasing fiber to unaffiliated companies for four years following the
date of the agreement. Also, under the terms of the agreement, INTERNEXT has the
right to an additional conduit for its exclusive use and to share costs and
capacity in certain future fiber cable installations in Level 3 conduits.
Japan-US Cable Network
On August 3, 1998, Level 3 and a group of other global telecommunications
companies entered into an agreement to construct an undersea cable system
connecting Japan and the United States to be completed by mid-year 2000. The
parties to this agreement are investing in excess of $1 billion to build the
network, of which Level 3 is expected to contribute approximately $130 million.
Each party will have joint responsibility for the cost of network oversight,
maintenance and administration. The Company has recorded $24 million of costs
associated with this project in network construction-in-progress in 1998.
Commonwealth Telephone Enterprises, Inc.
On September 25, 1998, Commonwealth Telephone Enterprises, Inc.
("Commonwealth Telephone") announced that it was commencing a rights offering of
3.7 million shares of its common stock. Under the terms of the offering, each
stockholder received one right for every five shares of Commonwealth Telephone
Common Stock or Commonwealth Telephone Class B Common Stock held. The rights
enabled the holder to purchase Commonwealth Telephone Common Stock at a
subscription price of $21.25 per share. Each right also carried the right to
oversubscribe at the subscription price for the offered shares not purchased
pursuant to the initial exercise of rights.
Level 3, which owned approximately 48% of Commonwealth Telephone prior to
the rights offering, exercised 1.8 million rights it received with respect to
the subscription rights 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.
GeoNet Communications, Inc. Acquisition
On September 30, 1998, Level 3 acquired GeoNet Communications, Inc.
("GeoNet"), a regional Internet service provider located in northern California.
The Company issued approximately 0.6 million shares and options in exchange for
GeoNet's capital stock, which valued the transaction at approximately $19
million. Liabilities exceeded assets acquired, and goodwill of $21 million was
recognized from this transaction which is being amortized over five years.
Global Crossing Agreement
On October 14, 1998, Level 3 announced that it had signed an agreement with
Global Crossing Ltd. ("Global") for trans-oceanic capacity on Global's fiber
optic cable network. The agreement, covering 25 years and valued at
approximately $108 million, will provide Level 3 with as-needed dedicated
capacity across the Atlantic Ocean. Level 3 also will have the option of
utilizing capacity on other segments of Global's worldwide network. In 1998, the
Company recorded as network construction-in-progress, $32 million of costs
associated with this agreement.
10.5 % Senior Discount Notes
On December 2, 1998, the Company announced that it sold $834 million
principal amount at maturity of 10.5% Senior Discount Notes Due 2008 in a
transaction exempt from registration under the Securities Act of 1933. These
notes are senior, unsecured obligations of the Company, ranking pari passu with
all existing and future senior unsecured indebtedness of the Company.
The net proceeds of $486 million after deducting anticipated offering
expenses, are intended to be used to accelerate the implementation of the
Company's business plan, primarily the funding for the increase in the committed
(prefunded) number of route miles of the Company's U.S. intercity network.
Debt issuance costs of $14 million have been capitalized and will be
amortized over the term of the Senior Discount Notes.
Equity Offering
Level 3 filed a "universal" shelf registration statement covering up to
$3.5 billion of common stock, preferred stock, debt securities and depositary
shares that became effective February 17, 1999. On March 9, 1999 the Company
sold 28.75 million shares through a primary offering. The net proceeds from the
offering of approximately $1.5 billion will be used for working capital, capital
expenditures, acquisitions and other general corporate purposes in connection
with the implementation of the Company's Business Plan 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.
IXC Communications Agreement
On December 18, 1998 Level 3 announced an agreement with IXC
Communications, Inc. ("IXC") to lease capacity on IXC's network. The dedicated
network will enhance the Company's ability to offer a wide array of data and
voice services to a greater number of customers in key U.S. markets. The
arrangement is unique in that IXC will reserve the network for the exclusive use
of Level 3, which expects to begin using the network increments beginning in
Spring, 1999. The Company paid IXC $40 million under this agreement in 1998 and
included this amount in property, plant and equipment.
BusinessNet Limited
On January 5, 1999 Level 3 acquired BusinessNet Limited, a leading
London-based Internet service provider in a largely stock-for-stock deal. After
completion of post-closing adjustments, the Company issued approximately 400,000
shares of Common Stock and paid approximately $1 million in exchange for
BusinessNet's capital stock. The transaction was valued at approximately $18
million and was accounted for as a purchase.
Results of Operations 1998 vs. 1997
In late 1997, the Company announced a plan to increase substantially its
information services business and to expand the range of services it offers by
building an advanced, international, facilities-based communications network
based on IP technology. Since the Business Plan represents a significant
expansion of the Company's communications and information services business, the
Company does not believe that the Company's financial condition and results of
operations for prior periods will serve as a meaningful indication of the
Company's future financial condition or results of operations. The Company
expects to incur substantial net operating losses for the foreseeable future,
and there can be no assurance that the Company will be able to achieve or
sustain operating profitability in the future.
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 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
IP 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
BellAtlantic ("BellAtlantic"). These agreements require the company originating
a call to compensate the company terminating the call. The Federal Communication
Commission ("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 may be unable to
recover their costs or will be compensated at a significantly lower rate.
BellAtlantic 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 to the Company.
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 Edison Company ("Commonwealth") was
partially offset by the expiration of a long-term contract also with
Commonwealth. In 1998 the Company and Commonwealth amended their contract to
allow Commonwealth to accelerate delivery of coal. The amended contract requires
Commonwealth to take delivery of its year 2001 coal commitments in 1998, 1999
and 2000. Of the 2001 commitments, 50% was taken in 1998 and 25% will be taken
in both 1999 and 2000. The expiration of the long-term contract was partially
offset by contracts with new customers in 1998. If current market conditions
continue, the Company will experience a significant decline in coal revenue and
earnings over the next several years as delivery requirements under long-term
contracts decline as these long-term contracts begin to expire.
Other revenue is primarily attributable to California Private
Transportation Company, L.P. ("CPTC") the owner operator of the SR91 tollroad in
southern California. Revenues increased in 1998 primarily due to higher traffic
counts and increases in toll rates.
Operating Expenses increased 22% from $163 million in 1997 to $199 million
in 1998 primarily due to expenses incurred in connection with the Company's
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 IP related applications. Operating expenses related to coal
mining were consistent with the prior year.
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.
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, "Accounting for Stock - Based
Compensation." 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
American Institute of Certified Public Accountant's ("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. 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 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 IP based network and the existing public
switched telephone network.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated
to acquired in-process research and development, and was taken as a
nondeductible charge to earnings in the second quarter of 1998. In October
1998, the SEC issued new guidelines for valuing acquired research and
development which are applied retroactively. Consequently, the Company has
reduced the charge by $85 million, which also increases goodwill by a
corresponding amount. Goodwill associated with the XCOM transaction is being
amortized over a 5 year period.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guideline and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
EBITDA, 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 noncash compensation due to its adoption of the expense recognition
provisions of SFAS No. 123. EBITDA decreased from $84 million in 1997 to
($100) 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 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 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 9.125% Senior Notes Due 2008 issued on April 28,
1998 and $834 million aggregate principal amount at maturity of 10.5% 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 increased to $132 million in
1998 primarily due to the equity losses attributable to RCN Corporation, Inc.
("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 Opportunity Fund, LP, ("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 Telephone Enterprises, Inc., a
Pennsylvania public utility providing telephone services, and equity losses of
Cable Michigan, Inc. ("Cable Michigan") prior to its sale in 1998, a cable
television operator in the State of Michigan.
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 increased significantly in 1998 due to the sale of
Cable Michigan to Avalon Cable of Michigan, Inc. in November 1998. The Company
recognized a gain of approximately $90 million from the cash for stock
transaction. Also included in gains on the disposal of assets are $8 million and
$1 million of gains on the disposal of property, plant and equipment in 1998 and
1997 respectively, and $9 million of gains on the sale of marketable securities
in both periods.
Income Tax (Provision) Benefit 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 US 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 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.
Results of Operations 1997 vs. 1996
In 1997, C-TEC Corporation ("C-TEC") announced that its board of directors
had approved the planned restructuring of C-TEC into three publicly traded
companies. The transaction was effective September 30, 1997. As a result of the
restructuring plan, the Company owned less than 50% of the outstanding shares
and voting rights of each entity, and therefore has accounted for each entity
using the equity method as of the beginning of 1997. In accordance with
generally accepted accounting principles, C-TEC's financial position, results of
operations and cash flows are consolidated in the 1996 financial statements.
Revenue for the years ended December 27, 1997 and December 28, 1996 is
summarized as follows (in millions):
1997 1996
---- ----
Communications and Information Services $ 95 $ 42
Coal Mining.Mining 222 234
Other 15 376
------ ------
$332 $ 652
==== =====
Communications and Information Services revenue increased $53 million or
126% to $95 million in 1997. Revenue from computer outsourcing services
increased 22% to $50 million in 1997 up from $41 million in 1996. The increase
was due to new computer outsourcing contracts signed in 1997. Revenue for
systems integration grew to $45 million in 1997 from $1 million in 1996. Strong
demand for Year 2000 renovation services fueled the Group'sgrowth for systems
integration's revenue.
Revenue from coal mines declined 5% in 1997 compared tofrom $234 million in 1996.
Alternate source coal revenue declined by $16 million in 1997. The mine's
primary customer, Commonwealth Edison, accelerated its contractual commitments
in 1996 for alternate source, thus reducing its obligations in 1997. In addition
to the decline in tonnage shipped, the price of coal sold to Commonwealth
declined 1%. Revenue attributable to other contracts increased by approximately
$4 million. The actual amount of coal shipped to these customers increased 5% in
1997, but the price at which it was sold was 4% lower than 1996.
Margin, as a percentageIn 1996 other revenue was comprised of $367 million of revenue attributable
to the C-TEC companies and $9 million of revenue attributable to CPTC. CPTC's
revenue increased to $15 million in 1997 as the tollroad became fully
operational in the second half of 1996 and traffic levels increased throughout
1997.
Operating Expenses declined 11%39% from $268 million in 1996 to 1997. Margins$163 million
in 1996 were higher than normal1997 due to the additional high margin alternate source coal soldconsolidation of C-TEC in 1996. Excluding C-TEC expenses of
$143 million, operating expenses actually increased 30% from $125 million to
Commonwealth
in 1996 and the refund of premiums from a captive insurance
company that insured against black lung disease. The decline in
Commonwealth shipments and an overall decline in average selling
price, adversely affected the results for 1997. If current
market conditions continue, the Group expects a decline in coal
revenue and earnings after 1998 as certain long-term contracts
begin to expire.
Information Services. Revenue increased by 126% to $94$163 million in 1997 from $421997. Operating expenses related to Communications and
Information Services increased $30 million in 1996. Revenue from computer
outsourcing services increased 20% to $49 million in 1997 from
$41 million in 1996. The increase was due to new computer
outsourcing contracts signed in 1997. Revenue for systems
integration grew to $45 million in 1997 from less than $1 million
in 1996. Strong demand for Year 2000 renovation services fueled
the growth for systems integration's revenues.
Margin, as a percentresult of revenue, decreased to 28% in 1997 from
41% in 1996 for the computer outsourcing business. The reduction
of the gross margin was due to up-front migration
costs associated with new contracts and significant increases in personnel costs
due to the tightening supply of computer professionals. Gross margin forprofessionals in the computer outsourcing
business. Additional expenses were also incurred in 1997 due to the start up of
the systems integration businessbusiness. Also contributing to the increase in operating
expenses was approximately 40%the decline in 1997. A comparisonhigh margin alternate source coal sold to
Commonwealth Edison in 1997 and the absence of premium refunds received in 1996
gross margin
is not meaningfulfrom a captive insurance company that insured against black lung disease.
Depreciation and Amortization Expense decreased 84% to $20 million in 1997
primarily due to the start-up naturechange in accounting for C-TEC. Excluding $106 million of
the business.such expense attributable to C-TEC, depreciation and amortization expense was
consistent with that of 1996.
General and Administrative Expenses. Excluding C-TEC, general and
administrative expenses increased 20%23% to $114$106 million in 1997. The increase was
primarily attributable to a $41 million increase in the information services
business' general and administrative expenses. The majority of the increase is
attributable to additional compensation expense that was incurred due to the
conversion of a subsidiary'sthe information services' option and SAR plans to the Class DLevel 3
Stock option plan.Plan. The remainder of the increase relates to the increased expenses for
new sales offices established in 1997 for the systems integration business and
the additional personnel hired in 1997 to implement the expansion plan.Business Plan.
Exclusive of the information services business, general and administrative
expenses decreased 26%28% to $62$54 million in 1997. A decrease in professional
services and the mine management fees were partially offset by increased
compensation expense. Due to the favorable resolution of certain environmental
and legal matters, costs that were previously accrued for these issues were
reversed in 1997. Partially offsetting this reduction were legal, tax and
consulting expenses associated with the CalEnergy
transactionMidAmerican Transaction and the
separation of the Construction and Mining
Group and Diversified Group.
Equity Losses. The losses for the Group's equity investments
increasedInterest Income decreased $17 million from $9$50 million in 1996 due to $43 millionthe
change in 1997. Had
theaccounting for C-TEC. In 1996, C-TEC entities been accounted for using the equity method in
1996, the losses would have increased to $13 million. The
expenses associated with the deployment and marketing of the
advanced fiber networks in New York, Boston and Washington D.C.,
and the costs incurred in connection with the buyout of a
marketing contract with minority shareholders are primarily
responsible for the increase in equity losses attributable to RCN
from $6 million in 1996 to $26 million in 1997. The Group's
share of Cable Michigan's losses decreased to $6 million in 1997
from $8 million in 1996. This improvement is attributable to the
gains recognized on the sale of Cable Michigan's Florida cable
systems. Commonwealth Telephone's earnings were consistent with
that of 1996. The Group recorded equity earnings of $9 million
in each year attributable to Commonwealth Telephone. The Group
also recorded equity losses attributable to several developing
businesses.
Investment Income. Investment income increased 7% in 1997
after excluding C-TEC's $14 million
of investment income in 1996.
Gains recognized on the sale of marketable securities, primarily
within the Kiewit Mutual Fund ("KMF"), increased from $3 million
in 1996 to $9 million in 1997. In 1997, KMF repositioned the
securities within its portfolios to more closely track the
overall market. Partially offsetting these additional gains was
ainterest income. The remaining decline in interest income was due to an
overall reduction of yieldyields earned by the KMFKiewit Mutual Fund portfolios.
Interest Expense.Expense, Net. Interest expense increased significantly in 1997
after excluding $28 million of interest attributable to C-
TECC-TEC in 1996. CPTC, the
owner-operator of a privatized tollroad in California, incurred interest costs
of approximately $9 million and $11 million in 1996 and 1997. In 1996, interest
of $5 million was capitalized due to the construction of the tollroad.
Construction was completed in August 1996, and all interest incurred subsequent
to that date was charged against earnings. Interest associated with the
financing of the Aurora, Colorado property of $1 million, also contributed to
the increase in interest expense.
Other Income. Other incomeEquity Losses in 1996 includes $2 million of
other expenses attributable to C-TEC. Excluding theseUnconsolidated Subsidiaries. The losses other income declinedfor the Company's
equity investments increased from $8$9 million in 1996 to $1$43 million in 1997. Had
the C-TEC entities been accounted for using the equity method in 1996, the
losses would have been $13 million. The expenses associated with the deployment
and marketing of the advanced fiber networks in New York, Boston and Washington
D.C., and the costs incurred in connection with the buyout of a marketing
contract with minority shareholders were primarily responsible for the increase
in equity losses attributable to RCN from $6 million in 1996 to $26 million in
1997. The absenceCompany's share of Cable Michigan's losses decreased slightly in 1997.
The Company also recorded $15 million of equity losses attributable to Gateway
in 1997.
Gains on Sale of Assets. Gains on the disposal of assets was consistent
with that of 1996, however, the composition of the gains changed. In 1996, the
gains primarily consisted of $6 million of gains recognized on the sale of
timberlands and $3 million of gains on the sale of timberland properties
and other assets, which accounted for $6marketable securities. In
1997, the Company did not recognize any gains on the disposition of timberlands
but realized $9 million of income in
1996, is responsible forgains on the decline.sale of marketable securities. In both
periods the Company recognized $1 million of gains on the disposal of property,
plant and equipment.
Income Tax Benefit (Provision) Benefit.. The effective income tax rate for 1997 is
less than the expected statutory rate of 35% due primarily 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 Class DLevel 3 Stock plan.Plan. In 1996, the effective rate was also lower
than the statutory rate due to the prior year tax adjustments. These adjustments
were partially offset by nondeductible costs associated with goodwill
amortization and taxes on foreign operations. In 1997 and 1996, the GroupCompany
settled a number of disputed tax issues related to prior years that have been
included in prior year tax adjustments.
Discontinued Operations - Construction. The Construction and
Mining Group's operations can be separated into two components;
construction and materials.Discontinued Operations -
Construction revenues increased significantly in 1997. Revenue attributable to
the construction segment increased $414 million, during 1997 comparedprimarily due to 1996. Thethe
consolidation of ME Holding Inc. (due to the increase, which was consolidated in ownership from 49% to 80%)
("ME Holding") contributed $261 million, almost two-thirds of the
increase. In addition to ME Holding1997 and several
large projects and joint ventures becamebecoming fully mobilized during the latter part of
the year and were well into the
"peak" construction phase. Material revenuesThe acquisitions of several small plant sites and
strong market conditions resulted in a $47 million increase in materials
revenue.
Earnings for the Construction Group increased 19% to $290 million44% in 1997 from
$243 million in 1996. The acquisition of additional plant sites
accounts for 22% of the increase in sales. The remaining
increase wasas a result of
the strong market for material products
in Arizona. This raised sales volume from existing plant sites
and allowed for slightly higher selling prices. The inclusion of
$10 million of revenues from the Oak Mountain facility in Alabama
also contributed to the increase.
Construction margins increased to 13% of revenue in 1997 as
compared to 10% in 1996. The favorable resolution of project uncertainties, several change order
settlements, and cost savings orand early completion bonuses received during the
year contributed
to this increase.
Material margins decreased from 10%year.
The separate financial statements and management's discussion and analysis
of revenue in 1996 to 4% in
1997. Losses at the Oak Mountain facility in Alabama were the
sourcefinancial condition and results of operations of Peter Kiewit Sons', Inc.
should be obtained for a more detailed discussion of the decrease. The materials margins from sources other
than Oak Mountain remained stable as higher unit sales1997 and selling prices were offset by increases in raw materials costs.
General and administrative expenses1996 results
of operations of the Construction Group
increased 11% in 1997 after deducting $17 million of expenses
attributable to ME Holding. Compensation and profit sharing
expenses increased $9 million and $2 million, respectively, from
1996. The increase in these costs is a direct result of higher
construction earnings.
The effective income tax rates in 1997 and 1996 for the
Construction Group differ from the expected statutory rate of 35%
primarily due to state income taxes and prior year tax
adjustments.Group.
Discontinued Operations - Energy. Income from discontinued operations
increased to $29$10 million in 1997 from $9 million in 1996. The acquisition of
Northern Electric plc. in late 1996 and the commencement of operations at the
Mahanagdong geothermal facility in July, 1997 were the primary factors that
resulted in the increase.
In October 1997, CalEnergyMidAmerican sold approximately 19.1 million shares of its
common stock. This sale reduced the Group'sCompany's ownership in CalEnergyMidAmerican to
approximately 24% but increased its proportionate share of CalEnergy'sMidAmerican's equity.
It is the Group'sCompany's policy to recognize gains or losses on the sale of stock by
its investees. The GroupCompany recognized an after-tax gain of approximately $44
million from transactions in CalEnergyMidAmerican stock in the fourth quarter of 1997.
On July 2, 1997, the Labour Party in the United Kingdom announced the
details of its proposed "Windfall Tax" to be levied against privatized British
utilities. This one-time tax is 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 July, 1997. The total after-tax impact to Level 3, directly through its
investment in CE Electric and indirectly through its interest in CalEnergy,MidAmerican,
was $63 million.
Results of Operations 1996 vs. 1995
Coal Mining. Revenue and net earnings improved primarily due
to increased alternate source tons sold to Commonwealth Edison
Company in 1996 and the liquidation of a captive insurance
company which insured against black lung disease. Upon
liquidation, the Group received a refund of premiums paid plus
interest in excess of reserves established by the Group for this
liability. Since 1993, the amended contract with Commonwealth
provided that delivery commitments would be satisfied with coal
produced by unaffiliated mines in the Powder River Basin in
Wyoming. Coal produced at the Group's mines did not change
significantly from 1995 levels
Information Services. Revenue increased 17% to $42 million in
1996 from $36 million in 1995. The increase was primarily due to
new computer outsourcing contracts signed in 1996. Less than $1
million of revenue was generated by the operations of the new
systems integration business, started in February, 1996.
Margin, as a percent of revenue, for the outsourcing business
decreased to 41% in 1996 from 45% in 1995. The reduction of the
margin was primarily due to up-front migration costs for new
customers which were recognized as an expense when incurred.
Telecommunications. Revenue for the telecommunications segment
increased 13% to $367 million for fiscal 1996. C-TEC's telephone
group's $10 million, or 8%, increase in sales and C-TEC's cable
group's $33 million or 26% increase in revenue were the primary
contributors to the improved results. The increase in telephone
group revenue is due to higher intrastate access revenue from the
growth in access minutes, an increase of 13,000 access lines, and
higher internet access and video conferencing sales. Cable group
revenue increased primarily due to higher average subscribers and
the effects of rate increases in April 1995 and February 1996.
Subscriber counts increased primarily due to the acquisition of
Pennsylvania Cable Systems, formerly Twin County Trans Video,
Inc., in September 1995, and the consolidation of Mercom, Inc.
since August 1995. Pennsylvania Cable Systems and Mercom account
for $23 million of the increase in cable revenue in 1996.
The 1996 operating expenses for the telecommunications business
increased $38 million or 18% compared to 1995. The telephone
group experienced a 9% increase in expenses and the cable group's
costs increased 31%. The increase for the telephone group was
primarily attributable to higher payroll expenses resulting from
additional personnel, wage increases and higher overtime. Also
contributing to the increase, were fees associated with the
internet access services and consulting services for a variety of
regulatory and operational matters. The cable group's increase
was due to increased depreciation, amortization and compensation
expenses associated with the acquisition of Pennsylvania Cable
Systems and the consolidation of Mercom's operations. Also
contributing to the higher costs were rate increases for existing
programming and the costs for additional programming.
General and Administrative Expenses. General and
administrative expenses declined 5% to $181 million in 1996.
Decreases in expenses associated with legal and environmental
matters were partially offset by higher mine management fees paid
to the Construction & Mining Group, the costs attributable to C-
TEC and the opening of the SR91 toll road. C-TEC's corporate
overhead and other costs increased approximately 13% in 1996.
This increase is attributable to costs associated with the
development of the RCN business in New York and Boston, the
acquisition of Pennsylvania Cable Systems, the consolidation of
Mercom and the investigation of the feasibility of various
restructuring alternatives.
Equity Earnings, net. Losses attributable to the Group's
equity investments increased to $9 million in 1996 from $5
million in 1995. The additional losses were attributable to an
enterprise engaged in the renewable fuels business and to C-TEC's
investment in MegaCable S.A. de C.F., Mexico's second largest
cable television operator.
Investment Income, net. Investment income increased 24% in
1996 compared to 1995. Increased gains on the sale of marketable
and equity securities and interest income were partially offset
by a slight decline in dividend income.
Interest Expense, net. Interest expense in 1996 increased 43%
compared to 1995. The increase was primarily due to interest on
the CPTC debt that was capitalized through July 1996, and C-TEC's
redeemable preferred stock, issued in the Pennsylvania Cable
Systems acquisition, that began accruing interest in 1996.
Gain on Subsidiary's Stock Transactions, net. The issuance of
MFS stock for acquisitions by MFS and the exercise of MFS
employee stock options resulted in a $3 million net gain to the
Group in 1995.
Other, net. The decline of other income in 1996 was primarily
attributable to the 1995 settlement of the Whitney Benefits
litigation.
Income Tax Benefit (Provision). The effective income tax rate
for 1996 differs from the statutory rate of 35% primarily because
of adjustments to prior year tax provisions, partially offset by
state taxes and nondeductible amounts associated with goodwill
amortization. In 1995, the rate was lower than 35% due primarily
to $93 million of income tax benefits from the reversal of
certain deferred tax liabilities originally recognized on gains
from MFS stock transactions that were no longer required due to
the tax-free spin-off of MFS, and adjustments to prior year tax
provisions.
Discontinued Operations - Construction. Revenue from
construction decreased 1% to $2,303 million in 1996. This
resulted from the completion of several major projects during the
year, while many new contracts were still in the start-up phase.
KCG's share of joint venture revenue remained at 30% of total
revenues in 1996. Revenue from materials increased by less than
1% in 1996. Increased demand for aggregates in the Arizona
market was offset by a decline in precious metal sales. KCG sold
its gold and silver operations in Nevada to Kinross Gold
Corporation ("Kinross") and essentially liquidated its metals
inventory in 1995.
Opportunities in the construction and materials industry
continued to expand along with the economy. Because of the
increased opportunities, KCG was able to be selective in the
construction projects it pursued. Gross margins for construction
increased from 8% in 1995 to 10% in 1996. This resulted from the
completion of several large projects and increased efficiencies
in all aspects of the construction process. Gross margins for
materials declined from 13% in 1995 to 10% in 1996. The lack of
higher margin precious metals sales in 1996 combined with
slightly lower construction materials margins produced the
reduction in operating margin.
In 1995, the exchange of KCG's gold and silver operations in
Nevada for 4,000,000 shares of common stock of Kinross led to a
$21 million gain for KCG. The gain was the difference between
KCG's book value in the gold and silver operations and the market
value of the Kinross shares at the time of the exchange. Other
income was also primarily comprised of mining management fees
from the Diversified Group, of $37 million and $30 million in
1996 and 1995, and gains on the disposition of property, plant
and equipment and other assets of $17 million and $ 12 million in
1996 and 1995.
The effective income tax rate for 1996 differs from the
statutory rate of 35% primarily because of adjustments to prior
year tax provisions and state taxes. In 1995, the rate was
higher than 35% due primarily to state income taxes.
Discontinued Operations - Energy. Income from discontinued
operations declined in 1996 by 36% to $9 million. Losses
attributable to the Group's interest in the Casecnan project,
additional development expenses for international activities, and
the costs associated with the Northern Electric transaction were
partially offset by increased equity earnings from CalEnergy.
Financial Condition - December 27, 199731, 1998
The Group'sCompany's working capital excluding C-TEC and discontinued
operations, increased $392 million or 106%$2.1 billion during 1997. This is1998 primarily
due to the $182 million of cash generated by operations,
primarily coal operations, and the significant financing activities described below.
Cash provided by operating activities decreased in 1998 primarily due to
the costs of implementing the Company's Business Plan.
Investing activities include $452 millionusing the proceeds from the debt offerings and
MidAmerican and Cable Michigan sales to purchase marketable securities, $42$67
million of investments, net of cash acquired, and $26$910 million of capital
expenditures, including $14 millionprimarily for the existingexpanding IP communications and information
services business and $6 million for a corporate jet.businesses. The investments primarily include the Group's $22a $38 million investment in the
Pavilion Towers office complex, locatedCommonwealth Telephone's rights offering, $14 million of investments in
Aurora, Colorado,information services businesses and $15 million of investments in developing
businesses. Funding a portionGateway.
Sources of these activities wasfinancing in 1998 consisted primarily of the net proceeds of
$1.94 billion from the sale of marketable securitiesSenior Notes in April and the net proceeds of
$167 million.
Sources$486 million from the sale of financing10.5% Senior Discount Notes in December.
Additional sources include $138the conversion of 2.3 million for the issuance of
Class D Stock, $72 million for the exchangeshares of Class C
stock for
Class D stock and $16Stock, with a redemption value of $122 million, for the financing for Pavilion
Towers. Uses consist primarilyinto 21 million shares of $12 million for the payment
of dividends, and $2 million of payments on long-term debt.
Prior to the execution of an agreement with CalEnergyCommon
Stock in September, 1997, the Group invested $31 million in the Dieng,
Patuha and Bali power projects in Indonesia.
In October 1996, the PKS Board of Directors directed PKS
management to pursue a listing of Class D Stock as a way to
address certain issues created by PKS' two-class capital stock
structure and the need to attract and retain the best management
for PKS' businesses. During the course of its examination of the
consequences of a listing of Class D Stock, management concluded
that a listing of Class D Stock would not adequately address
these issues, and instead began to study a separation of the
Construction and Mining Group and the Diversified Group. At the
regular meeting of the Board on July 23, 1997, management
submitted to the Board for consideration a proposal for
separation of the Construction and Mining Group and Diversified
Group through a spin-off of the Construction and Mining Group
("the Transaction"). At a special meeting on August 14, 1997,
the Board approved the Transaction.
In connection withJanuary, proceeds from the sale of approximately 10Common Stock of $21 million and the
exercise of the Company's stock options for $10 million. In 1998, Level 3 issued
$183 million of stock for the acquisition of several IP businesses and reflected
in the equity accounts the $164 million fair value of the issuance and forced
conversion of the Class D sharesR Stock. The company repaid $12 million of long term
debt during 1998.
The Company also received $967 million of net proceeds from the sale of its
energy business to employees inMidAmerican.
Liquidity and Capital Resources.
Since late 1997, the Company has retainedsubstantially increased the rightemphasis it
places on and the resources devoted to purchaseits communications and information
services business. The Company has commenced the relevant Class D shares at the then current Class D Stock price
if the Transactionimplementation of a plan to
become a facilities-based provider (that is, definitely abandoned by formal actiona provider that owns or leases a
substantial portion of the PKS Board or the employees voluntarily terminate their employment
on various dates priorproperty, plant and equipment necessary to January 1, 1999.
The separationprovide
its services) of the Construction and Mining Group and the
Diversified Group was contingent upon a numberbroad range of conditions,
including the favorable ratification by a majority of both Class
C and Class D shareholders and the receipt byintegrated communications services. To reach
this goal, the Company of an
Internal Revenue Service ruling or other assurance acceptable to
the Board that the separation would be tax-free to U.S.
shareholders. On December 8, 1997, PKS' Class C and Class D
shareholders approved the transaction and on March 5, 1998 PKS
received a favorable ruling from the Internal Revenue Service.
The Transaction is anticipated to be effective on March 31, 1998.
Level 3 has recently decided to substantially increase its
emphasis on and resources to its information services to
business. Pursuant to the plan, Level 3 intendsplans to expand substantially its current information servicesthe business through
the expansion of its
existing businesssubsidiary, PKS Information Services, Inc., ("PKSIS") and the creation,to create, through a
combination of construction, leasingpurchase and purchaseleasing of facilities and other
assets, an international, end-to-end, facilities-based communications network.
The Company is designing its network based on IP technology in order to leverage
the efficiencies of this technology to provide lower cost communications
services.
The development of the Business Plan will require significant capital
expenditures, a substantial facilities-based internet
communications network.
Using this network Level 3 intendsportion of which will be incurred before any
significant related revenues from the Business Plan are expected to provide (a) a range of
internet access services at varying capacity levelsbe realized.
These expenditures, together with the associated early operating expenses, will
result in substantial negative operating cash flow and as
technology development allows, at specified levels of quality of
service and security and (b) a number of business oriented
communications services which may include fax service, which are
transmitted in part over private or limited access Transmission
Control Protocol/Internet Protocol ("TCP/IP") networks and are
offered at lower prices than public telephone network-based fax
service, and voice message storing and forwarding oversubstantial net operating
losses for the same
TCP/IP-based networks.
Level 3Company for the foreseeable future. Although the Company believes
that over time, a substantial number of
businesses will convert existing computer application systems to
computer systems which communicate using TCP/IPits cost estimates and build-out schedule are accessed
by users employing Web browsers. Level 3 further believes that
businesses will prefer to contract for assistance in making this
conversion with those vendors able to provide a full range of
services from initial consulting to internet access with
requisite quality and security levels.
Level 3 anticipatesreasonable, there can be no
assurance that the actual construction costs or the timing of the expenditures
will not deviate from current estimates. The Company's capital expenditures required to
implement this expansion plan will be substantial. Level 3
estimates that these costs may be in
excess of $500connection with the Business Plan were $908 million in 1998 and could exceed $1.5are expected to
approximate $2.3 billion in 1999. Level 3's current
financial condition, borrowing capacity andManagement believes the Company's liquidity at
December 31, 1998, in addition to the net proceeds of $1.5 billion from the
CalEnergy transaction described belowequity offering completed in March 1999, and the cost sharing agreement with
INTERNEXT, should be sufficient for
immediate operating, implementionto fund the currently committed portions of the
Business Plan.
The Company currently estimates the implementation of the Business Plan, as
currently contemplated, will require between $8 and investing activities.
However, Level 3$10 billion over the next 10
years. The Company's ability to implement the Business Plan and meet its
projected growth is dependent upon its ability to secure substantial additional
financing in the future. The Company expects to raisemeet its additional capital
needs with the proceeds from bothsales or issuance of additional equity securities,
credit facilities and other borrowings, or additional debt securities. The
Senior Notes and Senior Discount Notes were issued under an indenture which
permits the Company and its subsidiaries to incur substantial amounts of debt.
The Company also has available approximately $2 billion of unused securities
available under its "universal" shelf registration that was declared effective
by the Securities and Exchange Commission in February 1999. 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 capacity, its
conduits or access to its conduits. There can be no assurance that the Company
will be successful in producing sufficient cash flow, raising sufficient debt or
equity capital on terms that it will consider acceptable, or selling or leasing
fiber optic capacity or access to its conduits, or that proceeds of dispositions
of the Company's assets will reflect the assets' intrinsic value. Further, there
can be no assurance that expenses will not exceed the Company's estimates or
that the financing needed will not likewise be higher than estimated. Failure to
generate sufficient funds may require the Company to delay or abandon some of
its future expansion or expenditures, which could have a material adverse effect
on the implementation of the Business Plan.
There can be no assurance that the Company will be able to obtain such
financing if and debt markets duewhen it is needed or that, if available, such financing will be
on terms acceptable to the significant capital requirementsCompany. 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 business,
reduce the scope of the information services expansion plan.its plans and operations.
In connection with implementing the ExpansionBusiness Plan, Level 3 expects to
devote substantially more management time and capital resources
to its information services business with a view to makingwill continue
reviewing the information services business, over time, the principal business
of Level 3. In that respect, management is conducting a
comprehensive reviewexisting businesses of the existing Level 3 businessesCompany to determine how those
businesses will complement Level 3'sthe 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, Level 3the Company may dispose of that business.
In JanuaryNew Accounting Pronouncement
On June 15, 1998, the FASB issued Statement of Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"). SFAS No. 133 is effective for fiscal years beginning after June 15, 1999
(January 1, 2000 for the Company). SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at the fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
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.
Disclosure of Year 2000 Issues
General
The Company's wholly owned subsidiary, Level 3 Communications, LLC is a new
company that is implementing new technologies to provide Internet Protocol (IP)
technology-based communications services to its customers. This company has
adopted a strategy to select technology vendors and CalEnergy closedsuppliers that provide
products that are represented by such vendors and suppliers to be Year 2000
compliant. In negotiating its vendor and supplier contracts, the salecompany secures
Year 2000 warranties that address the Year 2000 compliance of the applicable
product(s). As part of the Company's Year 2000 compliance program, plans will be
put into place to test these products to confirm they are Year 2000 ready.
PKS Systems Integration LLC ("PKS Systems"), a subsidiary of PKSIS,
provides a wide variety of information technology services to its customers. In
fiscal year 1998, approximately 57% of the revenue generated by PKS Systems
related to projects involving Year 2000 assessment and renovation services
performed by PKS Systems for its customers. These contracts generally require
PKS Systems to identify date affected fields in certain application software of
its customers and, in many cases, PKS Systems undertakes efforts to remediate
those date-affected fields so that Year 2000 data may be processed. Thus, Year
2000 issues affect many of the services PKS Systems provides to its customers.
This exposes PKS Systems to potential risks that may include problems with
services provided by PKS Systems to its customers and the potential for claims
arising under PKS Systems' customer contracts. PKS Systems attempts to
contractually limit its exposure to liability for Year 2000 compliance issues.
However, there can be no assurance as to the effectiveness of these contractual
limitations.
Outlined below is additional information with respect to the Year 2000
compliance programs that are being pursued by Level 3 Communications, LLC and
PKSIS.
Level 3 Communications, L.L.C. ("Level 3 LLC")
Level 3 Communications, LLC., uses software and related technologies
throughout its business that may be affected by the date change in the Year
2000. The inability of systems to appropriately recognize the Year 2000 could
result in a disruption of Level 3's energy assets to CalEnergy.3 LLC's operations. Level 3 received proceedsLLC has one main
line of $1,159 million and expectsbusiness: delivery of communications services to recognize an after-tax gaincommercial clients over
fiber optic cable. The delivery of approximately $324 million in 1998. The after-tax proceeds from
this transaction of approximately $967 millionservice will be usedover Level 3 LLC cable when
the network construction is complete. In the interim, services will be delivered
over both owned and leased lines.
Level 3 LLC faces two primary Year 2000 issues with respect to fundits
business. First, Level 3 LLC must assess the expansion planreadiness of its systems that are
required to provide its customers communication's services ("Service Delivery
Systems"). Second, Level 3 LLC must evaluate the Year 2000 readiness of its
internal business support systems ("Internal Business Support Systems"). Level 3
LLC must also verify the readiness of the information services business.
In January 1998, Class C shareholders converted 2.3 million
shares, with a redemption valueproviders of $122 million, into 10.5
million shares of Class D Stock.
In February 1998,the leased lines
currently in use.
Level 3 announced that it was moving its
corporate headquartersLLC, has designated a full-time Year 2000 director in addition to
Broomfield, Colorado,establishing a northwest
suburb of Denver. The campus facility is expected to encompass
over 500,000 square feet ofprogram office space at a construction cost
of over $70 million.staffed in part by experienced Year 2000
consultants. Level 3 is leasing space inprogressing through a comprehensive program to evaluate
and address the Denver area
while the campus is under construction. The first phaseeffect of the complex is scheduled for completionYear 2000 on its Internal Business Support
Systems, and the Service Delivery Systems. The plans' focus upon Year 2000
issues consists of the following phases:
Phase
(I) Assessment - Awareness, commitment, and evaluation which includes a
detailed inventory of systems and services that the Year 2000 may impact.
(II) Detailed Plan - Establishment of priorities, development of specific action
steps and allocation of resources to address the issues as outlined in
Phase I.
(III)Implementation - Completion of the summernecessary changes as delineated in
Phase II.
(IV) Verification - Determining whether the conversions implemented in Phase III
have resolved the Year 2000 problem so that date related calculations will
function properly, both as individual units and on an integrated basis.
This will culminate in an end-to-end system test to ensure that the
customer services being delivered by Level 3 LLC will function properly and
that all support services necessary to business operations will be Year
2000 compliant.
(V) Contingency Plans - Establishment of 1999.
In March 1998, PKS announcedalternative plans should any of the
services or suppliers that Level 3 requires to do business fail to be Year
2000 ready.
With respect to its Class D StockYear 2000 plans, Level 3 currently has activities underway
in each of the five phases above. The current stage of activities varies based
upon the type of component, system, and/or customer service at issue.
Business Functions Operational Effect Current Status
Customer Delivery Systems Inability to deliver Phases I to Phase V*
Customer Services
Internal Business Support Systems Failures of Internal Phases I to Phase V*
Support Services and
Customer Billing
* Level 3 anticipates this range of activity to continue through the 1999 as
it adds new equipment and services while building its infrastructure.
Additionally, the upgrading of service delivery through its proprietary
systems will begin
tradingrequire that the delivery systems go through verification with
each new innovation.
The expenses associated with this project by Level 3, as well as the
related potential effect on April 1Level 3' earnings, are not expected to have a
material effect on the Nasdaq National Market underfuture operating results or financial condition of Level
3. There can be no assurance, however, that the symbol
"LVLT". The Nasdaq listing will follow the separationYear 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's financial condition and results
of operations.
Level 3 has significant relationships and dependencies with regard to
systems and technology provided and supported by third party vendors and service
providers. In particular, the customer delivery business of Level 3 is dependent
upon third parties who provide telecommunication services while the
infrastructure continues to be built. As part of its Year 2000 program, Level 3
has sought to obtain formal Year 2000 compliance representation from vendors who
provide products and services to Level 3. The vendor compliance process is being
performed concurrently with the company's ongoing Year 2000 validation
activities. This compliance process consists of obtaining information from
disclosures made publicly available on company websites, reviewing test plans
and results made available from suppliers, and following up with letters and
phone calls to any vendors who have not made such information available to Level
3 as yet.
Because of the aforementioned reliance placed on third party vendors, Level
3' estimate of costs to be incurred could change substantially should one or
more of the vendors be unable to timely deliver Year 2000 compliant products.
Level 3 does not own the proprietary hardware technology or third party software
source code utilized in its business and therefore, Level 3 cannot actually
renovate the hardware or third party software identified as having Year 2000
support issues. The standard components supplied by vendors for the customer
delivery systems have been tested in laboratory settings and certified as to
their compliance.
With respect to the contingency plans for Level 3, such plans generally
fall into two categories. Concerning the customer delivery systems of Level 3,
Level 3 has certain redundant and backup facilities, such as on-site generators.
With respect to systems obtained from third party vendors, contingency plans are
developed by Level 3 on a case by case basis where deemed appropriate.
PKSIS
PKSIS and its subsidiaries use software and related technologies throughout
its business that may be affected by the date change in the Year 2000. The
inability of systems to appropriately recognize the Year 2000 could result in a
disruption of PKSIS operations. PKSIS has two main lines of business: computer
outsourcing and systems integration. The computer outsourcing business is
managed by PKS Computer Services LLC ("PKSCS"). The systems integration is
managed by PKS Systems Integration LLC ("PKSSI").
PKSCS generally faces two primary Year 2000 issues with respect to its
business. First, PKSCS must evaluate the Year 2000 readiness of its internal
support systems. Second, PKSCS must assess and, if necessary, upgrade the
operating systems which PKSCS provides for its outsourcing customers. PKSCS
outsourcing customers are responsible for their own application code
remediation.
PKSCS established a corporate-wide Year 2000 program in 1997, which in
relation to other business projects and objectives has been assigned a high
priority, including the designation of a full-time year 2000 director. PKSCS is
progressing through a comprehensive program to evaluate and address the effect
of the Year 2000 on its internal operations and support systems, and the
Construction Groupoperating systems which PKSCS is responsible for providing to its outsourcing
customers. Due to the nature of PKS,its business, PKSCS has developed and is
administering approximately twenty separate Year 2000 project plans.
Approximately eighteen of these plans are devoted to the specific operating
systems software upgrades to be undertaken by PKSCS for its outsourcing
customers according to software vendor specifications. The remaining plans focus
upon Year 2000 issues relating to PKSCS internal support systems. PKSCS is
utilizing both internal and external resources in implementing these plans.
These PKSCS plans generally consist of the following phases:
Phase
(I) Assessment - Awareness, commitment, and evaluation, to including a detailed
inventory of systems and services that the Year 2000 may impact.
(II) Detailed Plan - Establishment of priorities, development of specific action
steps and allocation of resources to address the issues as outlined in
Phase I.
(III)Implementation - Completion of the necessary changes per vendor
specifications, (that is, replacement or retirement) as outlined in Phase
II.
(IV) Verification - With respect to PKSCS' internal support systems, determining
whether the conversions implemented in Phase III have resolved the Year
2000 problem so that date related calculations will function properly, both
as individual units and on an integrated basis.
(V) Completion - The final rollout of components into an operational unit.
With respect to its Year 2000 plans, PKSCS currently has activities underway in
each of phases III through V. The current stage of activities varies based upon
the type of component, system, and/or customer service at issue.
PKSSI generally faces two primary Year 2000 issues with respect to its
business. First, PKSSI provides a wide variety of information technology
services to its customers which could potentially expose PKSIS to contractual
liability for Year 2000 related risks if services are not performed in a timely
or satisfactory manner. Second, PKSSI must evaluate and, if necessary, upgrade
or replace its internal business support systems which may have date
dependencies. PKSSI believes the primary internal systems affected by the Year
2000 issue which could have an impact on its business are desktop and network
hardware and software. PKSSI has completed its Year 2000 assessment of desktop
hardware and software, and, based on vendor representations, has determined that
material upgrades or replacements are not required. PKSSI is in the process of
communicating with its vendors to assess its servers and communications hardware
for Year 2000 readiness. This assessment is expected to be completed on March 31, 1998.by
approximately April 1, 1999.
In connectionfiscal year 1998, approximately 39% of the revenue generated by PKSSI
related to projects involving Year 2000 assessment and renovation services
performed by PKSSI for its customers. This is a reduction from 80% in 1997. Some
of these contracts require PKSSI to identify date affected fields in certain
application software of its customers and, in many cases, PKSSI undertakes
efforts to remediate those date-affected fields so that Year 2000 data may be
processed. Thus, Year 2000 issues affect certain services PKSSI provides to its
customers. This exposes PKSSI 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. In some cases PKSSI has contractual warranties
which could require PKSSI to perform Year 2000 related services after the year
2000. PKSSI attempts to contractually limit its exposure to liability for Year
2000 compliance issues. However, there can be no assurance as to the
effectiveness of such contractual limitations.
The following chart describes the status of PKSIS' Year 2000 program with
respect to Computer Outsourcing Services and Systems Integration Services.
Business Functions Current Areas of Focus Operational Impact Current Status
- - ---------------------------- ---------------------------- ------------------------- ---------------------
Computer Outsourcing Large & Mid-Range CPU Inability to continue Mid Phase III to
Service OEM Software critical processing of Phase V
OS Systems customer's systems
Network Equipment
Support Facilities
Internal Support Systems & Failures of Internal Mid Phase III to
Business Processes Support Services Phase V
Systems Integration Internal Support Systems & Failures of critical Assessment of
Services Business Processes Internal Support desktop hardware
Services and software has
been completed.
Assessment of
services and
communications
hardware is
expected to be
completed by
approximately April
1, 1999
PKSIS has significant relationships and dependencies with regard to systems
and technology provided and supported by third party vendors and service
providers. In particular, the computer outsourcing business of PKSCS is
dependent upon third parties who provide telecommunication service, electrical
utilities and mainframe and midrange hardware and software providers. As part of
its Year 2000 program, PKSIS has sought to obtain formal Year 2000 compliance
representation from vendors who provide products and services to PKSIS. The
vendor compliance process is being performed concurrently with the separation,companies
ongoing Year 2000 remediation activities. PKSCS is also working with its
outsourcing customers to inform them of certain dependencies which exist which
may affect PKSIS' Year 2000 efforts and certain critical actions which PKSIS
believes must be undertaken by the customer in order to allow PKSIS to implement
its Year 2000 efforts concerning the operating software system provided by PKSCS
for its customers.
To date, PKSCS has received written responses from approximately 40% of the
vendors from whom it has sought Year 2000 compliance statements. With respect to
those key third party vendors and suppliers who have failed to respond in
writing, PKS is following up directly with such vendors and suppliers and
obtaining information from other sources, such as disclosures made publicly
available on company websites.
Because of this reliance on third party vendors, PKSIS' estimate of costs
to be incurred could change substantially should one or more of the vendors be
unable to timely deliver Year 2000 compliant products. PKSCS does not own the
proprietary hardware technology or third party software source code utilized in
its business and therefore, PKSCS cannot actually renovate the hardware or
software identified as having Year 2000 support issues.
The expenses associated with PKSIS' Year 2000 efforts, as well as the
related potential effect on PKS' construction subsidiary will be renamed "Peter Kiewit Sons',
Inc." and PKS Class D Stock will becomeearnings, are not expected to have a material
effect on the common stockfuture operating results or financial condition of Level 3 Communications, Inc.
PKS' certificate3. There
can be no assurance, however, that the Year 2000 problem, and any loss incurred
by any customers of incorporation gives stockholders the
right to exchange their Class C Stock for Class D Stock under a
set conversion formula. That right will be eliminatedPKS as a result of the separationYear 2000 problem, will not have a
material adverse effect on Level 3's financial condition and results of
operations.
With respect to the contingency plans for PKSCS, such plans generally fall
into two categories. Concerning the internal support systems of PKSCS, PKSCS has
certain redundant and backup facilities, such as on-site generators, water
supply and pumps. PKSCS has undertaken contingency plans with respect to these
internal systems by performing due diligence with the vendors of these systems
in order to investigate the Year 2000 compliance status of these systems, and
such systems are tested on a monthly basis. With respect to the operating
systems obtained from third party vendors and maintained by PKSCS for its
outsourcing customers, contingency plans are developed by PKSCS and its
customers on a case by case basis as requested, contracted and paid for by
PKSCS' customers. However, there is no contingency plan for the failure of
operating system software to properly handle Year 2000 date processing. If the
operating system software provided to PKS by third party vendors fails at the
PKSCS Data Center, such vendor supplied software is expected to fail everywhere
and no immediate work around could be supplied by PKSCS. In the event computer
hardware supplied by PKSCS for its outsourcing customer fails, some customers
have contracted for contingency plans through disaster recovery arrangements
with a third party which supplies disaster recovery services.
Costs of Year 2000 Issues
Level 3 currently expects to incur approximately $12.5 million of
costs in aggregate, through the end of 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 has estimated the time and
effort expended by its employees on Year 2000 projects based on an analysis of
Year 2000 project plans.
PKSIS has incurred approximately $4.2 million of costs to implement its
Year 2000 program through 1998, and currently expects to incur an additional
approximately $3.6 million of costs in aggregate, through the end of 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 Construction Group.
To replace that conversion right, Class C stockholders received
6.5cost 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 $2.1 million sharesfor 1998 and are
estimated to be approximately one million dollars for 1999 through September
1999, when such projects are currently scheduled for completion. These
labor costs will necessarily increase if such projects take longer to
complete. Costs for software upgrades, additional equipment costs and a
test system for PKSCS' Year 2000 projects were estimated to be $2.1 million
for 1998 and are estimated to be $2.5 million for 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.
Risks Associated with Year 2000 Issues
Due to the complexity of the issues presented by the Year 2000 date change
and the proposed solutions, and the interdependence of external vendor support
services, it is difficult to assess with any degree of accuracy the future
effect of a new Class R stockfailure in January, 1998,any one aspect or combination of aspects of the Company's
Year 2000 activities. The Company cannot provide assurance that actual results
will not differ from management's estimates due to the complexity of upgrading
the systems and related technologies surrounding the Year 2000 issue.
Failure by the Company to complete its Year 2000 activities in a timely or
complete manner, within its estimate of projected costs, or failure by third
parties, such as financial institutions and related networks, software
providers, local telephone companies, long distance providers and electricity
providers among others, to correct their systems, with which the Company's
systems interconnect, could have a material effect on the Company's future
results of operations and financial position. Other factors which might cause a
material difference from management's estimate would include, but not be limited
to, the availability and cost of personnel with appropriate skills and abilities
to locate and upgrade relevant computer systems and similar uncertainties, as
well as the collateral effects on the Company of the Year 2000 problem on the
economy in general, or on the Company's business partners and customers in
particular.
ITEM 7A. MARKET RISK DISCLOSURE
Level 3 is convertible into Class D Stocksubject to market risks arising from changes in accordance with terms
ratified by stockholders in December 1997.
The PKS Board of Directors has approved in principle a plan
to force conversion of all shares of Class R stock outstanding.interest rates,
equity prices and foreign exchange rates. Due to certain provisionsthe Company's significant
marketable securities position at December 31, 1998, fluctuations in interest
rates could have a material effect on the value of these securities. However,
any fluctuation is partially mitigated by the Class R stock, conversion will
not be forced prior to May 1998,Company's strategy of investing in
short-term government and the final decision to force
conversion would be made by Level 3's Boardgovernment agency securities with maturities of Directors at that
time. Level 3's Board may choose not to force conversion if it
were to decide that conversion is notone
year or less. A 50 basis point increase in the best interestslevel of the stockholders of Level 3. If, as currently anticipated, Level
3's Board determines to force conversion of the Class R stock on
or before June 30, 1998, certain adjustments will be made to the
cost sharing and risk allocation provisions of the separation
agreement between Level 3 and the Construction business.
If Level 3's Board of Directors determines to force
conversion of the Class R stock, each share of Class R stock will
be convertible into $25 worth of Level 3 (Class D) common stock,
based upon the average trading price of the Level 3 common stockinterest rates on the
Nasdaq National Market forCompany's marketable securities portfolio at December 31, 1998 would have a $5
million impact on the last fifteen trading daysvalue of these securities.
In 1998, the month prior to the determination by the BoardCompany issued approximately $2.5 billion of Directors
to force conversion. When the spin-off occurs, Level 3Senior Notes and
Senior Discount Notes (the "Notes"). Fluctuations in interest rates will increase paid in capital and reduce retained earnings byaffect
the fair value of the Class R shares.
Immediately priorthis debt but interest expense will not be affected due to the
spin-offfixed interest rates of the Kiewit ConstructionNotes. Level 3 has the ability to redeem all or a
portion of the Senior Notes and Mining Group,Senior Discount Notes beginning in 2003. If
interest rates decrease significantly, the amount of redemptions, if any, could
be affected. The Company continues to evaluate alternatives to limit interest
rate risk.
Level 3 has investments in several 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 $818 million
as of December 31, 1998, which is significantly higher than their carrying value
of $300 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 $162 million change in
fair value of these investments. The Company does not currently utilize
financial instruments to minimize its exposure to price fluctuations in equity
securities.
The Company is implementing its Business Plan in Europe and as a result is
exposed to certain foreign currency risks. Exposure to these risks was not
significant at December 31, 1998 due to the limited amount of net assets
invested in Europe as of that date. In 1999, the Company will recognize a gain equalcontinue to expand
its presence in Europe and enter the difference between the carrying valueAsian market, and will continue to analyze
risk management strategies to reduce foreign currency exchange risk.
The changes in interest rates, equity security prices and foreign exchange
rates are based on hypothetical movements and are not necessarily indicative of
the Constructionactual results that may occur. Future earnings and Mining Grouplosses will be affected
by actual fluctuations in interest rates, equity prices and its fair value. The Company will then reflect
the fair value of Kiewit Construction and Mining Group as a
dividend to shareholders.foreign currency
rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.DATA
Financial statements and supplementary financial information for Level 3
Communications, Inc. (f/k/a Peter Kiewit Sons', Inc.) and Subsidiaries begin on
page P1.
SeparateF-1.
The financial statements of an equity method investee (RCN Corporation) are
required by Rule 3.09 and other information pertaining toare incorporated by reference from RCN's Form 10-K for
the Kiewit Construction & Mining Group and the Kiewit Diversified
Group have beenyear ended December 31, 1998, filed as Exhibits 99.A and 99.B to this report.
The Company will furnish a copy of such exhibits without charge
upon the written request of a stockholder addressed to Stock
Registrar, Peter Kiewit Sons', Inc., 1000 Kiewit Plaza, Omaha,
Nebraska 68131.
Itemunder Commission No. 000-22825.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART IIIDISCLOSURE
The following information with regard to the Company's change of
independent accountants was first reported by the Company's filing of a Current
Report on Form 8-K on September 1, 1998.
The following information is provided in response to the requirements of
Item 304(a)(1) of Regulation S-K.
i) PricewaterhouseCoopers LLP (formerly Coopers & Lybrand L.L.P. which
became PricewaterhouseCoopers LLP on July 1, 1998) was dismissed as the
Company's independent accountants effective as of the close of business on
August 25, 1998.
ii) The reports of PricewaterhouseCoopers LLP on the consolidated financial
statements of the Company at December 27, 1997 and December 28, 1996, and for
the three years ended December 27, 1997 contain no adverse opinion or disclaimer
of opinion and were not qualified or modified as to uncertainty, audit scope or
accounting principle.
iii) The Company's Audit Committee participated in and approved the
decision to change independent accountants.
iv) In connection with its audits for the two most recent fiscal years and
through August 25, 1998 there were no disagreements with PricewaterhouseCoopers
LLP on any matter of accounting principle or practice, financial statement
disclosure, or auditing scope or procedure, which disagreements if not resolved
to the satisfaction of PricewaterhouseCoopers LLP, would have caused
PricewaterhouseCoopers LLP to make reference thereto in their report on the
financial statements for such years.
v) During the two most recent fiscal years and through August 25, 1998
there were no reportable events (as defined in Regulation S-K Item
304(a)(1)(v)).
The following information is provided in response to the requirements of
Item 304(a)(2) of Regulation S-K.
The Company engaged Arthur Andersen LLP as its new independent accountants
as of August 26, 1998. During the most recent two fiscal years and through
August 25, 1998, the Company has not consulted with Arthur Andersen LLP on items
which (1) were or should have been subject to an AICPA Statement on
Auditing Standards No. 50, "Reports on the Application of Accounting
Principles," or (2)concerned the subject matter of a disagreement or
reportable event with the Company's former auditor (both as set forth in
Regulation S-K Item 304(a)(2)).
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
ITEM 11. EXECUTIVE COMPENSATION.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.REGISTRANT
The information required by Part IIIthis Item 10 is incorporated by reference to
the Company's definitive proxy statement for the 19981999 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission, however
certain information is included above under the caption "Directors and Executive
Officers" under Item 1. Business.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to
the Company's definitive proxy statement for the 1999 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.
However, certainITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is set forth underincorporated by reference to
the caption "DirectorsCompany's definitive proxy statement for the 1999 Annual Meeting of
Stockholders to be filed with the Securities and Executive OfficersExchange Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is incorporated by reference to
the Company's definitive proxy statement for the 1999 Annual Meeting of
Stockholders to be filed with the Registrant" following Item 4 above.
PART IVSecurities and Exchange Commission.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.8-K
(a) Financial statements and financial statement schedules required to be filed
for the registrant under Items 8 or 14 are set forth following the index
page at page P1.F1. Exhibits filed as a part of this report are listed below.
Exhibits incorporated by reference are indicated in parentheses.
Exhibit Number Description
3.1 Restated Certificate of Incorporation, effective January 8, 1992 (Exhibit
3.1 to Company's Form 10-K for 1991).
3.2 Certificate of Amendment of Restated Certificate of Incorporation of Peter
Kiewit Sons', Inc., effective December 8, 1997.
3.43.3 By-laws, composite copy, including all amendments, as of March 19, 1993
(Exhibit 3.4 to Company's Form 10-K for 1992).
10.1 Separation Agreement, dated December 8, 1997, by and among PKS, Kiewit
Diversified Group Inc., PKS Holdings, Inc. and Kiewit Construction Group
Inc. (Exhibit 10.1 to the Company's Form 10-K for 1997).
10.2 Amendment No. 1 to Separation Agreement, dated March 18, 1997, by and among
PKS, Kiewit Diversified Group Inc., PKS Holdings, Inc. and Kiewit
Construction Group Inc. (Exhibit 10.1 to the Company's Form 10-K for 1997).
10.3 Cost Sharing and IRU Agreement between Level 3 Communications, LLC and
INTERNEXT, LLC dated July 18, 1998 (Exhibit 10.1 to the Company's Quarter
Report on Form 10-Q for the three months ended September 30, 1998).
21 List of subsidiaries of the Company.
2323.1 Consent of Coopers & LybrandArthur Andersen LLP
23.2 Consents of PricewaterhouseCoopers LLP
23.3 Consents of PricewaterhouseCoopers LLP
27 Financial data schedules.
99.A Kiewit Construction & Mining Group Financial Statements and
Other Information.
99.B Diversified Group Financial Statements and Other
Information.
(b) No reportsReports on Form 8-K were filed by the Company during the fourth quarter of 1997.
On October 1, 1998, the Company filed a Current Report on Form 8-K relating
to the issuance of an aggregate of 150,609 shares of Common Stock pursuant
to Regulation S in connection with the acquisition of miknet Internet Based
Services GmbH.
On October 5, 1998, the Company filed a Current Report on Form 8-K relating
to the issuance of an aggregate of 13,935 shares of Common Stock pursuant
to Regulation S in connection with the acquisition of GeoNet
Communications, Inc. The total number of shares issued in this acquisition
was 511,719.
On December 3, 1998, the Company filed a Current Report on Form 8-K
relating to the issuance of press releases announcing the offering and
completion of an offering of 10.5% Senior Discount Notes due 2008 in a
transaction exempt from registration under the Securities Act of 1933, as
amended.
On December 7, 1998, the Company filed a Current Report on Form 8-K
describing certain risks associated with the implementation of the
Company's business plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrantregistrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 30ththis 31st day of
March, 1998.
PETER KIEWIT SONS', INC.1999.
Level 3 Communications, Inc.
By: /s/ Walter Scott, Jr.James Q. Crowe
----------------------------------
Name: Walter Scott, Jr.James Q. Crowe
Title: Chairman of the BoardPresident and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicatedand on the 30th day of March, 1998.dates indicated.
Name Title Date
/s/ Walter Scott, Jr. Chairman of the Board and PresidentMarch 31, 1999
- - ---------------------------
Walter Scott, Jr.
(principal executive officer)President, Chief Executive Officer
/s/ James Q. Crowe and Director March 31, 1999
- - ---------------------------
James Q. Crowe
Executive Vice President, Chief
/s/ R. Douglas Bradbury Executive Vice President of Level 3Financial Officer and Director March 31, 1999
R. Douglas Bradbury Communications, Inc. (principal financial officer)
/s/ Eric J. Mortensen Controller (principal accounting March 31, 1999
- - --------------------------- officer)
Eric J. Mortensen
(principal accounting officer)
/s/ Richard W. ColfWilliam L. Grewcock Director March 31, 1999
- - ---------------------------
William L. Grewcock
/s/ Philip B. Fletcher Director March 31, 1999
- - ---------------------------
Philip B. Fletcher
/s/ Richard R. Jaros Richard W. Colf, Director March 31, 1999
- - ---------------------------
Richard R. Jaros
Director
/s/ James Q. Crowe /s/ Tait P. Johnson
James Q. Crowe, Director Tait P. Johnson,
Director
/s/ Robert B. DaughertyE. Julian Director March 31, 1999
- - ---------------------------
Robert E. Julian
/s/ Allan K. Kirkwood
Robert B. Daugherty,David C. McCourt Director Allan K. Kirkwood,
Director
/s/ Richard Geary /s/ Peter Kiewit, Jr.
Richard Geary, Director Peter Kiewit, Jr.,
Director
/s/ Bruce E. GrewcockMarch 31, 1999
- - ---------------------------
David C. McCourt
/s/ Kenneth E. Stinson Bruce E. Grewcock, Director March 31, 1999
- - ---------------------------
Kenneth E. Stinson
/s/ Michael B. Yanney Director /s/ William L. Grewcock /s/ GeorgeMarch 31, 1999
- - ---------------------------
Michael B. Toll, Jr.
William L. Grewcock, Director George B. Toll, Jr.,
Director
/s/ Charles M. Harper
Charles M. Harper, Director
PETER KIEWIT SONS',Yanney
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
ReportReports of Independent Public Accountants
Financial Statements as of December 27, 199731, 1998 and December 28, 199627, 1997 and for the
three years ended December 27, 1997:31, 1998:
Consolidated Statements of Earnings
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Comprehensive Income
Notes to Consolidated Financial Statements
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.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Level 3 Communications, Inc.:
We have audited the consolidated balance sheet of Level 3 Communications, Inc.
and subsidiaries (a Delaware corporation) as of December 31, 1998 and the
related consolidated statements of earnings, cash flows, changes in
stockholders' equity and comprehensive income for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Level 3
Communications, Inc. and subsidiaries as of December 31, 1998 and the
consolidated results of their operations and their cash flows for the year then
ended in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Denver, Colorado
March 29, 1999
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 financial statementsbalance sheet of Level 3 Communications, Inc.
and Subsidiaries (formerly, Peter Kiewit Sons', Inc.) as of December 27, 1997
and Subsidiaries as listedthe related consolidated statements of earnings, cash flows, changes in
stockholders' equity and comprehensive income for each of the two years in the
index on the
preceding page of this Form 10-K.period ended December 27, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Peter Kiewit Sons',Level 3
Communications, Inc. and Subsidiaries as of December 27, 1997 and December 28, 1996, and the
consolidated results of their operations and their cash flows for each of the
threetwo years in the period ended December 27, 1997 in conformity with generally
accepted accounting principles.
Coopers & Lybrand L.L.P.LLP
Omaha, Nebraska
March 30, 1998
PETER KIEWIT SONS',LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
For the three years ended December 27, 1997
(dollars in millions, except per share data) 1997 1996 1995
Revenue $ 332 $ 652 $ 580
Cost of Revenue (175) (384) (345)
------ ------ -----
157 268 235
General and Administrative Expenses (114) (181) (190)
------ ------ -----
Operating Earnings 43 87 45
Other (Expense) Income:
Equity losses, net (43) (9) (5)
Investment income, net 45 56 45
Interest expense, net (15) (33) (23)
Gain on subsidiary's stock transactions, net - - 3
Other, net 1 6 125
------ ------ -----
(12) 20 145
Equity Loss in MFS - - (131)
------ ------ -----
Earnings Before Income Taxes, Minority Interest
and Discontinued Operations 31, 107 59
Income Tax Benefit (Provision) 48 (3) 79
Minority Interest in Net Loss (Income)
of Subsidiaries 4 - (12)
------ ------ -----
Income from Continuing Operations 83 104 126
Discontinued Operations:
Construction, net of income tax
(expense) of ($107), ($72) and ($60) 155 108 104
Energy, net of income tax benefit (expense)
of $1, ($9) and ($8) 10 9 14
------ ------ -----
Income from Discontinued Operations 165 117 118
------ ------ -----
Net Earnings $ 248 $ 221 $ 244
====== ====== =====
Earnings Per Share:
Continuing Operations:
Class D Stock
Basic $ .66 $ .90 $1.17
====== ====== =====
Diluted $ .66 $ .90 $1.17
====== ====== =====
Net Income:
Class C Stock
Basic $15.99 $10.13 $7.78
====== ====== =====
Diluted $15.35 $ 9.76 $7.62
====== ====== =====
Class D Stock
Basic $ .74 $ .97 $1.29
====== ====== =====
Diluted $ .74 $ .97 $1.29
====== ====== =====1998
(dollars in millions, except per share data) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Revenue $ 392 $ 332 $ 652
Cost and Expenses:
Operating expenses (199) (163) (268)
Depreciation and amortization (66) (20) (124)
General and administrative expenses (332) (106) (173)
Write-off of in process research and development (30) - -
-------- -------- --------
Total costs and expenses (627) (289) (565)
-------- -------- --------
Earnings (Loss) from Operations (235) 43 87
Other Income (Expense):
Interest income 173 33 50
Interest expense, net (132) (15) (33)
Equity losses in unconsolidated subsidiaries (132) (43) (9)
Gain on equity investee stock transactions 62 - -
Gain on sale of assets 107 10 10
Other, net 4 7 2
--------- ---------- ---------
Total other income (expense) 82 (8) 20
--------- ---------- ---------
Earnings (Loss) Before Income Taxes
and Discontinued Operations (153) 35 107
Income Tax Benefit (Provision) 25 48 (3)
--------- --------- ----------
Income (Loss) from Continuing Operations (128) 83 104
Discontinued Operations:
Gain on Split-off of Construction Group 608 - -
Construction operations net of income tax
expense of ($107) and ($72) - 155 108
Gain on disposition of energy business net of income tax
expense of $175 324 - -
Energy, net of income tax benefit (expense)
of $1 and ($9) - 10 9
-------- -------- --------
Income from discontinued operations 932 165 117
-------- -------- --------
Net Earnings $ 804 $ 248 $ 221
======== ======== ========
Earnings (Loss) Per Share of Level 3 Common Stock
(Basic and Diluted):
Continuing operations $ (.43) $ .33 $ .45
========= ========= =========
Discontinued operations excluding construction operations $ 3.09 $ .04 $ .03
======== ========= =========
Net earnings excluding construction operations $ 2.66 $ .37 $ .48
======== ========= =========
Net earnings excluding gain on
Split-off of Construction Group $ .64 $ .37 $ .48
========= ========= =========
See accompanying notes to consolidated financial statements.
PETER KIEWIT SONS', INC
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and December 27, 1997
and December 28, 1996
(dollars in millions) 1997 1996
Assets
Current Assets:
Cash and cash equivalents $ 87 $ 147
Marketable securities 678 372
Restricted securities 22 17
Receivables, less allowance of $-, and $3 42 76
Investment in discontinued operations - energy 643 608
Other 22 26
------- ------
Total Current Assets 1,494 1,246
Property, Plant and Equipment, at cost:
Land 15 18
Buildings and leasehold improvements 122 159
Equipment 275 810
------- ------
412 987
Less accumulated depreciation and amortization (228) (345)
------- ------
Net Property, Plant and Equipment 184 642
Investments 383 189
Investments in Discontinued Operations-Construction 652 562
Intangible Assets, net 21 353
Other Assets 45 74
------- ------
$ 2,779 $3,066
(dollars in millions) 1998 1997
- - ------------------------------------------------------------------------------------------------------------------
Assets
Current Assets:
Cash and cash equivalents $ 848 $ 87
Marketable securities 2,863 678
Restricted securities 26 22
Receivables, net 57 42
Investment in discontinued operations - energy - 643
Income taxes receivable 54 2
Other 29 20
------ -------
Total Current Assets 3,877 1,494
Net Property, Plant and Equipment 1,061 184
Investments 323 383
Investments in Discontinued Operations - Construction - 652
Other Assets, net 264 66
------ -------
$5,525 $ 2,779
======= ======= ======
See Note 17 for 1997 pro forma balance sheet information.
See accompanying notes to consolidated financial statements.
PETER KIEWIT SONS',
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDAIRIESSUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and December 27, 1997
and December 28, 1996
(continued)
(dollars in millions) 1997 1996
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 31 $ 79
Current portion of long-term debt:
Telecommunications - 55
Other 3 2
Accrued reclamation and other mining costs 19 19
Deferred income taxes 15 5
Other 21 87
------ ------
Total Current Liabilities 89 247
Long-Term Debt, less current portion:
Telecommunications - 207
Other 137 113
Deferred Income Taxes 83 148
Accrued Reclamation Costs 100 98
Other Liabilities 139 216
Minority Interest 1 218
Stockholders' Equity:
Preferred stock, no par value, authorized
250,000 shares:
no shares outstanding in 1997 and 1996 - -
Common stock, $.0625 par value, $2.1
billion aggregate redemption value:
Class B, authorized 8,000,000 shares:
- outstanding in 1997 and 263,468
outstanding in 1996 - -
Class C, authorized 125,000,000 shares:
10,132,343 outstanding in 1997 and 10,743,173
outstanding in 1996 1 1
Class D, authorized 500,000,000 shares:
135,517,140 outstanding in 1997 and 115,901,215
outstanding in 1996 8 1
Class R, authorized 8,500,000 shares:
- outstanding in 1997 and 1996 - -
Additional paid-in capital 427 235
Foreign currency adjustment (7) (7)
Net unrealized holding gain 2 23
Retained earnings 1,799 1,566
------ ------
Total Stockholders' Equity 2,230 1,819
------ ------
$2,779 $3,066
====== ======
See Note 17 for 1997 pro forma balance sheet information.
(dollars in millions) 1998 1997
- - ------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 276 $ 31
Current portion of long-term debt 5 3
Accrued reclamation and other mining costs 16 19
Accrued interest 33 2
Deferred income taxes 2 15
Other 38 19
------- -------
Total Current Liabilities 370 89
Long-Term Debt, less current portion 2,641 137
Deferred Income Taxes 86 83
Accrued Reclamation Costs 96 100
Other Liabilities 167 140
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $.01 par value, authorized 10,000,000 shares in 1998,
250,000 shares in 1997: no shares outstanding in 1998 and 1997 - -
Common stock:
Common stock, $.01 par value in 1998 and $.0625 par value in 1997,
authorized 500,000,000 shares: 307,874,706 outstanding in
1998 and 271,034,280 outstanding in 1997 3 8
Class B, no shares outstanding in 1997 - -
Class C, 10,132,343 shares outstanding in 1997 - 1
Class R, $.01 par value, authorized 8,500,000 shares:
no shares outstanding in 1998 and 1997 - -
Additional paid-in capital 765 427
Accumulated other comprehensive income (loss) 4 (5)
Retained earnings 1,393 1,799
------- -------
Total Stockholders' Equity 2,165 2,230
------- -------
$ 5,525 $ 2,779
======= =======
See accompanying notes to consolidated financial statements.
PETER KIEWIT SONS', INC. AND SUBSIDAIRIES
Consolidated Statements of Cash Flows
For the three years ended December 27, 1997
(dollars in millions) 1997 1996 1995
Cash flows from continuing operations:
Income from continuing operations $ 83 $ 104 $ 126
Adjustments to reconcile income from
continuing operations to net
cash provided by continuing operations:
Depreciation, depletion and amortization 24 132 96
Gain on sale of property, plant and
equipment, and other investments (9) (3) (7)
Gain on subsidiary's stock transactions, net - - (3)
Compensation expense attributable
to stock options 21 - -
Equity losses, net 43 10 130
Minority interest in subsidiaries (4) - 12
Retirement benefits paid (7) (6) (2)
Federal income tax refunds 146 - 35
Deferred income taxes (103) (68) (152)
Change in working capital items:
Receivables (9) (1) 11
Other current assets (1) 6 -
Payables (3) 9 (3)
Other liabilities (5) 13 34
Other 6 - (4)
------ ------ ------
Net cash provided by continuing operations 182 196 273
Cash flows from investing activities:
Proceeds from sales and maturities of
marketable securities 167 378 383
Purchases of marketable securities (452) (311) (440)
Increase in restricted securities (2) (2) (2)
Investments and acquisitions, net of
cash acquired (42) (59) (136)
Proceeds from sale of property, plant
and equipment, and other investments 1 7 14
Capital expenditures (26) (117) (118)
Other
LEVEL 3 (8) (2)
------ ------ ------
Net cash used in investing activities $ (351) $ (112) $ (301)
See accompanying notes to consolidated financial statements.
PETER KIEWIT SONS',COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three years ended December 27, 1997
(continued)31, 1998
(dollars in millions) 1998 1997 1996 1995
Cash flows from financing activities:
Long-term debt borrowings $ 17 $ 38 $ 49
Payments on long-term debt, including
current portion (2) (60) (49)
Issuances of common stock 138 - 2
Issuances of subsidiaries' stock - 1 -
Repurchases of common stock - (11) (3)
Dividends paid (12) (11) -
Exchange of Class C Stock for Class
D Stock, net 72 20 155
------ ------ ------
Net cash provided by (used in)
financing activities 213 (23) 154
Cash flows from discontinued operations:
Discontinued energy operations 3 5 8
Investments in discontinued energy operations (31) (282) (101)
Proceeds from sales of discontinued
packaging operations - - 29
------ ------ ------
Net cash used in discontinued operations (28) (277) (64)
Cash and cash equivalents of C-TEC in 1997
and MFS in 1995 at beginning of year (76) - (22)
Effect of exchange rates on cash - - 2
------ ------ ------
Net change in cash and cash equivalents (60) (216) 42
Cash and cash equivalents at beginning of year 147 363 321
------ ------ ------
Cash and cash equivalents at end of year $ 87 $ 147 $ 363
====== ====== ======
Supplemental disclosure of cash
flow information:
Taxes paid $ 62 $ 55 $ 132
Interest paid 13 38 33
Noncash investing and financing activities:
Conversion of CalEnergy convertible
debentures to common stock $ - $ 66 $ -
Dividend of investment in MFS - - 399
Issuance of C-TEC redeemable preferred stock
for acquisition
- - -----------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Earnings $ 804 $ 248 $ 221
Less: Income from Discontinued Operations (932) (165) (117)
-------- -------- --------
Income (loss) from continuing operations (128) 83 104
Adjustments to reconcile income (loss) from
continuing operations to net cash provided
by continuing operations:
Write-off in process research and development 30 - -
Equity losses, net 132 43 9
Depreciation and amortization 66 20 124
Amortization of discounts on marketable securities (24) - -
Amortization of debt issuances costs 3 - -
Gain on sale of property, plant and
equipment and other assets (17) (10) (10)
Gain on equity investee's stock transactions (62) - -
Gain on sale of Cable Michigan (90) - -
Compensation expense attributable to stock awards 39 21 -
Federal income tax refunds 46 146 -
Deferred income taxes (50) (103) (68)
Accrued interest on marketable securities (39) - -
Change in working capital items:
Receivables (1) (9) (1)
Other current assets (10) (1) 6
Payables 239 (3) 9
Other liabilities 39 (5) 13
Other (3) - 3
-------- --------- ---------
Net Cash Provided by Continuing Operations 170 182 189
Cash Flows from Investing Activities:
Proceeds from sales and maturities of marketable
securities 3,214 167 378
Purchases of marketable securities (5,334) (452) (311)
Purchases of restricted securities (2) (2) (2)
Capital expenditures (910) (26) (117)
Investments and acquisitions, net of cash acquired (67) (42) (59)
Proceeds from sale of property, plant
and equipment, and other investments 27 1 14
Proceeds from sale of Cable Michigan 129 - -
Other - 3 (8)
-------- ---------- ----------
Net Cash Used in Investing Activities $(2,943) $ (351) $ (105)
See accompanying notes to consolidated financial statements.
PETER KIEWIT SONS',
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three years ended December 31, 1998
(continued)
(dollars in millions) 1998 1997 1996
- - -----------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Long-term debt borrowings, net of issuance costs $ 2,426 $ 17 $ 38
Payments on long-term debt, including current portion (12) (2) (60)
Issuances of common stock 21 117 -
Exchange of Class C Stock for Class D Stock, net 122 72 20
Stock options exercised 11 21 -
Issuances of subsidiaries' stock - - 1
Repurchases of common stock (1) - (11)
Dividends paid - (12) (11)
-------- --------- ---------
Net Cash Provided by (Used in) Financing Activities 2,567 213 (23)
Cash Flows from Discontinued Operations:
Proceeds from sale of discontinued energy operations,
net of income tax payments of $192 million 967 - -
Discontinued energy operations - 3 5
Investments in discontinued energy operations - (31) (282)
-------- --------- --------
Net Cash Provided by (Used in) Discontinued Operations 967 (28) (277)
Cash and Cash Equivalents of C-TEC at the Beginning of 1997 - (76) -
-------- --------- -----------
Net Change in Cash and Cash Equivalents 761 (60) (216)
Cash and Cash Equivalents at Beginning of Year 87 147 363
-------- --------- --------
Cash and Cash Equivalents at End of Year $ 848 $ 87 $ 147
======== ========= ========
Supplemental Disclosure of Cash Flow Information:
Income taxes paid $ 246 $ 62 $ 55
Interest paid 104 13 38
Noncash Investing and Financing Activities:
Issuances of stock for acquisitions:
XCOM Technologies, Inc. $ 154 $ - $ -
GeoNet Communications, Inc. 19 - -
Others 10 - -
Conversion of MidAmerican convertible debentures
to common stock $ - $ - $ 66
The activities of the Construction Group have been removed from the consolidated
statements of cash flows. The Construction Group had cash flows of ($62)
million, $59 million and $79 million for the three months ended March 31, 1998,
(the date of the Split-off) and fiscal 1997 and 1996, respectively.
See accompanying notes to consolidated financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders'
Equity For the three years ended December 27, 199731, 1998
Class Accumulated
B&C Additional Other
Common Common Paid-in Comprehensive Retained
(dollars in millions) Stock Stock Capital Income (Loss) Earnings Total
- - ------------------------------------------------------------------------------------------------------------------
Net
Class Class Unrealized
B&C D Additional Foreign Holding
(dollars in Common Common Paid-in Currency Gain Retained
millions) Stock Stock Capital Adjustment (Loss) Earnings Total
Balance at
December 31, 199430, 1995 $ 1 $ 1 $ 182210 $ (7)11 $ (8)1,384 $ 1,567 $1,7361,607
Common Stock:
Issuances of stock - - 29 - - - 29- - -
Repurchases of stock - - (1) - (10) (11)
Dividends(a) - - - - (12) (12)
Class C Stock:
Issuances - - 27 - - 27
Repurchases - - (1) - (4) (5)
(6)
Foreign currency
adjustmentDividends (a) - - - - (13) (13)
Net Earnings - - - - 221 221
Other Comprehensive
Income - - - 5 - 5
----------- ----------- ----------- ---------- ----------- ----------
Balance at
December 28, 1996 1 1 235 16 1,566 1,819
Common Stock:
Issuances - - 117 - - 117
Stock options exercised - - 21 - - 21
Stock dividend - 7 (7) - - -
Stock option grants - - 27 - - 27
Class C Stock:
Issuances - - 33 - - 33
Repurchases - - - - (2) (2)
Dividends (b) - - - - (13) (13)
Conversion of
debentures - - 1 - - 1
Net unrealized
holding gainEarnings - - - - 25 - 25
Net earnings248 248
Other Comprehensive
Loss - - - (21) - - 244 244
Dividends:(a)
Class C ($1.05
per common share) - - - - - (12) (12)
Class D ($.10 per
common share) - - - - - (11) (11)
MFS Dividend - - - - - (399) (399)
----- ----- ----- ----- ----- ----- -----(21)
----------- ----------- ----------- --------- ----------- ---------
Balance at
December 30, 1995 $ 1 1 210 (6) 17 1,384 1,607
Issuances of stock - - 27, - - - 27
Repurchases of stock - - (2) - - (14) (16)
Foreign currency
adjustment - - - (1) - - (1)
Net unrealized
holding gain - - - - 6 - 6
Net earnings - - - - - 221 221
Dividends: (b)
Class C ($1.30
per common share) - - - - - (13) (13)
Class D ($.10 per
common share) - - - - - (12) (12)
----- ----- ----- ----- ----- ----- -----
Balance at
December 28, 19961997 $ 1 $ 18 $ 235427 $ (7)(5) $ 23 $1,566 $1,8191,799 $ 2,230
(a) Includes $.70 and $.05 per share for dividends on Class C and Common
Stock, respectively, declared in 1996 but paid in January 1997.
(b) Includes $.80 per share for dividends on Class C declared in 1997 but
paid in January 1998.
See accompanying notes to consolidated financial statements
PETER KIEWIT SONS',statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the three years ended December 27,199731,1998
(continued)
Class Accumulated
B&C Additional Other
Common Common Paid-in Comprehensive Retained
(dollars in millions) Stock Stock Capital Income (Loss) Earnings Total
- - ------------------------------------------------------------------------------------------------------------------
Net
Class Class Unrealized
Class Class Foreign Holding
(dollars in B&C D Additional Currency Gain Retained
millions) Stock Stock Capital Adjustment (Loss) Earnings Total
Balance at
December 28, 1996 $ 1 $ 1 $ 235 $ (7) $ 23 $1,566 $1,819
Issuances of stock - - 172 - - - 172
Repurchases of stock - - - - - (2) (2)
Option Activity - - 27 - - - 27
Class D Stock Split - 7 (7) - - - -
Foreign currency
adjustment - - - - - - -
Net unrealized
holding loss - - - - (21) - (21)
Net earnings - - - - - 248 248
Dividends: (c)
Class C ($1.50 per
common share) - - - - - (13) (13)
---- ---- ----- ----- ---- ------ ------
Balance at
December 27, 1997 $ 1 $ 8 $ 427 $ (7)(5) $ 2 $1,799 $2,230
==== ==== ===== ===== ==== ====== ======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
=========== ========== ======== ========== ======= =======
(a) Includes $.60 and $.10 per share for dividends on Class C and
Class D Stock, respectively, declared in 1995 but paid in
January 1996.
(b) Includes $.70 and $.10 per share for dividends on Class C and
Class D Stock, respectively, declared in 1996 but paid in
January 1997.
(c) Includes $.80 per share for dividends on Class C declared in
1997 put paid in January 1998.
See accompanying notes to consolidated financial statements.
PETER KIEWIT SONS'
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
For the three years ended December 31,1998
(dollars in millions) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Net Earnings $ 804 $ 248 $ 221
Other Comprehensive Income Before Tax:
Foreign currency translation adjustments 1 - (1)
Unrealized holding gains (losses) arising during period (2) (23) 12
Reclassification adjustment for gains
included in net earnings (9) (9) (3)
------- -------- --------
Other Comprehensive Income (Loss), Before Tax (10) (32) 8
Income Tax Benefit (Expense) Related to Unrealized
Holding Gains (Losses) 4 11 (3)
------- -------- --------
Other Comprehensive Income (Loss) Net of Taxes (6) (21) 5
------- -------- --------
Comprehensive Income $ 798 $ 227 $ 226
======= ======== ========
See accompanying notes to consolidated financial statements.
LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Reorganization - Discontinued Construction Operations
In October 1996, the Board of Directors (the "Board") of Level 3 Communications,
Inc. ("Level 3" or the "Company"), directed management of the Company to pursue
a listing of the Company's Class D Diversified Group Convertible Exchangeable
Common Stock, par value $.0625 per share (the "Class D Stock"), as a way to
address certain issues created by the Company's then two-class capital stock
structure and the need to attract and retain the best management for the
Company's businesses. During the course of its examination of the consequences
of a listing of the Class D Stock, management concluded that a listing of the
Class D Stock would not adequately address these issues, and instead began to
study a separation of the construction operations ("Construction Group") from
the other businesses of the Company (the "Diversified Group"), thereby forming
two independent companies. At the time, the performance of the Diversified Group
was reflected by the Class D Stock. The performance of the Construction Group
was reflected by the Company's Class C Construction & Mining Group Restricted
Redeemable Convertible Exchangeable Common Stock, par value $.0625 per share
(the "Class C Stock"). At the regular meeting of the Board on July 23, 1997,
management submitted to the Board for consideration a proposal for the
separation of the Construction Group and the Diversified Group through a
split-off of the Construction Group (the "Split-off"). At a special meeting on
August 14, 1997, the Board approved the Split-off.
The separation of the Construction Group and the Diversified Group was
contingent upon a number of conditions, including the favorable ratification by
a majority of the holders of both the Company's Class C and the Class D Stock,
and the receipt by the Company of an Internal Revenue Service ruling or other
assurance acceptable to the Board that the separation would be tax-free to U.S.
stockholders. On December 8, 1997, the holders of Class C Stock and Class D
Stock approved the Split-off and on March 5, 1998, the Company received a
favorable private letter ruling from the Internal Revenue Service. The Split-off
was effected on March 31, 1998. In connection with the Split-off, (i) the
Company exchanged each outstanding share of Class C Stock for one share of
Common Stock of PKS Holdings, Inc. ("New PKS"), the Company formed to hold the
Construction Group, to which eight-tenths of a share of the Company's Class R
Convertible Common Stock, par value $.01 per share (the "Class R Stock"), was
attached to replace certain conversion features in the Class C Stock which would
terminate upon the Split-off (ii) New PKS was renamed "Peter Kiewit Sons', Inc."
(iii) the Company was renamed "Level 3 Communications, Inc.", and (iv) the Class
D Stock was designated as common stock, par value $.01 per share (the "Common
Stock"). As a result of the Split-off, the Company no longer owns any interest
in New PKS or the Construction Group. Accordingly, the separate financial
statements and management's discussion and analysis of financial condition and
results of operations of Peter Kiewit Sons', Inc. should be obtained to review
the financial position of the Construction Group as of December 27, 1997, and
the results of operations for the two years ended December 27, 1997.
On March 31, 1998, the Company reflected the fair value of the Construction
Group as a distribution to the Class C stockholders because the distribution was
considered non-pro rata as compared to the Company's previous two-class capital
stock structure. The Company recognized, a gain of $608 million within
discontinued operations, equal to the difference between the carrying value of
the Construction Group and its fair value in accordance with Financial
Accounting Standards Board Emerging Issues Task Force Issue 96-4, "Accounting
for Reorganizations Involving a Non-Pro Rata Split-off of Certain Nonmonetary
Assets to Owners". No taxes were provided on this gain due to the tax-free
nature of the Split-off.
In connection with the Split-off, Level 3 and the Construction Group entered
into various agreements including a Separation Agreement, a Tax Sharing
Agreement and an amended Mine Management Agreement.
The Separation Agreement, as amended, provides for the allocation of certain
risks and responsibilities between Level 3 and the Construction Group and for
cross-indemnifications that are intended to allocate financial responsibility to
the Construction Group for liabilities arising out of the construction business
and to allocate to Level 3 financial responsibility for liabilities arising out
of the non-construction businesses. The Separation Agreement also allocates
certain corporate-level risk exposures not readily allocable to either the
construction business or the non-construction businesses.
Under the Tax Sharing Agreement, with respect to periods, or portions thereof,
ending on or before the Split-off, Level 3 and the Construction Group generally
will be responsible for paying the taxes relating to such returns, including any
subsequent adjustments resulting from the redetermination of such tax
liabilities by the applicable taxing authorities, that are allocable to the
non-construction businesses and construction businesses, respectively. The Tax
Sharing Agreement also provides that Level 3 and the Construction Group will
indemnify the other from certain taxes and expenses that would be assessed if
the Split-off were determined to be taxable, but solely to the extent that such
determination arose out of the breach by Level 3 or the Construction Group,
respectively, of certain representations made to the Internal Revenue Service in
connection with the private letter ruling issued with respect to the Split-off.
If the Split-off was determined to be taxable for any other reason, those taxes
would be allocated equally to Level 3 and the Construction Group. Finally, under
certain circumstances, Level 3 would make certain liquidated damage payments to
the Construction Group if the Split-off was determined to be taxable, in order
to indirectly compensate Class C stockholders for taxes assessed upon them in
that event.
In connection with the Split-off, the Mine Management Agreement, pursuant to
which the Construction Group provides mine management and related services to
Level 3's coal mining operations, was amended to provide the Construction Group
with a right of offer in the event that Level 3 were to determine to sell any or
all of its coal mining properties. Under the right of offer, Level 3 would be
required to offer to sell those properties to the Construction Group. If the
Construction Group were to decline to purchase the properties at that price,
Level 3 would be free to sell them to a third party for an amount greater than
or equal to that price. If Level 3 were to sell the properties to a third party,
thus terminating the Mine Management Agreement, it would be required to pay the
Construction Group an amount equal to the discounted present value of the Mine
Management Agreement determined, if necessary, by an appraisal process.
Following the Split-off, the Company's common stock began trading on The Nasdaq
National Market on April 1, 1998, under the symbol "LVLT". In connection with
the Split-off, the construction business was renamed "Peter Kiewit Sons', Inc."
and the Class D Stock became the common stock of Level 3 Communications, Inc.
("Common Stock"). Summarized financial information for the Construction Group is
presented below; however, the separate financial statements of Peter Kiewit
Sons', Inc. should be obtained to review the financial position of the
Construction Group as of December 27, 1997 and the results of operations for
each of the two years ended December 27, 1997.
The following is summarized financial information of the Construction Group:
Operations (in millions) 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Revenue $ 2,764 $ 2,303
Net Earnings 155 108
Financial Position (in millions) 1997
- - --------------------------------------------------------------------------------------------------------------------
Current Assets $ 1,057
Other Assets 284
--------
Total assets 1,341
Current Liabilities 579
Other Liabilities 99
Minority Interest 11
--------
Total liabilities 689
Net Assets $ 652
========
The following details the earnings per share calculations for Class C Stock:
Class C Stock 1997 1996
- - -------------------------------------------------------------------------------------------------------------------
Net Income Available to Common Shareholders (in millions) $ 155 $ 108
Add: Interest Expense, Net of Tax Effect Associated with
Convertible Debentures 1 -*
--------- --------
Net Income for Diluted Shares $ 156 $ 108
========= =========
Total Number of Weighted Average Shares Outstanding Used to Compute
Basic Earnings per Share (in thousands) 9,728 10,656
Additional Dilutive Shares Assuming Conversion of Convertible Debentures 441 437
--------- --------
Total Number of Shares Used to Compute Diluted Earnings Per Share 10,169 11,093
======== =======
Net Income
Basic earnings per share $ 15.99 $ 10.13
======== =======
Diluted earnings per share $ 15.35 $ 9.76
======== =======
*Interest expense attributable to convertible debentures was less than $1
million in 1996.
The Company's certificate of incorporation gave stockholders the right to
exchange their Class C Stock for Class D Stock under a set conversion formula.
That right was eliminated as a result of the Split-off. To replace that
conversion right, Class C stockholders received 6.5 million shares of a new
Class R Stock in January 1998, which was convertible into Common Stock in
accordance with terms ratified by stockholders in December 1997. The Company
reflected in the equity accounts the exchange of the conversion right and
issuance of the Class R Stock at its fair value of $92 million at the date of
the Split-off.
On May 1, 1998, the Board of Directors of Level 3 Communications, Inc.
determined to force conversion of all shares of the Company's Class R Stock into
shares of Common Stock, effective May 15, 1998. The Class R Stock was converted
into Common Stock in accordance with the formula set forth in the certificate of
incorporation of the Company. The formula provided for a conversion ratio equal
to $25, divided by the average of the midpoints between the high and low sales
prices for Common Stock on each of the fifteen trading days during the period
beginning April 9, 1998 and ending April 30, 1998. The average for that period
was $32.14, adjusted for the stock dividend issued August 10, 1998.
Accordingly, each holder of Class R Stock received .7778 of a share of Common
Stock for each share of Class R Stock held. In total 6.5 million shares of Class
R Stock were converted into 5.1 million shares of Common Stock. The value of the
Class R Stock at the time of the forced conversion was $25 times the 6.5 million
shares outstanding, or $164 million. The Company recognized the additional $72
million of value upon conversion of the Class R Stock to Common Stock in the
equity accounts. As a result of the forced conversion, certain adjustments were
made to the cost sharing and risk allocation provisions of the Separation
Agreement and Tax Sharing Agreement between the Company and Peter Kiewit Sons',
Inc. that were executed in connection with the Split-off. The effect of these
adjustments was to reduce certain Split-off costs and risks allocated to the
Company.
The Company has embarked on a plan to become a facilities-based provider (that
is, a provider that owns or leases a substantial portion of the plant, property
and equipment necessary to provide its services) of a broad range of integrated
communications services in the United States, Europe and Asia. To reach this
goal, the Company plans to expand substantially the business of its PKS
Information Services, Inc. subsidiary and to create, through a combination of
construction, purchase and leasing of facilities and other assets, an
international, end-to-end, facilities-based communications network (the
"Business Plan"). The Company is designing the network based on Internet
Protocol ("IP") technology in order to leverage the efficiencies of this
technology to provide lower cost communications services.
(2) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Peter Kiewit Sons',Level 3
Communications, Inc. and subsidiaries in which it has control, ("PKS" or "the Company"), which are engaged
in enterprises primarily related to construction, coal mining,
energy generation,communications and information services, and
telecommunications.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 including construction joint ventures and
energy projects, are accounted for by
the equity method. The
Company accounts for its share of the operations of the construction
joint ventures on a pro rata basis in the consolidated statements
of earnings. All significant intercompany accounts and transactions have
been eliminated.
In 1997, the Company agreed to sell its energy assets to MidAmerican Energy
Holding Company (f/k/a CalEnergy Company, Inc.) ("CalEnergy"MidAmerican") and to spin-offsplit-off
the construction business.Construction Group. Therefore, the assets and liabilities, and results of
operations, of boththese businesses have been classified as discontinued operations
on the consolidated balance sheet, statements of earnings and cash flows.
(See notes 21 and 3)
On September 5,In 1997, C-TEC Corporation ("C-TEC") announced that its board of directors had
approved the planned restructuring of C-TEC into three publicly traded
companies. The transaction was effective September 30, 1997. As a result of the
restructuring plan, the Company ownsowned less than 50% of the outstanding shares
and voting rights of each entity, and therefore has accounted for each entity
using the equity method as of the beginning of 1997. In accordance with
Generally Accepted Accounting Principles,generally accepted accounting principles, C-TEC's financial position, results of
operations and cash flows are consolidated in the 1996 and 1995 financial statements.
Communications and Information Services Revenue
Information services revenue is primarily derived from the computer outsourcing
business and the systems integration business. Level 3 provides outsourcing
service, typically through contracts ranging from 3-5 years, to firms that
desire to focus their resources on their core businesses. Under these contracts,
Level 3 recognizes revenue in the month the service is provided. The resultssystems
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 operationscompletion basis depending on the
extent of MFS Communications Company, Inc.
("MFS"), (which later merged into WorldCom Inc.) priorthe services provided.
Revenue from communications services is recognized monthly as the services are
provided. Amounts billed in advance of the service month are recorded as
deferred revenue, however that amount is not material.
Concentration of credit risk with respect to its
spin-off on September 30, 1995,accounts receivable are limited due
to the dispersion of customer base among geographic areas and remedies provided
by terms of contracts and statutes.
As noted previously, the investments in the three former C-TEC companies
have been classified as a
single line item onaccounted for using the statements of earnings
The Company investsequity method in the portfolios of the Kiewit Mutual Fund,
("KMF"), a registered investment company. KMF is not
consolidated in the Company's financial statements.
Description of Business Groups
Holders of Class C Stock ("Construction & Mining Group")1998 and Class D Stock ("Diversified Group") are stockholders of PKS.
The Construction & Mining Group ("KCG") contains the
Company's traditional construction and materials operations
performed by Kiewit Construction Group Inc. The Diversified
Group through Level 3 Communications, Inc. (formerly Kiewit
Diversified Group Inc.) ("Level 3") contains coal mining
properties owned by Kiewit Coal Properties Inc., energy
investments, including a 24% interest in CalEnergy and a 30%
interest in CE Electric UK plc ("CE Electric"), investments
in international energy projects, information services
businesses, telecommunications companies owned by C-TEC, as
well as other assets. Corporate assets and liabilities which
are not separately identified with the ongoing operations of
the Construction & Mining Group or the Diversified Group are
allocated equally between the groups.
Construction Contracts
KCG operates generally within the United States and Canada as a
general contractor and engages in various types of
construction projects for both public and private owners.
Credit risk is minimal with public (government) owners since
KCG ascertains that funds have been appropriated by the
governmental project owner prior to commencing work on public
projects. Most public contracts are subject to termination
at the election of the government. In the event of
termination, KCG is entitled to receive the contract price on
completed work and reimbursement of termination related
costs. Credit risk with private owners is minimized because
of statutory mechanics liens, which give KCG high priority in
the event of lien foreclosures following financial
difficulties of private owners.
The construction industry is highly competitive and lacks firms
with dominant market power. A substantial portion of KCG's
business involves construction contracts obtained through
competitive bidding. The volume and profitability of KCG's
construction work depends to a significant extent upon the
general state of the economies in which it operates and the
volume of work available to contractors. KCG's construction
operations could be adversely affected by labor stoppages or
shortages, adverse weather conditions, shortages of supplies,
or other governmental action.
KCG recognizes revenue on long-term construction contracts and
joint ventures on the percentage-of-completion method based
upon engineering estimates of the work performed on
individual contracts. Provisions for losses are recognized on
uncompleted contracts when they become known. Claims for
additional revenue are recognized in the period when allowed.
It is at least reasonably possible that engineering estimates
of the work performed on individual contracts will be revised
in the near term.1997.
Coal Sales Contracts
Level 3's coal is sold primarily under long-term contracts with electric
utilities, which burn coal in order to generate steam to produce electricity. A
substantial portion of Level 3's coal sales were made under long-term contracts
during 1998, 1997 1996 and 1995.1996. The remainder of Level 3's sales are made on the
spot market where prices are substantially lower than those in the long-term
contracts. As the long-term contracts expire, a higher proportion of Level 3's
sales will occur on the spot market.
The coal industry is highly competitive. Level 3 competes not only with other
domestic and foreign coal suppliers, some of whom are larger and have greater
capital resources than Level 3, but also with alternative methods of generating
electricity and alternative energy sources. Many of Level 3's competitors are
served by two railroads and, due to the competition, often benefit from lower
transportation costs than Level 3 which is served by a single railroad.
Additionally, many competitors have lower stripping ratiosmore 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 foron the sale of coal. Prior
to 1993, one of the primary customers deferred receipt of certain commitments by
purchasing undivided fractional interestsinterest 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 interestsinterest 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.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.
Information Services Revenue
Information services revenue is primarily derived from the
computer outsourcing business and the systems integration
business. Level 3 provides outsourcing service, typically
through contracts ranging from 3-5 years, to firms that
desire to focus their resources on their core businesses.
Under these contracts, Level 3 recognizes revenue in the
month the service is provided. The systems integration
business helps customers define, develop and implement cost-
effective information systems. Revenue from these services
is billed on a time and materials basis or percentage of
completion basis depending on the extent of the services
provided.
Telecommunications Revenue
In 1996 and 1995 C-TEC's most significant operating groups are
its local telephone service and cable system operations.
C-TEC's telephone network access revenues are derived from
net access charges, toll rates and settlement arrangements
for traffic that originates or terminates within C-TEC's
local telephone company. Revenues from telephone services
and basic and premium cable programming services are recorded
in the month the service is provided.
The telecommunications industry is subject to local, state and
federal regulation. Consequently, the ability of the
telephone and cable groups to generate increased volume and
profits is largely dependent upon regulatory approval to
expand customer bases and increase prices.
Competition for the cable group's services traditionally has come
from broadcast television, video rentals and direct broadcast
satellite received on home dishes. Future competition is
expected from telephone companies.
Concentration of credit risk with respect to accounts receivable
are limited due to the dispersion of customer base among
geographic areas and remedies provided by terms of contracts
and statutes.
As noted previously, the investment in C-TEC has been
accounted for using the equity method in 1997.
Depreciation and Amortization.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.methods based on the following useful
lives:
Facility and Leasehold Improvements 35 - 40 years
Operating Equipment 3 - 7 years
Network Construction Equipment 5 - 7 years
Furniture and Office Equipment 3 - 7 years
Other 2 - 10 years
Depletion of mineral properties is provided primarily on an units-of-extraction
basis determined in relation to estimated reserves.coal committed under sales contracts.
Software Development Costs
On March 4, 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). The
effective date of this pronouncement is for fiscal years beginning after
December 15, 1998, however, the Company has elected to account for internal
software development costs incurred in developing its integrated business
support systems in accordance with SOP 98-1 in 1998. The Company recognized $27
million of expense for the development of operating support systems in 1998 that
would have previously been capitalized prior to adoption of SOP 98-1.
Start-Up Costs
On April 3, 1998, the AICPA issued Statement of Position 98-5, "Reporting on the
Costs of Start-Up Activities", ("SOP 98-5"), which provides guidance on the
financial reporting for start-up and organization costs. It requires costs of
start-up activities and organization costs to be expensed as incurred. SOP 98-5
is effective for financial statements for fiscal years beginning after December
15, 1998, however, the Company elected to adopt SOP 98-5 in 1998. The adoption
of SOP 98-5 did not result in a significant charge to earnings in 1998.
Subsidiary and Investee Stock Activity
The Company recognizes gains and losses from the sale, issuance and repurchase
of stock by its subsidiaries and equity method investees in the statements of
earnings.
Earnings Per Share
Basic earnings per share have been computed using the weighted average number of
shares during each period. Diluted earnings per share is computed by including
stock options and other securities considered to be dilutive.
Intangible Assets
Intangible assets primarily include amounts allocated upon purchaseacquisitions of
existing operations,businesses, franchises and subscriber lists. These assets are amortized on a
straight-line basis over the expected period of benefit,benefit.
For intangibles originating from IP 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 doesdo not exceed 40 years.
Long Lived Assets
The Company reviews the carrying amount of long lived assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. Measurement of any impairment would include a comparison
of estimated future operating cash flows anticipated to be generated during the
remaining life of the asset to the net carrying value of the asset.
Reserves for Reclamation
Level 3The Company follows the policy of providing an accrual for reclamation of mined
properties, based on the estimated total cost of restoration of such properties
into meet compliance with laws governing strip mining. Itmining, 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 bases of the Company's assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income", which requires that changes in comprehensive income be shown in a
financial statement that is at least reasonably possible
thatdisplayed with the estimated cost of restoration will be revisedsame prominence as other
financial statements. The Company has adopted this statement in 1998 as the
near-term.Company has unrealized gains and losses on marketable securities classified as
available for sale and has operations in foreign countries and restated 1997 and
1996 to present information on a comparable basis.
Foreign Currencies
Generally, local currencies of foreign subsidiaries are the functional
currencies for financial reporting purposes. Assets and liabilities are
translated into U.S. dollars at year-end exchange rates. Revenue and expenses
are translated using average exchange rates prevailing during the year. Gains or
losses resulting from currency translation are recorded as adjustments toa component of
accumulated other comprehensive income (loss) in stockholders' equity.
Subsidiaryequity and Investee Stock Activity
The Company recognizes gains and losses fromin the
sale, issuance
and repurchasestatements of stock by its subsidiaries.
Earnings Per Share
In 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share". The
Statement establishes standards for computing and presenting
earnings per share and requires the restatement of prior per
share data presented. Basic earnings per share have been
computed using the weighted average number of shares during
each period. Diluted earnings per share is computed by
including stock options and convertible debentures considered
to be dilutive common stock equivalents.
Potentially dilutive stock options are calculated in accordance
with the treasury stock method which assumes that proceeds
from the exercise of all options are used to repurchase
common stock at the average market value. The number of
shares remaining after the proceeds are exhausted represent
the potentially dilutive effect of the options. The
potentially dilutive convertible debentures are calculated in
accordance with the "if converted" method. This method
assumes that the after-tax interest expense associated with
the debentures is an addition to income and the debentures
are converted into equity with the resulting common shares
being aggregated with the weighted average shares
outstanding.
The following details the earnings per share calculations for
Class D Stock and Class C Stock:
Class D Stock 1997 1996 1995
Income from continuing operations
available to common shareholders
(in millions) $ 83 $ 104 $ 126
Add: Interest expense, net of tax
effect associated with convertible
debentures - - -*
-------- -------- --------
Income from continuing operations
for fully diluted shares 83 104 126
Income from discontinued operations 10 9 14
--------- -------- --------
Net Income $ 93 $ 113 $ 140
========= ======== ========
Total number of weighted average shares
outstanding used to compute basic
earnings per share (in thousands) 124,647 116,006 108,594
Additional dilutive stock options 539 311 -
Additional dilutive shares assuming
conversion of convertible debentures - - 257
--------- ------- -------
Total number of shares used to
compute diluted earnings per share 125,186 116,317 108,851
========= ======= =======
Continuing Operations:
Basic earnings per share $ .66 $ .90 $ 1.17
========= ======= =======
Diluted earnings per share $ .66 $ .90 $ 1.17
========= ======= =======
Discontinued Operations:
Basic earnings per share $ .08 $ .07 $ .12
========= ======= =======
Diluted earnings per share $ .08 $ .07 $ .12
========= ======= =======
Net Income:
Basic earnings per share $ .74 $ .97 $ 1.29
========= ======= =======
Diluted earnings per share $ .74 $ .97 $ 1.29
========= ======= =======
*Interest expense attributable to convertible debentures was
less than $1 million in 1995.
Class C Stock 1997 1996 1995
Net income available to common
shareholders (in millions) $ 155 $ 108 $ 104
Add: Interest expense, net of tax effect
associated with convertible debentures 1 -* -*
-------- ------- --------
Net income for diluted shares $ 156 $ 108 $ 104
======== ======= ========
Total number of weighted average
shares outstanding used to compute
basic earnings per share (in thousands) 9,728 10,656 13,384
Additional dilutive shares assuming
conversion of convertible debentures 441 437 312
-------- -------- --------
Total number of shares used to
compute diluted earnings per share 10,169 11,093 13,696
======== ======== ========
Net Income
Basic earnings per share $ 15.99 $ 10.13 $ 7.78
======== ======== ========
Diluted earnings per share $ 15.35 $ 9.76 $ 7.62
======== ======== ========
*Interest expense attributable to convertible debentures was
less than $1 million in 1996 and 1995.comprehensive income.
Stock Dividend
Effective August 10, 1998 and December 26, 1997, the PKS BoardCompany issued dividends of
Directors
approved a dividend ofone and four shares, respectively, of Common Stock (previously Class D StockStock)
for every
oneeach share of Class DLevel 3 Common Stock held.outstanding. All share information and
per share data have been restated to reflect this dividend.
Income Taxes
Deferred income taxes are provided for the temporary
differences between the financial reporting basis 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.these stock dividends.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Recently Issued Accounting PronouncementsSegment Disclosures
In June 1997, the Financial Accounting Standards Board
("FASB") issued SFAS No. 130, "Reporting Comprehensive
Income", which requires that changes in comprehensive income
be shown in a financial statement that is displayed with the
same prominence as other financial statements.
Also in 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"), which changes the way
public companies report information about segments. SFAS No. 131, which is based
on the management approach to segment reporting, includes requirements to report
selected segment information quarterly, and entity wide disclosures about
products and services, major customers, and geographic data. These statements areThe Company has
provided the information required by SFAS No. 131 in Note 14.
Recently Issued Accounting Pronouncements
On June 15, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 is effective
for financial statements for
periodsfiscal years beginning after DecemberJune 15, 1997. Management1999 (January 1, 2000 for the
Company). SFAS No. 133 requires that all derivative instruments be recorded on
the balance sheet at the fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of 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 expectincrease the utilization of these derivative instruments by the
effective date of SFAS No. 133, the adoption of these statementsthis standard is not expected to
materially affecthave a significant effect on the Company's results of operations or its
financial statements.
Reclassifications
Where appropriate, items within the consolidated financial
statements and notes thereto have been reclassified from
previous years to conform to current year presentation.position.
Fiscal Year
TheOn May 1, 1998, the Company's Board of Directors changed Level 3's fiscal year
ends onend from the last Saturday in December.December to a calendar year end. The results of
operations for the additional five days in the 1998 fiscal year are reflected in
the Company's Form 10-K for the period ended December 31, 1998 and were not
material to the overall results of operations and cash flows. There were 52
weeks in fiscal years 1997 1996 and 1995.
(2) Reorganization
In October 1996, the PKS Board of Directors directed PKS
management1996.
Reclassifications
Certain prior year amounts have been reclassified to pursue a listing of Class D Stock as a way to
address certain issues created by PKS' two-class capital
stock structure and the need to attract and retain the best
management for PKS' businesses. During the course of its
examination of the consequences of a listing of Class D
Stock, management concluded that a listing of Class D Stock
would not adequately address these issues, and instead began
to study a separation of the Construction and Mining Group
and the Diversified Group. At the regular meeting of the
Board on July 23, 1997, management submittedconform to the Board for
consideration a proposal for separation of the Construction
and Mining Group and Diversified Group through a spin-off of
the Construction and Mining Group ("the Transaction"). At a
special meeting on August 14, 1997, the Board approved the
Transaction.
The separation of the Construction and Mining Group and the
Diversified Group was contingent upon a number of conditions,
including the favorable ratification by a majority of both
Class C and Class D shareholders and the receipt by the
company of an Internal Revenue Service ruling or other
assurance acceptable to the Board that the separation would
be tax-free to U.S. shareholders. On December 8, 1997, PKS'
Class C and Class D shareholders approved the transaction
and on March 5, 1998 PKS received a favorable ruling from the
Internal Revenue Service. The Transaction is anticipated to
be effective on March 31, 1998. As a result of these events
the Company has reflected the financial position and results of
operations of the Kiewit Construction and Mining Group as discontinued
operations on the consolidated balance sheets and consolidated
statements of earnings for all periods presented. The activities
of the Construction and Mining Group have been removed from the
statements of cash flows. The financial statements of Kiewit
Construction and Mining Group can be found in Exhibit 99.A of
this document.
The following is summarized financial information of the
Kiewit Construction and Mining Group:
Operations (dollars in millions) 1997 1996 1995
Revenue $ 2,764 $ 2,303 $ 2,330
Net income 155 108 104
Financial Position (dollars in millions) 1997 1996
Current assets $ 1,057 $ 764
Other assets 284 274
-------- -------
Total assets $ 1,341 $ 1,038
======== =======
Current liabilities 579 397
Other liabilities 99 79
Minority interest 11 -
------- -------
Total liabilities 689 476
------- -------
Net assets $ 652 $ 562
======= =======
Immediately prior to the spin-off of the Kiewit Construction and
Mining Group, the Company will recognize a gain equal to the
difference between the carrying value of the Construction and
Mining Group and its fair value. The Company will then reflect
the fair value of Kiewit Construction and Mining Group as a dividend
to shareholders.
Level 3 has recently decided to substantially increase its
emphasis on and resources to its information services business.
Pursuant to the plan, Level 3 intends to expand substantially
its current information services business, through the
expansion of its existing business and the creation, through a
combination of construction, leasing and purchase of facilities
and other assets, of a substantial facilities-based internet
communications network (the "Expansion Plan").
Using the network Level 3 intends to provide (a) a range of
internet access services at varying capacity levels and, as
technology development allows, at specified levels of quality
of service and security and (b) a number of business oriented
communications services which may include fax service, which
are transmitted in part over private or limited access
Transmission Control Protocol/Internet Protocol ("TCP/IP")
networks and are offered at lower prices than public telephone
network-based fax service, and voice message storing and
forwarding over the same TCP/IP-based networks.year
presentation.
(3) Discontinued Energy Operations:
In connection withOperations
On January 2, 1998, the Expansion Plan, Level 3 expectsCompany completed the sale of its energy assets to
devote
substantially more management time and capital resources to its
information services business with a view to making the
information services business, over time, the principal
business of Level 3. In that respect, the management is
conducting a comprehensive review of the existing Level 3
businesses to determine how those businesses will complement
Level 3's focus on information services. If it is decided that
an existing business is not compatible with the information
services business and if a suitable buyer can be found, Level 3
may dispose of that business.
On September 10, 1997, Level 3 and CalEnergy entered into an
agreement whereby CalEnergy contracted to purchase Level 3's
energy investments for $1,155 million, subject to adjustments.MidAmerican. These energy investments includeassets included approximately 20.2 million shares of
CalEnergyMidAmerican common stock (assuming the exercise of 1 million options held by
Level 3), Level 3's 30% ownership
interest in CE Electric and Level 3's investments made jointly
with CalEnergy, in
international power projects in Indonesia and the Philippines. ThePhilippines ("Energy
Projects"). Level 3 recognized an after-tax gain on the disposition of
$324 million and the after-tax proceeds of approximately $967 million from
the transaction are being used in part to fund the Business Plan. Results of
operations for the period through January 2, 1998 were not considered
significant and the gain on disposition was subject tocalculated using the satisfactory completion of certain provisionscarrying
amount of the agreementenergy assets as of December 27, 1997.
The following is summarized financial information for discontinued energy
operations for the fiscal years ended December 27, 1997 and closed on January 2, 1998. These assets comprised the
energy segmentDecember 28, 1996
and as of Level 3. Therefore, the Company has
reflected these assets, the earnings and losses attributable to
these assets, and the related cash flow items as discontinued
operations on the balance sheets, statements of earnings and
cash flows for all periods presented.December 27, 1997:
Income from Discontinued Operations (in millions) 1997 1996
- - --------------------------------------------------------------------------------------------------------------------
Operations
Equity in:
MidAmerican earnings, net $ 16 $ 20
CE Electric earnings, net 17 (2)
International energy projects earnings, net 5 (5)
Investment Income from MidAmerican - 5
Income Tax Expense (9) (9)
------- --------
Income from operations 29 9
MidAmerican Stock Transactions
Gain on Investee Stock Activity 68 -
Income Tax Expense (24) -
------- ---------
Gain on MidAmerican stock activity 44 -
Extraordinary Loss - Windfall Tax
Level 3's Share from MidAmerican (39) -
Level 3's Share from CE Electric (58) -
Income Tax Benefit 34 -
------- ---------
Extraordinary loss (63) -
------- ---------
Income from Discontinued Energy Operations $ 10 $ 9
======= ========
In order to fund the purchase of theseLevel 3's energy assets, CalEnergyMidAmerican sold, in October
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 CalEnergyMidAmerican to
approximately 24% but increased its proportionate share of CalEnergy'sMidAmerican's
equity.
It is the Company's policy to recognize gains or losses on the
sale of stock by its investees. Level 3 recognized an after-
taxafter-tax gain of approximately $44 million
from MidAmerican transactions in CalEnergy stock in the fourth quarter of 1997.
The Agreement with CalEnergy included a provision whereby
CalEnergy and Level 3 shared equally any proceeds from the
offering above or below a specified amount. The offering was
conducted at a price above that provided in the agreement and
therefore, Level 3 received additional proceeds of $16 million
at the time of closing.
Level 3 expects to recognize an after-tax gain on the
disposition of its energy assets in 1998 of approximately $324
million. The after-tax proceeds from the transaction of
approximately $967 million will be used to fund the expansion
plan of the information services business.
The following is summarized financial information for
discontinued energy operations:
Income from Discontinued Operations 1997 1996 1995
Operations
Equity in:
CalEnergy earnings, net $ 16 $ 20 $ 10
CE Electric earnings, net 17 (2) -
International energy projects earnings, net 5 (5) 6
Investment income from CalEnergy - 5 6
Income tax expense (9) (9) (8)
----- ----- ------
Income from operations $ 29 $ 9 $ 14
===== ===== ======
CalEnergy Stock Transactions
Gain on investee stock activity $ 68 $ - $ -
Income tax expense (24) - -
----- ----- ------
$ 44 $ - $ -
===== ===== ======
Extraordinary Loss - Windfall Tax
Level 3's share from CalEnergy $ (39) $ - $ -
Level 3's share from CE Electric (58) - -
Income tax benefit 34 - -
----- ----- ------
Extraordinary loss $ (63) $ - $ -
===== ===== ======
Investments in Discontinued Operations 1997 1996
Investment in CalEnergy $ 337 $ 292
Investment in CE Electric 135 176
Investment in international energy projects 186 149
Restricted securities 2 8
Deferred income tax liability (17) (17)
------- -------
Total $ 643 $ 608
======= =======
At December 27, 1997, Level 3 owned 19.2 million shares or 24%
of CalEnergy's outstanding common stock and had a cumulative
investment in CalEnergy common stock of $337 million. CalEnergy
common stock is traded on the New York Stock Exchange. On
December 27, 1997, the market value of Level 3's
investment in CalEnergy common stock was $548 million.
The following is summarized financial information of CalEnergy
Company, Inc.:
Operations (dollars in millions) 1997 1996 1995
Revenue $ 2,271 $ 576 $ 399
Income before extraordinary item 52 92 62
Extraordinary item - Windfall tax (136) - -
Level 3's share:
Income before extraordinary item 18 22 13
Goodwill amortization (2) (2) (3)
------- ------ -----
Equity in income of CalEnergy before
extraordinary item $ 16 $ 20 $ 10
======= ====== =====
Extraordinary item - Windfall tax $ (39) $ - $ -
======= ====== =====
Financial Position (dollars in millions) 1997 1996
Current assets $ 2,053 $ 945
Other assets 5,435 4,768
--------- --------
Total assets 7,488 5,713
Current liabilities 1,440 1,232
Other liabilities 4,494 3,301
Minority interest 134 299
--------- --------
Total liabilities 6,068 4,832
--------- --------
Net assets $ 1,420 $ 881
========= ========
Level 3's share:
Equity in net assets $ 337 $ 267
Goodwill - 25
--------- --------
Investment in CalEnergy $ 337 $ 292
========= ========
In December 1996, CE Electric, which is 70% owned by CalEnergy
and 30% owned by Level 3, acquired majority ownership of the
outstanding ordinary share capital of Northern Electric, plc.
pursuant to a tender offer (the "Tender Offer") commenced in
the United Kingdom by CE Electric in November 1996. As of
March 1997, CE Electric effectively owned 100% of Northern's
ordinary shares.
As of December 27, 1997, CalEnergy and Level 3 had contributed to
CE Electric approximately $410 million and $176 million,
respectively, of the approximately $1.3 billion required to
acquire all of Northern's ordinary and preference shares in
connection with the Tender Offer. The remaining funds
necessary to consummate the Tender Offer were provided by a
term loan and a revolving facility agreement obtained by CE
Electric. Level 3 has not guaranteed, and is not otherwise
subject to recourse for, amounts borrowed under these
facilities.
On July 2, 1997 the Labour Party in the United Kingdom announced the details of its proposedimplemented a "Windfall Tax" to be
levied
against privatized British utilities. This one-time tax iswas 23% of the
difference between the value of Northern Electric, plc.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 July
1997. The total after-tax impact to Level 3
directly through its investment in CE Electric and indirectly through its
interest in CalEnergy,MidAmerican, was $63 million.
Investments in Discontinued Operations (in millions) 1997
- - -------------------------------------------------------------------------------------------------------------------
Investment in MidAmerican $ 337
Investment in CE Electric 135
Investment in International Energy Projects 186
Restricted Securities 2
Deferred Income Tax Liability (17)
-------
Total $ 643
======
The following is summarized financial information of MidAmerican, CE Electric,
and the Energy Projects:
Operations (in millions) 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Revenue
MidAmerican $ 2,271 $ 576
CE Electric 1,564 37
Net Earnings (Loss)
MidAmerican $ (84) $ 92
CE Electric (136) -
Energy Projects 2 (12)
CE Energy
Financial Position at December 27, 1997 (in millions) MidAmerican Electric Projects
Current Assets $ 2,053 $ 419 $ 530
Other Assets 5,435 2,519 811
------- -------- --------
Total assets 7,488 2,938 1,341
Current Liabilities 1,440 1,166 172
Other Liabilities 4,494 1,265 737
Minority Interest 134 56 -
------- -------- --------
Total liabilities 6,068 2,487 909
------- -------- --------
Net Assets $ 1,420 $ 451 $ 432
======= ======== ========
(4) Earnings Per Share
The Company had a loss from continuing operations for the year ended December
31, 1998, therefore, no potential common shares related to Company stock options
and other dilutive securities have been included in the computation of the
diluted earnings per share because the resulting computation would be
anti-dilutive. For the two years ending December 27, 1997, potentially dilutive
stock options are calculated in accordance with the treasury stock method which
assumes that proceeds from exercise of all options are used to repurchase common
stock at the average market value. The number of shares remaining after the
proceeds are exhausted represent the potentially dilutive effect of the options.
The Company had 23,147,051 potentially dilutive securities outstanding that were
not included in the computation of diluted earnings per share because to do so
would have been anti-dilutive for the year ended December 31, 1998.
The following details the earnings (loss) per share calculations for Level 3
Common Stock. A calculation of the earnings per share for the Class C Stock in
1996 and 1997 can be found in Note 1 to the consolidated financial statements.
Years Ended
1998 1997 1996
Earnings (Loss) from Continuing Operations (in millions) $ (128) $ 83 $ 104
Earnings from Discontinued Energy Operations 324 10 9
Gain on Separation of Construction Operations 608 - -
--------- ------ ------
Net Earnings Excluding Discontinued Construction Operations $ 804 $ 93 $ 113
========= ====== =======
Total Number of Weighted Average Shares Outstanding used to
Compute Basic Earnings Per Share (in thousands) 301,976 249,293 232,012
Additional Dilutive Stock Options - 1,079 622
------- ------- -------
Total Number of Shares used to Compute Dilutive Earnings Per Share 301,976 250,372 232,634
======= ======= =======
Earnings (Loss) Per Share (Basic and Diluted):
Continuing operations $ (.43) $ .33 $ .45
========= ======= ========
Discontinued energy operations $ 1.07 $ .04 $ .03
========= ======= ========
Gain on split-off of discontinued construction operations $ 2.02 $ - $ -
========= ======= ========
Net earnings excluding discontinued construction operations $ 2.66 $ .37 $ .48
========= ======= ========
Net earnings excluding gain on split-off of construction operations $ .64 $ .37 $ .48
========= ======= ========
(5) Acquisitions
On April 23, 1998, the Company acquired XCOM Technologies, Inc. ("XCOM"), a
privately held company that has developed technology which the Company believes
will provide certain key components necessary for the Company to develop an
interface between its IP-based network and the existing public switched
telephone network. The Company issued approximately 5.3 million shares of Level
3 Common Stock and 0.7 million options and warrants to purchase Level 3 Common
Stock in exchange for all the stock, options and warrants of XCOM.
The Company accounted for this transaction, valued at $154 million, as a
purchase. Of the total purchase price, $115 million was originally allocated to
in-process research and development and was taken as a nondeductible charge to
earnings in the second quarter of 1998. The purchase price exceeded the fair
value of the net assets acquired by $30 million which was recognized
as goodwill.
In October 1998, the Securities and Exchange Commission ("SEC") issued new
guidelines for valuing acquired research and development which are applied
retroactively. The Company believes its accounting for the acquisition was made
in accordance with generally accepted accounting principles and established
appraisal practices at the time of the acquisition. However, due to the
significance of the charge relative to the total value of the acquisition, the
Company reviewed the facts with the SEC. Consequently, using the revised guide-
lines and assumptions, the Company reduced the charge for in-process research
and development from $115 to $30 million, and increased the related goodwill by
$85 million. The goodwill associated with the XCOM transaction is being
amortized over a five year period.
XCOM's in-process research and development value is comprised primarily of
one project to develop an interface between an IP-based network and the
existing public switched telecommunications network. Remaining development
efforts for this project include various phases of design, development and
testing. The anticipated completion date for the project in progress is
expected to be over the next 12 months, at which time the Company expects to
begin generating the full economic benefits from the technology. Funding for
this project is expected to be obtained from internally generated sources.
The value of the in-process research and development represents the estimated
fair value based on risk-adjusted cash flows related to the incomplete project.
At the date of acquisition, the development of this project had not yet reached
technological feasibility and the research and development ("R&D") in progress
had no alternative future uses. Accordingly, these costs were expensed as of December 31,the
acquisition date.
The Company used independent third-party appraisers to assess and allocate
the value to the in-process research and development. The value assigned to the
asset was determined, using the income approach, by identifying significant
research projects for which technological feasibility had not been established.
The nature of the efforts to develop the acquired in-process technology into
commercially viable products and services principally relate to the completion
of all planning, designing, prototyping, high-volume verification, and testing
activities that are necessary to establish that the proposed technologies meet
their design specifications including functional, technical, and economic
performance requirements.
The value assigned to purchased in-process technology was determined by
estimating the contribution of the purchased in-process technology to developing
a commercially viable product, estimating the resulting net cash flows from the
expected product sales over a 15 year period, and discounting the net cash flows
to their present value using a risk-adjusted discount rate of 30%, and adjusting
it for the estimated stage of completion.
The Company believes that the foregoing assumptions used in the forecasts were
reasonable at the time of the acquisition. No assurance can be given, however,
that the underlying assumptions used to estimate expected project sales,
development costs or profitability, or the events associated with such projects,
will transpire as estimated. For these reasons, actual results may vary from the
projected results.
Management expects to continue their support of this effort and believes the
Company has a reasonable chance of successfully completing the R&D project.
However, there is risk associated with the completion of the project and there
is no assurance that it will meet with either technological or commercial
success. If the XCOM project is not successful, the Company would not realize
its investment in XCOM and would be required to modify its business plan to
utilize alternative technologies which may increase the cost of its network.
The Company believes that its resulting charge for acquired research and
development conforms to the SEC's expressed guidelines and methodologies.
However, no assurances can be given that the SEC will not require additional
adjustments.
On September 30, 1998, Level 3 acquired GeoNet Communications, Inc. ("GeoNet"),
a regional Internet service provider located in Northern California. The Company
issued approximately 0.6 million shares and options in exchange for GeoNet's
capital stock, which valued the transaction at approximately $19 million.
Acquired liabilities exceeded assets, and goodwill of $21 million was recognized
from this transaction which is being amortized over five years.
XCOM's and GeoNet's 1997 and December 31, 1996:
Operations (dollars in millions) 1997 1996
Revenue $ 1,564 $ 37
Income before extraordinary item 58 -
Extraordinary item - Windfall tax (194) -
Level 3's share:
Income before extraordinary item $ 17 $ -
Management fee paid to CalEnergy - (2)
-------- ------
17 (2)
======== ======
Extraordinary item - Windfall tax $ (58) $ -
======== ======
Financial Position (dollars in millions) 1997 1996
Current assets $ 419 $ 583
Other assets 2,519 1,772
------- -------
Total assets 2,938 2,355
Current liabilities 1,166 785
Other liabilities 1,265 718
Preferred stock 56 153
Minority interest - 112
------- ------
Total liabilities 2,487 1,768
------- ------
Net assets $ 451 $ 587
======= ======
Level 3's Share:
Equity in net assets $ 135 $ 176
======= ======
CE Electric's 1995 and 19961998 operating results prior to the acquisitionacquisitions
were not significant relative to Level 3's results
after giving effect to certain pro forma adjustments related to
the Company's results.
For the Company's acquisitions, primarily increased amortization and interest
expense.
In 1993, Level 3 and CalEnergy formed a venture to develop power
projects outsidethe excess purchase price over the fair market
value of the United States. Since 1993,
construction has begun on the Mahanagdong, Casecnanunderlying assets was allocated to goodwill and Dieng
power projects. The Mahanagdong project is a 165 MW geothermal
power facility located on the Philippine island of Leyte. The
Casecnan project is a combined irrigation and 150 MW
hydroelectric power generation facility located on the island
of Luzon in the Philippines. Dieng Unit I is a 55 MW
geothermal facility on the Indonesian island of Java. An
additional five units are expected to be constructed on a
modular basis at the Dieng site, as geothermal resources are
developed. In June 1997, Level 3 and CalEnergy closed a $400
million revolving credit facility to finance the development
and construction of the remaining Indonesian projects. The
credit facility is collateralized by the Indonesianother intangible
assets and is nonrecourse to Level 3.
Generally, costs associated with the development, financing and
constructionproperty based upon preliminary estimates of the international energy projects have been
capitalized by each of the projects and will be amortized over
the life of each project.fair value. The following is summarized financial information for the
international energy projects:
Financial Position
(dollars in millions) Mahanagdong Casecnan Dieng Other Total
1997
Current assets $ 42 $ 334 $ 87 $ 67 $ 530
Other assets 252 148 240 171 811
------ ------ ----- ------ -----
Total assets 294 482 327 238 1,341
Current liabilities 11 12 88 61 172
Other liabilities 186 372 123 56 737
------- ------ ----- ------ -----
Total liabilities
(with recourse only
to the projects) 197 384 211 117 909
------- ------ ----- ------ -----
Net assets $ 97 $ 98 $ 116 $ 121 $ 432
======= ====== ===== ====== =====
Group's share:
Equity in net assets $ 48 $ 49 $ 46 $ 43 $ 186
======= ====== ===== ====== =====
1996
Current assets $ 1 $ 441 $ 15 $ 10 $ 467
Other assets 239 51 118 36 444
------- ------ ----- ----- -----
Total assets 240 492 133 46 911
Current liabilities 15 9 24 11 59
Other liabilities 153 372 35 - 560
------- ------ ----- ----- -----
Total liabilities
(with recourse only
to the projects) 168 381 59 11 619
------- ------- ------ ----- -----
Net assets $ 72 $ 111 $ 74 $ 35 $ 292
======= ======= ====== ===== =====
Group's share:
Equity in net assets $ 36 $ 55 $ 36 $ 17 $ 144
Loan to Project - - 5 - 5
------- ------- ------ ----- -----
$ 36 $ 55 $ 41 $ 17 $ 149
======= ======= ====== ===== =====
In late 1995, the Casecnan joint venture closed financing for
the construction of the project with bonds issued by the
project company. The difference between the interest expense
on the debt and the interest earned on the unused funds prior
to payment of construction costs resulted in a loss to the
venture of $12 million in 1997 and 1996. Level 3's share of
these losses were $6 million in each year. The Mahanagdong
facility commenced operation in July, 1997. Level 3's
proportionate share of the earnings attributable to Mahanagdong
was $7 million 1997. No income or losses were incurred by the
international projects in 1995. In addition to the equity
earnings and losses, Level 3 has project development and
insurance expenses, and received management fee income related
to the international projects in all years.
In late 1995, a Level 3 and CalEnergy venture, CE Casecnan
Water and Energy Company Inc. ("CE Casecnan") closed financing
and commenced construction of a $495 million irrigation and
hydroelectric power project located on the Philippine island of
Luzon. Level 3 and CalEnergy each made $62 million of equity
contributions to the project.
The CE Casecnan project was being constructed on a joint and
several basis by Hanbo Corporation and Hanbo Engineering &
Construction Co. Ltd. On May 7, 1997, CE Casecnan announced
that it had terminated the Hanbo Contract. In connection with
the contract termination, CE Casecnan made a $79 million draw
request under the letter of credit issued by Korea First Bank
("KFB") to pay for certain transition costs and other damages
under the Hanbo Contract. KFB failed to honor the draw
request; the matter is being litigated. If KFB would not be
required to honor its obligations under the letter of credit,
such action may have a material adverse effect on the CE
Casecnan project. Level 3
does not expectbelieve that the outcome of the
litigation to affect its financial position due to the
transaction with CalEnergy.
(4) MFS Spin-off
In September 1995, the PKS Board of Directors approved a plan to
make a tax-free distribution of its entire ownership interest
in MFS to the Class D stockholders (the "Spin-off") effective
on September 30, 1995. Shares were distributed on the basis of
approximately .348 shares of MFS Common Stock and approximately
.130 shares of MFS Preferred Stock for each share of
outstanding Class D Stock.
The net investment in MFS distributed on September 30, 1995 was
approximately $399 million.
Operating results of MFS through September 30, 1995 are
summarized as follows:
(dollars in millions) 1995
Revenue $ 412
Loss from operations (176)
Net loss (196)
Level 3's share of loss in MFS (131)
Included in the income tax benefit on the statement of earnings
for the year ended December 30, 1995, is $93 million of tax
benefitsfinal purchase price allocation will vary
significantly from the reversal of certain deferred tax liabilities
recognized on gains from previous MFS stock transactions that
were not taxed due to the Spin-off.
(5) Gain on Subsidiary's Stock Transactions, net
Stock issuances by MFS for acquisitions and employee stock
options, reduced Level 3's ownership in MFS prior to the Spin-
off in 1995 to 66% from 67% in 1994. As a result, Level 3
recognized a gain of $3 million in 1995 representing the
increase in Level 3's proportionate share of MFS' equity.
Deferred income taxes had been established on this gain prior
to the Spin-off.preliminary estimates.
(6) Disclosures about Fair Value of Financial Instruments
The following methods and assumptions were used to determine classification and
fair values of financial instruments:
Cash and Cash Equivalents
Cash equivalents generally consist of funds invested in the
Kiewit Mutual Fund-Money Market Portfolio and highly liquid
instruments purchased with an original maturity of three months or less. The
securities are stated at cost, which approximates fair value.
Marketable Securities,and Restricted Securities and Non-current
Investments
Level 3 has classified all marketable securities,and restricted securities and marketable non-current investments not accounted
for under the equity method as
available-for-sale. Restricted securities primarily include investments in
various portfolios
of the Kiewit Mutual Fundmutual funds that are restricted to fund certain reclamation liabilities of its
coal mining ventures. Due to
the anticipated increase in capital expenditures, Level 3 has
reclassified its investments in marketable equity securities
from non-current to current in 1997. 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 reported as a separate component ofincluded in accumulated other comprehensive income within
stockholders' equity, net of tax.
At December 27, 199731, 1998 and December 28, 199627, 1997 the amortized cost, unrealized
holding gains and losses, and estimated fair values of marketable securities,and restricted
securities and marketable
non-current investments were as follows:
Unrealized Unrealized
Amortized Holding Holding Fair
(dollars in millions) Cost Gains Losses Value
1997:
Marketable Securities:
Kiewit Mutual Fund:
Short-term government $ 234 $ - $ - $ 234
Intermediate term bond 195 3 - 198
Tax exempt 154 3 - 157
Equity 7 4 - 11
Collateralized mortgage
obligations - 1 - 1
Equity securities 48 9 - 57
Other securities 20 - - 20
------ ----- ----- ------
$ 658 $ 20 $ - $ 678
Restricted Securities:
Kiewit Mutual Fund:
Intermediate term bond $ 10 $ - $ - $ 10
Equity 12 - - 12
------ ----- ----- ------
$ 22 $ - $ - $ 22
====== ===== ===== ======
1996:
Marketable Securities:
Kiewit Mutual Fund:
Short-term government $ 100 $ - $ - $ 100
Intermediate term bond 65 2 - 67
Tax exempt 126 2 - 128
Equity 5 2 - 7
Corporate debt securities
(held by C-TEC) 47 - - 47
Collateralized mortgage
obligations - 1 - 1
Other securities 20 2 - 22
------ ----- ----- -----
$ 363 $ 9 $ - $ 372
====== ===== ===== =====
Restricted Securities:
Kiewit Mutual Fund:
Intermediate term bond $ 8 $ - $ - $ 8
Equity 7 2 - 9
------ ----- ----- ----
$ 15 $ 2 $ - $ 17
====== ===== ===== ====
Non-current investments:
Equity securities $ 49 $ 26 $ - $ 75
====== ===== ===== ====
Other securities consist of bonds issued by the Casecnan
project and purchased by Level 3.
Unrealized Unrealized
Amortized Holding Holding Fair
(dollars in millions) Cost Gains Losses Value
1998:
Marketable Securities:
U.S. Treasury securities $ 2,147 $ 8 $ - $ 2,155
U.S. Government Agency securities 639 1 - 640
Equity securities 54 - (3) 51
Other securities 20 - (3) 17
--------- ----------- ---------- ---------
$ 2,860 $ 9 $ (6) $ 2,863
======= ========== ========== =======
Restricted Securities:
Wilmington Trust:
Intermediate term bond fund $ 13 $ - $ - $ 13
Equity fund 10 3 - 13
--------- ---------- ----------- ---------
$ 23 $ 3 $ - $ 26
========= ========== =========== =========
1997:
Marketable Securities:
Kiewit Mutual Fund:
Short-term government $ 234 $ - $ - $ 234
Intermediate term bond 195 3 - 198
Tax exempt 154 3 - 157
Equity 7 4 - 11
Equity securities 48 9 - 57
Other securities 20 1 - 21
--------- ---------- ----------- ---------
$ 658 $ 20 $ - $ 678
======== ========= =========== ========
Restricted Securities:
Kiewit Mutual Fund:
Intermediate term bond $ 10 $ - $ - $ 10
Equity 12 - - 12
--------- ----------- ----------- ---------
$ 22 $ - $ - $ 22
========= =========== =========== =========
For debt securities, amortized costs do not vary significantly from principal
amounts. Realized gains and losses on sales of marketable and equity securities
were $10 million and $1 million in 1998, $9 million and $- million in 1997, and
$3 million and $- million in 1996, and $1 million and
$2 million in 1995.respectively.
At December 27, 1997,31, 1998, the contractual maturities of the debt securities are as
follows:
(dollars in millions) Amortized Cost Fair Value
Other securities:
10+ years $ 20 $ 20
====== ======
(dollars in millions) Amortized Cost Fair Value
U.S. Treasury Securities:
Less than 1 year $ 2,147 $ 2,155
======= =======
U.S. Government Agency Securities:
Less than 1 year $ 639 $ 640
======== ========
Other Securities:
10+ years $ 20 $ 17
========= =========
Maturities for the mutual fund, equity securities and collateralized mortgage obligationsrestricted securities have not been presented as
they do not have a single maturity date.
Long-termLong-Term Debt
The fair value of long-term debt was estimated using the Company's incremental
borrowing rates of Level 3 for debt of the same remainingsimilar maturities.
The carrying amount and estimated fair valuevalues of Level 3's financial instruments
are as follows:
1998 1997
------------------- -------------------
Carrying Fair Carrying Fair
(dollars in millions) Amount Value Amount Value
Cash and Cash Equivalents (Note 6) $ 848 $ 848 $ 87 $ 87
Marketable Securities (Note 6) 2,863 2,863 678 678
Restricted Securities (Note 6) 26 26 22 22
Investment in C-TEC Entities (Note 8) 300 818 335 776
Investments in Discontinued Energy Operations (Note 3) - - 643 854
Long-term Debt (Note 10) 2,646 2,613 140 140
(7) Property Plant and Equipment
Construction in Progress
The Company is currently constructing its communications network. Costs
associated directly with the uncompleted network and interest expense incurred
during construction are capitalized based on the weighted average accumulated
construction expenditures and the interest rates related to borrowings
associated with the construction. These costs are not yet being depreciated, as
the assets have not yet been placed in service. As segments of the debt approximatesnetwork
become operational, the carrying amount.
(7) Investments
Investments consistassets 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 following at December 27,projects, the total cost of the business
support systems will be amortized over its useful life of 3 years.
Capitalized business support systems and network construction costs that have
not been placed in service have been classified as construction-in-progress
within Property, Plant & Equipment below.
Accumulated Book
(dollars in millions) Cost Depreciation Value
1998
Land and Mineral Properties $ 32 $ (11) $ 21
Facility and Leasehold Improvements
Communications 80 (1) 79
Information Services 24 (2) 22
Coal Mining 18 (15) 3
CPTC 91 (5) 86
Operating Equipment
Communications 245 (18) 227
Information Services 53 (30) 23
Coal Mining 180 (155) 25
CPTC 17 (4) 13
Network Construction Equipment 46 (1) 45
Furniture and Office Equipment 67 (10) 57
Other 32 (2) 30
Construction-in-Progress 430 - 430
------- -------- -------
$ 1,315 $ (254) $ 1,061
======= ======== =======
1997
Land and Mineral Properties $ 15 $ (11) $ 4
Facility and Leasehold Improvements
Communications - - -
Information Services 12 (2) 10
Coal Mining 19 (15) 4
CPTC 91 (4) 87
Operating Equipment
Communications - - -
Information Services 42 (23) 19
Coal Mining 190 (159) 31
CPTC 17 (3) 14
Furniture and Office Equipment 11 (5) 6
Other 14 (6) 8
Construction-in-Progress 1 - 1
-------- -------- -------
$ 412 $ (228) $ 184
======== ======== =======
Depreciation expense was $48 million in 1998, $20 million in 1997 and December 28, 1996:
(dollars$124
million in millions) 1997 1996
Commonwealth Telephone Enterprises Inc. $ 75 $ -
RCN Corporation 214 -
Cable Michigan 46 -
Pavilion Towers 22 -
Equity securities (Note 6) - 75
C-TEC investments:
Megacable S.A. de C.V. - 74
Other - 12
Other 26 28
------ ------
$ 383 $ 189
====== ======
On September 5,1996.
(8) Investments
In 1997, C-TEC announced that its boardBoard of directorsDirectors had approved the planned
restructuring of C-TEC into three publicly traded companies effective September
30, 1997. Under the terms of the restructuring C-TEC shareholdersstockholders received stock
in the following companies:
- Commonwealth Telephone Enterprises, Inc., ("Commonwealth Telephone")
containing the local telephone group and related engineering business;
- Cable Michigan, Inc., containing the cable television
operations in Michigan; and
-business.
RCN Corporation Inc.,("RCN") which consists of RCN Telecom Services; C-TEC'sC-TEC,
existing cable systems in the Boston-Washington D.C. corridor; and the
investment in Megacable S.A. de C.V., a cable operator in Mexico. RCN
Telecom Services is a provider of packaged local and long distance
telephone, video and internet access services provided over fiber optic
networks to residential customers in Boston, New York City and Washington D.C.customers.
Cable Michigan, Inc. ("Cable Michigan") containing the cable
television operation.
As a result of the restructuring, Level 3 ownsowned less than 50% of each of the
outstanding shares and voting rights of each entity, and therefore accountsbegan
accounting for each entity using the equity method as of the beginning of 1997.
C-TEC'sThe following is summarized financial position,information of the Company had C-TEC been
accounted for utilizing the equity method for the fiscal year ended December 28,
1996. Fiscal years 1998 and 1997 include C-TEC accounted for utilizing the
equity method and are presented here for comparative purposes only.
(dollars in millions) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Revenue $ 392 $ 332 $ 285
Costs and Expenses:
Operating expenses (199) (163) (125)
Depreciation and amortization (66) (20) (18)
General and administrative expenses (332) (106) (86)
Write-off of in process research and development (30) - -
------- ----------- -----------
Total costs and expenses (627) (289) (229)
------- ----------- -----------
Earnings (Loss) from Operations (235) 43 56
Other Income (Expense):
Interest income 173 33 36
Interest expense (132) (15) (5)
Equity losses (132) (43) (13)
Gain on investee stock transactions 62 - -
Gain on disposal of assets 107 10 10
Other, net 4 7 9
---------- ---------- ----------
Total other income (expense) 82 (8) 37
--------- ---------- ---------
Earnings (Loss) before Income Taxes and
Discontinued Operations (153) 35 93
Income Tax Benefit 25 48 11
--------- --------- ---------
Income (Loss) from Continuing Operations (128) 83 104
Income from Discontinued Operations 932 165 117
-------- -------- --------
Net Earnings $ 804 $ 248 $ 221
======== ======== ========
On June 4, 1998, Cable Michigan announced that its Board of Directors had
reached a definitive agreement to sell the company to Avalon Cable of Michigan,
Inc. for $40.50 per share in a cash-for-stock transaction. Level 3 received
approximately $129 million when the transaction closed on November 6, 1998 and
recognized a pre-tax gain of approximately $90 million in the fourth quarter.
The $90 million gain was calculated using the Company's carrying value as of
September 30, 1998, as Cable Michigan's results of operations and cash flows are consolidatedfor the period
October 1, 1998 through November 6, 1998 were not considered significant
relative to the Company's results.
On September 25, 1998, Commonwealth Telephone announced that it was commencing a
rights offering of 3.7 million shares of its common stock. Under the terms of
the offering, each stockholder received one right for every five shares of
Commonwealth Telephone Common Stock or Commonwealth Telephone Class B Common
Stock held. The rights enabled the holder to purchase Commonwealth Telephone
Common Stock at a subscription price of $21.25 per share. Each right also
carried the right to oversubscribe at the subscription price for the offered
shares not purchased pursuant to the initial exercise of rights.
Level 3, which owned approximately 48% of Commonwealth Telephone prior to the
rights offering, exercised its 1.8 million rights it received with respect to
the shares it held for $38 million. As a result of subscriptions made by other
stockholders, Level 3 maintained its 48% ownership interest in Commonwealth
Telephone after the 1996 and
1995 consolidated financial statements.rights offering.
The following is summarized financial information of the three entities created
as a result of the C-TEC restructuring:
Operations (dollars in millions) 1997 1996 1995
Commonwealth Telephone Enterprises
Revenue $ 197 $ 186 $ 174
Net income available to common stockholders 20 20restructuring for each of the three years ended
December 31, Level 3's share:
Net income 10 10 15
Goodwill amortization (1) (1) 1
------ ------ ------
Equity in net income $ 9 $ 9 $ 16
====== ====== ======
Cable Michigan
Revenue $ 81 $ 76 $ 60
Net loss available to common stockholders (4) (8) (10)
Level 3's share:
Net loss (2) (4) (5)
Goodwill amortization (4) (4) (4)
------ ------ -----
Equity in net loss $ (6) $ (8) $ (9)
====== ====== =====
RCN Corporation
Revenue $ 127 $ 105 $ 91
Net income (loss) available to
common stockholders (52) (6) 2
Level 3's share:
Net income (loss) (26) (3) 1
Goodwill amortization - (3) 1
------ ------ -----
Equity in net (loss) income $ (26) $ (6) $ 2
====== ====== =====
Commonwealth
Telephone Cable RCN
Enterprises Michigan Corporation
Financial Position (in millions) 1997 1996 1997 1996 1997 1996
Current assets $ 71 $ 51 $ 23 $ 10 $ 698 $ 143
Other assets 303 266 120 139 453 485
----- ----- ----- ----- ------ -----
Total assets 374 317 143 149 1,151 628
Current liabilities 76 59 16 24 70 57
Other liabilities 260 189 166 190 708 175
Minority interest - - 15 15 16 5
----- ----- ----- ----- ------ -----
Total liabilities 336 248 197 229 794 237
----- ----- ----- ----- ------ -----
Net assets (liabilities) $ 38 $ 69 $ (54) $ (80) $ 357 $ 391
===== ===== ===== ===== ====== =====
Level 3's Share:
Equity in net assets $ 18 $ 33 $ (26) $ (38) $ 173 $ 189
Goodwill 57 72 72 75 41 41
----- ----- ----- ----- ------ -----
$ 75 $ 91 $ 46 $ 37 $ 214 $ 230
===== ===== ===== ===== ====== ======
On1998 and as of December 31, 1998 and December 27, 1997 (in
millions):
Year Ended
Operations: 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Commonwealth Telephone Enterprises, Inc.:
Revenue $ 226 $ 197 $ 186
Net income available to common shareholders 8 20 20
Level 3's Share:
Net income 4 10 10
Goodwill amortization (2) (1) (1)
-------- -------- --------
Equity in net income $ 2 $ 9 $ 9
======== ======== ========
RCN Corporation:
Revenue $ 211 $ 127 $ 105
Net loss available to common shareholders (205) (52) (6)
Level 3's Share:
Net loss (91) (26) (3)
Goodwill amortization (1) - (3)
-------- ------ ------
Equity in net loss $ (92) $ (26) $ (6)
======= ======= ======
Cable Michigan, Inc.*:
Revenue $ 66 $ 81 $ 76
Net loss available to common shareholders (9) (4) (8)
Level 3's Share*:
Net loss (4) (2) (4)
Goodwill amortization (3) (4) (4)
-------- ------ ------
Equity in net loss $ (7) $ (6) $ (8)
======== ======= =======
*1998 revenue and net loss amounts are through September 30, 1998.
Commonwealth
Telephone RCN Cable
Enterprises, Inc. Corporation Michigan, Inc.
Financial Position: 1998 1997 1998 1997 1997
- - ---------------------------------------------------------------------------------------------------------------
Current Assets $ 79 $ 71 $ 1,092 $ 703 $ 23
Other Assets 354 303 816 448 120
-------- -------- ------- -------- --------
Total assets 433 374 1,908 1,151 143
Current Liabilities 85 76 178 70 16
Other Liabilities 223 260 1,282 708 166
Minority Interest - - 77 16 15
-------- -------- ------- -------- --------
Total liabilities 308 336 1,537 794 197
-------- -------- ------- -------- --------
Net assets (liabilities) $ 125 $ 38 $ 371 $ 357 $ (54)
======== ======== ======= ======== ========
Level 3's Share:
Equity in net assets (liabilities) $ 60 $ 18 $ 150 $ 173 $ (26)
Goodwill 56 57 34 41 72
--------- --------- --------- --------- ---------
$ 116 $ 75 $ 184 $ 214 $ 46
======== ========= ======== ======== =========
The Company recognizes gains from the market valuesale, issuance and repurchase of Level 3's investmentsstock by
its subsidiaries and equity method investees in Commonwealth Telephone, Cable Michiganits statements of earnings.
During 1998, RCN issued stock in a public offering and RCN was $215
million, $76 million and $485 million, respectively.
In February 1997, Level 3 purchasedfor certain acquisitions
which diluted the Pavillion Towers office
buildings in Aurora, Colorado for $22 million.
Investments in 1996 also include C-TEC's 40%Company's ownership of Megacable S.A. de C.V., Mexico's second largest cable operator,
accounted for using the equity method.
(8) Intangible Assets
Intangible assets consist of the followingRCN from 48% at December 27, 1997 to
41% at December 31, 1998. The increase in the Company's proportionate share of
RCN's net assets as a result of these transactions resulted in a pre-tax gain of
$62 million for the Company in 1998.
The market value of the Company's investment in Commonwealth Telephone and RCN
on December 31, 1998, was $352 million, and $466 million,respectively, based on
the closing stock price of each company on December 31, 1998.
Investments also include $23 million for the Company's investment in an office
building in Aurora, Colorado.
(9) Other Assets
At December 31, 1998 and December 28, 1996:
(dollars27, 1997 other assets consisted of the
following:
(in millions) 1998 1997
- - ------------------------------------------------------------------------------------------------------------------
Goodwill:
XCOM, net of accumulated amortization of $15 $ 100 $ -
GeoNet, net of accumulated amortization of $1 20 -
Other, net of accumulated amortization of $1 21 -
Deferred Debt Issuance Costs 67 -
Deferred Development and Financing Costs 15 21
Unrecovered Mine Development Costs 15 16
Leases 9 11
Timberlands 6 7
Other 11 11
-------- --------
Total other assets $ 264 $ 66
======= ========
Goodwill amortization expense, excluding amortization expense attributable to
the equity method investees, was $18 million in millions)1998 and $- in 1997 1996
CPTC intangibles and other $ 23 $ 23
C-TEC:
Goodwill - 198
Franchise and subscriber lists - 229
Other - 34
------ ------
23 484
Less accumulated amortization (2) (131)
------ ------
$ 21 $ 353
====== ======
(9)1996.
(10) Long-Term Debt
At December 27, 199731, 1998 and December 28, 1996,27, 1997, long-term debt was as follows:
(dollars in millions) 1998 1997
- - ------------------------------------------------------------------------------------------------------------------
Senior Notes
(9.125% due 2008) $ 2,000 $ -
Senior Discount Notes
(10.5% due 2008) 504 -
CPTC Long-term Debt (with recourse only to CPTC):
Bank Note
(7.6% due 2008) 64 65
Institutional Notes
(9.45% due 2017) 35 35
OCTA Debt
(9.0% due 2004) 9 8
Subordinated Debt
(9.3-9.5% no maturity) 8 6
------- --------
116 114
Other:
Pavilion Towers Debt (8.4% due 2007) 15 15
Capitalized Leases 8 6
Other 3 5
------- --------
26 26
------- --------
2,646 140
Less current portion (5) (3)
------- --------
$ 2,641 $ 137
======= ========
9.125% Senior Notes
On April 28, 1998, the Company received $1.94 billion of net proceeds from an
offering of $2 billion aggregate principal amount 9.125% Senior Notes Due 2008
("Senior Notes"). Interest on the notes accrues at 9.125% per annum and will be
payable in millions) 1997 1996
CPTC Long-termcash semiannually in arrears.
The Senior Notes are subject to redemption at the option of the Company, in
whole or in part, at any time or from time to time on or after May 1, 2003, plus
accrued and unpaid interest thereon to the redemption date, if redeemed during
the twelve months beginning May 1, of the years indicated below:
Year Redemption 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 is using the net proceeds of the Senior Notes
offering in connection with the implementation of its Business Plan to increase
substantially its information services business and to expand the range of
services it offers by building an advanced, international, facilities-based
communications network based on IP technology.
Debt (with recourse onlyissuance costs of $65 million were capitalized and are being amortized over
the term of the Senior Notes.
10.5% Senior Discount Notes
On December 2, 1998, the Company sold $834 million principal amount 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 will accrete at a rate of 10.5% per annum,
compounded semiannually, to CPTC):
Bankan 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 (7.7% due 2008) $ 65 $ 65
Institutionalwill on the elected commencement date be reduced to
the accreted value of the Senior Discount Note (9.45% due 2017) 35 35
OCTAas 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.
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:
Year Redemption 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 pasu with all existing and future senior unsecured indebtedness of
the Company. The Senior Discount Notes contain certain covenants which, among
other things, restrict the Company`s ability to incur additional debt, make
certain restricted payments, pay dividends, enter into sale and leaseback
transactions, enter into transactions with affiliates, and sell assets or merge
with another company.
The net proceeds of $486 million are intended to be used to accelerate the
implementation of its Business Plan, primarily the funding for the increase in
committed number of route miles of the Company's U.S. intercity network.
Debt (9.0% due 2006) 8 6
Subordinated Debt
(9.5% No Maturity) 6 2
------ ------
114 108
Other:
Pavilion Towers Debt (8.4% due 2007) 15 -
Capitalized Leases 6 1
Other 5 6
------- ------
26 7
C-TEC Long-term Debt (with recourse onlyissuance costs of $14 million have been capitalized and are being amortized
over the term of the Senior Discount Notes.
The Company capitalized $15 million of interest expense and amortized debt
issuance costs related to C-TEC):
Credit Agreement - National Banknetwork construction and business systems development
projects for Cooperatives
(7.51% due 2009) - 110
Senior Secured Notes
( 9.65% due 1999) - 134
Term Credit Agreement - Morgan Guaranty
Trust Company (7% due 2002) - 18
-------- ------
- 262
-------- ------
140 377
Less current portion (3) (57)
-------- ------
$ 137 $ 320
======== ======the year ended December 31, 1998.
CPTC:
In August 1996, CPTCCalifornia Private Transportation Company, L.P. ("CPTC")
converted its construction financing note into a term note with a consortium of
banks ("Bank Debt"Note"). The interest rate on the Bank DebtNote is based on LIBOR plus a
varying rate with interest payable quarterly. Upon completion of the SR91 toll
road, CPTC entered into an interest rate swap arrangementagreement with the same parties.
The swap agreement expires in January 2004 and fixes the interest rate on the
Bank Debt from 9.21% to 9.71% during the term of the swap agreement.
The institutional note is withnotes are held by Connecticut General Life Insurance Company,
a subsidiary of CIGNA Corporation.Corporation and Lincoln National Life Insurance Company.
The note converted intoto a term loan upon completion of the SR91 toll road.
Substantially all the assets of CPTC and the partners' equity interest in CPTC
secure the term debt.
Orange County Transportation Authority ("OCTA") holds $8$9 million of subordinated
debt which is due in varying amounts over 10
years.through 2004. Interest accrues at 9% and is
payable quarterly beginning in 2000.when CPTC generates sufficient cash flows to cover
operating expenses and other debt requirements.
In July 1996, CPTC borrowed from the partners $2 million to facilitate the
completion of the project. In 1998 and 1997, CPTC borrowed an additional $2
million and $4 million, respectively, from the partners in order to comply with
equity maintenance provisions of the contracts with the State of California and
its lenders. The debt is generally subordinated to all other debt of CPTC.
Interest on the subordinated debt compounds annually at 9.5%9.3-9.5% and is payable
only as CPTC generates excess cash flows.
In 1996, CPTC capitalized interest of $- million, $5 million and $7
million in 1997, 1996 and 1995.of interest prior to completing
construction of the SR91 tollroad.
Other:
In June 1997, a mortgage withloan was obtained from Metropolitan Life was
established.Life. The Pavilion
Towers building in Aurora, COColorado collateralizes this debt.
Scheduled maturities of long-term debt through 2002 are as follows (in millions): 1998 - $3; 1999 -$6;5;
2000 - $5;$6; 2001 - $6; 2002 - $9; 2003 - $9 and $2,611 thereafter.
(11) Employee Benefit Plans
The Company adopted the recognition provisions of SFAS No. 123, "Accounting for
Stock Based Compensation" ("SFAS No. 123") in 1998. Under SFAS No. 123, the fair
value of an option (as computed in accordance with accepted option valuation
models) on the date of grant is amortized over the vesting periods of the
options in accordance with FASB Interpretation No. 28 "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans"("FIN 28").
The recognition provisions of SFAS No. 123 are applied prospectively upon
adoption. As a result, the recognition provisions are applied to all stock
awards granted in the year of adoption and are not applied to awards granted in
previous years unless those awards are modified or settled in cash after
adoption of the recognition provisions.
The Company believes that the fair value method of accounting more appropriately
reflects the substance of the transaction between an entity that issues stock
options, or other stock-based instruments, and its employees and consultants;
that is, an entity has granted something of value to an employee and consultants
(the stock option or other instrument) generally in return for their continued
employment and services. The Company believes that the value of the instrument
granted to employees and consultants should be recognized in financial
statements because nonrecognition implies that either the instruments have no
value or that they are free to employees and consultants, neither of which is an
accurate reflection of the substance of the transaction. Although the
recognition of the value of the instruments results in compensation or
professional expenses in an entity's financial statements, the expense differs
from other compensation and professional expenses in that these charges will not
be settled in cash, but rather, generally, through issuance of common stock.
The Company believes that the adoption of SFAS No. 123 will result in material
non-cash charges to operations in 1999 and thereafter. The amount of the
non-cash charge will be dependent upon a number of factors, including the number
of grants and the fair value of each grant estimated at the time of its award.
On a pro forma basis, adopting SFAS No. 123 would not have had a material effect
on the results of operations for the years ended December 27, 1997 and December
28, 1996.
Non-qualified Stock Options and Warrants
In December 1997, stockholders approved amendments to the 1995 Level 3 Stock
Plan ("the Plan"). The amended plan, among other things, increases the number of
shares reserved for issuance upon the exercise of stock based awards to
70,000,000; increases the maximum number of options granted to any one
participant to 10,000,000; provides for the acceleration of vesting in the event
of a change in control; allows for the grant of stock based awards to directors
of Level 3 and other persons providing services to Level 3; and allows for the
grant of nonqualified stock options ("NQSO") with an exercise price less than
the fair market value of Common Stock. In December 1997, Level 3 converted both
option and stock appreciation rights plans of a subsidiary, to the Plan. This
conversion resulted in the issuance of 7.4 million options to purchase Common
Stock at $4.50 per share. Level 3 recognized an expense and a corresponding
increase in equity as a result of the transaction. The increase in equity and
the conversion of the stock appreciation rights liability to equity are
reflected as option activity in the Statement of Changes in Stockholders'
Equity. The options vest over three or five years with a five or ten year life.
In addition to 7,466,247 NQSOs granted in 1998, 1,898,036 warrants were granted
to third parties to acquire shares of Common Stock at exercise prices ranging
from $18.50 - $20.00 per share. The warrants vest quarterly through June 30,
2001.
The expense recognized in accordance with SFAS No. 123 for NQSOs and warrants in
1998 was $6 million and $8$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 2002.
(10)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 25% except for when the minimum volatility of .001%, was used
by the Company prior to becoming publicly traded in April 1998. The fair value
of the NQSO and warrants granted in 1998, in accordance with SFAS No. 123 was
$28 million.
The Company exchanged approximately 700,000 options and 100,000 options,
ranging in prices from $0.12 to $1.76 and primarily from $0.90 to $1.79 for
the XCOM and GeoNet acquisitions, respectively.
Transactions involving stock options granted under the NQSO plan are summarized
as follows:
Weighted
Exercise Price Average
Shares Per Share Exercise Price
Balance December 30, 1995 2,680,000 $ 4.04 $ 4.04
Options granted 1,790,000 4.95 4.95
Options cancelled (30,000) 4.04 4.04
Options exercised - - -
-----------
Balance December 28, 1996 4,440,000 $ 4.04 - $ 4.95 $ 4.40
================= =========
Options granted 14,990,930 $ 4.50 - $ 5.42 $ 4.96
Options cancelled (106,000) 4.95 4.95
Options exercised (4,636,930) 4.04 - 4.95 4.46
-----------
Balance December 27, 1997 14,688,000 $ 4.04 - $ 5.42 $ 4.95
================= =========
Options granted 7,466,247 $ 0.12 - $41.25 $ 8.67
Options cancelled (668,849) 0.12 - 34.69 5.52
Options exercised (2,506,079) 0.12 - 34.69 4.22
-----------
Balance December 31, 1998 18,979,319 $ 0.12 - $41.25 $ 6.50
========== ================ =========
Options exercisable
December 28, 1996 530,000 $ 4.04 $ 4.04
December 27, 1997 2,590,538 $ 4.04 - $ 4.95 $ 4.35
December 31, 1998 5,456,640 $ 0.12 - $ 41.25 $ 4.67
The weighted average remaining contractual life for the 18,979,319 options
outstanding on December 31, 1998 is 8.47 years.
Options Outstanding Options Exercisable
Weighted Weighted
Number Average Average Number Weighted
Range of Outstanding Remaining Exercise Price Exercisable Average
Exercise Prices as of 12/31/98 Life (years) Outstanding as of 12/31/98 Exercise Price
$ 0.12 - $ 0.12 187,036 9.04 $ 0.12 39,558 $ 0.12
0.90 - 0.90 34,764 6.26 0.90 21,230 0.90
1.76 - 1.79 78,010 8.50 1.77 19,060 1.79
4.04 - 5.43 12,965,014 8.51 5.04 5,331,448 4.71
6.20 - 8.50 4,875,600 9.06 6.98 45,100 6.82
17.50 - 25.03 272,374 4.62 19.42 - -
26.80 - 39.13 500,521 4.48 31.37 244 34.69
40.38 - 41.25 66,000 4.62 40.59 - -
---------- ---------
18,979,319 8.47 $ 6.50 5,456,640 $ 4.67
========== ==== ======== ========= ========
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 has a two-year moratorium on exercising. Once a
participant is 100% vested, the two year moratorium is lifted. Therefore, each
grant has an exercise window of two years.
The fair value and expense recognized under SFAS No. 123 for OSOs granted to
employees and consultants for services performed in 1998 was $64 million and $24
million, respectively. In addition, $3 million that was capitalized for
employees directly involved in the construction of the IP network and
development of business support systems.
The fair value of the options granted was calculated by applying the
Black-Scholes method with an S&P 500 expected dividend yield rate of 1.8% and an
expected life of 2.5 years. The Company used a blended volatility rate of 24%
between the S&P 500 expected volatility rate of 16% and the Level 3 Common Stock
expected volatility rate of 25%. The expected correlation factor of 0.4 was used
to measure the movement of Level 3 stock relative to the S&P 500.
Transactions involving stock awards granted in 1998 under the OSO plan are
summarized below:
Weighted
Option Price Average
Shares Per Share Option Price
Options granted 2,139,075 $29.78 - $37.13 $ 34.28
Options cancelled (46,562) 29.78 - 37.13 35.53
Options exercised - - -
----------
Balance December 31, 1998 2,092,513 $29.78 - $37.13 $ 34.25
========== =============== =========
Options vested but not exercisable as of
December 31, 1998 234,305 $29.78 - $37.13 $ 34.85
======== =============== =========
The weighted average remaining contractual life for the 2,092,513 outperform
options outstanding on December 31, 1998 is 3.6 years.
Restricted Stock
In 1998, 177,183 shares of restricted stock were granted to employees. The
restricted stock shares are granted to employees at no cost. The shares vest
immediately; however, the employees are restricted from selling these shares for
3 years. The fair value of restricted stock of $6 million was calculated using
the value of the Common Stock the day prior to the grant. The expense recognized
in 1998 under SFAS No. 123 for restricted stock grants was $3 million.
Shareworks - Level 3 has designed its compensation programs with particular
emphasis on equity-based, long-term incentive programs. The Company has
developed two plans under its Shareworks program: the Match Plan and the Grant
Plan.
Match Plan - The Match Plan allows eligible employees to defer between 1% and 7%
of their eligible compensation to purchase Common Stock at the average stock
price for the quarter. Any full time employee is considered eligible on the
first day of the calendar quarter after their hire. The Company matches the
shares purchased by the employee on a one-for-one basis. Stock purchased with
payroll deductions is fully vested. Stock purchased with the Company's matching
contributions vests three years after the end of the quarter in which it was
made.
The Company's quarterly matching contribution is amortized over 36 months. In
1998, the Company's matching contribution was $2 million under the Match Plan.
The compensation expense recognized in 1998 under this plan was less than $1
million.
Grant Plan - The Grant Plan enables the Company to grant shares of Common Stock
to eligible employees based upon a percentage of that employee's eligible salary
up to a maximum of 3%. Level 3 employees on December 31 of each year, who are
age 21 or older with a minimum of 1,000 hours credited service are considered
eligible. The shares granted are valued at the fair market value as of the last
business day of the calendar year. All prior and future grants vest immediately
upon the employees' third anniversary of joining the Shareworks Plan.
The annual grant is expensed in the year of the grant. Compensation expense
recorded for the Shareworks Grant Plan for 1998 was approximately $1 million. In
addition to the compensation expense recognized, the Company capitalized less
than $1 million of non-cash compensation costs related to the Shareworks Plans
for employees directly involved in the construction of the IP network and the
development of the business support systems.
401(k) Plan
The Company and its subsidiaries offer its qualified employees the opportunity
to participate in a defined contribution retirement plan qualifying under the
provisions of Section 401(k) of the Internal Revenue Code. Each employee was
eligible to contribute, on a tax deferred basis, a portion of annual earnings
not to exceed $10,000 in 1998. The Company does not match employee contributions
and therefore does not incur any expense related to the 401(k) plan.
(12) Income Taxes
An analysis of the income tax (provision) benefit attributable to earnings
(loss) from continuing operations before income taxes and
minority interest for the three years ended
December 27, 199731, 1998 follows:
(dollars in millions) 1997 1996 1995
Current:
U.S. federal $ (54) $ (61) $ (66)
Foreign - (4) (4)
State (1) (6) (3)
------ ------ ------
(55) (71) (73)
Deferred:
U.S. federal 103 67 145
Foreign - - 3
State - 1 4
------- ------ ------
103 68 152
------- ------ ------
$ 48 $ (3) $ 79
======= ====== ======
(dollars in millions) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
Current:
U.S. federal $ (15) $ (54) $ (61)
Foreign - - (4)
State (10) (1) (6)
-------- --------- ---------
(25) (55) (71)
Deferred:
U.S. federal 50 103 67
State - - 1
---------- ---------- ---------
50 103 68
-------- ------- --------
$ 25 $ 48 $ (3)
======== ======== =========
The United States and foreign components of earnings (loss) from continuing
operations for tax reporting purposes, before equity
loss in MFS (recorded net of tax), minority interest and income taxes follows:
(dollars in millions) 1997 1996 1995
United States $ 31 $ 106 $ 187
Foreign - 1 3
------ ------ ------
$ 31 $ 107 $ 190
====== ====== ======
(dollars in millions) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
United States $ (142) $ 35 $ 106
Foreign (11) - 1
-------- ---------- ---------
$ (153) $ 35 $ 107
======= ======== =======
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 equity loss in
MFS (recorded net of tax), minority interest and income taxes for the three years ended December
27, 199731, 1998 follows:
(dollars in millions) 1997 1996 1995
Computed tax at statutory rate $ (11) $ (37) $ (67)
State income taxes (1) (3) -
Depletion 3 3 2
Goodwill amortization - (3) (2)
Tax exempt interest 2 2 2
Prior year tax adjustments 62 44 51
Compensation expense attributable
to options (7) - -
MFS deferred tax - - 93
Taxes on foreign operations - (2) 1
Other - (7) (1)
------ ------ ------
$ 48 $ (3) $ 79
====== ====== ======
(dollars in millions) 1998 1997 1996
- - -----------------------------------------------------------------------------------------------------------------
Computed Tax at Statutory Rate $ 53 $ (12) $ (37)
State Income Taxes (7) (1) (3)
Write-off of In Process Research & Development (11) - -
Coal Depletion 2 3 3
Goodwill Amortization (5) - (3)
Tax Exempt Interest - 2 2
Prior Year Tax Adjustments - 62 44
Compensation Expense Attributable to Options - (7) -
Taxes on Unutilized Losses of Foreign Operations (4) - (2)
Other (3) 1 (7)
--------- --------- ---------
$ 25 $ 48 $ (3)
======== ======== =========
During the threetwo years ended December 27, 1997, the Company settled a number of
disputed tax issues related to prior years that have been included in prior year
tax adjustments.
Possible taxes, beyond those provided on remittances of
undistributed earnings of foreign subsidiaries, are not
expected to be material.
The components of the net deferred tax liabilities for the years ended December
27, 199731, 1998 and December 28, 199627, 1997 were as follows:
(dollars in millions) 1997 1996
Deferred tax liabilities:
(dollars in millions) 1998 1997
- - -----------------------------------------------------------------------------------------------------------------
Deferred Tax Liabilities:
Investments in securities $ 2 $ 7 $ 11
Investments in joint ventures 27 33 45
Asset bases - accumulated depreciation 83 53 225
Coal sales 32 41
Other 20 16
-------- --------
Total Deferred Tax Liabilities 164 150
Deferred Tax Assets:
Compensation - and related benefits 35 25
Investment in subsidiaries 14 8
Provision for estimated expenses 14 7
Foreign and general business tax credits - 3
Other 13 9
-------- ---------
Total Deferred Tax Assets 76 52
-------- --------
Net Deferred Tax Liabilities $ 88 $ 98
======== ========
(13) Stockholders ' Equity
Issuances of Common Stock, for sales, 41 15
Other 16 16
----- ------
Total deferred tax liabilities 150 312
Deferred tax assets:
Compensation - retirement benefits 25 29
Investment in subsidiaries 8 2
Provision for estimated expenses 7 26
Net operating losses of subsidiaries - 6
Foreignconversions, option exercises and
general business tax credits 3 67
Alternative minimum tax credits - 16
Other 9 19
Valuation allowances - (6)
----- ------
Total deferred tax assets 52 159
----- ------
Net deferred tax liabilities $ 98 $ 153
===== ======
(11) Stockholders' Equity
PKS is generally committed to purchase all common stock in
accordance with the Certificate of Incorporation. Issuancesacquisitions, and repurchases of common shares including conversions, for the three years ended
December 27, 1997 were as follows:
Class Class
B&C Stock D Stock
Shares issued in 1995 1,021,875 530,610
Shares repurchased in 1995 136,057 210,735
Class B&C shares converted31, 1998 are shown below. Prior to the Split-off, the Company was
obligated to repurchase Class D shares 6,092,877 12,847,155
Shares issued in 1996 896,640 -
Shares repurchased in 1996 146,893 1,276,080
Class B&C shares converted
to Class D shares 623,475 2,052,425
Shares issued in 1997 893,924 13,113,015
Shares repurchased in 1997 44,256 14,805
Class B&C shares converted
to Class D shares 1,723,966 6,517,715from stockholders. The 1996 activity includes 150,995 Class D shares converting to 47,007 Class
C shares. The 1997 activity includes 1,880 Class D shares converting to 510
Class C shares.
(12) Class DLevel 3 Stock Plan
In December 1997, stockholders approved amendmentspermits option holders to tender shares to the 1995
Class D Stock Plan ("the Plan"). The amended plan, among other
things, increases the number of shares reserved for issuance
upon the exercise of stock based awardsCompany to 35,000,000,
increases the maximum number of options granted to any one
participant to 5,000,000, 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 with an exercise price less than
the fair market value of Class D Stock.
In December 1997, Level 3 converted bothcover income taxes due
on option and stock
appreciation rights plans of a subsidiary, to the Class D Stock
plan. This conversion resulted in the issuance of 3.7 million
options to purchase Class D Stock at $9 per share. Level 3
recognized an expense, and a corresponding increase in equity,
as a result of the transaction. This 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 years and expire
in December 2002.
Level 3 has elected to adopt only the required disclosure
provisions and not the optional expense recognition provisions
under SFAS No. 123 "Accounting for Stock Based Compensation",
which established a fair value based method of accounting for
stock options and other equity instruments. The fair value of
the options outstanding was calculated using the Black-Scholes
method using risk-free interest rates ranging from 5.5% to
6.77% and expected lives of 75% of the total life of the option.
Level 3 used an expected volatility rate of 0%, which is
allowed for private entities under SFAS No. 123. Once Level 3's
stock is listed, volatility factors will be incorporated in
determining fair value. Level 3's net income and earnings per
share for 1997 and 1996 would have been reduced to the pro forma
amounts shown below had SFAS No. 123 been applied.
1997 1996
Net Income of Level 3
As Reported $ 93 $ 113
Pro Forma 93 112
Basic Earnings per Share
As Reported $ .74 $ .97
Pro Forma .74 .97
Diluted Earning per Share
As Reported $ .74 $ .97
Pro Forma .74 .96
The 1995 historical and pro forma and as reported amounts did not vary as
the options granted in 1995 had not vested.
Transactions involving stock options granted under the Plan are
summarized as follows:
Option Price Weighted Avg.
Shares Per Share Option Price
Balance December 31, 1994 - $ - $ -
Options granted 1,340,000 8.08 8.08
Options cancelled - - -
Options exercised - - -
---------
Balance December 30, 1995 1,340,000 $ 8.08 $ 8.08
======== ========
Options granted 895,000 $ 9.90 $ 9.90
Options cancelled (15,000) 8.08 8.08
Options exercised - - -
---------
Balance December 28, 1996 2,220,000 $8.08 - $9.90 $ 8.81
============= ========
Options granted 7,495,465 $9.00 - $10.85 $ 9.93
Options cancelled (53,000) $9.90 $ 9.90
Options exercised (2,318,465) $8.08 - $9.90 $ 8.93
----------
Balance December 27, 1997 7,344,000 $8.08 - $10.85 $ 9.91
========== ============== ========
Options exercisable
December 30, 1995 - $ - $ -
December 28, 1996 265,000 8.08 8.08
December 27, 1997 1,295,269 $8.08 - $9.90 8.70
The weighted average remaining life for the 7,344,000 options
outstanding on December 27, 1997 is 8.3 years.
(13)exercises.
December 30, 1995 230,249,740
Shares Issued -
Shares Repurchased (2,552,160)
Issuances for Class C Stock Conversions 4,104,850
--------------
December 28, 1996 231,802,430
Shares Issued 21,589,100
Shares Repurchased (29,610)
Issuances for Class C Stock Conversions 13,035,430
Option Activity 4,636,930
--------------
December 27, 1997 271,034,280
Shares Issued 2,240,467
Shares Repurchased (30,506)
Issuances for Class C Stock Conversions 20,934,244
Issuances for Class R Stock Conversions 5,084,568
Option Activity 2,506,079
Shares Issued for Acquisitions 6,105,574
--------------
December 31, 1998 307,874,706
===========
(14) Industry and Geographic Data
In the fourth quarter of 1998, the Company adopted SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information". SFAS No. 131
establishes standards for reporting information about operating segments in
annual financial statements and requires selected information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for disclosures about products and services and geographic
areas. Operating segments are components of an enterprise for which separate
financial information is available and which is evaluated regularly by the
Company's chief operating decision maker, or decision making group, in deciding
how to allocate resources and assess performance. Operating segments are managed
separately and represent strategic business units that offer different products
and serve different markets.
The Company conducts in continuing operations primarily in
threeCompany's reportable segments:segments include: communications and information
services telecommunications(including communications, computer outsourcing and systems integration
segments), and coal mining. Other primarily includes CPTC, the C-TEC investments
and other corporate investments and overhead not attributable to a specific
segmentsegment.
Industry and marketable securities.
Equitygeographic data for the Company's discontinued construction and
energy operations are not included.
EBITDA, as defined by the Company, consists of earnings is included(loss) before interest,
income taxes, depreciation, amortization, non-cash operating expenses(including
stock-based compensation (and in process research and development expenses) and
other non-operating income or expense. The Company excludes noncash compensation
due to its adoption of the significant equity
investmentsexpense recognition provisions of SFAS No. 123.
EBITDA is commonly used in the telecommunications business.communications industry to analyze companies on
the basis of operating performance. EBITDA is not intended to represent cash
flow for the periods.
In 1998, 1997, 1996 and 19951996 Commonwealth Edison Company, a coal mining customer,
accounted for 34%, 43%, 23% and 23% of Level 3's revenues.
Industry and geographic data forsegment financial information follows. Certain prior year information
has been reclassified to conform with the construction and energy
businesses have been recorded under discontinued operations.
A summary of the Company's operations by industry and
geographic region is as follows:1998 presentation.
Communications & Information Services
Computer Systems Coal
(dollars in millions) Communications Outsourcing Integration Mining Other Total
1998
Telecom-
Industry Data munications
(dollars in Information C-TEC Coal Discontinued
millions) Services Entities) Mining Other Operations ConsolidatedRevenue $ 24 $ 63 $ 57 $ 228 $ 20 $ 392
EBITDA (139) 14 (23) 92 (44) (100)
Identifiable Assets 999 59 42 429 3,996 5,525
Capital Expenditures 818 25 4 2 61 910
Depreciation and
Amortization 37 8 3 5 13 66
1997
Revenue $ 94- $ 50 $ 45 $ 222 $ 15 $ 332
EBITDA - 13 1 88 (18) 84
Identifiable Assets - 42 19 499 924 1,484
Capital Expenditures - 9 5 3 9 26
Depreciation and
Amortization - 6 2 5 7 20
1996
Revenue $ - $ 22241 $ 16 $ - $ 332
Operating
Earnings (16) - 82 (23) - 43
Equity Losses,
net - (23) - (20) - (43)
Identifiable
Assets 61 336 449 588 1,295 2,779
Capital
Expenditures 14 - 3 9 - 26
Depreciation,
Depletion &
Amortization 8 - 8 8 - 24
1996
Revenue $ 42 $ 3671 $ 234 $ 9 $ -376 $ 652
Operating
Earnings (3) 31 94 (35)EBITDA - 87
Equity Losses,
net (1) (1) - (7) - (9)
Identifiable
Assets 29 1,100 387 380 1,170 3,06612 (5) 103 101 211
Capital Expenditures 11 87- 8 3 2 17 -104 117
Depreciation Depletionand
Amortization - 5 2 9 108 124
The following table presents a geographic breakout for revenue, EBITDA, and
identifiable assets:
Communications & Amortization 10 106 12 4 - 132
1995
Revenue $ 36 $ 325 $ 216 $ 3 $ - $ 580
Operating
Earnings 4 37 77 (73) - 45
Equity
Losses, net - (3) - (2) - (5)
Identifiable
Assets 34 1,143 368 614 786 2,945
Capital
Expenditures 6 72 4 36 - 118
Depreciation,
Depletion &
Amortization 5 81 7 3 - 96
Information Services
Computer Systems Coal
(dollars in millions) Communications Outsourcing Integration Mining Other Total
1998
Telecom-
Geographic Data munications
(dollars in Information C-TEC Coal Discontinued
millions) Services Entities) MiningRevenue:
United States $ 23 $ 62 $ 56 $ 228 $ 20 $ 389
Other Operations Consolidated1 1 1 - - 3
---------- ---------- ---------- ----------- ----------- ----------
$ 24 $ 63 $ 57 $ 228 $ 20 $ 392
========= ========= ========= ======== ========= ========
EBITDA:
United States $ (128) $ 14 $ (23) $ 92 $ (44) $ (89)
Other (11) - - - - (11)
--------- ----------- ----------- ----------- ----------- ---------
$ (139) $ 14 $ (23) $ 92 $ (44) $ (100)
======== ========= ========= ========= ========= ==========
Identifiable Assets:
United States $ 886 $ 59 $ 42 $ 429 $ 3,996 $ 5,412
Other 113 - - - - 113
-------- ----------- ----------- ----------- ----------- --------
$ 999 $ 59 $ 42 $ 429 $ 3,996 $ 5,525
======== ========= ========= ======== ======= =======
1997
Revenue:
United States $ 94- $ -50 $ 45 $ 222 $ 16 $ -15 $ 332
Other - - - - - -
------ ------- ------ ----- ------ --------
$ 94----------- ----------- ----------- ----------- ----------- -----------
$ - $ 50 $ 45 $ 222 $ 1615 $ 332
=========== ========= ========= ======== ========= ========
EBITDA:
United States $ - $ 332
====== ======= ====== ===== ====== =======
Operating Earnings:
United States13 $ (16)1 $ -88 $ 82(18) $ (23) $ - $ 4384
Other - - - - - -
----- ------- ------ ----- ------ -------
$ (16)----------- ----------- ----------- ----------- ----------- -----------
$ - $ 8213 $ (23)1 $ -88 $ 43
===== ======= ====== ===== ====== =======(18) $ 84
=========== ========= ========== ========= ========= =========
Identifiable Assets:
United States $ 59- $ 33642 $ 19 $ 499 $ 588924 $ 870 $ 2,3521,484
Other 2 - - - 425 427
----- ------- ------ ----- ------ -------- - -
----------- ----------- ----------- ----------- ----------- -----------
$ 61- $ 33642 $ 19 $ 499 $ 588 $1,295924 $ 2,779
===== ======= ====== ===== ======1,484
=========== ========= ========= ======== ======== =======
1996
Revenue:
United States $ 42- $ 36741 $ 1 $ 234 $ 9 $ -376 $ 652
Other - - - - - -
----- ------- ------ ----- ------ ------------------ ----------- ----------- ----------- ----------- -----------
$ 42- $ 36741 $ 1 $ 234 $ 9376 $ 652
=========== ========= ========== ======== ======== ========
EBITDA:
United States $ - $ 652
===== ======= ====== ===== ====== =======
Operating Earnings:
United States12 $ (3)(5) $ 31103 $ 94101 $ (35) $ - $ 87211
Other - - - - - -
----- ------- ------ ----- ------- -------
$ (3) $ 31 $ 94 $ (35)----------- ----------- ----------- ----------- ----------- -----------
$ - $ 87
===== ======= ====== ===== ======= =======
Identifiable Assets:
United States12 $ 29(5) $ 1,100103 $ 387101 $ 380 $ 761 $ 2,657
Other211
=========== ========= ========== ======== ======== ========
The following information provides a reconciliation of EBITDA to income from
continuing operations for the three years ended December 31, 1998:
(in millions) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------------
EBITDA $ (100) $ 84 $ 211
Depreciation and Amortizaqtion Expense (66) (20) (124)
Non-Cash Compensation Expense (39) (21) -
Write-off of In Process Research and Development (30) - -
409 409
----- ---------------- --------- ---------
Earnings (Loss) from Operations (235) 43 87
Other Income (Expense) 82 (8) 20
Income Tax Benefit (Provision) 25 48 (3)
--------- --------- ----------
Income (Loss) from Continuing Operations $ (128) $ 83 $ 104
======== ========= ========
(15) Commitments and Contingencies
On March 23, 1998, the Company and Frontier Communications International, Inc.
("Frontier") entered into an agreement ("Frontier Agreement") enabling the
Company to lease for a period of up to five years approximately 8,300 miles of
network capacity on Frontier's new 13,000 mile fiber optic, IP-capable network,
currently under construction. The leased network will initially connect 15 of
the larger cities across the United States. While requiring an aggregate minimum
payment of $165 million over its five-year term, the Frontier Agreement does not
impose monthly minimum consumption requirements on the Company, allowing the
Company to order, alter or terminate circuits as it deems appropriate. The
Company recognized $4 million of operating expenses in the second half of 1998
as portions of the network became operational.
On April 2, 1998, the Company announced it had reached a definitive agreement
with Union Pacific Railroad Company ("Union Pacific") granting the Company
rights-of-way along Union Pacific's rail routes for construction of the
Company's North American intercity network. The Company expects that the Union
Pacific agreement will satisfy substantially all of its anticipated right-of-way
requirements west of the Mississippi River and approximately 50% of the
right-of-way requirements for its North American intercity network. The
agreement provides for initial fixed payments of up to $8 million to Union
Pacific upon execution of the agreement and throughout the construction period,
and recurring payments in the form of cash, communications capacity, and other
communications services based on the number of conduits that are operational and
certain construction obligations of the Company to provide fiber or conduit
connections for Union Pacific at the Company's incremental cost of construction.
In 1998, the Company recorded $9 million of payments made under this agreement
in network construction-in-progress.
On June 18, 1998, Level 3 selected Peter Kiewit Sons', Inc. ("Kiewit") to build
the majority of its nearly 16,000 mile U.S. intercity communications network.
The overall cost of the project is estimated at $2 billion. Construction of the
network began in the third quarter of 1998 and is expected to be completed
during the first quarter of 2001. The contract provides that Kiewit will be
reimbursed for its costs relating to all direct and indirect project level
costs. In addition, Kiewit will have the opportunity to earn an award fee that
will be based on cost and speed of construction, quality, safety and program
management. The award fee will be determined by Level 3's assessment of Kiewit's
performance in each of these areas.
On June 23, 1998, the Company signed a master easement agreement with Burlington
Northern and Santa Fe Railway Company ("BNSF"). The agreement grants Level 3
right-of-way access to BNSF rail routes in as many as 28 states, over which to
build its network. Under the easement agreement, Level 3 will make annual
payments to BNSF and provide communications capacity to BNSF for its internal
requirements. The amount of the annual payments is dependent upon the number of
conduits installed, the number of conduits with fiber, and the number of miles
of conduit installed along BNSF's route.
On July 20, 1998, Level 3 entered into a network construction cost-sharing
agreement with INTERNEXT, LLC, a subsidiary of NEXTLINK Communications, Inc.
valued at $700 million. The agreement provides for INTERNEXT to acquire the
right to use conduits, fibers and certain associated facilities installed along
the entire route of Level 3's nearly 16,000 mile intercity fiber optic network
in the United States. INTERNEXT paid Level 3 $26 million in 1998 which was
deferred and included in other liabilities as of December 31, 1998 and will pay
the remaining balance as segments of the intercity network are completed. The
Company will recognize income as the segments of the network are completed and
accepted.
The network as provided to INTERNEXT will not include the necessary electronics
that allow the fiber to carry communications transmissions. INTERNEXT will be
restricted from selling or leasing fiber to unaffiliated companies for four
years following the date of the agreement. Also, under the terms of the
agreement, INTERNEXT has the right to an additional conduit for its exclusive
use and to share costs and capacity in certain future fiber cable installations
in Level 3 conduits.
On August 3, 1998, Level 3 and a group of other global telecommunications
companies entered into an agreement to construct an undersea cable system
connecting Japan and the United States by mid-year 2000. The parties to this
agreement are investing in excess of $1 billion to build the network, of which
Level 3 expects to contribute approximately $130 million. Each party will have
joint responsibility for the cost of network oversight, maintenance and
administration. The Company has recorded $24 million of costs associated with
this project in network construction-in-progress at December 31, 1998.
On October 14, 1998, Level 3 announced it signed an agreement with Global
Crossing Ltd. ("Global") for trans-oceanic capacity on Global Crossing's fiber
optic cable network. The agreement, covering 25 years and valued at
approximately $108 million, will provide Level 3 with as-needed dedicated
capacity across the Atlantic Ocean. Additionally, Level 3 will have the option
of utilizing capacity on other segments of Global's worldwide network. In 1998,
the Company recorded as network construction-in-progress, $32 million of costs
associated with this agreement.
On December 18, 1998 Level 3 announced an agreement with IXC Communications,
Inc. ("IXC") to lease capacity on IXC's network. The dedicated network will
enhance the Company's ability to offer a wide array of data and voice services
to a greater number of customers in key U.S. markets. The arrangement is unique
in that IXC will reserve the network for the exclusive use of Level 3, which
expects to begin running traffic across the network beginning in Spring 1999.
The Company paid IXC $40 million under this agreement in 1998 and recorded this
amount in property, plant and equipment.
Operating Leases
The Company is leasing rights of way, communications capacity and premises under
various operating leases which, in addition to rental payments, require payments
for insurance, maintenance, property taxes and other executory costs related to
the lease. Certain leases provide for adjustments in lease cost based upon
adjustments in the consumer price index and increases in the landlord's
management costs. The lease agreements have various expiration dates through
2014.
In addition to the items described above, future minimum payments for the next
five years, under the non-cancelable operating leases with initial or remaining
terms of one year or more, consist of the following at December 31, 1998 (in
millions):
1999 $ 35
2000 34
2001 31
2002 24
2003 24
Thereafter 182
------
----- ------- -------
$ 29 $ 1,100 $ 387 $ 380 $ 1,170 $ 3,066
===== ======= ====== ===== ======= =======
1995
Revenue:
United States $ 36 $ 325 $ 216 $ 3 $ - $ 580330
======
Rent expense under these lease agreements was $18 million in 1998, $1 million
in 1997 and $3 million in 1996.
(16) Related Party Transactions
Peter Kiewit Sons', Inc. acted as the general contractor on several projects for
the Company in 1998. These projects include the intercity network, local loops
and gateway sites, the Company's new corporate headquarters in Colorado and a
new data center in Tempe, Arizona. Kiewit provided approximately $130 million of
construction services related to these projects in 1998.
In 1999, the Company entered into an agreement with RCN whereby RCN will lease
cross country capacity on Level 3's nationwide network. Also in 1999, the
Company and RCN announced that it had reached joint construction agreements in
several RCN markets, through which the companies will share the cost of
constructing their respective fiber optic networks.
Level 3 also receives certain mine management services from Peter Kiewit Sons',
Inc. The expense for these services was $34 million for 1998, $32 million for
1997, and $37 million for 1996, and is recorded in general and administrative
expenses. The revenue earned by Peter Kiewit Sons', Inc. in 1997 and 1996 is
included in discontinued operations.
(17) Other Matters
Prior to the Split-off, as of January 1 of each year, holders of Class C Stock
had the right to convert Class C Stock into Class D Stock, subject to certain
conditions. In January 1998, holders of Class C Stock converted 2.3 million
shares, with a redemption value of $122 million, into 21 million shares of Class
D Stock (now known as Common Stock).
The Company is involved in various lawsuits, claims and regulatory proceedings
incidental to its business. Management believes that any resulting liability for
legal proceedings beyond that provided should not materially affect the
Company's financial position, future results of operations or future cash flows.
It is customary in Level 3's industries to use various financial instruments in
the normal course of business. These instruments include items such as letters
of credit. Letters of credit are conditional commitments issued on behalf of
Level 3 in accordance with specified terms and conditions. As of December 31,
1998, Level 3 had outstanding letters of credit of approximately $22 million.
The Company does not believe it is practicable to estimate the fair value of the
letters of credit and does not believe exposure to loss is likely.
(18) Subsequent Events
On January 5, 1999 Level 3 acquired BusinessNet Limited, a leading London-based
Internet service provider in a largely stock-for-stock transaction. The Company
granted approximately 400,000 shares of Common Stock and paid $1 million in cash
in exchange for BusinessNet's capital stock. The transaction was valued at
approximately $18 million and will be accounted for as a purchase.
Level 3 filed a "universal" shelf registration statement covering up to $3.5
billion of common stock, preferred stock, debt securities and depositary shares
that became effective February 17, 1999. On March 9, 1999 the Company sold 28.75
million shares through a primary offering. The net proceeds from the offering of
approximately $1.5 billion will be used for working capital, capital
expenditures, acquisitions and other general corporate purposes in connection
with the implementation of the Company's Business Plan.
On February 25, 1999 the Board approved an increase in the number of authorized
shares outstanding from 500 million to 1 billion. This is subject to approval of
the shareholders which will be voted on at the Company's 1999 Annual Meeting.
(19) Unaudited Quarterly Financial Data:
(in millions except March June September December
per share data) 1998 1997 1998 1997 1998 1997 1998 1997
- - - - - -
----- ------- ------ ---- ------- -------
$ 36 $ 325 $ 216 $ 3 $ - $ 580
===== ======= ====== ==== ======= =======
Operating Earnings:
United States $ 4 $ 37 $ 77 $(73) $ - $ 45
Other - - - - - -
----- ------- ------ ---- ------- -------
$ 4 $ 37 $ 77 $(73) $ - $ 45
===== ======= ====== ==== ======= =======
Identifiable Assets:
United States $ 34 $ 1,143 $ 368 $614 $ 614 $ 2,773
Other - - - - 172 172
----- ------- ----- ---- ------- -------
$ 34 $ 1,143 $ 368 $614 $ 786 $ 2,945
===== ======= ===== ==== ======= =======
(14) Related Party Transactions
Level 3 receives certain mine management services from the
Construction & Mining Group. The expense for these services
was $32 million for 1997, $37 million for 1996 and $30 million
for 1995, and is recorded in general and administrative
expenses. The revenue earned by the Construction and Mining
Group is included in discontinued operations.
(15) Fair Value of Financial Instruments
The carrying and estimated fair values of Level 3's financial
instruments are as follows:
1997 1996
Carrying Fair Carrying Fair
(dollars in millions) Amount Value Amount Value
Cash and cash equivalents (Note 6)------------------------------------------------------------------------------------------------------------------
Revenue $ 87 $ 8780 $ 147103 $ 147
Marketable securities (Note 6) 678 678 372 372
Restricted securities (Note 6) 22 22 17 17
Investment in equity securities
(Notes 6 & 7) - - 75 75
Investment in C-TEC entities (Note 7) 335 776 355 315
Investments in discontinued
operations (Note 4) 643 854 608 960
Long-term debt (Notes 6 & 9) 140 140 377 384
(16) C-TEC Restructuring
The following is financial information of the Company had C-TEC
been accounted for utilizing the equity method as of December
27, 199781 $ 106 $ 81 $ 96 $ 90
Earnings (Loss) from
Operations (9) 20 (41) 16 (52) 13 (133) (6)
Net Earnings (Loss) 926 35 (34) 56 (49) (10) (39) 167
Earnings (Loss) per Share
(Basic and December 28, 1996 and for each of the three years
ended December 27, 1997. The 1997 financial statements include
C-TEC accounted for utilizing the equity method and are
presented here for comparative purposes only.
Operations (dollars in millions) 1997 1996 1995
Revenue $ 332 $ 285 $ 255
Cost of Revenue (175) (134) (133)
------ ------ ------
157 151 122
General and Administrative Expenses (114) (95) (114)
------ ------ ------
Operating Earnings 43 56 8
Other (Expense) Income:
Equity earnings (losses), net (43) (13) 7
Investment income, net 45 42 30
Interest expense, net (15) (5) (1)
Gain on subsidiary's stock transactions, net - - 3
Other, net 1 11 120
----- ----- ------
(12) 35 159
Equity Loss in MFS - - (131)
Earnings fromDiluted):
Continuing Operations before Income Taxes and Minority Interest 31 91 36
Income Tax Benefit 48 11 90
Minority Interest in Net Loss of Subsidiaries 4 2 -
----- ----- ------
Income from Continuing Operations 83 104 126
Income from$ (.02) $ .06 $ (.11) $ .06 $ (.16) $ .03 $ (.13) $ .18
Discontinued Operations
165 117 118
----- ----- ------Excluding Construction
Operations 3.19 .02 - .03 - (.21) - .18
Net Earnings $ 248 $ 221 $ 244
===== ===== ======
Financial Position (dollars in millions) 1997 1996
Assets
Current Assets:
Cash and cash equivalents $ 87 $ 71
Marketable securities 678 325
Restricted securities 22 17
Receivables 42 34
Investment in Discontinued operations - Energy 643 608
Other 22 12
------- -------
Total Current Assets 1,494 1,067Excluding
Construction Operations 3.17 .08 (.11) .09 (.16) (.18) (.13) .36
Net Property, Plant and Equipment 184 174
Investments 383 458
Investments in Discontinued Operations-Construction 652 562
Intangible Assets, net 21 23
Other Assets 45 49
------- -------
$ 2,779 $ 2,333
======= =======
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 31 $ 41
Current portionEarnings Excluding Gains
On Split-Off of long-term debt 3 2
Accrued reclamation and other mining costs 19 19
Other 36 27
------- --------
Total Current Liabilities 89 89
Long-term Debt, less current portion 137 113
Deferred Income Taxes 83 47
Accrued Reclamation Costs 100 98
Other Liabilities 139 163
Minority Interest 1 4
Stockholders' Equity 2,230 1,819
-------- --------
$ 2,779 $ 2,333
======== ========
(17) Pro Forma Information (unaudited).
The following information represents the pro forma financial
position of Level 3 after reflecting the impact of the
transactions with CalEnergy (Note 3), the conversion of Class C
shares to Class D shares (Note 19) and transactions related to
the spin-off of the Construction and Mining Group (Note 2), all
of which took place or are expected to happen in the first
quarter of 1998.
1997 1997
(dollars in millions) Historical Adjustments Pro Forma
Current Assets
Cash & marketable securities $ 765 $ 122 (a) $ 2,046
1,159 (b)
Investment in discontinued
operations - energy 643 (643)(b) -
Other current assets 86 86
------- ------ -------
Total Current Assets 1,494 638 2,132
Property, Plant & Equipment, net 184 184
Investment in Discontinued Operations -
Construction 652 (122)(a) -
350 (c)
(880)(d)
Other Non-current assets 449 449
------- ------ -------
$ 2,779 $ (14) $ 2,765
======= ====== =======
Current Liabilities $ 89 $ 192 (b) $ 281
Non-current Liabilities 459 459
Minority Interest 1 1
Stockholders' Equity 2,230 324 (b) 2,024
350 (c)
(880)(d)
------- ------- -------
$ 2,779 $ (14) $ 2,765
======= ======= =======
(a) Reflect conversion of 2.3 million Class C shares to 10.5
million Class D shares
(b) Reflect sale of energy assets to CalEnergy and related income
tax liability.
(c) Reflect fair value gain on the distribution of the
Construction and Mining Group.
(d) Reflect spin-off of the Construction and Mining Group.
(18) Other Matters
In connection with the sale of approximately 10 million Class D
shares to employees in 1997, the Company has retained the right
to purchase the relevant Class D shares at the then current Class
D Stock price if the Transaction is definitely abandoned by formal
action of the PKS Board or the employees voluntarily terminate their
employment on various dates prior to January 1, 1999.
In May 1995, the lawsuit titled Whitney Benefits, Inc. and
Peter Kiewit Sons' Co. v. The United States was settled. In
1983, plaintiffs alleged that the enactment of the Surface
Mining Control and Reclamation Act of 1977 had prevented the
mining of their Wyoming coal deposit and constituted a
government taking without just compensation. In settlement of
all claims, plaintiffs agreed to deed the coal deposits to the
government and the government agreed to pay plaintiffs $200
million, of which Peter Kiewit Sons' Co., a Level 3 subsidiary,
received approximately $135 million in June 1995 and recorded
it in other income on the statements of earnings.
The Company is involved in various other lawsuits, claims and
regulatory proceedings incidental to its business. Management
believes that any resulting liability, beyond that provided,
should not materially affect the Company's financial position,
future results of operations or future cash flows.
Level 3 leases various buildings and equipment under both
operating and capital leases. Minimum rental payments on
buildings and equipment subject to noncancelable operating
leases during the next 7 years aggregate $29 million.
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 27, 1997, Level 3 had outstanding letters of credit of
approximately $22 million.
(19) Subsequent Events
In January 1998, approximately 2.3 million shares of Class C
Stock, with a redemption value of $122 million, were converted
into 10.5 million shares of Class D Stock.
In March 1998, PKS announced that its Class D Stock will begin
trading on April 1 on the Nasdaq National Market under the
symbol "LVLT". The Nasdaq listing will follow the separation
of the Level 3 and the Construction
Group of PKS, which is
expected to be completed on March 31, 1998. In connection with
the separation, PKS' construction subsidiary will be renamed
"Peter Kiewit Sons', Inc." and PKS Class D stock will become
the common stock of Level 3 Communications, Inc.
PKS' certificate of incorporation gives stockholders the right to
exchange their Class C Stock for Class D Stock under a set
conversion formula. That right will be eliminated as a result
of the separation of Level 3 and the Construction Group. To
replace that conversion right, Class C stockholders received
6.5 million shares of a new Class R stock in January, 1998,
which is convertible into Class D Stock in accordance with
terms ratified by stockholders in December 1997.
The PKS Board of Directors has approved in principle a plan to
force conversion of all shares of Class R stock outstanding.
Due to certain provisions of the Class R stock, conversion will
not be forced prior to May 1998, and the final decision to
force conversion would be made by Level 3's Board of Directors
at that time. Level 3's Board may choose not to force
conversion if it were to decide that conversion is not in the
best interests of Level 3 stockholders. If, as currently
anticipated, Level 3's Board determines to force conversion of
the Class R stock on or before June 30, 1998, certain
adjustments will be made to the cost sharing and risk
allocation provisions of the separation agreement between Level
3 and the Construction business.
If Level 3's Board of Directors determines to force conversion of
the Class R stock, each share of Class R stock will be
convertible into $25 worth of Level 3 (Class D) common stock,
based upon the average trading price of the Level 3 common
stock on the Nasdaq National Market for the last fifteen
trading days of the month prior to the determination by the
Board of Directors to force conversion. When the spin-off occurs,
Level 3 will increase paid in capital and reduce retained earnings
by the fair value of the Class R shares.1.09 .08 (.11) .09 (.16) (.18) (.13) .36
Earnings (loss) per share was calculated for each three-month period on a
stand-alone basis. As a result of all the stock transactions, the sum of the
earnings (loss) per share for the four quarters of each year may not equal
the earnings(loss) per share for the twelve month periods.
The earnings (loss) per share amounts above are those of Level 3 Common Stock.
On January 2, 1998 the Company completed the sale of its energy assets to
MidAmerican, as discussed in Note 3, and recognized an after-tax gain on the
disposition of $324 million.
On March 31, 1998, as a result of the Split-off as discussed in Note 1, the
Company recognized a gain of $608 million equal to the difference between the
carrying value of the Construction Group and its fair value in accordance with
Financial Accounting Standards Board Emerging Issues Task Force Issue 96-4. No
taxes were provided on this gain due to the tax-free nature of the Split-off.
The Company reflected the fair value of the Construction Group as a distribution
to the Class C stockholders.
As described in Note 5, the Company reduced its charge for the acquired in-
process research and development rlated to it acquisition of XCOM, which was
originally recorded in the second quarter of 1998, from $115 million to $30
million, and increased the related goodwill $85 million. The unaudited quarterly
financial data above reflects that revision as if it occurred in the seocnd
quarter of 1998. As a result, the amounts presented above differ from those
reported in the Company's 1998 Forms 10-Q for the second and third quarters.
Loss from operations, net loss and losses per share as reported in the second
quarter Form 10-Q were $123 million, $116 million and $0.39, respectively, a
change of $82 million, $82 million and $.28 per share, respectively, from
the information presented above due to the reduced charge for in-process
research and development and an increase in goodwill amortization. Loss from
operations, net loss and losses per share as reported in the third quarter
Form 10-Q were $48 million, $45 million and $0.15, respectively, a change of
$4 million, $4 million and $0.01 per share, respectively, from the information
presented above due to an increase in goodwill amortization.