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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
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 NUMBER 000-50040
---------------
WILTEL COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)
NEVADA 01-0744785
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE TECHNOLOGY CENTER, TULSA, OKLAHOMA 74103
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(918) 547-6000
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
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| 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. | |
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes |X| No | |
The aggregate market value of common stock of Williams Communications
Group, Inc. (the predecessor to the registrant) held by non-affiliates as of the
close of business on June 28, 2002, calculated based on the closing price of OTC
trading, was approximately $10.3 million.
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes |X| No | |
The number of shares of the registrant's Common Stock outstanding at
February 28, 2003, was 50,000,000.
DOCUMENTS INCORPORATED BY REFERENCE
Not applicable.
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WILLIAMS COMMUNICATIONS GROUP, INC.
FORM 10-K
PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
WilTel Communications Group, Inc. ("WilTel" or, together with its direct
and indirect subsidiaries and predecessor companies, the "Company") was
incorporated under the laws of the State of Nevada on October 14, 2002. The
principal executive offices of WilTel are located at One Technology Center,
Tulsa, Oklahoma 74103 (telephone 918-547-6000).
WilTel is the holding company for a business that, until October of 2002,
was owned by Williams Communications Group, Inc. ("WCG"). The following is a
brief description of the development of the business as well as a summary of the
bankruptcy reorganization that resulted with WilTel emerging as the successor to
WCG.
UNCERTAINTY IN THE TELECOMMUNICATIONS INDUSTRY
The telecommunications industry has experienced a great deal of
instability during the past several years. During the 1990s, forecasts of very
high levels of future demand brought a significant number of new entrants and
new capital investments into the industry. However, many industry participants
have gone through bankruptcy, those forecasts have not materialized,
telecommunications capacity now far exceeds actual demand, and the resulting
marketplace is characterized by fierce price competition as traditional and next
generation carriers compete to secure market share. Resulting lower prices have
eroded margins and have kept many carriers--including the Company--from
attaining positive cash flow from operations. Many network providers, and their
customers, have and are undergoing reorganizations through bankruptcy,
contemplating bankruptcy, or experiencing significant operating losses while
consuming much of their remaining liquidity.
The Company does not know if and when the current state of aggressive
pricing will end, or whether the current instability in the sector will lead to
industry consolidation. If industry consolidation does occur, it would not
necessarily benefit the Company or ensure that pricing rationality will return
to the industry. However, if consolidation does not occur and new investment
capital continues to flow into telecommunications carriers, pricing pressures
could continue and supply may continue to outpace demand for the foreseeable
future. While the Company will examine opportunities to acquire other carriers
or large blocks of business if such opportunities are presented to the Company,
and even if such transactions could be consummated at prices deemed to be
attractive, no assurance can be given that the Company could successfully
complete such acquisitions or that the Company could obtain the necessary
capital or lender approvals to do so.
The Company has continued to incur losses during the period
subsequent to its emergence from the chapter 11 proceedings and the adoption of
fresh start accounting. The Company expects these losses will continue, in part
because the rates the Company charges for its services have declined, consistent
with industry-wide experience, and downward pricing may continue if current
market conditions do not change. In addition, the Company has experienced a loss
of customers due to customer bankruptcies, industry consolidation and lower
demand. The Company expects it will continue to incur losses until it can grow
the volume of its business or increase the prices it charges for its services.
The projected losses in its current business plan are higher than contemplated
in the bankruptcy plan. Although the Company believes that its current business
plan will enable it to attain profitability in the future, the Company is unable
to predict with certainty if, and when, it will be able to report profitable
results of operations.
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The Company's current focus is to retain its existing business by
providing a high quality of service, to obtain new business if it can be done on
a profitable basis, to reduce its operating expenses to the greatest extent
possible, and to conserve liquidity. At December 31, 2002, the Company had
$291.3 million of cash and cash equivalents to meet its cash requirements, and
believes that it has sufficient liquidity to meet its needs through 2004. The
Company has $375 million of debt due under its Exit Credit Agreement, and
approximately $142 million of debt under the OTC Notes. Approximately $157
million of this debt matures during 2005. Unless the Company is able to generate
significant cash flows from operations through profitable revenue growth,
expense reductions or some combination of both, it is likely that new capital
will have to be raised to meet its maturing debt obligations in 2005.
A BRIEF HISTORY OF THE BUSINESS
In 1985, The Williams Companies, Inc. ("TWC") entered the communications
business by placing fiber-optic cables in pipelines no longer in use. By 1989,
through a combination of construction projects and acquisitions, TWC had
completed the fourth nationwide digital fiber-optic network, consisting of
approximately 9,700 miles. At the time, TWC operated this network business under
the name "WilTel." In January 1995, TWC sold its network business to LDDS
Communications (now WorldCom) except for an approximately 9,700-route mile
network comprised of a single fiber-optic strand and associated equipment along
the original nationwide network. TWC retained a telecommunications equipment
distribution business and a business unit called Vyvx Services. In January 1998,
TWC reentered the communications network business through its wholly-owned
subsidiary, WCG. By the end of 2001, WCG had completed a new network that, at
the time, was a 27,000-mile network. As a result of a series of transactions
begun in 1999, by April 2001 most of WCG's outstanding common stock was publicly
held and TWC retained only 5%.
THE BANKRUPTCY REORGANIZATION
During and subsequent to fourth quarter 2001, due to negative developments
in the telecommunications industry and the lack of progress in negotiations with
the Company's secured lenders, the Company considered various alternatives for
a financial restructuring. By late February 2002, the Company announced that it
was also evaluating restructuring under chapter 11 of title 11 of the United
States Code ("Bankruptcy Code").
On April 22, 2002, WCG along with one of its subsidiaries (CG Austria,
Inc., collectively with WCG referred to as the "Debtors") filed petitions for
relief under the Bankruptcy Code with the United States Bankruptcy Court for the
Southern District of New York (the "Bankruptcy Court"). From April 22, 2002,
through October 15, 2002, the Debtors managed their property as debtors in
possession, subject to the supervision of the Bankruptcy Court and in accordance
with the provisions of the Bankruptcy Code. On September 30, 2002, the
Bankruptcy Court entered an order confirming the Debtors' plan of
reorganization, which became effective on October 15, 2002. For a more
comprehensive overview of the Chapter 11 reorganization, see Item 1(d) "Other
Information--Overview of the Chapter 11 Proceedings" below.
(b) FINANCIAL INFORMATION ABOUT SEGMENTS
See Part II, Item 8 "Financial Statements and Supplementary Data."
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(c) NARRATIVE DESCRIPTION OF BUSINESS
Substantially all operations of WilTel are conducted through subsidiaries.
As it is used in this report, the term "WilTel" also includes its operating
subsidiaries where the context requires. Restrictions contained in certain of
WilTel's debt agreements limit the ability of the Company's principal operating
subsidiary, WilTel Communications, LLC ("WCL"), to transfer funds to its parent,
WilTel, except for certain payments permitted under the long-term credit
facility.
WilTel's operating segments include two reportable segments, Network and
Vyvx, the operations of which are described below.
NETWORK
Through its Network segment, WilTel owns or leases and operates a
nationwide inter-city fiber-optic network, extended locally and globally.
WilTel's Network segment is a provider of Internet, data, voice, and video
services to companies that use high capacity communications as an integral part
of their service offerings. WilTel also offers rights of use in dark fiber,
which is fiber that it installs but for which it does not provide communications
transmission services. Network has built networks and entered into strategic
relationships to provide services in the United States and connectivity to Asia,
Australia, New Zealand, Canada, Mexico, and Europe.
WilTel's global network includes ownership interests in or rights to use:
- nearly 30,000 miles of fiber optic cable, of which 28,554 is
currently in service;
- local fiber optic cable networks within 20 of the largest U.S.
cities;
- 120 network centers located in 107 U.S. cities;
- operational border crossings between the U.S. and Mexico in
California and Texas, and between the U.S. and Canada in Washington,
Michigan, and New York; and
- capacity on five major undersea cable systems connecting the
continental U.S. with Europe, Asia, Australia, New Zealand, and
Hawaii.
WilTel also has rights to use dark fiber or wavelengths in Europe
connecting the UK, France, Germany, Belgium, the Netherlands, Norway, Denmark,
Finland, and Sweden. These rights have not been exercised.
REVENUES
Excluding sales made by Network to the Vyvx segment, Network contributed
the following revenue for the past three years:
TOTAL REVENUE PERCENTAGE OF
YEAR (IN THOUSANDS) CONSOLIDATED REVENUES
---- -------------- ---------------------
2002 $ 1,047,626 88%
2001 $ 1,021,199 86%
2000 $ 670,745 80%
WilTel believes it provides customers with a cost-effective foundation
from which to build or expand their businesses. WilTel operates and provides
services through its:
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U.S. voice network. WilTel's functional switching solutions provide the
platform to deliver a broad suite of basic and enhanced voice services across
its multi-service backbone network. WilTel offers its voice network to major
service providers (e.g., Regional Bell Operating Companies (known as "RBOCs"),
foreign governmental or privatized postal, telephone, and telegraph authorities
(known as "PTTs"), voice resellers and other voice service providers).
Optical transport network. WilTel combines optical and electronic
transmission and switching equipment in its network. WilTel's core network
employs optical restorable mesh architecture, and is augmented with regional
SONET (Synchronous Optical Network) rings. This architecture provides the
restorability benefits of a SONET ring architecture, but with greater capacity
efficiency. This enables WilTel to provide its customers with the flexibility to
control their own service on the WilTel network rather than build these
capabilities or networks for themselves.
U.S. enhanced data services network. WilTel's data services network
employs a technology allowing it to interwork multiple protocols of Layer 2 and
Layer 3 data networking technology. This interworking capability enables
customers to independently pick and choose the type of networking technology or
protocols they wish to use on a location-by-location basis.
Internet infrastructure. WilTel's Internet Protocol ("IP") backbone
network allows customer access at more than 120 network centers nationwide,
including access to international connectivity, using the customer's choice of
protocols including Asynchronous Transfer Mode ("ATM"), Frame Relay, Private
Line, SONET, and Ethernet.
Out-source network infrastructure. Network's Managed Services group
designs, builds, and operates network infrastructure for its customers. WilTel
believes it can help customers expand into new markets by building out their
infrastructures and implementing new network services.
International connectivity. WilTel owns or has rights to use capacity in
five undersea cables connecting its domestic network to facilities in the United
Kingdom, Europe, Australia, New Zealand, Asia, and Hawaii. Utilizing its sub-sea
cable capacity and border crossings into Mexico and Canada, WilTel links its
North American network to international facilities. The undersea cables and
border crossings enable WilTel to increase the utilization of its core U.S.
network by providing domestic and global connectivity for WilTel's U.S. and
international customers.
PROPERTIES
U.S. Inter-City Network
MILES IN AVERAGE NO. OF
THE WILTEL NETWORK ROUTE MILES OPERATION FIBERS PER CABLE
------------------ ----------- --------- ----------------
Wholly owned fiber routes, built by WilTel 16,938 15,948 123
Fiber routes jointly owned (1) 1,258 1,258 12
Fiber routes through dark fiber rights (2) 11,348 11,348 17
------ ------
Total (3) 29,544 28,554
(1) This category consists of Network's fiber rights in routes that have been
jointly constructed by FTV Communications, LLC ("FTV"), a limited
liability company in which WilTel shares equal ownership and control with
two other parties. FTV constructed the portion of the route between
Portland and Las Vegas and obtained rights in dark fiber in the portion of
the route between Las Vegas and Los Angeles and in the Detroit-Cleveland
route. FTV owns the right of way over some of the route it constructed,
with each of its members also contributing rights of way. FTV granted
rights in dark fibers on the completed routes to WilTel and its other
members.
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(2) This category consists of rights in dark fiber and conduits that Network
has obtained. Network has obtained approximately 11,348 route miles, all
of which have had fiber-optic cable installed. Network manages the
transmission equipment on the routes it acquired, and it typically pays
for the maintenance of fiber-optic strands and rights of way.
(3) In 2002, WilTel completed a route-by-route audit to verify and update
route mileages for all network segments.
Network also leases capacity from both long-distance and local
telecommunications carriers, including its competitors, in order to meet the
needs of its customers. Leases of capacity are distinguished from rights in dark
fiber in that capacity leases are for only a portion of the fiber capacity and
the lessor supplies and operates the equipment to transmit over the fiber.
Capacity leases are generally for terms of one month to five years, but can be
longer. Network leases from third parties less than one and a half percent of
its U.S. network capacity currently in use. These leases are for areas where
Network does not have on-network capacity, or such capacity is not currently
sufficient to meet the expected near-term demand.
In September 2001, Network acquired two gateway switches from Ameritech
Global Gateway Services ("AGGS"), a subsidiary of SBC Communications, Inc., and
in turn, WilTel assumed the wholesale international long-distance business
conducted by AGGS (now called WilTel Global Voice Services or WGVS). The
gateways allow the company to offer outbound foreign termination and inbound
domestic termination to other carrier customers.
The domestic voice network grew to eighteen switches in 2002.
City-by-city routes. The following table sets forth details about the
operational route miles in Network's completed network.
ROUTE MILES
--------------------------------------------
WHOLLY JOINTLY DARK FIBER TOTAL MILES
FIBER BUILD SEGMENT OWNED OWNED RIGHTS IN OPERATION
- ------------------- ----- ----- ------ ------------
ACI (1) 1,007 -- -- 1,007
Albany - Boston 182 -- -- 182
Atlanta - Jacksonville 357 -- -- 357
Atlanta - Chicago 1,003 -- 30 1,033
Chicago - Cleveland 226 -- -- 226
Cleveland - Washington -- -- 629 629
Chicago - Indianapolis -- -- 304 304
China/Japan Cable: Bandon
Connections 194 -- 93 287
China/Japan Cable: West Coast
Connections 445 -- 240 685
Cleveland - New York City -- 51 701 752
Dallas - Houston -- 21 230 251
Daytona Beach - Tampa 152 -- -- 152
Denver - Dallas -- 15 1,061 1,076
Denver - Salt Lake City 568 -- -- 568
Detroit - Cleveland -- 7 216 223
New York - Washington 250 -- 98 348
Houston - Washington (2) 2,703 -- 85 2,788
Houston - Chicago 1,429 -- -- 1,429
Houston - San Antonio -- 11 702 713
Jacksonville - Miami 358 -- 3 361
Kansas City - Denver 630 -- -- 630
Los Angeles - New York City -- 8 3,635 3,643
Los Angeles - Houston 1,831 -- -- 1,831
San Diego - Anaheim -- 126 -- 126
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(continued from prior page) ROUTE MILES
--------------------------------------------
WHOLLY JOINTLY DARK FIBER TOTAL MILES
FIBER BUILD SEGMENT OWNED OWNED RIGHTS IN OPERATION
- ------------------- ----- ----- ------ ------------
Los Angeles - Anaheim 25 -- -- 25
Los Angeles - Sacramento (2) 740 12 755 1,507
San Francisco - San Jose 48 -- -- 48
San Francisco - Sacramento 121 -- -- 121
Miami - Tallahassee 543 -- -- 543
Minneapolis - Kansas City 453 -- -- 453
Minneapolis - Chicago 425 -- 37 462
Minneapolis - Detroit -- 12 763 775
New Orleans - Tallahassee 471 -- -- 471
New York - Boston (2) 156 -- 416 572
Miscellaneous Metro (Local)
builds 85 -- 2 87
Portland - Seattle (2) 177 1 180 358
Portland - Los Angeles -- 995 330 1,325
Sacramento-Portland (2) 680 -- 680 1,360
Salt Lake City - Sacramento 661 -- -- 661
PAIX Interconnect to San
Francisco 3 -- 2 5
San Diego - Mexico 26 -- -- 26
TAT 14 1 -- 153 154
------ ----- ------ ------
TOTAL (3) 15,950 1,259 11,345 28,554
(1) In September 2000, the Company acquired the long distance network assets
of Ameritech Communications, Inc., a subsidiary of SBC Communications,
Inc. The assets acquired are located in the states of Illinois, Indiana,
Michigan, Ohio and Wisconsin, and include a 1,997-mile fiber optic network
over four routes, indefeasible rights of use in dark fiber and 15 data
centers. 1,007 of the 1,997 route mile network is currently operational.
(2) Each of these segments includes two separate routes; therefore, the route
miles reflected in the table above include mileage for each of the two
separate routes.
(3) In 2002, the Company completed a route-by-route audit to verify and update
route mileages for all network segments.
In 2002, the Company completed six regional SONET rings. Deployment of the
regional rings allows for a fully restorable service to be provided in 92% of
the U.S. cities served on the network. In the event of a network outage,
customers using the rings are expected to have their services restored by means
of traditional SONET approaches.
Network architecture and technology. WilTel's network operating system
includes the following features:
- Multi-service networking -- WilTel's network architecture allows
for the bundling of video, Internet, data, and voice services across an
integrated network platform.
- Optical switching -- Switched optical systems allow WilTel to
deliver reliable network services with differentiated levels of service.
- IP routing -- Internet protocol networks allow for multimedia
traffic delivery and management. Traffic destined for either the public
Internet or internal corporate locations is handled across WilTel's IP
backbone.
- ATM switching -- ATM switching is a packet switching technology,
which provides for the delivery of multiple quality of service levels and
is designed to transfer video, voice, and data in fixed-sized cells.
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- MPLS networking -- Multi-protocol label switching allows for the
interworking of IP, ATM, and optical systems. MPLS facilitates management
of quality of service, traffic administration, and service differentiation
across the network, especially in the IP domain.
- Voice switching -- WilTel employs scalable, functional switching
solutions to deliver basic and enhanced voice services across its
multi-service backbone.
- Multiprotocol media transport -- Broadcast quality video support
is provided over the multi-services network infrastructure with customer
connections to private line, ATM, IP, and satellite networks.
- Flexible metro access services -- WilTel offers access to its
multi-services network via a variety of connectivity mechanisms. Supported
speeds include OC-3 to OC-192, ten megabits per second Ethernet to one
gigabit Ethernet, and DS1/T1 to DS3/T3. Each access can deliver video,
voice, Internet or data services.
- Nationwide Ethernet services -- Beyond the metro access areas,
WilTel provides Ethernet connectivity on both a local and national basis.
With full VLAN (virtual local area network) support, this service offers
connectivity ranging from one megabit per second to a full one gigabit per
second bandwidth in one megabit per second increments.
- Meshed SONET technology -- Optically meshed SONET provides options
for the management and integration of nationwide network implementations.
Complementing SONET ring technology, meshed SONET architecture is a more
efficient utilization of network bandwidth as compared with traditional
SONET architectures.
- DWDM -- Dense wave division multiplexing is a technology that
allows transmission of multiple wavelengths of light over a single
fiber-optic strand, thereby increasing network capacity without additional
fiber builds.
- Closer spacing of transmission electronics and optronics --
Network spaces its transmission electronics and optronics at 40-mile
intervals resulting in a reduction in noise, dispersion, and other factors
inherent with longer intervals.
- Advanced fiber optic cable -- Newer fiber-optic cable, including
Corning's Enhanced LEAF(TM) fiber and Lucent's TruWave(TM) fiber, has a
wider spectral range than previously deployed fibers, enabling a greater
number of wavelengths to be sent over long distances.
Network centers. As of December 31, 2002, Network had 120 network centers
across the U.S. Network centers are environmentally controlled, secure sites
designed to house transmission, routing, and switching equipment and local
operational staff, as well as space and power for collocation customers.
Conduit and fiber-optic cable. The WilTel network was built for
expandability and flexibility and contains multiple conduits along more than 90
percent of the routes it constructed. To construct fiber-optic cable, the
manufacturer places fiber-optic strands inside small plastic tubes, wraps
bundles of these tubes with plastic, and strengthens them with metal. Network
then places these bundles inside a conduit, which is high-density polyethylene
hollow tubing one-and-one-half to two inches in diameter. The conduit is
generally buried approximately 42 inches underground along pipeline or other
rights of way corridors. Network also uses steel casing in high-risk areas,
including railroad crossings and high-population areas, thereby providing
greater protection for the cable. The first conduit contains a cable generally
housing between 96 and 144 fibers, and the second conduit or, where constructed,
third conduit, serves as a spare. The spare conduits allow for future technology
upgrades, potential conduit sales, and expansion of capacity at costs
significantly below the cost of
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new construction. After existing and anticipated leases of dark fiber, Network
generally plans to retain from 8 to 24 fibers throughout the network for its own
use.
Rights of way. The WilTel network was primarily constructed by digging
trenches along rights of way, or rights to use the property of others, which
Network obtained throughout the United States from various landowners.
Generally, where feasible, Network used the rights of way of pipeline companies
that WilTel believed provided greater physical protection of the fiber system
and resulted in lower construction costs than systems built over more public
rights of way. Almost all of its rights of way extend through at least 2018.
Rights of way are generally for terms of at least 20 years, and most cover
distances of less than one mile.
Monitoring. WilTel Communications uses its "One Call Center" to protect
against third-party activity (including activities like construction or
excavation in or near a network right of way) that could disturb the network's
fiber-optic cables. The Company's One Call Center was formed in 2002 and
protects approximately 16,000 miles of WilTel fiber-optic cable, operating in 38
states. The center works directly with state one-call agencies and is capable of
processing over one million tickets per year.
Local Network
As of December 31, 2002, Network had in operation on-net local services in
20 U.S. cities. These cities in which Network has completed local builds are:
Anaheim, Atlanta, Baltimore, Boston, Chicago, Dallas, Houston, Los Angeles,
Miami, Minneapolis, New York, Newark, Philadelphia, Phoenix, San Francisco, San
Jose, Santa Clara, Seattle, St. Louis, and Washington, D.C. The Company has
rights to utilize an additional 30,740 dark fiber miles in the U.S. through a
fiber lease agreement with Metromedia Fiber Network ("MFN"). In addition, under
the terms of this 2002 agreement with MFN, the Company has the right to lease an
additional 54,324 of dark fiber miles anywhere that MFN may construct or
currently owns dark fiber in the U.S. or Europe.
Global Network
Network has built facilities or entered into strategic relationships to
provide connectivity to Asia, Australia, New Zealand, Canada, Mexico, and
Europe. WilTel owns or has rights to use capacity in five undersea cables that
are described below. Sub-sea cable capacity is expressed using the European SDH
(Synchronous Digital Hierarchy) standard in terms of number of STM-1s, which has
a bit rate of approximately 155 million bits per second. It is equivalent to the
North American SONET standard OC-3. Utilizing its sub-sea capacity and border
crossings into Mexico and Canada, WilTel believes it may increase utilization of
its core U.S. network by providing domestic and global connectivity to WilTel's
U.S. and international customers.
China-U.S. cable and Japan-U.S. cable. WilTel acquired SBC's interests in
these two cables in June 2000. Both cables and their respective West Coast
interconnection points were operational at the end of 2001. The China-U.S. cable
is a 16,000-mile system, operating at 80 gigabits per second. The Japan-U.S.
cable is a 13,000 mile system, operating at 300 gigabits per second. WilTel has
14 STM-1s of capacity on China-U.S. and 98 STM-1s of capacity on Japan-U.S.
TAT-14 cable system. Under an agreement with Telia International Carrier
AB ("Telia"), the national communications service provider in Sweden, WilTel
obtained 16 STM-1s of capacity on the TAT-14 cable system, which connects the
United States with the United Kingdom, the Netherlands, Denmark, Germany, and
France. TAT-14 became operational in the fourth quarter of 2001 and operates at
640 gigabits per second.
AC-1 Network. In 1999, WilTel acquired one STM-1 of capacity from the
Atlantic Cable 1 Network connecting the continental U.S. and Europe. This cable
system was operational at the end of 2001 and operates at 40 gigabits per
second.
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Southern Cross Cable Network. WilTel acquired four STM-1s of capacity on
this network in April 2000. Southern Cross is an undersea cable network linking
Australia and New Zealand with Hawaii and the West Coast of the United States.
This cable became operational in November 2000 and operates at 200 gigabits per
second.
Europe. WilTel has the right to use up to approximately 27,000 kilometers
of European dark fiber (about 17,000 miles) or up to 31,000 kilometers of
European wavelengths (about 19,000 miles) from its agreements with Telia. WilTel
has the right to select either wavelengths or fiber strands across Telia's
network, depending on the route and WilTel's needs. The Telia network connects
22 of the largest European cities. Although WilTel has paid for these rights, it
is not using the fiber or wavelengths.
Australia. PowerTel, Ltd., a publicly traded company, operates
communications networks connecting and serving the three Australian cities of
Brisbane, Melbourne, and Sydney. WilTel, while owning a 45 percent economic
interest in PowerTel, consolidates PowerTel's results of operations with its own
because it is entitled to appoint a majority of the members of PowerTel's board
of directors (which, for consolidation purposes, constitutes control over
PowerTel's operations). In February 2003, WilTel's board of directors reviewed
options for the PowerTel investment, including whether or not WilTel should
pursue opportunities to sell its interest in PowerTel. While no firm commitments
have been approved, WilTel is actively engaged in discussions that could result
in a sale. WilTel's carrying value in PowerTel is not significant and any
proceeds received from a sale are not expected to have a significant impact on
WilTel.
Changes in Global Network assets during 2002. During 2002, consistent with
its efforts to streamline operations and focus on improving overall
profitability, WilTel relinquished certain capacity on the Tycom Atlantic cable
and the Asia-Pacific Cable Network (APCN-2) and sold certain capacity on other
sub-sea cable systems.
PRODUCTS AND SERVICES
Current Service Categories
Network's products and services fall into eight categories:
Packet-based data services. These services provide connectivity for
Internet, data, voice, and video networks at variable capacities to connect two
or more points. Specific packet-based data services include ATM, Frame Relay,
and Internet transport services as well as the virtual private network ("VPN")
service first introduced in March 2002. These services are provided over the
WilTel network and enable it to bill based on service features and usage.
Network also developed and provides transparent LAN services via wide-area
Ethernet services over its network.
Private line services. Network provides customers with fixed amounts of
point-to-point capacity. These services are billed on fixed monthly fees,
regardless of usage. Through Network's "Private Line QoS" capabilities,
introduced in 2001, a customer can choose from four different "quality of
service" levels in Network's Private Line service offerings to fit that
customer's applications based on options related to protection (back-up
capacity), service level agreements, pricing, and outage credits. Network has
international private line services over its TAT-14, Japan/US, China/US, and
Southern Cross cable systems, extending the domestic network to major global
demand centers.
Voice services. Network provides wholesale origination, transport, and
termination, as well as calling card, directory assistance, operator assistance,
and toll-free services. Network completes telephone calls to more than 200
countries worldwide.
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Optical wave services. This service is a point-to-point service, which has
no back-up capacity, that allows a customer exclusive use of a portion of the
transmission capacity of a fiber-optic strand rather than the entire fiber
strand. A purchaser of optical wave services installs its own electrical
interface, switching, and routing equipment.
Backhaul services. Network has interconnected international cable landing
stations on the West and East Coasts with fiber optic rings capable of
terminating cable traffic at specified Network centers. These services are made
available to providers that have their own respective undersea cable assets and
need domestic interconnection services only.
Dark fiber and conduit rights. Network sells rights to use dark fiber and
related services. In addition, from time to time, it sells rights to conduit and
installs conduit for its customers. Most of the network built by WilTel includes
two spare conduits and Network may sell rights to use at least one of them.
Purchasers of dark fiber rights install their own electrical and optical
transmission equipment. A purchaser of conduit rights typically installs its own
cable inside the conduit. Related services for both sales of rights for dark
fiber and conduits include collocation of customer equipment at Network's data
centers and other network equipment locations and maintenance of the purchased
fiber or conduit.
Collocation services. Network provides its customers with the opportunity
to reserve space in its network centers to install their own equipment necessary
to connect to the WilTel network. Customers have a variety of options on a
location-by-location basis, including standard collocation, bulk collocation
(either raw or ready-made), and Internet data center space.
Managed Services. Network Managed Services offers customers a single
source provider for end-to-end network solutions through a comprehensive suite
of products and services. Network Managed Services provides customers with an
array of services including, Lifecycle Program Management, Network Design,
Engineering, Implementation Services, Fiber and Facility Construction, Vendor
Support, Equipment Sales and Installation, IT Outsourcing, and Network
Operations including Field Maintenance.
CUSTOMERS
Network's customers currently include regional Bell operating companies,
cable television companies, Internet service providers, application service
providers, data storage service providers, managed network service providers,
digital subscriber line service providers, long distance carriers, local service
providers, utilities, governmental entities, educational institutions,
international carriers, and other communications services providers who desire
high-speed connectivity on a carrier services basis. Sales to SBC accounted for
47 percent of Network's 2002 revenues.
SALES AND MARKETING
Network's sales organization strives to develop strategic relationships
with customers to drive both incremental business and maintain current revenue
streams. Network targets a focused list of what it perceives to be quality
customers that require high volumes of bandwidth to operate. Product knowledge,
product application, pricing, delivery, and performance information are readily
available to provide products and services that are configured to allow the
Company to meet the unique needs of each customer. Sales teams are focused at
customer, channel, and geographic levels that are intended to allow WilTel to
manage the sales cycle effectively. As new network products and services become
available to customers, the sales organization focuses to expand existing
commercial relationships.
In support of WilTel's efforts to deliver an integrated portfolio of
innovative and competitive products to its customers, a centralized marketing
organization has been established to leverage synergies, focus sales and
10
business development efforts, and drive a company-wide approach to marketing and
product management. Key responsibilities of this organization include advanced
market planning and segmentation, product planning and development, product
marketing, lifecycle management, product economics, pricing, and competitive
analysis.
COMPETITION
As previously indicated under "Item 1(a) Uncertainty in the
Telecommunications Industry," the communications industry is highly competitive.
Some competitors in the markets of carrier services and fiber-optic network
providers may have personnel, financial, and other competitive advantages. In
the market for carrier services, Network competes primarily with AT&T, WorldCom,
Sprint, Qwest, Level 3, Global Crossing, 360 Networks, and Broadwing. Network
also competes with numerous other service providers that focus either on a
specific product or set of products or within a geographic region. Network
competes primarily on the basis of price, network reliability, customer service
and support, and transmission quality. Price competition has been fierce in
recent years and continues to be a major obstacle to achieving positive
operating cash flows. Network has only recently begun to offer some of its
services and products and, as a result, it may have fewer and less well
established customer relationships than some of its competitors. Network's
services within local markets in the United States face additional competitors,
including the traditional regional telephone companies and other local telephone
companies.
While it is possible that some of Network's competitors will cease
operations or lose business in the coming year due to the deteriorating economic
conditions and other difficulties that have affected companies throughout the
telecommunications industry, it is likely that a number of other competitors may
gain competitive advantages by successfully completing their respective
restructuring or bankruptcy reorganization processes or through consolidation
activities.
VYVX
Founded in 1989, Vyvx (formerly referred to as the "Emerging Markets"
segment) enables its customers to move media regardless of format (analog or
digital), method (fiber-optics or satellite), or geographic reach (domestic or
international). In 1990, Vyvx launched the first-ever video transmission over a
terrestrial network service offering and carried the first of fourteen
consecutive Super Bowls for the NFL and its broadcasters. For the past fourteen
years, Vyvx has provided high quality, reliable, network-based solutions for
aggregating, managing, and distributing mission-critical content for content
owners and rights holders. Vyvx also offers a fully integrated hybrid
satellite/terrestrial service to support dedicated and occasional requirements
for the distribution of live content for customers like CNN and Fox in their
coverage of breaking news events in remote geographies (e.g., war in the Middle
East).
REVENUES
Excluding sales made by Vyvx to the Network segment, Vyvx contributed the
following revenue for the past three years:
TOTAL REVENUE PERCENTAGE OF
YEAR (IN THOUSANDS) CONSOLIDATED REVENUES
---- -------------- ---------------------
2002 $ 144,037 12%
2001 $ 164,322 14%
2000 $ 168,332 20%
11
Vyvx is currently the media industry's market leader in video transmission
services over fiber. Vyvx offers a suite of services to the media industry for
video transmission of various formats and picture quality. In addition, Vyvx
works with its customers on new services based upon the customers' need.
PRODUCTS AND SERVICES
Vyvx's primary products and services fall into the following categories:
Fiber Optic and Satellite Video Transport Services. Vyvx uses the
following products to provide audio and video feeds over fiber or satellite for
its broadcast and production customers.
Occasional and Dedicated Fiber MPEG-2 Compressed Video. MPEG-2 compressed
video services provide multiple bandwidth choices over a single TV-1 local loop
terminating at a Vyvx video network center or a video-hub facility. The eight
megabits per second service is well suited for news feeds with cameo
appearances, while the 18 megabits per second service is more appropriate for
feeds containing rich content requiring editing and further production work.
Occasional and Dedicated 45 megabits per second Video. This is a 45
megabits per second transmission service between 42 Television Switching Centers
("TSCs") and five Television Centers in the U.S. The occasional service platform
supports news, sports, and special event broadcasting via connectivity to 47 of
the top designated market areas, in excess of 40 production facilities, and 100
sports facilities across the nation. The 45 megabits per second transmission
service includes the Sports Package and the VenueNet(R) options as well as the
First Video(R) Affiliate program.
Sports Package. This service bundles all transmission pieces required by
the sports leagues, providing customers with a centralized environment. Service
includes both local access circuits and phone lines and is available at all NFL,
NBA, MLB, and NHL venues.
VenueNet(R). An enhanced local access demarcation unit available at sports
venues, VenueNet permits advanced digital video transmission signal
capabilities, dual transmission paths to and from the venue, and diversity out
of the venue to the TSC within each city of origin. This service includes DS-3
and/or TV-1 connectivity and continuous monitoring, on-premises equipment rack,
weatherproof demarcation box, and multiple telephone connections.
First Video(R) Affiliates ("FVAs"). Members of this affiliate-marketing
program are full-service production facilities (production, post, and graphics)
that maintain full-time connectivity to the WilTel network. Serving as access
points to the WilTel network, FVAs use a combination of Vyvx services such as 45
megabits per second video, Fiber MPEG-2 Compressed Video, satellite, and
teleport to serve customers including national news organizations, film
production studios, and others requiring multimedia production and distribution.
Teleport and Transponder. Vyvx owns and operates four teleports located in
Atlanta, Denver, Los Angeles, and New Jersey. Transponder services include
commercial relationships with PanAmSat, Loral, and other providers or resellers
of satellite capacity. The Vyvx Teleport and Transponder Services deliver
custom-engineered solutions for Internet, video, and data transmissions via
satellite.
International Video Transmission. By combining the reach and capability of
the WilTel fiber optic network, teleports, and access to satellite transponders,
international video services enable large-capacity and broadcast-quality media
content distribution. Internet distribution is provided via satellite, Internet
peering, local connectivity, and customized telecommunications solutions to
facilitate the expansion of voice and data networks.
12
Advertising and Syndicated Programming Distribution Services
Audio Distribution. Vyvx sends over 470,000 radio spots to stations
annually via electronic and physical distribution. Spots are distributed to over
7,500 stations in North America via the Internet using no proprietary hardware.
Electronically distributed radio spots use a Secure Sockets Layer that ensures a
protected environment for spot transport, preview, and download.
Video Distribution. Through the combination of electronic and physical
distribution, Vyvx is an industry leader in advertising distribution by
delivering in excess of 2.5 million video spots in 2002.
Electronic Distribution. Using dedicated satellite and IP technologies,
Vyvx delivers studio-quality television spots to The Catch Server(TM) units,
located at more than 642 television stations across the United States. The files
are encoded and transmitted as MPEG-2, 4:2:2 format.
Physical Distribution. The Vyvx facility located in Memphis, Tennessee, is
situated within minutes of the FedEx(R) distribution hub, allowing the company
to offer late cut-off options for last-minute distribution.
In addition to the products and services detailed above, Vyvx offered,
until December 31, 2002, a number of services related to content collection,
management and distribution. The market for these products materialized at a
slower rate than expected, resulting in lower returns than had been anticipated.
Therefore, Vyvx decided to exit these business lines through sale of the product
line or discontinuation of the product offering. Affected products which are no
longer offered are as follows: Digital Exchange, Digital Library, Managed
Application Hosting, Managed Web Hosting, Activecast(SM), ActivecastFS(SM),
Talkpoint(SM), Web Content Publishing, and Streaming Distribution.
CUSTOMERS
Vyvx sells to media content service providers and businesses that use
media content as a component of their business. It does not compete with its
media customers for retail end-users. It has over 2,500 customers, including
major broadcast and cable television networks, news services, professional and
collegiate sports organizations, advertising agencies and their advertisers,
television companies, and movie production companies. Approximately 50% of
Vyvx's total revenue for 2002 was derived from its top 10 customers. Fox
Entertainment Group, Inc. and its parent company The News Corporation Limited,
through their various news, sports, and entertainment businesses, accounted for
approximately 14 percent of Vyvx's total revenues in 2002.
SALES AND MARKETING
Vyvx has sales personnel located in offices in 11 cities throughout the
United States who serve both domestic and international customers. The largest
sales office is in New York City, where many of Vyvx's largest clients are
based.
COMPETITION
No single competitor currently exists possessing the comprehensive set of
services being offered by Vyvx. Niche competitors for various services include
the following: Globecast for standard 45 megabit per second video transmission
service as well as Ascent Media and Triumph Communications for compressed video
transmission services. Advertising distribution competitors include Pathfire,
StarNet, LP, and DG Systems, Inc.
13
(d) OTHER INFORMATION
INVESTMENTS
In the past, the Company worked with and invested in technology companies
in their developmental stages to facilitate improvements in its network through
the rapid adoption and deployment of those technologies that offer the ability
to lower costs and increase transmission speeds and capacity. The Company is
currently considering disposing of these investments, which had a carrying
amount of zero at December 31, 2002. While the Company may continue to work with
technology companies in the future if it believes it could result in
improvements to its network, it is unlikely that the Company will be making any
investments of capital.
FOREIGN INVESTMENTS
As of December 31, 2002, the carrying value of the Company's investment in
Manquehue Net, S.A., a high-capacity communications services provider within the
Santiago, Chile metropolitan area, was zero. Additionally, in 2001, the Company
fully impaired its investment in Silica Networks, a network linking the major
Argentine cities with Santiago, Chile. In September 2002, the Company sold all
of its interests in Silica Networks.
STRATEGIC ALLIANCES AND RELATIONSHIPS
WilTel enters into strategic alliances with communications companies to
secure long-term, high-capacity commitments for traffic on the WilTel network
and to enhance its service offerings.
SBC Communications Inc. SBC is a major communications provider in the
United States. SBC currently provides local services in the south central and
Midwest regions of the United States and in California, Nevada, and Connecticut.
SBC is WilTel's largest customer, generating revenue that represents
approximately 43 percent of 2002 consolidated revenues.
WilTel has entered into agreements with SBC that provide that:
- until 2019, WilTel is SBC's preferred provider for domestic voice
and data long distance services and select international wholesale
services, requiring that SBC seek to obtain these services from
WilTel before it obtains them from any other provider; and
- until 2019, SBC is WilTel's preferred provider for select local
exchange and various other services, including platform services
supporting its switched voice services network, requiring that
WilTel seek to obtain these services from SBC before it obtains them
from any other provider.
For the services each must seek to obtain from the other, the prices,
determined separately for each product or service, generally will be equal to
the lesser of the cost of the product or service plus a specified rate of
return, the prices charged to other customers, or, in some circumstances, a
specific rate. If either party can secure lower prices for comparable services
that the other party will not match, then that party is free to utilize the
lowest cost provider.
Both WilTel and SBC can provide services or products to other persons. In
addition to being a preferred provider, each party may also sell or utilize the
products or services purchased from the other to provide products or services to
other persons. However, if SBC establishes a wholesale distribution channel to
resell the network capacity purchased from WilTel to another provider of carrier
services, WilTel has the right to increase the price it charges SBC for the
services SBC resells in this manner. While the terms of these agreements with
SBC are intended to comply with restrictions on SBC's provision of long distance
services, various aspects of these
14
arrangements have not been tested under the Telecommunications Act of 1996;
however, no party has challenged the validity of the arrangement.
WilTel and SBC have also agreed to a mechanism for the development of
projects that would allow the interconnection of the SBC network with the WilTel
network based on the unanimous decision of committees composed of an equal
number of representatives from WilTel and SBC. If a committee does not approve a
project, each of WilTel and SBC have the right, subject to certain exceptions,
to require the other party to develop a project in exchange for payment by the
requesting party of the direct costs and cost of capital required to complete
the project or to pursue the project on its own. In addition, upon SBC receiving
authorization from the FCC to provide long distance services in any state in its
traditional telephone exchange service region (see Item 1(d) "Other
Information--Regulation" below), SBC has the option to purchase from WilTel at
net book value all voice or data switching assets that are physically located in
that state and of which SBC has been the primary user. The option must be
exercised within one year of the receipt of authorization. WilTel then would
have one year after SBC's exercise of the option to migrate traffic to other
switching facilities, install replacement assets, and complete other transition
activities. This purchase option would not permit SBC to acquire any rights of
way that WilTel uses for its network or other transport facilities that it
maintains. This option has not been exercised and is no longer available for
some states where early authorization was received. Upon termination of the
alliance agreements with SBC, SBC has the right in certain circumstances to
purchase voice or data switching assets, including transport facilities, of
which SBC's usage represents 75 percent or more of the total usage of these
assets.
SBC may terminate the provider agreements if any of the following occurs:
- WilTel begins to offer retail long distance voice transport or local
exchange services on its network, except in limited circumstances;
- WilTel materially breaches its agreements with SBC, causing a
material adverse effect on the commercial value of the relationship
to SBC; or
- WilTel has a change of control without SBC's consent.
WilTel may terminate the provider agreements if any of the following occurs:
- SBC has a change of control; or
- there is a material breach by SBC of the agreements, causing a
material adverse effect on the commercial value of the relationship
to WilTel.
Either party may terminate a particular provider agreement if the action
or failure to act of any regulatory authority materially frustrates or hinders
the purpose of that agreement. There is no monetary remedy for such a
termination.
In the event of termination due to its actions, WilTel could be required
to pay SBC's transition costs of up to $200 million. Similarly, in the event of
termination due to SBC's actions, SBC could be required to pay WilTel's
transition costs of up to $200 million, even though WilTel's costs may be
higher.
Since June of 2000, the FCC has authorized SBC to provide long distance
service in Texas, Oklahoma, Kansas, Arkansas, Missouri, and California. SBC has
advised WilTel that it expects to be granted authorization in Michigan and
Nevada during the second quarter of 2003 and in Illinois, Indiana, Ohio and
Wisconsin within the next 12 months.
15
In August 2001, WilTel signed a preferred provider status agreement with
the long-distance telephone affiliate of SBC, SBC Long Distance ("SBC-LD").
WilTel is the preferred provider for SBC-LD's U.S.-originated international
long-distance traffic. In addition, as previously stated, in September 2001,
WilTel acquired two gateway switches from another SBC subsidiary, AGGS, and in
turn, WilTel assumed the wholesale international long-distance business
conducted by AGGS. These gateways allow the Company to offer outbound foreign
termination and inbound domestic termination to other carrier customers.
During 2002, SBC and WilTel negotiated a series of changes to the alliance
agreements that more clearly specify the products and services for which WilTel
is the preferred provider, establish pricing methodologies, and establish
tracking mechanisms and criteria for ensuring performance of both parties under
the agreements. The result of those negotiations were reflected in amendments
entered into on September 25, 2002, when SBC also entered into a stipulation
agreement to resolve issues related to the WCG bankruptcy (see Item 1(d) "Other
Information--Overview of the Chapter 11 Proceedings" below).
Other Strategic Alliances. WilTel has also established strategic alliances
with Telefonos de Mexico, S.A. de C.V., the largest communications provider in
Mexico that provides long distance and local services primarily in Mexico, and
with KDDI Corporation ("KDDI Japan") and KDDI America, Inc. ("KDDI") that are
each wholly owned subsidiaries of DDI Corporation, the largest international
telecommunications company in Japan. WilTel intends to continue to pursue
additional strategic alliances.
EMPLOYEES
As of December 31, 2002, the Company had a total of approximately 2,354
employees, one of whom was covered by a collective bargaining agreement. During
2002, the Company reduced its workforce by over 1,500 employees.
REGULATION
Overview
The Company is subject to federal, state, local, and foreign laws,
regulations, and orders that affect the rates, terms, and conditions of certain
of its service offerings, its costs, and other aspects of its operations.
Regulation of the telecommunications industry varies from state to state and
from country to country, and it changes regularly in response to technological
developments, competition, and government policies. Many regulations to which
the Company is subject are the subject of various judicial proceedings,
legislative hearings and administrative proposals, and may change. The Company
cannot predict what impact, if any, such proceedings or changes may have on its
business or results of operations, nor can it guarantee that domestic or
international regulatory authorities will not raise material issues regarding
its compliance with applicable regulations.
The FCC has jurisdiction over the Company's facilities and services to the
extent those facilities are used in the provision of interstate
telecommunications services (services that originate and terminate in different
states) or international telecommunications services (services that originate in
a foreign country and terminate in the U.S. or that originate in the U.S. and
terminate in a foreign country). State regulatory commissions generally have
jurisdiction over facilities and services to the extent the facilities are used
in intrastate telecommunications services. Foreign laws and regulations apply to
telecommunications that originate or terminate in a foreign country. Generally,
the FCC and state commissions do not regulate Internet, video conferencing, or
certain data services, although the underlying telecommunications services
components of such offerings may be regulated in some instances. The Company's
operations also are subject to a variety of environmental, building, safety,
health, and other governmental laws and regulations.
16
Federal Regulation
The Communications Act of 1934. The Communications Act of 1934, as amended
(the "Communications Act") grants the FCC authority to regulate interstate and
foreign communications by wire or radio. WilTel is regulated by the FCC as a
non-dominant carrier and is subject to less comprehensive regulation than
dominant carriers under the Communications Act, including certain provisions of
Title II of the Communications Act applicable to all common carriers. Pursuant
to Title II, WilTel must offer service upon reasonable request therefor and
pursuant to just and reasonable charges and practices, and may not make any
unjust or unreasonable discrimination in charges or practices. The FCC has
authority to impose more stringent regulatory requirements on non-dominant
carriers.
FCC regulations affect growth opportunities for WilTel and some of its
customers. Various aspects of the regulations are or will be subject to future
FCC and appellate proceedings. Under Section 10 of the Communications Act, the
FCC must not apply any regulation to a telecommunications carrier if it
determines that enforcement is not necessary to ensure that charges, practices,
classifications, and services are just and reasonable, and not unjustly or
unreasonably discriminatory; that enforcement is not necessary to protect
consumers, and that forbearance is consistent with the public interest. In
making this public interest determination, the FCC must consider whether
forbearance will promote competition in the market for telecommunications
services. Under Section 11 of the Communications Act, in every even-numbered
year the FCC must review all rules then in effect that apply to the operations
or activities of any telecommunications service provider, must determine whether
any such rule is no longer necessary in the public interest as the result of
meaningful economic competition between providers of such service, and must
repeal or modify any rule it determines to be no longer in the public interest.
While these provisions may result in diminished regulation over time, WilTel
cannot predict the outcome of any such future proceedings or their impact on
WilTel's business or operations.
WilTel has obtained authority from the FCC to provide international
services between the United States and foreign countries, and has registered
with the FCC as a provider of domestic, interstate long distance services.
WilTel believes that it is in compliance with applicable federal laws and
regulations, but cannot guarantee that the FCC or third parties will not raise
issues regarding its compliance with applicable regulations.
The Telecommunications Act of 1996. The Telecommunications Act of 1996
(the "1996 Act") amended the Communications Act to establish a framework for
fostering competition in the provision of local and long distance
telecommunications services.
Long Distance Regulation. Subject to specified limitations and conditions,
Section 271 of the Communications Act allows incumbent local exchange carriers
("ILECs"), including the RBOCs and their respective affiliates, to petition the
FCC for authority to enter the long distance telecommunications services market
by offering long distance service in any in-region state (defined as any state
in which an RBOC or its affiliate was authorized to provide wireline telephone
exchange service following the breakup of AT&T). The FCC may grant such
authority if it finds that a given RBOC satisfies certain procedural and
substantive requirements, including a fourteen-point competitive checklist set
forth in the 1996 Act, and determines that granting the petition is in the
public interest. The 1996 Act also allows each RBOC immediately to provide long
distance services in any out-of-region state and to own up to ten percent of the
equity of a long distance carrier operating in any in-region state. In a state
where an RBOC has received authority to provide long distance telecommunications
service, Section 272 of the Communications Act requires the RBOC to maintain a
separate affiliate, and to comply with certain structural and operational
safeguards, for its long distance operations. This separate affiliate
requirement expires on a state-by-state basis three years after an RBOC first
obtained approval to provide long distance service in a given state, unless the
FCC extends the three-year period.
To date, the FCC has granted Section 271 authority to SBC in six of its 14
in-region states; to Verizon in each of its fourteen in-region states; to
BellSouth in each of its nine in-region states; and to Qwest in nine of its
fourteen in-region states.
In addition, two of the RBOCs have Section 271 applications pending. SBC
has filed for approval in Michigan and Nevada; the FCC has until April 16, 2003,
and April 19, 2003, respectively, to render decisions on
17
those applications. Qwest has filed for authority to provide long distance
services in New Mexico, Oregon, and South Dakota; the FCC has until April 16,
2003, to render decisions on those applications. The Company expects these RBOCs
to file additional petitions for entry into the long distance market in all of
their remaining in-region states within the next twelve months. The timing of
such approvals depends on many variables and it is impossible to predict with
certainty when the RBOCs will receive such approvals in all states, or the
outcome of any appeals of such approvals.
The Company believes that the RBOCs' and other companies' entry into the
long distance market may provide opportunities for the Company to sell dark
fiber or lease high-volume long distance capacity. However, increased
competition from the RBOCs could have an adverse effect on WilTel's business, as
the RBOCs may be able to offer integrated local and long distance services and
may enjoy significant competitive advantages, but the Company cannot predict at
this time the likelihood or impact, if any, of such competition. In addition,
changes in an RBOC's ability to offer long distance service under the provisions
of Section 271 and Section 272 of the Communications Act are likely to have an
effect on the volume of traffic transported by WilTel for its RBOC customers and
could pose risks to WilTel's business in the future, although the impact of any
such change cannot yet be determined.
Local Service Regulation. In addition to overseeing the entry of the RBOCs
into the long distance market, the FCC was required, pursuant to the 1996 Act,
to establish national rules implementing the local competition provisions of the
1996 Act. More specifically, the 1996 Act imposed duties on all local exchange
carriers, including new entrants (sometimes referred to as competitive local
exchange carriers, or "CLECs") to provide network interconnection, reciprocal
compensation, resale, number portability, and access to rights-of-way. Where
WilTel provides local telecommunications services, it must comply with these
statutory obligations and the FCC's implementing rules.
The 1996 Act imposed additional duties on ILECs, including the duty to
negotiate in good faith with competitors to provide interconnection to their
networks; to permit collocation of competitors' equipment at ILEC premises; to
provide access on an unbundled basis to individual network elements ("UNEs"),
including network facilities, features, and capabilities, on non-discriminatory
and cost-based terms; and to offer their retail services for resale at wholesale
rates. The 1996 Act directed the FCC to prescribe methods for state regulatory
commissions to use in setting rates, and left intact the states' authority to
set rates.
In August 1996, the FCC issued comprehensive regulations implementing the
local competition provisions of the 1996 Act. A series of subsequent appellate
court decisions, including decisions from the Eighth Circuit Court of Appeals
and the United States Supreme Court, resolved that the FCC has jurisdiction to
implement such regulations, including the authority to establish pricing
guidelines and a forward-looking cost methodology referred to as total element
long run incremental cost ("TELRIC"). Although the FCC may revisit the TELRIC
methodology at some point, WilTel cannot predict the outcome of any such a
review or the effect of any resulting regulatory changes.
On February 21, 2003, the FCC adopted an order amending its UNE rules that
require ILECs to make UNEs available to competitors. Although the text of the
order has not yet been released, it has been reported that, among other changes,
the new rules provide a substantial role for state regulators to apply the
statutory "impairment" standard as interpreted by the FCC for purposes of
determining whether dark fiber, local switching, and other network elements must
be unbundled, and eliminate "line sharing" (a mandate to ILECs to unbundled the
high-frequency spectrum of copper loops). WilTel cannot at this time determine
the effect, if any, of the FCC's decision on WilTel's business or operations, or
the timing or outcome of any reconsideration or appellate proceedings.
The FCC's collocation rules generally require ILECs to permit competitors
to collocate, at ILEC premises, equipment used for interconnection and/or access
to UNEs. Changes to those rules, upheld in 2002 by the D.C. Circuit, allow
competitors to collocate multifunctional equipment and require ILECs to
provision cross-connects between collocated carriers. WilTel cannot determine
the effect, if any, of future changes in the FCC's collocation rules upon
WilTel's business or operations.
18
A carrier that seeks to interconnect with ILECs, obtain UNEs, or resell
ILEC services may negotiate its own agreement for interconnection or UNEs. It
may also adopt, in whole or in part, existing agreements approved by the
applicable state regulatory authority. Negotiated or adopted agreements must be
filed with and approved by state regulatory commissions. On February 21, 2003,
the FCC adopted a Notice of Proposed Rulemaking proposing to eliminate the "pick
and choose" rule that generally allows competitors to adopt selected provisions
of an approved interconnection agreement without adopting the entire agreement.
The text of that notice has not yet been released. Either party to a negotiated
agreement has the right to seek arbitration with the state regulatory authority
of any unresolved issues and arbitration decisions involving interconnection
arrangements may be appealed to federal courts. WilTel is not a party to any
interconnection agreement arbitration proceeding. Other interconnection
arbitration agreement proceedings before various state commissions may result in
decisions that could impact WilTel's business, but WilTel cannot at this time
determine the extent of such impact, if any.
To date, WilTel has entered into state-approved interconnection agreements
with ILECs for multiple states, including with Verizon in New York,
Massachusetts, Pennsylvania, Maryland, Virginia, and the District of Columbia;
with BellSouth in Florida and Georgia; and with SBC in California, Illinois,
Michigan, Ohio, Nevada, Missouri, and Texas. WilTel is in the process of
entering into interconnection agreements with Qwest in Arizona, Colorado,
Minnesota, Oregon, and Washington. Upon expiration of its agreements, which
typically are for two- or three-year terms, WilTel may negotiate or adopt a new
agreement, or in some instances an agreement may continue on a month-to-month
basis. WilTel's interconnection agreements contain provisions that allow changes
to the agreements based upon changes in law. The FCC's February 21, 2003, UNE
decision could result in adverse impacts on WilTel's business, but WilTel cannot
determine at this time the effect, if any, of that decision on its existing
interconnection agreements until the complete order is released.
Access Regulation. Federal regulation affects the cost and thus the demand
for long distance services through regulation of interstate access charges,
which are the local telephone companies' charges for use of their exchange
facilities in originating or terminating interstate transmissions. The FCC
regulates the interstate access rates charged to long distance carriers by ILECs
and CLECs for the local origination and termination of interstate long distance
traffic. Those access rates make up a significant portion of the cost of
providing long distance traffic. Since the 1996 Act, the FCC has restructured
the access charge system, resulting in significant downward changes in access
charge rate levels.
On May 31, 2000, the FCC adopted a proposal submitted by a coalition of
long distance companies and RBOCs, referred to as "CALLS," pursuant to which
ILEC access rates must be decreased in stages over five years. At the same time,
the FCC increased non-usage sensitive charges on local lines, eliminated
non-usage sensitive charges on interexchange carriers, modified the productivity
factor used in part to determine price caps on access charges for some local
telephone companies, and created an explicit universal service component to
recover some implicit subsidies in access charges that were effectively
eliminated by the order. On September 10, 2001, the United States Court of
Appeals for the Fifth Circuit upheld most of the FCC's CALLS order, but remanded
for further consideration portions of the order that created a new universal
service fund and that set a factor applied annually to reduce access rates at a
certain pace. WilTel cannot determine at this time the outcome or likely effect,
if any, of that remand proceeding on the business or operations of the Company.
On April 27, 2001, the FCC issued a ruling regarding the interstate access
charges levied by CLECs on long distance carriers. Effective June 20, 2001, CLEC
access charges were required to be reduced over a three-year period to the level
charged by ILECs in the competing area. The FCC-ordered reduction in CLEC access
charge rates has resulted in a substantial reduction in the per-minute rate
CLECs charge for interstate access services.
Over the last several years, the FCC has granted ILECs significant
flexibility in pricing interstate special and switched access services. More
specifically, in August 1999, the FCC granted immediate pricing flexibility to
many ILECs and established a framework for granting greater flexibility in the
pricing of all interstate access services once an ILEC market satisfies certain
prescribed competitive criteria. In February 2001, the D.C. Circuit
19
upheld the FCC's prescribed competitive criteria. To date, the FCC has granted
pricing flexibility in numerous specific markets to Verizon, BellSouth, SBC, and
Qwest. This pricing flexibility may result in ILECs lowering their prices in
high traffic density areas, including areas where WilTel competes or plans to
compete. WilTel anticipates that the FCC will grant ILECs greater pricing
flexibility as the number of actual and potential competitors increases in each
of these markets.
On April 19, 2001, the FCC adopted a Notice of Proposed Rulemaking seeking
to unify its inter-carrier compensation rules. The FCC seeks to address
disparities in rates for access charges and reciprocal compensation (the rates
that carriers pay each other for completing calls exchanged between them). The
FCC's proposal seeks comments on a transition to a "bill and keep" system
pursuant to which carriers would not exchange cash compensation, but would
provide call completion services free of charge. Adoption by the FCC of a
unified inter-carrier compensation regime that adopts a "bill and keep" regime
or that otherwise reduces the rates that carriers may charge for access charges
could significantly reduce WilTel's inter-carrier compensation revenues. WilTel
is unable to determine at this time the outcome of this proceeding or the
resulting impact, if any, on its business.
In a 1998 report to Congress, the FCC suggested, but did not conclude,
that telephone calls using Internet protocol ("IP") could be considered
telecommunications services. More recently, the FCC has been asked to consider,
in a limited fashion, the regulatory implications of such "voice-over-IP"
technology. Certain ILECs have asked the FCC to rule that certain transmission
services, such as calls made over the Internet, are subject to regulation as
telecommunications services including the assessment of interstate switched
access charges and universal service fund assessments. On October 18, 2002, AT&T
filed a petition for declaratory ruling that phone-to-phone IP telephone service
is an enhanced service carried over the same common Internet backbone facilities
as other public Internet traffic, that as such it is a local service exempt from
access charges, and that all other phone-to-phone IP and voice-over-IP telephony
services are exempt from access charges applicable to circuit-switched
interexchange calls unless the FCC prospectively rules otherwise. On February 5,
2003, pulver.com filed a petition for declaratory ruling that a service offering
that uses IP voice communications is neither telecommunications nor a
telecommunications service. The FCC may consider these and related questions,
including the implications for other types of IP technology and numbering, on a
broader scale later this year. As carriers and their customers migrate to IP and
packet-based technologies, the outcome of such proceedings is likely to affect
carrier-carrier and carrier-customer relationships. WilTel is unable to
determine at this time the outcome of any of these proceedings or the impact, if
any, they could have on its business.
Universal Service. Pursuant to the 1996 Act, the FCC in 1997 established a
significantly expanded universal service regime to subsidize the cost of
telecommunications services to high-cost areas, to low-income customers, and to
qualifying schools, libraries and rural health care providers. Providers of
interstate and international telecommunications services, and certain other
entities, must pay for these programs. The calculation of whether communications
are interstate typically is based on interstate minutes of use; however, FCC
rules also provide that if more than 10% of traffic carried over a private or
wide area telecommunications service line is interstate, then the revenues and
costs generated by the entire line are classified as interstate. With certain
exceptions, revenues derived from the provision of interstate and international
telecommunications services (including access to interexchange service, special
access, WATS, subscriber toll-free service, 900 services, message telephone
services, private line service, Frame Relay and similar services, telex,
telegraph, video services, satellite services, and resale services) to domestic
end-users, including enhanced services providers, are subject to assessment for
contributions to a Universal Service Fund. Excluded services and revenues
include information services; revenues from carrier billing and collection
services; revenues from the sale, lease, installation, maintenance, or insurance
of customer premises equipment; inside wiring charges; and the sale or lease of
transmission equipment, such as dark fiber, that is not provided as part of a
telecommunications service.
Current rules require contributors to make quarterly and annual filings
reporting their revenues, and the Universal Service Administrative Company
issues monthly bills for the required contribution amounts, based on a quarterly
contribution factor approved by the FCC. The FCC announced assessments for the
first quarter of 2003
20
of 7.28 percent, the same contribution factor used for the last two quarters of
2002. The contribution factor may be higher in future quarters. A portion of
WilTel's gross revenues from the provision of interstate and international
services are subject to these assessments, which may in many cases be recovered
from its customers. Unrecovered assessments increase WilTel's costs.
On December 13, 2002, the FCC issued revised universal service rules, and
proposed further changes to the universal service contribution methodology. The
new rules, which became effective January 29, 2003, and likely will be the
subject of further reconsideration and appellate proceedings, will apply on an
interim basis while the FCC considers additional changes. One such interim rule
requires that, beginning April 1, 2003, contributions will be based on
contributors' projected collected end-user telecommunications revenues, rather
than on historical gross-billed revenues. Contributors will be required to
report both historical gross-billed revenues from the prior quarter, and
projected gross-billed and collected end-user interstate and international
telecommunications revenues for the upcoming quarter. The FCC will continue to
set a quarterly contribution factor.
One change to the universal service contribution methodology the FCC is
considering is whether to adopt a "connection-based" or other system of
contribution. Under a connection-based system, contributions might be assessed
on the basis of a flat monthly fee, capacity, or telephone number assignments,
for residential, single-line and multi-line business, payphone, and mobile
wireless connections, both switched and private line. A change in the
contribution methodology could result in WilTel paying a larger percentage of
its revenues to the universal service fund.
WilTel and other contributors to the federal universal service fund may
recover their contributions in any manner that is equitable and
nondiscriminatory, but, beginning April 1, 2003, may not mark up their federal
universal service recovery above the amount of the contribution factor. Carriers
may recover their contribution costs through their end-user rates, or through a
line item (stated as a flat amount or percentage), provided that the line item
does not exceed the total amount associated with the contribution factor. This
rule is the subject of a petition for reconsideration pending before the FCC,
and, on February 21, 2003, several ILECs petitioned for an interim waiver of the
rule pending resolution of the reconsideration proceeding. The new rules also
allow contributors to renegotiate contract terms that prohibit the pass-through
of universal service recovery charges.
Detariffing. In November 1996, the FCC ordered non-dominant long distance
carriers to cease filing tariffs for domestic, long distance services. Tariffing
is a traditional requirement of telephone companies whereby such companies
publicly submit at state and federal regulatory agencies all terms, conditions,
pricing, and available services governing the sale of all regulated services to
the public. In March 1999, the FCC adopted further rules that, while maintaining
mandatory detariffing, required long distance carriers to make specific public
disclosures on Internet web sites of their rates, terms and conditions for
domestic interstate services. In April 2000, the D.C. Circuit affirmed the FCC's
mandatory detariffing order in its entirety. The FCC subsequently implemented a
transition period to allow carriers to withdraw federal tariffs and move to
contractual relationships with their customers. All carriers, including WilTel,
were required to complete the process of detariffing interstate domestic
commercial (customer-specific) services by January 31, 2001 and to detariff
consumer (mass market) services by July 31, 2001. The FCC further required those
carriers with corporate web sites to post information relating to the rates,
terms, and conditions of such services on their web sites. In March 2001, the
FCC imposed similar detariffing requirements with respect to international
services provided by non-dominant carriers such as WilTel. The detariffing of
international services was required to be completed by January 28, 2002. The FCC
requires carriers providing international interexchange services to adhere to
the same web site posting requirements as those applicable to domestic
detariffing. The FCC's detariffing actions may significantly affect the ability
of non-dominant, interstate and international service providers such as WilTel
to rely on filed rates, terms, and conditions as a means of providing notice to
customers of prices, terms and conditions under which they offer their domestic,
interstate and international services; such carriers instead will have to rely
on individually negotiated agreements with end users.
21
In 2002, a coalition of consumer-protection advocates and state regulatory
commissions filed a petition for expedited rulemaking with the FCC, asking the
FCC to require non-dominant interexchange carriers to give at least 30 days
advance written notice to their presubscribed customers of any material change
to the rates, terms or conditions of a carrier-customer agreement. The coalition
argues that since detariffing took effect, customer agreements generally offered
by large long-distance carriers reserve for the carriers the right to
unilaterally change rates, terms and conditions at any time, thereby preventing
consumers from making informed decisions regarding the terms under which they
acquire service from carriers. To date, the FCC has not instituted such a
proceeding. If adopted, such requirements could constrain the ability of WilTel
to modify its rates, terms and conditions in response to competitive market
pressures.
Broadband Regulation. The FCC to date has treated Internet service
providers as enhanced service providers rather than common carriers. As such,
Internet service providers generally have been exempt from various federal and
state regulations, including the obligation to pay access charges and contribute
directly to universal service funds. On December 20, 2001, the FCC issued a
Notice of Proposed Rulemaking seeking comment on whether ILEC broadband
offerings are telecommunications services subject to Title II jurisdiction or,
as the FCC already has concluded with respect to cable modem service,
information services subject only to Title I jurisdiction. A decision is
expected in the first quarter of 2003. In a separate Notice of Proposed
Rulemaking released February 15, 2002, the FCC sought comment on issues related
to broadband access to the Internet over domestic wireline facilities, including
whether facilities-based broadband Internet access providers should be required
to contribute to support universal service. On October 3, 2001, SBC filed a
petition for forbearance from the application of tariff requirements to its
provision of advanced services. On December 31, 2002, the FCC granted SBC's
petition to the extent it requested forbearance from tariff regulation of
advanced services that SBC provides through its advanced service affiliate,
which provides intraLATA advanced services in SBC's in-region states. The FCC
denied other aspects of the petition without prejudging issues under
consideration in the ILEC broadband rulemaking. WilTel cannot determine at this
time the outcome of these proceedings or the impact, if any, such outcome may
have on its business.
State Regulation
The Communications Act generally prohibits state and local governments
from enforcing any law, rule, or legal requirement that prohibits or has the
effect of prohibiting any person from providing any interstate or intrastate
telecommunications service. As a result, WilTel is free to provide the full
range of local, long distance and data services in all states in which it
currently operates, and in any states into which it may wish to expand. This
regulatory environment both increases WilTel's potential for growth and
increases the amount of competition to which WilTel may be subject. However,
states retain substantial jurisdiction over intrastate matters, and generally
have adopted regulations intended to protect public safety and welfare, ensure
the continued quality of communications services, and safeguard the rights of
consumers. Some states impose assessments for state universal service programs
and for other purposes. To the extent that WilTel provides intrastate
telecommunications services, WilTel is subject to various state laws and
regulations.
Most state public utility and public service commissions require some form
of certificate of authority or registration before offering or providing
intrastate services, including competitive local telecommunications services.
Currently, WilTel or its subsidiary, WilTel Local Network, LLC, hold
authorizations to provide such services, at least to some extent, in 50 states
and the District of Columbia.
In most states, in addition to the requirement to obtain a certificate of
authority, WilTel must request and obtain prior regulatory approval of price
lists or tariffs containing rates, terms and conditions for its regulated
intrastate services. WilTel is required to update or amend these tariffs when it
adjusts its rates or adds new products. WilTel believes that most states do not
regulate its provision of dark fiber. If a state did regulate its provision of
dark fiber, WilTel could be required to provide dark fiber in that state
pursuant to tariffs and at regulated rates.
22
The Company is also subject to various reporting and record-keeping
requirements in states in which it is authorized to provide intrastate services.
Many states also require prior approval for transfers of control of certified
providers, corporate reorganizations, acquisitions of telecommunications
operations, assignment of carrier assets, carrier stock offerings and
undertaking of significant debt obligations. States generally retain the right
to sanction a service provider or to condition, modify, or revoke certification
if a service provider violates applicable laws or regulations. Fines and other
penalties also may be imposed for such violations. While WilTel believes that it
is in compliance with applicable state laws and regulations, it cannot guarantee
that state regulatory authorities or third parties will not raise issues with
regard to its compliance.
State regulatory commissions generally regulate the rates that ILECs
charge for intrastate services, including intrastate access services paid by
providers of intrastate long distance services. WilTel's intrastate services
compete against the regulated rates of these carriers and also utilize certain
ILEC services. State regulatory commissions also regulate the rates ILECs charge
for interconnection of network elements with, and resale of, services by
competitors. As a result of the FCC's February 21, 2003, decision on UNEs,
WilTel expects that state commissions will initiate proceedings that have the
potential to affect the rates, terms and conditions of intrastate services.
WilTel, through its subsidiary WilTel Local Network, LLC, has entered into or is
in the process of entering into interconnection agreements with various ILECs
and the rates, terms, and conditions contained in such agreements will be
affected by such state proceedings.
Local Regulation
Some jurisdictions require WilTel to obtain street use and construction
permits and licenses and/or franchises before installing or expanding its
fiber-optic network using municipal rights-of-way. Termination of, or failure by
WilTel to renew, its existing franchise or license agreements could have a
material adverse effect on its operations. In some municipalities where WilTel
has installed or may construct facilities, it is required to pay license or
franchise fees based on a percentage of gross revenue, a flat annual fee, or a
per linear foot basis. WilTel cannot guarantee that fees will remain at their
current levels following the expiration of existing franchises. In addition,
WilTel could be at a competitive disadvantage if its competitors do not pay the
same level of fees as it does. The Communications Act requires municipalities to
manage public rights of way in a competitively neutral and non-discriminatory
manner and prohibits the imposition of right-of-way fees as a means of raising
revenue. A considerable amount of litigation has challenged right-of-way fees on
the grounds that such fees violate the Communications Act. The outcome of such
litigation may affect WilTel's costs of operations.
Other U.S. Regulation
WilTel's operations are subject to a variety of federal, state, local, and
foreign environmental, safety and health laws, and governmental regulations.
These laws and regulations govern matters such as the generation, storage,
handling, use, and transportation of hazardous materials, the emission and
discharge of hazardous materials into the atmosphere, the emission of
electromagnetic radiation, the protection of wetlands, historic sites, and
endangered species, and the health and safety of employees. WilTel also may be
subject to environmental laws requiring the investigation and cleanup of
contamination at sites it owns or operates or at third-party waste disposal
sites. Such laws often impose liability even if the owner or operator did not
know of, or was not responsible for, the contamination.
WilTel owns or operates numerous sites in connection with its operations.
Although the Company is aware of one instance of alleged liability relating to
contamination at a single site, the Company is not aware of any liability or
alleged liability at any owned or operated sites or third-party waste disposal
sites that would be expected to have a material adverse effect on the Company.
Although WilTel monitors compliance with environmental, safety, and health laws
and regulations, it cannot give assurances that it has been or will be in
complete compliance with these laws and regulations. WilTel may be subject to
fines or other sanctions imposed
23
by governmental authorities if it fails to obtain certain permits or violates
their respective laws and regulations. WilTel's capital or other expenditures
for compliance with laws, regulations, or permits relating to the environment,
safety, and health were not material in 2002.
WilTel has ownership interests in and utilizes certain submarine cable
systems for the provision of telecommunications services. WilTel may be subject
to certain state and federal laws and regulations governing the construction,
maintenance and use of such facilities. Such laws and regulations may include
corridor restrictions, exclusionary zones, undersea cable fees, or right-of-way
use fees for submerged lands. Increased regulation of cable assets or
assessments may affect the cost and ultimately the demand for services provided
over such facilities.
Foreign Regulation
The provision of telecommunications services in the countries in which
WilTel operates is regulated. Telecommunications carriers are generally required
to obtain permits, licenses, or authorizations to initiate or terminate
communications in a country. The regulatory requirements vary from country to
country, although in some significant respects regulation in the Western
European markets is harmonized under the regulatory structure of the European
Union. Many regulatory systems have only recently faced the issues raised by
competition and are still in the process of development. Telecommunications laws
and regulations are changing generally to promote competition and new offerings.
WilTel cannot determine at this time the impact, if any, that such future
regulatory, judicial, or legislative activities may have on the business or
operations of WilTel.
Generally, WilTel must obtain and maintain authorizations from regulatory
bodies in the countries in which it wants to offer telecommunications services.
The number and type of authorizations, if any, depend on whether WilTel
constructs or leases its facilities, and whether it offers dark fiber, switched
voice, private line, data, video, or enhanced services in the countries in which
it plans to operate. WilTel must also comply with environmental, planning, and
property laws in those countries where it constructs and/or operates fiber-optic
systems. Some countries may require WilTel to file and obtain prior regulatory
approval of the rates, terms, and conditions for its services. Authorizations
can generally be conditioned, modified, or revoked by regulators for failure to
comply with applicable laws or regulations. Fines and other penalties also may
be imposed for violations. WilTel has received, and expects to apply for and
acquire, various authorizations to operate its foreign facilities and provide
its telecommunications services though it cannot guarantee that its licenses
will not be delayed or include burdensome conditions.
Authorizations to operate as a new carrier are not available in some
countries, may be available in other countries with limitations on the number
and characteristics of carriers, and may not be required at all in other
countries. In addition, while some countries require complex application
procedures for authorizations, some countries simply require registration with
or notification to the regulatory agency. Within a country, moreover, some
services or activities may require a full authorization while others may require
a simple registration or notification, or no filing at all. Authorizations and
regulations impose a range of restrictions on the carriers' operations,
corporate governance, and shareholders, with penalties for noncompliance,
including loss of license and monetary fines. For example, many countries place
limits on foreign ownership of telecommunications carriers and require
regulatory approval of transfers of control.
In granting authorizations, regulators frequently establish service
obligations for the operator. Typical obligations include nondiscrimination,
build-out or service coverage, and interconnection obligations, as well as
requirements regarding the quality of service provided and the approval of new
service offerings. Many regulators also require licensed carriers to pay certain
fees or charges that, among other things, cover the costs of regulation and to
support the availability of services, and these fees may in some cases be
significant. Many national regulators require interconnection between carriers
and resolve disputes as to the reasonableness of particular interconnection
arrangements and pricing. Many regulators require a dominant carrier in the
market to offer
24
competing carriers interconnection on reasonable and nondiscriminatory terms and
conditions, and a number of regulators also require incumbent carriers to
unbundle their local loops, allowing increasing competition in local services.
In some countries, all telecommunications carriers are required to provide
interconnection to other carriers. WilTel may be required to provide
interconnection to its foreign network as well as access to its facilities for
the installation of other carriers' telecommunications equipment.
Although WilTel does not intend to construct or install fiber-optic
networks in any foreign market, if it decided to do so, it would also be
required to obtain street use and construction permits and licenses and/or
franchises to install and expand its fiber-optic network using public rights of
way. In some countries where it has installed networks, and it may be required
to pay license or franchise fees.
Submarine telecommunications cable systems require national authorizations
from each country in which they land and operate. Cable landing authorizations
typically involve environmental reviews as well as approvals by
telecommunications authorities to provide international telecommunications
facilities and services. In addition, municipal and state permits may be
necessary. Any such authorization may involve burdensome conditions.
Telecommunications carriers using capacity on the cables usually need licenses
from each country in which they operate and may need different licenses to
provide different services. For example, WilTel has received a Public
Telecommunications Operator license in the United Kingdom in order to provide
services over the TAT-14 undersea cable.
Japan
WilTel's Japanese subsidiary, Williams Communications K.K., has obtained a
Type I license to land its interest in an undersea cable and to provide
telecommunications services in Japan over this undersea cable. Under the Type I
license, Williams Communication K.K. must meet several obligations, such as
appointing a chief engineer, reporting about revenues and costs, and meeting
performance specifications.
United Kingdom
WilTel's subsidiary in the United Kingdom, Williams Communications UK
Limited, has received a Public Telecommunications Operator license to provide
telecommunications services in the United Kingdom. This subsidiary intends to
apply to the Office of Telecommunications for "Annex II" interconnection status,
which will give it the right to interconnect with other carriers in the United
Kingdom. The Public Telecommunications Operator license requires WilTel's
subsidiary to comply with a number of conditions, including but not limited to
interconnection with other telecommunications companies and payment of license
fees.
Chile
Chile currently has a highly competitive, multi-carrier system for long
distance and local services. There is no regulatory limit on the number of
concessions that could be granted to companies that would compete against
Manquehue Net S.A. The largest provider of local telecommunications services in
Santiago is Compania de Telecomunicaciones de Chile with approximately 77% of
the local market.
Manquhue Net S.A. holds a Public Telecommunications License to install and
operate a high capacity fiber optic cable network in Santiago and the towns
surrounding it, and provides public switched voice services over that network.
The license is for a renewable 30-year term. The license provided for network
construction to end on December 23, 1998, with service to begin on January 23,
1999. The company requested an extension of these terms, which was granted by
the telecommunications authority and approved by the Republic Comptrollership's
Office for formal amendment of the license. Service was originally required to
begin by April 4, 2002. Manquehue Telecomunicaciones de Larga Distancia S.A. and
Metrocom S.A. are subsidiaries of Manquehue Net S.A. Manquehue
Telecomunicaciones de Larga Distancia S.A. holds an intermediate services
concession to
25
provide long distance services and resells capacity from other carriers.
Metrocom holds an intermediate service concession and provides long distance
services to subscribers.
Neither Manquehue Larga Distancia nor Metrocom nor Manquehue Net are
subject to a maximum rate. The maximum rate structure is determined every five
years and applies to the incumbent only. Local providers must also give long
distance service providers equal access conditions to their network connections.
Hong Kong
WilTel's subsidiary in Hong Kong, Williams Communications (Hong Kong)
Limited, has been granted a Public Non-Exclusive Telecommunications Services
license. The license allows WilTel's subsidiary to provide a range of
international telecommunications services to customers in Hong Kong. The license
is granted subject to a number of conditions, including payments of annual
licensing fees and restrictions on anti-competitive behavior.
Canada
WilTel's subsidiary in Canada, Williams Communications Network, Inc., has
been granted a Class A international telecommunications license. The license
allows WilTel's subsidiary to provide a range of international
telecommunications services in Canada over its own network or over the network
of a third party. The license is subject to several conditions, including
payment of contribution fees on applicable services, compliance with reporting
requirements and restrictions on anti-competitive behavior.
Settlement Costs for International Traffic
International switched long distance traffic between two countries
historically is exchanged under correspondent agreements between carriers, each
owning network transmission facilities in their respective countries.
Correspondent agreements generally provide for, among other things, the
termination of switched traffic in, and return switched traffic to, the
carriers' respective countries at a negotiated accounting rate. Settlement
costs, typically one-half of the accounting rate, are reciprocal fees owed by
one international carrier to another for transporting traffic on its facilities
and terminating that traffic in the other country. The FCC and regulators in
foreign countries may regulate agreements between U.S. and foreign carriers.
The FCC's international settlements policy governs the settlements between
U.S. carriers and their foreign correspondents and prevents foreign carriers
from discriminating among U.S. carriers in bilateral accounting rate
negotiations. The policy requires:
- the equal division of accounting rates;
- non-discriminatory treatment of U.S. carriers; and
- proportionate return of inbound traffic.
Agreements governed under the policy must be filed publicly with and
approved by the FCC. The policy applies only to U.S. carrier arrangements with
certain foreign carriers with market power in their respective countries. For
example, U.S. carrier arrangements with Telefonos de Mexico continue to be
subject to the policy, but U.S. carrier arrangements with a Telefonos de Mexico
competitor in Mexico are not subject to the policy. The FCC also recently
decided to exempt certain foreign routes from the policy, depending upon the
ability of U.S. carriers to terminate traffic on those routes at rates
substantially below benchmarks set by the agency. However, Mexico is not
currently an exempted route. Other countries have policies similar to that of
the FCC.
Provision of switched voice services over international private lines
allows carriers to bypass the settlement rate system, and, therefore, bypass the
need to negotiate accounting rates with foreign carriers with market power and
obtain termination of international traffic in the United States and foreign
countries at substantially reduced
26
rates. The FCC's private line resale policy currently prohibits a carrier from
providing switched voice services over international private lines to or from a
country unless certain conditions are met or unless the carrier provides such
services in conjunction with a non-dominant carrier in that country.
Currently, Mexican carriers other than Telefonos de Mexico can engage in
such resale under FCC rules, but the Mexican regulator has not permitted such
resale. If Mexico approves such resale but the FCC continues to restrict
Telefonos de Mexico from engaging in such resale, competitors of Telefonos de
Mexico would be permitted to engage in low-cost termination of traffic between
the United States and Mexico, but Telefonos de Mexico would be precluded from
doing so.
International Settlements
In October 2002, the FCC issued a Notice of Proposed Rulemaking to
consider further reforms to its International Settlement Policy, International
Simple Resale policy, and benchmark policy, based on increased participation and
competition in the U.S.-international market, decreased settlement and end-user
rates, and increased liberalization and privatization in foreign markets. The
FCC is expected to issue a decision before the end of 2003. The outcome of this
proceeding could result in lower rates for some international services and
increased demand for these services by some of WilTel's customers, with a
resulting increased demand for capacity on WilTel's U.S. facilities, including
its domestic network.
OVERVIEW OF THE CHAPTER 11 PROCEEDINGS
On April 22, 2002, WCG and one of its subsidiaries, CG Austria, Inc.
(collectively, the "Debtors"), filed petitions for relief under chapter 11 of
title 11 of the United States Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court").
On September 30, 2002, the Bankruptcy Court entered an order confirming the
Second Amended Joint Chapter 11 Plan of Reorganization of the Debtors (the
"Plan"), which became effective on October 15, 2002 (the "Effective Date").
A copy of the Plan was filed as Exhibit A to Exhibit 99.2 to WCG's Current
Report on Form 8-K, dated August 13, 2002. Modifications to the Plan were filed
as Exhibit 99.3 to WCG's Current Report on Form 8-K, dated September 30, 2002
(the "Confirmation Date 8-K"). A copy of the Confirmation Order was filed as
Exhibit 99.1 to the Confirmation Date 8-K. All such filings are incorporated
herein by reference.
Described below is a summary of certain significant agreements and
important events that have occurred in and following the bankruptcy
reorganization. The summary should be read in conjunction with and is qualified
in its entirety by reference to the Plan and the material transaction documents
discussed herein and made available as exhibits to WCG's and WilTel's public
filings, including those filed with the SEC.
Plan of Reorganization
On September 30, 2002, the Bankruptcy Court approved and entered an order
confirming the Plan, which had been proposed by the Debtors, the official
committee of unsecured creditors (the "Committee") and Leucadia National
Corporation ("Leucadia"). The Plan was designed to meet the requirements of the
Settlement Agreement (described in greater detail below) and the pre-petition
Restructuring Agreement. By implementing both the Settlement Agreement and the
Restructuring Agreement, the Plan allowed WCG to raise the $150 million new
investment from Leucadia. That additional investment allowed WCG to further
reduce its secured debt without sacrificing working capital (see below for a
discussion of the Escrow Agreement and the ultimate release from escrow of the
$150 million investment).
27
Settlement Agreement
On July 26, 2002, TWC, the Committee, and Leucadia entered into a
settlement agreement (the "Settlement Agreement") that provided for, among other
things, (a) the mutual release of each of the parties, (b) the purchase by
Leucadia of TWC's unsecured claims against WCG (approximately $2.35 billion face
amount) for $180 million, (c) the satisfaction of such TWC claims and a $150
million investment in the Company by Leucadia in exchange for 44% of the
outstanding WilTel common stock, and (d) modification of WCG's sale and
subsequent leaseback transaction covering the WCG headquarters building and
modification of the TWC Continuing Contracts (as defined in the Settlement
Agreement). An order approving the Settlement Agreement was issued on August 23,
2002.
TWC's unsecured claims related to arrangements between WCG and TWC.
Approximately $1.4 billion of those claims related to the Trust Notes, which
were senior secured notes issued by a WCG subsidiary in March 2001. The proceeds
from the sale of the Trust Notes were (i) transferred to WCG in exchange for
WCG's $1.5 billion 8.25% senior reset note due 2008 (the "Senior Reset Note")
and (ii) contributed by WCG as capital to WCL to provide liquidity following the
tax-free spin-off from TWC. Obligations of WCG and its affiliates under the
Trust Notes were secured by the Senior Reset Note and were effectively
guaranteed by TWC. In July 2002, TWC exchanged $1.4 billion of new senior
unsecured notes of TWC (the "New TWC Notes") for all of the outstanding Trust
Notes. TWC, as agent under the Trust Notes indenture, had the right to sell the
Senior Reset Note to achieve the highest reasonably available market price and
the Bankruptcy Court found that the TWC sale of the TWC Assigned Claims to
Leucadia met this requirement.
Approximately $754 million of TWC's unsecured claims arose in connection
with an operating lease agreement covering a portion of the fiber-optic network
referred to as an "asset defeasance program" (the "ADP") that WCG entered into
in 1998. The total cost of the network assets covered by the lease agreement was
$750 million. Pursuant to the ADP, WCG had the option to purchase title to those
network assets at any time for an amount roughly equal to the original purchase
price, and TWC was expressly obligated to pay the purchase price under an
intercreditor agreement entered into by TWC in connection with the then-existing
WCL credit facility. In March 2002, WCG exercised its purchase option and TWC
funded the purchase price of approximately $754. In exchange for this payment
from TWC, the intercreditor agreement provided that TWC was entitled to either
the issuance of WCG equity or WCG unsecured subordinated debt (meaning debt that
was subordinate in priority to WCL's credit facility), each on terms reasonably
acceptable to the lenders under WCL's pre-petition credit facility. On March 29,
2002, WCG tendered an unsecured note to TWC for approximately $754 million that
was not accepted by TWC. Any and all causes of action of TWC or any of its
direct or indirect subsidiaries against a Debtor relating to the ADP were
resolved pursuant to the terms of the Settlement Agreement.
The terms of the Settlement Agreement also resolved "Pre-Spin Services
Claims" of TWC arising from a Services Agreement entered into between WCG and
TWC when WCG was a wholly-owned subsidiary of TWC. Pursuant to this agreement,
TWC and certain of its affiliates performed payroll, administrative, and related
services for WCG and its affiliates. Pre-Spin Services Claims were also resolved
pursuant to the Settlement Agreement.
The Settlement Agreement also resolved WCG's defaults under the sale and
subsequent leaseback transaction (discussed below) as a result of WCG's
bankruptcy filing, thus negating any threat or risk that the Company would be
evicted or otherwise lose possession of its headquarters due to the bankruptcy.
SBC Stipulation
On September 25, 2002, the Bankruptcy Court approved a stipulation
agreement (the "Stipulation Agreement") between the Company and SBC conditioned
upon the consummation of the Plan. The Stipulation Agreement provided for the
necessary SBC approval of the Plan and resolved change-of-control issues that
SBC had raised
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regarding WCG's spin-off from TWC. At the same time, SBC and WCL executed
amendments to the