LEVEL 3 COMMUNICATIONS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2004
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period to

Commission file number 0-15658

LEVEL 3 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)

Delaware (State of Incorporation)		47-0210602 (I.R.S. Employer Identification No.)
1025 Eldorado Blvd., Broomfield, CO (Address of principal executive offices)		80021 (Zip Code)
(720) 888-1000 (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports(s)), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

The number of shares outstanding of each class of the issuer's common stock, as of November 1, 2004:

Common Stock: 685,444,425 shares

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES


Part I—Financial Information
Item 1.		Unaudited Financial Statements:
		Consolidated Statements of Operations
		Consolidated Balance Sheets
		Consolidated Statements of Cash Flows
		Consolidated Statement of Changes in Stockholders' Equity (Deficit)
		Consolidated Statements of Comprehensive Income (Loss)
		Notes to Consolidated Financial Statements
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures about Market Risk
Item 4.		Controls and Procedures
Part II—Other Information
Item 6.		Exhibits and Reports on Form 8-K
Signatures
Certifications

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(unaudited)

				Three Months Ended September 30,						Nine Months Ended September 30,
				2004			2003			2004			2003
				(dollars in millions, except per share data)
Revenue:
	Communications (Note 4)			$	423		$	413		$	1,203		$	1,548
	Information Services				392			437			1,389			1,434
	Coal Mining				25			24			65			56

		Total revenue			840			874			2,657			3,038
Costs and Expenses (exclusive of depreciation and amortization shown separately below):
	Cost of revenue:
		Communications			116			91			316			283
		Information Services			353			400			1,257			1,317
		Coal Mining			18			18			48			44

			Total cost of revenue		487			509			1,621			1,644
	Depreciation and amortization				170			210			526			645
	Selling, general and administrative				234			250			712			795
	Restructuring charges				—			14			2			34

			Total costs and expenses		891			983			2,861			3,118

Operating Income (Loss)					(51	)		(109	)		(204	)		(80	)
Other Income (Expense):
	Interest income				3			5			9			15
	Interest expense, net				(120	)		(156	)		(365	)		(439	)
	Other, net				(3	)		(2	)		181			(104	)

		Total other income (expense)			(120	)		(153	)		(175	)		(528	)

Loss from Continuing Operations Before Income Tax and Change in Accounting Principle					(171	)		(262	)		(379	)		(608	)
Income Tax Benefit (Expense)					—			12			(2	)		12

Loss from Continuing Operations					(171	)		(250	)		(381	)		(596	)
Income from Discontinued Operations					—			3			—			1

Net Loss Before Change in Accounting Principle					(171	)		(247	)		(381	)		(595	)
Cumulative Effect of Change in Accounting Principle					—			—			—			5

Net Loss				$	(171	)	$	(247	)	$	(381	)	$	(590	)

Earnings (Loss) per Share of Level 3 Common Stock (Basic and Diluted):
			Loss from Continuing Operations	$	(0.25	)	$	(0.38	)	$	(0.56	)	$	(1.12	)
			Income from Discontinued Operations		—			—			—			—
			Cumulative Effect of Change in Accounting Principle		—			—			—			0.01

			Net Loss	$	(0.25	)	$	(0.38	)	$	(0.56	)	$	(1.11	)

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(unaudited)

		September 30, 2004		December 31, 2003
		(dollars in millions)
Assets
Current Assets:
	Cash and cash equivalents	$	467	$	1,129
	Marketable securities		225		42
	Restricted cash		50		74
	Receivables, less allowances of $27 and $28, respectively		375		561
	Other		115		140

Total Current Assets			1,232		1,946
Property, Plant and Equipment, net			5,402		5,727
Marketable Securities			164		—
Restricted Cash			65		61
Goodwill and Intangibles, net			448		459
Other Assets, net			84		100

		$	7,395	$	8,293

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(continued)

(unaudited)

			September 30, 2004			December 31, 2003
			(dollars in millions, except per share data)
Liabilities and Stockholders' Equity (Deficit)
Current Liabilities:
	Accounts payable		$	431		$	651
	Current portion of long-term debt			144			125
	Accrued payroll and employee benefits			89			135
	Accrued interest			97			100
	Deferred revenue			158			189
	Other			156			231

Total Current Liabilities				1,075			1,431
Long-Term Debt, less current portion				5,032			5,250
Deferred Revenue				984			954
Other Liabilities				463			477
Commitments and Contingencies
Stockholders' Equity (Deficit):
	Preferred stock, $.01 par value, authorized 10,000,000 shares: no shares outstanding			—			—
	Common stock:
		Common stock, $.01 par value, authorized 1,500,000,000 shares: 683,380,656 outstanding in 2004 and 677,828,634 outstanding in 2003		7			7
		Class R, $.01 par value, authorized 8,500,000 shares: no shares outstanding		—			—
	Additional paid-in capital			7,417			7,360
	Accumulated other comprehensive loss			(106	)		(90	)
	Accumulated deficit			(7,477	)		(7,096	)

Total Stockholders' Equity (Deficit)				(159	)		181

			$	7,395		$	8,293

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

				Nine Months Ended September 30,
				2004			2003
				(dollars in millions)
Cash Flows from Continuing Operations:
	Net loss			$	(381	)	$	(590	)
	Income from discontinued operations				—			(1	)
	Cumulative effect of change in accounting principle				—			(5	)

	Loss from continuing operations				(381	)		(596	)
	Adjustments to reconcile loss from continuing operations to net cash used in continuing operations:
		Equity earnings, net			—			(3	)
		Depreciation and amortization			526			645
		Induced conversion expense on convertible debt			—			200
		Gain on debt extinguishments, net			(147	)		(4	)
		Gain on sale of property, plant and equipment, toll road operations and other assets			(32	)		(70	)
		Non-cash compensation expense attributable to stock awards			29			63
		Deferred revenue			—			(349	)
		Amortization of debt issuance costs			11			38
		Accreted interest on long-term discount debt			55			81
		Accrued interest on long-term debt			(4	)		1
		Change in working capital items net of amounts acquired:
			Receivables		176			172
			Other current assets		32			50
			Payables		(204	)		(196	)
			Other liabilities		(112	)		(34	)
		Other			(2	)		(3	)

Net Cash Used in Continuing Operations					(53	)		(5	)
Cash Flows from Investing Activities:
	Purchase of marketable securities				(410	)		—
	Proceeds from sale and maturity of marketable securities				61			—
	Decrease (increase) in restricted cash and securities, net				20			(9	)
	Capital expenditures				(202	)		(142	)
	Release of capital expenditure accruals				8			23
	ICG acquisition				(30	)		—
	Genuity transaction				—			(144	)
	Investments and acquisitions				—			(2	)
	Proceeds from sale of toll road operations				—			46
	Proceeds from sale of property, plant and equipment, and other assets				19			51

Net Cash Used in Investing Activities				$	(534	)	$	(177	)

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(continued)

(unaudited)

		Nine Months Ended September 30,
		2004			2003
Cash Flows from Financing Activities:
	Long-term debt borrowings, net of issuance costs	$	—		$	361
	Payments on long-term debt, including current portion		(77	)		(29	)
	Proceeds from stock options exercised		—			3

Net Cash Provided by (Used in) Financing Activities			(77	)		335
Net Cash Provided by Discontinued Operations			—			17
Effect of Exchange Rates on Cash and Cash Equivalents			2			5

Net Change in Cash and Cash Equivalents			(662	)		175
Cash and Cash Equivalents at Beginning of Period			1,129			1,142

Cash and Cash Equivalents at End of Period		$	467		$	1,317

Supplemental Disclosure of Cash Flow Information:
	Cash interest paid	$	300		$	319
Noncash Investing and Financing Activities:
	Common stock issued in exchange for long-term debt	$	—		$	838
	Common stock issued for Telverse acquisition		—			29
	Accrued interest paid with common stock		—			10
	Long-term debt principal retired by issuing common stock		—			657
	Settlement of obligation with restricted securities		—			10
	Long-term debt extinguished due to sale of toll road operations		—			139

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Stockholders' Equity (Deficit)

For the nine months ended September 30, 2004

(unaudited)

		Common Stock		Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Accumulated Deficit			Total
		(dollars in millions)
Balances at December 31, 2003		$	7	$	7,360	$	(90	)	$	(7,096	)	$	181
Common Stock:
	Stock plan grants		—		16		—			—			16
	Shareworks plan		—		28		—			—			28
	401(k) plan		—		13		—			—			13
Net Loss			—		—		—			(381	)		(381	)
Other Comprehensive Loss			—		—		(16	)		—			(16	)

Balances at September 30, 2004		$	7	$	7,417	$	(106	)	$	(7,477	)	$	(159	)

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
		(dollars in millions)
Net Loss		$	(171	)	$	(247	)	$	(381	)	$	(590	)
Other Comprehensive Income (Loss) Before Tax:
	Foreign currency translation adjustments		7			—			—			21
	Unrealized holding losses and other arising during period		—			26			(2	)		18
	Reclassification adjustment for (gains) losses included in net loss		3			—			(14	)		(1	)

Other Comprehensive Income (Loss), Before Tax			10			26			(16	)		38
Income Tax Benefit Related to Items of Other Comprehensive Income (Loss)			—			—			—			—

Other Comprehensive Income (Loss) Net of Taxes			10			26			(16	)		38

Comprehensive Loss		$	(161	)	$	(221	)	$	(397	)	$	(552	)

See accompanying notes to consolidated financial statements.

LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies

The consolidated financial statements include the accounts of Level 3 Communications, Inc. and subsidiaries (the "Company" or "Level 3") in which it has control, which are engaged in enterprises primarily related to communications, information services, and coal mining. Fifty-percent-owned mining joint ventures are consolidated on a pro rata basis. Investments in other companies in which the Company exercises significant influence over operating and financial policies or has significant equity ownership are accounted for by the equity method. All significant intercompany accounts and transactions have been eliminated.

The consolidated balance sheet of Level 3 Communications, Inc. and subsidiaries at December 31, 2003 has been taken from the Company's audited statements included in its Annual Report on Form 10-K for the year ended December 31, 2003. All other financial statements contained herein are unaudited and, in the opinion of management, contain all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented. The Company's accounting policies and certain other disclosures are set forth in the notes to the consolidated financial statements contained in the Company's Annual Report on Form 10-K, for the year ended December 31, 2003. These financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities and the reported amount of revenue and expenses during the reported period. Actual results could differ from these estimates.

The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results expected for the full year.

Termination revenue is recognized when a customer disconnects service prior to the end of the contract period, for which Level 3 had previously received consideration and for which revenue recognition was deferred. In addition, termination revenue is recognized when customers make termination penalty payments to Level 3 to settle contractually committed purchase amounts that the customer no longer expects to meet. Settlement revenue is recognized when a customer and Level 3 renegotiate a contract under which Level 3 is no longer obligated to provide product or services for consideration previously received and for which revenue recognition has been deferred. Termination/settlement revenue is reported in the same manner as the original product or service provided, and amounted to less than $1 million and $13 million during the three and nine months ended September 30, 2004, respectively, and $10 million and $343 million during the three and nine months ended September 30, 2003, respectively (See Note 4).

SFAS No. 143 establishes accounting standards for recognition and measurement of a liability for an asset retirement obligation and the associated asset retirement cost. The fair value of a liability for an asset retirement obligation is to be re