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Level 3 Communications 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-12
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2007

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

 

47-0210602

(State of Incorporation)

 

(I.R.S. Employer

 

 

Identification No.)

 

 

 

1025 Eldorado Blvd., Broomfield, CO

 

80021

(Address of principal executive offices)

 

(Zip Code)

 

(720) 888-1000

(Registrant’s telephone number,

including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of an “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (Check One):

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  x

The number of shares outstanding of each class of the issuer’s common stock, as of August 3, 2007:

Common Stock:  1,534,248,798 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

 

 

Consolidated Statements of Comprehensive Loss

 

 

Supplementary Stockholders’ Equity Information

 

 

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 1

Legal Proceedings

 

 

 

 

Item 1A.

Risk Factors

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

Item 6.

Exhibits

 

 

 

 

Signatures

 

 

 

 

Certifications

 

 




LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(unaudited)

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(dollars in millions, except per share data)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Communications

 

$

1,035

 

$

819

 

$

2,072

 

$

1,623

 

Coal mining

 

17

 

16

 

36

 

34

 

Total revenue

 

1,052

 

835

 

2,108

 

1,657

 

 

 

 

 

 

 

 

 

 

 

Costs and Expenses (exclusive of depreciation and amortization shown separately below):

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Communications

 

437

 

385

 

887

 

781

 

Coal mining

 

17

 

14

 

33

 

30

 

Total cost of revenue

 

454

 

399

 

920

 

811

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

247

 

164

 

468

 

351

 

Selling, general and administrative

 

428

 

283

 

868

 

559

 

Restructuring and impairment charges

 

2

 

7

 

6

 

11

 

Total costs and expenses

 

1,131

 

853

 

2,262

 

1,732

 

Operating Loss

 

(79

)

(18)

 

(154

)

(75

)

 

 

 

 

 

 

 

 

 

 

Other Income (Expense):

 

 

 

 

 

 

 

 

 

Interest income

 

12

 

16

 

33

 

25

 

Interest expense

 

(138

)

(170

)

(303

)

(320

)

Loss on early extinguishment of debt, net

 

 

(55

)

(427

)

(28

)

Other, net

 

3

 

4

 

4

 

8

 

Total other expense

 

(123

)

(205

)

(693

)

(315

)

Loss from Continuing Operations Before Income Taxes

 

(202

)

(223

)

(847

)

(390

)

 

 

 

 

 

 

 

 

 

 

Income Tax Expense

 

 

(1

)

(2

)

 

Loss from Continuing Operations

 

(202

)

(224

)

(849

)

(390

)

 

 

 

 

 

 

 

 

 

 

Income from Discontinued Operations

 

 

23

 

 

21

 

Net Loss

 

$

(202

)

$

(201

)

$

 (849

)

$

(369

)

 

 

 

 

 

 

 

 

 

 

Loss Per Share of Common Stock (Basic and Diluted):

 

 

 

 

 

 

 

 

 

Loss from Continuing Operations

 

$

 (0.13

)

$

(0.25

)

$

 (0.57

)

$

(0.45

)

Income from Discontinued Operations

 

 

.02

 

 

.02

 

Net Loss

 

$

 (0.13

)

$

(0.23

)

$

 (0.57

)

$

(0.43

)

 

See accompanying notes to consolidated financial statements.

2




LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(unaudited)

(dollars in millions, except share data)

 

June 30,
2007

 

December 31,
2006

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

739

 

$

1,681

 

Marketable securities

 

68

 

235

 

Restricted cash and securities

 

28

 

46

 

Receivables, less allowances of $17 and $17, respectively

 

455

 

326

 

Other

 

133

 

101

 

Total Current Assets

 

1,423

 

2,389

 

 

 

 

 

 

 

Property, Plant and Equipment, net

 

6,729

 

6,468

 

Restricted Cash and Securities

 

92

 

90

 

Goodwill

 

1,295

 

408

 

Other Intangibles, net

 

810

 

511

 

Other Assets, net

 

160

 

128

 

Total Assets

 

$

10,509

 

$

9,994

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

401

 

$

391

 

Current portion of long-term debt

 

31

 

5

 

Accrued payroll and employee benefits

 

82

 

92

 

Accrued interest

 

124

 

143

 

Deferred revenue

 

171

 

142

 

Other

 

174

 

156

 

Total Current Liabilities

 

983

 

929

 

 

 

 

 

 

 

Long-Term Debt, less current portion

 

6,828

 

7,357

 

Deferred Revenue

 

772

 

753

 

Other Liabilities

 

592

 

581

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $.01 par value, authorized 10,000,000 shares: no shares outstanding

 

 

 

Common stock, $.01 par value, authorized 2,250,000,000 shares: 1,530,787,724 outstanding in 2007 and 1,178,423,105 outstanding in 2006

 

15

 

12

 

Additional paid-in capital

 

10,944

 

9,305

 

Accumulated other comprehensive income (loss)

 

163

 

(4

)

Accumulated deficit

 

(9,788

)

(8,939

)

Total Stockholders’ Equity

 

1,334

 

374

 

Total Liabilities and Stockholders’ Equity

 

$

10,509

 

$

9,994

 

 

See accompanying notes to consolidated financial statements.

3




LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

 

Six Months Ended
June 30,

 

(dollars in millions)

 

2007

 

2006

 

 

 

 

 

 

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net loss

 

$

(849

)

$

(369

)

Income from discontinued operations

 

 

(21)

 

Loss from continuing operations

 

(849

)

(390

)

Adjustments to reconcile loss from continuing operations to net cash (used in) provided by operating activities of continuing operations:

 

 

 

 

 

Depreciation and amortization

 

468

 

351

 

Gain on sale of property, plant and equipment and other assets

 

(2

)

(4

)

Non-cash compensation expense attributable to stock awards

 

48

 

34

 

Loss on extinguishment of debt, net

 

427

 

28

 

Non-cash impairment expenses

 

1

 

7

 

Amortization of debt issuance costs

 

8

 

7

 

Accreted interest on long-term discount debt

 

15

 

20

 

Accrued interest on long-term debt

 

(9

)

52

 

Change in working capital items, net of amounts acquired:

 

 

 

 

 

Receivables

 

(42

)

37

 

Other current assets

 

(26

)

(15

)

Payables

 

(79

)

 

Deferred revenue

 

41

 

(29

)

Other current liabilities

 

(68

)

(45

)

Other

 

3

 

 

Net Cash (Used in) Provided by Operating Activities of Continuing Operations

 

(64

)

53

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Capital expenditures

 

(325

)

(131

)

Proceeds from sales and maturities of marketable securities

 

288

 

5

 

Purchases of marketable securities

 

 

(98

)

Decrease (increase) in restricted cash and securities, net

 

13

 

(12

)

Proceeds from sale of property, plant and equipment, and other assets

 

2

 

2

 

Acquisitions, net of cash acquired

 

(622

)

(82

)

Distributions from discontinued operations

 

 

2

 

Net Cash Used in Investing Activities

 

(644

)

(314

)

 

(continued)

See accompanying notes to consolidated financial statements.

4




LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (continued)

(unaudited)

 

 

 

Six Months Ended
June 30,

 

(dollars in millions)

 

2007

 

2006

 

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Long-term debt borrowings, net of issuance costs

 

$

2,352

 

$

1,007

 

Proceeds from warrants and stock-based compensation plans

 

24

 

 

Equity offering

 

 

543

 

Payments and repurchases of long-term debt

 

(2,615

)

(104

)

Net Cash (Used in) Provided by Financing Activities

 

(239

)

1,446

 

 

 

 

 

 

 

Discontinued Operations:

 

 

 

 

 

Net cash provided by discontinued operating activities

 

 

20

 

Net cash used in investing activities

 

 

(5

)

Net effect of exchange rates on cash and cash equivalents

 

 

(1

)

Net Cash Provided by Discontinued Operations

 

 

14

 

 

 

 

 

 

 

Effect of Exchange Rates on Cash and Cash Equivalents

 

5

 

7

 

 

 

 

 

 

 

Net Change in Cash and Cash Equivalents

 

(942

)

1,206

 

 

 

 

 

 

 

Cash and Cash Equivalents at Beginning of Period:

 

 

 

 

 

Cash attributable to continuing operations

 

1,681

 

379

 

Cash attributable to discontinued operations

 

 

73

 

 

 

 

 

 

 

Cash and Cash Equivalents at End of Period:

 

 

 

 

 

Cash attributable to continuing operations

 

$

739

 

$

1,571

 

Cash attributable to discontinued operations

 

$

 

$

87

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

Cash interest paid

 

$

289

 

$

241

 

Income taxes paid

 

1

 

2

 

 

 

 

 

 

 

Noncash Investing and Financing Activities:

 

 

 

 

 

Common stock issued for acquisitions

 

$

692

 

$

197

 

Equity issued to retire debt

 

879

 

 

Long-Term debt retired by conversion to equity

 

702

 

 

Amendment and restatement of $730 million credit facility

 

 

730

 

Long-Term debt issued in exchange transaction

 

 

619

 

Long-Term debt retired in exchange transaction

 

 

692

 

 

See accompanying notes to consolidated financial statements.

5




LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Stockholders’ Equity

For the six months ended June 30, 2007

(unaudited)

(dollars in millions)

 

Common
Stock

 

Additional
Paid-in
Capital

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Accumulated
Deficit

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at December 31, 2006

 

$

12

 

$

9,305

 

$

(4

)

$

(8,939

)

$

374

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock:

 

 

 

 

 

 

 

 

 

 

 

Acquisitions

 

1

 

691

 

 

 

692

 

Exercise of warrants and options

 

 

24

 

 

 

24

 

Stock plan grants

 

 

33

 

 

 

33

 

401(k) plan

 

 

14

 

 

 

14

 

Debt conversion to equity

 

2

 

877

 

 

 

879

 

Net Loss

 

 

 

 

(849

)

(849

)

Other Comprehensive Income

 

 

 

167

 

 

167

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at June 30, 2007

 

$

15

 

$

10,944

 

$

163

 

$

(9,788

)

$

1,334

 

 

See accompanying notes to consolidated financial statements.

6




LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Loss

(unaudited)

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(dollars in millions)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Net Loss

 

$

(202

)

$

(201

)

$

(849

)

$

(369

)

 

 

 

 

 

 

 

 

 

 

Other Comprehensive Income (Loss) Before Tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation income and adjustment for losses included in net loss

 

12

 

23

 

76

 

30

 

Unrealized appreciation of available-for-sale investment

 

58

 

 

58

 

 

Unrealized appreciation of interest rate swap

 

27

 

 

28

 

 

Other

 

 

(5

)

5

 

(3

)

 

 

 

 

 

 

 

 

 

 

Other Comprehensive Income Before Income Tax

 

97

 

18

 

167

 

27

 

 

 

 

 

 

 

 

 

 

 

Income Tax Benefit Related to Items of Other Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Comprehensive Income, Net of Income Taxes

 

97

 

18

 

167

 

27

 

 

 

 

 

 

 

 

 

 

 

Comprehensive Loss

 

$

(105

)

$

(183

)

$

(682

)

$

(342

)

 

Supplementary Stockholders’ Equity Information

(unaudited)

(dollars in millions)

 

Net Foreign
Currency
Translation
Adjustment

 

Unrealized
Appreciation of
Investment and
Interest Rate
Swap

 

Other

 

Total

 

Accumulated Other Comprehensive Income (Loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2006

 

$

29

 

$

 

$

(33

)

$

(4

)

Change

 

76

 

86

 

5

 

167

 

Balance at June 30, 2007

 

$

105

 

$

86

 

$

(28

)

$

163

 

 

See accompanying notes to consolidated financial statements.

7




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 enterprises primarily engaged in the communications and coal mining businesses.  Fifty-percent-owned mining joint ventures are consolidated on a pro rata basis.  All significant intercompany accounts and transactions have been eliminated.

The Company acquired Progress Telecom, LLC (“Progress Telecom”) on March 20, 2006; ICG Communications, Inc. (“ICG Communications”) on May 31, 2006; TelCove, Inc. (“TelCove”) on July 24, 2006; Looking Glass Networks Holding Co., Inc. (“Looking Glass”) on August 2, 2006; Broadwing Corporation (“Broadwing”) on January 3, 2007; and the Content Delivery Network services business (“CDN Business”) of SAVVIS, Inc. on January 23, 2007.  The results of operations, cash flows and financial position attributable to these acquisitions are included in the consolidated financial statements from the respective dates of their acquisition (See Note 2).

On September 7, 2006, Level 3 sold Software Spectrum, Inc. (“Software Spectrum”), the Company’s software reseller business, to Insight Enterprises, Inc. (“Insight Enterprises”).  This business comprised the remaining operations of Level 3’s information services segment in 2006.  The results of operations and cash flows for the Software Spectrum business have been classified as discontinued operations in the consolidated financial statements for all periods presented in this report (See Note 3).

The consolidated balance sheet of Level 3 at December 31, 2006 has been audited.  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 accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information. Accordingly, these statements do not include all of the information and notes required for complete financial statements.

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 Form 10-K for the year ended December 31, 2006.  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 six months ended June 30, 2007 are not necessarily indicative of the results expected for the full year.

Recently Issued Accounting Pronouncements

The significant accounting policies set forth in Note 1 to the consolidated financial statements in the Company’s Form 10-K for the year ended December 31, 2006 appropriately represent, in all material respects, the current status of the Company’s critical accounting policies, and are incorporated herein by reference.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN No. 48”), which was effective for Level 3 starting January 1, 2007. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN No. 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return that results in a tax benefit. Additionally, FIN No. 48 provides guidance on de-recognition, income statement classification of interest and penalties, accounting in interim periods and disclosure. The Company’s policy is to recognize interest and penalty expense associated with uncertain tax positions as a component of income tax expense in the

8




consolidated statements of operations. The adoption of FIN No. 48 did not have an effect on the Company’s consolidated results of operations or financial condition for the three and six months ended and as of June 30, 2007.

In June 2006, the FASB ratified the consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (“EITF No. 06-3”), which was effective for Level 3 starting January 1, 2007.  The scope of EITF No. 06-3 includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, sales, use, value added, Universal Service Fund (“USF”) contributions and some excise taxes. The Task Force concluded that entities should present these taxes in the income statement on either a gross or a net basis, based on their accounting policy, which should be disclosed pursuant to APB Opinion No. 22, “Disclosure of Accounting Policies”. If such taxes are significant and are presented on a gross basis, the amounts of those taxes should be disclosed. The Company records USF contributions on a gross basis in its consolidated statements of operations, but records sales, use, value added and excise taxes billed to its customers on a net basis in its consolidated statements of operations. Communications revenue on the consolidated statements of operations includes USF contributions totaling $17 million and $30 million for the three and six months ended June 30, 2007 and $5 million and $9 million for the three and six months ended June 30, 2006, respectively.  The adoption of EITF No. 06-3 did not have a material effect on the Company’s consolidated results of operations or financial condition for the three and six months ended and as of June 30, 2007 as the policy followed was consistent before and after adoption.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This statement is effective for fiscal years beginning after November 15, 2007 and interim periods within that fiscal year. The Company is currently assessing the potential effect that the adoption of SFAS No. 157 will have on its consolidated results of operations or financial condition.

On February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, applies to all entities with available-for-sale and trading securities. The FASB’s stated objective in issuing this standard is as follows: “to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.”  The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  The Company is currently assessing whether fair value accounting is appropriate for any of its eligible items and is assessing the potential effect that the adoption of SFAS No. 159 will have on its consolidated results of operations or financial condition.

2. Acquisitions

In 2006, the Company embarked on strategies to both expand its presence in metropolitan markets and begin offering services to enterprise customers through its Business Markets Group. This strategy will allow the Company to terminate traffic over its owned facilities rather than paying third parties to terminate the traffic. The expansion into new metro markets should also provide additional opportunities to sell services to bandwidth intensive businesses on the Company’s national and international networks. In order to expedite the expansion of its metro presence and its enterprise business, Level 3 acquired Progress Telecom, ICG Communications, TelCove and Looking Glass in 2006 and Broadwing in the first quarter of 2007.  Level 3 has also embarked on a strategy to expand its content delivery network services with the acquisition of the CDN Business in the first quarter of 2007.  The results of operations attributable to each acquisition are included in the consolidated financial statements from the date of acquisition. The value of Level 3 common stock issued in connection with the acquisitions was determined based on the average closing price for Level 3 common stock two days before and two days after the date the acquisition was announced multiplied by the number of shares issued.

CDN Business AcquisitionOn January 23, 2007, Level 3 completed the acquisition of the Content Delivery Network  services business of SAVVIS, Inc. Level 3 paid $134 million in cash (including transaction costs) to acquire the assets of the

9




CDN Business, including network elements, customer contracts and intellectual property used in the CDN Business.  The purchase price was subsequently increased by less than $1 million for working capital and other contractual matters.  The Company paid this adjustment in April 2007.

Broadwing AcquisitionOn January 3, 2007, Level 3 acquired Broadwing Corporation, a publicly held provider of optical network communications services.  Under the terms of the merger agreement dated October 16, 2006, Level 3 paid $8.18 of cash plus 1.3411 shares of Level 3 common stock for each share of Broadwing common stock outstanding at closing.  In total, Level 3 initially paid approximately $752 million of cash, including $8 million of transaction costs, and issued approximately 123 million shares of the Company’s common stock, valued at $688 million.  As part of the Broadwing acquisition, approximately 3.8 million previously issued Broadwing warrants (valued at approximately $4 million) became exercisable for approximately 5.1 million shares of Level 3 common stock.  In the second quarter of 2007, the Company subsequently reduced the total consideration paid by $4 million for insurance proceeds received in June 2007 that related to the settlement of an insurance claim that occurred prior to acquisition.

In connection with the acquisition of Broadwing, the Company guaranteed $180 million in aggregate principal amount of Broadwing Corporation’s 3.125% Convertible Senior Debentures due 2026 (the “Broadwing Debentures”) and the transaction included $24 million in capital lease obligations related primarily to a metro fiber IRU agreement.  As of February 16, 2007, the holders of $179 million in aggregate principal amount of the Broadwing Debentures converted their Broadwing Debentures into a total of 17 million shares of Level 3 common stock and approximately $105 million in cash pursuant to the terms of the indenture governing the Broadwing Debentures and the agreement whereby Level 3 acquired Broadwing.  The remaining $1 million in aggregate principal amount of the Broadwing Debentures was repurchased by Broadwing at 100% of par as required by the indenture governing the Broadwing Debentures.

Looking Glass AcquisitionOn August 2, 2006, Level 3 completed the acquisition of Looking Glass, a privately held Illinois-based telecommunications company.  The consideration paid by Level 3 consisted of approximately $13 million in cash, including $4 million of transaction costs, and approximately 21 million shares of Level 3 common stock valued at $84 million.  In addition, at the closing, Level 3 repaid approximately $67 million of Looking Glass liabilities.

Level 3 entered into certain transactions with Looking Glass prior to the acquisition of Looking Glass by Level 3, whereby Level 3 received cash for communications services to be provided in the future and which was originally recognized as deferred revenue.  As a result of the acquisition, Level 3 can no longer amortize this deferred revenue into earnings and, accordingly, reduced the purchase price applied to the net assets acquired in the Looking Glass transaction by $2 million, which was the amount of the unamortized deferred revenue balance on August 2, 2006.

TelCove AcquisitionOn July 24, 2006, Level 3 completed the acquisition of TelCove, a privately held Pennsylvania-based telecommunications company. Under the terms of the agreement, Level 3 paid $446 million in cash and issued approximately 150 million shares of Level 3 common stock, valued at $623 million.  In addition, Level 3 repaid $132 million of TelCove debt.  The transaction also included $12 million in TelCove capital leases.  Also, the Company paid third party costs of approximately $15 million related to the transaction, which included certain costs incurred by TelCove.

Level 3 entered into certain transactions with TelCove prior to the acquisition of TelCove by Level 3, whereby Level 3 received cash for communications services to be provided in the future and which was originally recognized as deferred revenue.  As a result of the acquisition, Level 3 can no longer amortize this deferred revenue into earnings and, accordingly, reduced the purchase price applied to the net assets acquired in the TelCove transaction by $3 million, which was the amount of the unamortized deferred revenue balance on July 24, 2006.

ICG CommunicationsOn May 31, 2006, Level 3 acquired all of the outstanding stock of ICG Communications, a privately held Colorado-based telecommunications company, from MCCC ICG Holdings, LLC excluding certain assets and liabilities.  Under the terms of the purchase agreement, Level 3 purchased ICG Communications for consideration consisting of approximately 26 million shares of Level 3 common stock, valued at $131 million, and approximately $45 million in cash.  The Company also incurred costs of less than $1 million related to the transaction.  Post-closing adjustments, primarily working capital and other contractual matters resulted in additional consideration of approximately $3 million.

Level 3 entered into certain transactions with ICG Communications prior to the acquisition of ICG Communications by Level 3, whereby Level 3 received cash for communications services to be provided in the future and which was originally recognized as deferred revenue.  As a result of the acquisition, Level 3 can no longer amortize this deferred revenue into earnings and,

10




accordingly, reduced the purchase price applied to the net assets acquired in the ICG Communications transaction by $1 million, which was the amount of the unamortized deferred revenue balance on May 31, 2006.

Progress Telecom:  On March 20, 2006, Level 3 completed its acquisition of all of the membership interests of Progress Telecom from PT Holding Company LLC (“PT Holding”) excluding certain specified assets and liabilities of Progress Telecom.  Progress Telecom was owned by PT Holding which is jointly owned by Progress Energy, Inc. and Odyssey Telecorp, Inc.  Under the terms of the purchase agreement, Level 3 purchased Progress Telecom for a purchase price consisting of approximately $69 million in cash and approximately 20 million shares of Level 3 common stock, valued at $66 million.  The purchase price was subsequently reduced by $2 million for working capital and other contractual matters.  The Company received payment of the $2 million adjustment in July 2006.

Level 3 entered into certain transactions with Progress Telecom prior to the acquisition of Progress Telecom by Level 3, whereby Level 3 received cash for communications services to be provided in the future and which was originally recognized as deferred revenue.  As a result of the acquisition, Level 3 can no longer amortize this deferred revenue into earnings and, accordingly, reduced the purchase price applied to the net assets acquired in the Progress Telecom transaction by $4 million, which was the amount of the unamortized deferred revenue balance on March 20, 2006.

Pro Forma Financial Information

The unaudited financial information in the table below summarizes the combined results of operations of Level 3 and the acquired businesses, on a pro forma basis, as though the companies acquired in 2006 and 2007 had been combined as of the beginning of each of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisitions had taken place at the beginning of each of the periods presented. The pro forma financial information for all periods presented includes the preliminary business combination accounting effect on historical revenues of the acquired companies, adjustments to depreciation on acquired property, amortization charges from acquired intangible assets, restructuring costs and acquisition costs reflected in the historical statements of operations for periods prior to Level 3’s acquisition.

 

 

Unaudited
Pro Forma
Three Months Ended
June 30,

 

Unaudited
Pro Forma
Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(dollars in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

1,052

 

$

1,187

 

$

2,109

 

$

2,376

 

 

 

 

 

 

 

 

 

 

 

Loss from Continuing Operations

 

$

(202

)

$

(248

)

$

(849

)

$

(440

)

Income from Discontinued Operations

 

 

23

 

 

21

 

Net Loss

 

$

(202

)

$

(225

)

$

(849

)

$

(419

)

Per share:

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.13

)

$

(0.21

)

$

(0.57

)

$

(0.38

)

Income from discontinued operations

 

 

0.02

 

 

0.02

 

Net loss

 

$

(0.13

)

$

(0.19

)

$

(0.57

)

$

(0.36

)

 

 

 

 

 

 

 

 

 

 

Pro Forma Weighted Shares Outstanding (in thousands)

 

1,529,614

 

1,188,150

 

1,502,156

 

1,165,645

 

 

The fair value of the assets acquired and the liabilities assumed in the Broadwing and CDN Business transactions are based upon preliminary valuations as of their respective acquisition dates after reflecting other contractual purchase price adjustments and are subject to change due to further analysis of the assets acquired and liabilities assumed as well as integration plans.

During the second quarter of 2007, the Company received a revised valuation for the CDN Business that indicates a significantly higher value of the identifiable intangible assets, primarily patents and customer-related intangible assets. The identifiable intangible assets for the CDN Business increased from $23 million in the preliminary valuation to $133 million in the revised valuation as a result of additional analysis of the estimated cash flows expected to be generated from the patents and customers acquired in the CDN Business acquisition.  The increase in the value of the identifiable intangible assets for the CDN Business eliminated the $110 million of goodwill originally recorded on the transaction.

11




During the second quarter of 2007, the Company also recorded purchase price allocation adjustments for the Broadwing acquisition that resulted in a net increase of $4 million to goodwill, resulting in total goodwill of $943 million for the Broadwing acquisition as of June 30, 2007.  The purchase price allocation adjustments included increases in goodwill of $8 million to record liabilities incurred by Broadwing prior to the acquisition and decreases to goodwill for the receipt of $4 million in insurance proceeds related to the settlement of an insurance claim that occurred prior to the acquisition.

The fair value of assets acquired and liabilities assumed in the Progress Telecom, ICG Communications, TelCove and Looking Glass transactions are based upon final valuations after reflecting other contractual purchase price adjustments.

During the second quarter of 2007, the Company received the final valuation for the ICG Communications acquisition that included revised valuations for both the identifiable tangible and intangible assets. The fixed assets acquired for ICG Communications increased from $10 million in the preliminary valuation to $93 million in the final valuation as a result of a detailed analysis to physically identify and estimate the fair value of the fixed assets acquired. As a result of the changes to the valuation of the fixed assets, the valuation of the identifiable intangible assets decreased from $49 million in the preliminary valuation to $18 million in the final valuation.

The adjusted fair values of the assets acquired and the liabilities assumed for the companies Level 3 acquired in 2006 and 2007 are as follows. 

 

 

CDN Business

 

Broadwing

 

Looking Glass

 

TelCove

 

ICG
Communications

 

Progress
Telecom

 

 

 

(dollars in millions)

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 

$

257

 

$

3

 

$

3

 

$

6

 

$

 

Marketable securities

 

 

46

 

 

 

 

 

Accounts receivable

 

 

82

 

8

 

23

 

7

 

3

 

Other current assets

 

 

19

 

2

 

5

 

2

 

2

 

Property, plant and equipment, net

 

2

 

240

 

183

 

796

 

93

 

77

 

Goodwill

 

 

943

 

 

179

 

73

 

30

 

Identifiable intangible assets

 

133

 

254

 

9

 

273

 

18

 

36

 

Other assets

 

 

31

 

1

 

 

5

 

 

Total Assets

 

$

135

 

$

1,872

 

$

206

 

$

1,279

 

$

204

 

$

148

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

1

 

$

42

 

$

5

 

$

21

 

$

6

 

$

1

 

Accrued payroll

 

1

 

15

 

1

 

6

 

2

 

1

 

Other current liabilities

 

 

120

 

9

 

20

 

10

 

7

 

Current portion of capital leases

 

 

2

 

 

3

 

 

1

 

Long-term debt

 

 

203

 

 

 

 

 

Capital leases

 

 

22

 

 

9

 

3

 

8

 

Deferred revenue—Acquired Company

 

 

13

 

1

 

 

4

 

 

Deferred revenue—Level 3

 

 

 

(2

)

(3

)

(1

)

(4

)

Other liabilities

 

 

15

 

28

 

7

 

2

 

 

Total Liabilities

 

2

 

432

 

42

 

63

 

26

 

14

 

Purchase Price

 

$

133

 

$

1,440

 

$

164

 

$

1,216

 

$

178

 

$

134

 

 

(3) Discontinued Operations

Level 3’s information services segment was comprised of Software Spectrum in 2006.  The Company sold Software Spectrum in September 2006 and, as a result, has presented it as discontinued operations in these financial statements.

12




Software Spectrum

On September 7, 2006, Level 3 sold Software Spectrum, Inc. to Insight Enterprises, a leading provider of information technology products and services.  In connection with the transaction, Level 3 received total proceeds of $353 million in cash, consisting of a base purchase price of $287 million and a working capital adjustment of approximately $66 million.  The purchase price was subject to working capital and certain other post-closing adjustments.  During the fourth quarter of 2006, the Company paid $2 million to Insight Enterprises as the final working capital adjustment.  Level 3 recognized a $33 million gain on the transaction in the third quarter of 2006 after transaction costs.

The following is the summarized results of operations of the Software Spectrum business for the three and six month periods ended June 30, 2006:

 

 

Three Months

 

Six Months

 

 

 

Ended

 

Ended

 

 

 

June 30, 2006

 

June 30, 2006

 

 

 

(dollars in millions)

 

Revenues

 

$

695

 

$

1,140

 

Costs and Expenses:

 

 

 

 

 

Cost of revenue

 

627

 

1,032

 

Depreciation and amortization

 

3

 

6

 

Selling, general and administrative

 

43

 

80

 

Restructuring and impairment charges

 

 

1

 

Total costs and expenses

 

673

 

1,119

 

Income from Operations

 

22

 

21

 

 

 

 

 

 

 

Other Income, Net

 

3

 

3

 

Income from Operations Before Income Taxes

 

25

 

24

 

 

 

 

 

 

 

Income Tax Expense

 

(2

)

(3

)

Income from Discontinued Operations

 

$

23

 

$

21

 

 

(4) Restructuring and Impairment Charges

Restructuring Charges

During the period from December 23, 2005 through June 30, 2007, the Company initiated cumulative workforce reductions expected to affect approximately 2,200 employees in its North American communications business related to the integration of businesses acquired since December 2005.  Of the 2,200 employees, approximately 23% were expected to be legacy Level 3 employees and approximately 77% were expected to be employees of acquired businesses.

In December 2005 and during 2006, the Company initiated cumulative workforce reductions expected to affect approximately 1,200 employees in its North American communications business related to the integration of WilTel Communications Group, LLC (“WilTel”), Progress Telecom, ICG Communications, TelCove and Looking Glass into Level 3’s operations. Of the 1,200 employees, approximately 22% were expected to be employees of legacy Level 3 and 78% were expected to be employees of the acquired companies.  Separately, in January 2005, Level 3 initiated and completed workforce reductions affecting 472 employees in the legacy Level 3 business that were not related to integration of acquired businesses.

In the first quarter of 2007, Level 3 initiated additional workforce reductions expected to affect approximately 1,000 employees in its North American communications business related to the integration of Broadwing and the previous acquisitions. Of the 1,000 employees, approximately 25% were expected to be employees of legacy Level 3 and approximately 75% were expected to be employees of the acquired companies.

The accounting treatment for the severance costs associated with the workforce reductions is dependent on whether those individuals affected are former employees of the acquired companies or legacy Level 3 employees. For the period from January 1, 2006 through June 30, 2007, the Company had notified or terminated a total of 1,538 employees (430 employees of legacy Level 3 and 1,108 employees of acquired businesses) pursuant to integration activities.

13




The estimated severance costs earned by employees of the acquired companies as of the acquisition date are included as a liability in the balance sheet as of the acquisition date.  The Company expects cumulative severance and related costs to total approximately $63 million for former WilTel, Progress Telecom, ICG Communications, TelCove, Looking Glass and Broadwing employees.  During the six months ended June 30, 2007, Level 3 paid $14 million of severance and related costs for these employees resulting in cumulative payments from January 1, 2006 to June 30, 2007 of $33 million for severance and related charges.

The workforce reduction attributable to the WilTel integration activity was substantially complete by the end of 2006. The workforce reductions attributable to the Progress Telecom, ICG Communications, TelCove, Looking Glass and Broadwing integration activities are expected to be substantially completed in 2007.

An analysis of the liability for the severance and related activity associated with the integration of the acquired companies follows:

 

Severance and Related
Costs for Acquired Company Employees

 

 

 

Number of
Employees

 

Amount

 

 

 

 

 

(in millions)

 

Balance December 31, 2004

 

 

$

 

2005 Accruals

 

765

 

26

 

Balance December 31, 2005

 

765

 

26

 

2006 Accruals

 

445

 

12

 

2006 Change in Estimate

 

(277

)

(8

)

2006 Payments

 

(547

)

(19

)

Balance December 31, 2006

 

386

 

11

 

2007 Accruals

 

750

 

33

 

2007 Payments

 

(561

)

(14

)

Balance June 30, 2007

 

575

 

$

30

 

 

Severance costs attributable to legacy Level 3 employees are recorded as a restructuring charge in the statement of operations once the employees are notified that their position will be eliminated and the severance arrangements are communicated to the employee.  For the three and six months ended June 30, 2007, the Company recorded approximately $1 million and $5 million, respectively, in restructuring charges for affected legacy Level 3 employees.  As of June 30, 2007, the Company had remaining obligations of less than $1 million for those legacy Level 3 employees terminated or notified.

A summary of the restructuring charges and related activity for legacy Level 3 employees follows:

 

Severance and Related
Costs for Legacy Level 3 Employees

 

 

 

 

 

Number of
Employees

 

Amount

 

Facilities Related
Amount

 

 

 

 

 

(in millions)

 

(in millions)

 

Balance December 31, 2004

 

 

$

 

$

16

 

2005 Charges

 

472

 

15

 

(1

)

2005 Payments

 

(472

)

(15

)

(3

)

Balance December 31, 2005

 

 

 

12

 

2006 Charges

 

248

 

5

 

 

2006 Payments

 

(242

)

(5

)

(2

)

Balance December 31, 2006

 

6

 

 

10

 

2007 Charges

 

182

 

5

 

 

2007 Payments

 

(153

)

(5

)

 

Balance June 30, 2007

 

35

 

$

 

$

10

 

 

Impairment Charges

The Company recognized non-cash impairment charges of $1 million in both the three and six months ended June 30, 2007, respectively.  These non-cash impairment charges resulted from the decision to terminate certain information technology projects in the communications business which had been previously capitalized. These projects have identifiable costs which Level 3 can separately evaluate for impairment. The costs incurred for these projects, including capitalized labor, were impaired as the carrying value of these projects were not expected to provide any future benefit to the Company.

14




Non-cash impairment charges were $4 million and $7 million for the three and six months ended June 30, 2006, respectively.  In the second quarter of 2006, Level 3 recognized $4 million of non-cash impairment charges primarily related to excess land of the communications business held for sale in Germany.  This charge resulted from the difference between the recorded carrying value and the estimated market value of the land.  In addition, the Company recognized $3 million of non-cash impairment charges in the first quarter of 2006 that resulted from the decision to terminate projects for certain voice services and certain information technology projects in the communications business.

 (5) Loss Per Share

The Company had a loss from continuing operations for the three and six months ended June 30, 2007 and 2006. Therefore, the effect of the approximately 314 million and 480 million shares issuable pursuant to the convertible debt securities outstanding at June 30, 2007 and 2006, respectively, have not been included in the computation of diluted loss per share because their inclusion would have been anti-dilutive to the computation. In addition, the effect of approximately 54 million and 52 million stock options, outperform stock options, restricted stock units and warrants outstanding at June 30, 2007 and 2006, respectively, have not been included in the computation of diluted loss per share because their inclusion would have been anti-dilutive to the computation.

The following details the loss per common share calculations for Level 3 for the three and six months ended June 30, 2007 and 2006 (dollars in millions, except per share data):

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Loss from Continuing Operations

 

$

(202

)

$

(224

)

$

(849

)

$

(390

)

Income from Discontinued Operations

 

 

23

 

 

21

 

Net Loss

 

$

(202

)

$

(201

)

$

(849

)

$

(369

)

Total Number of Weighted Average Common Shares Outstanding used to Compute Basic and Diluted Earnings (Loss) Per Share (in thousands)

 

1,529,614

 

881,155

 

1,499,555

 

851,700

 

 

 

 

 

 

 

 

 

 

 

Earnings (Loss) Per Share of Level 3 Common Stock (Basic and Diluted):

 

 

 

 

 

 

 

 

 

Loss from Continuing Operations

 

$

(0.13

)

$

(0.25

)

$

(0.57

)

$

(0.45

)

Income from Discontinued Operations

 

 

0.02

 

 

0.02

 

Net Loss

 

$

(0.13

)

$

(0.23

)

$

(0.57

)

$

(0.43

)

 

15




(6) Marketable Securities

In 2005, the Company invested $10 million in Infinera Corporation (“Infinera”) and accounted for this investment using the cost method and included the investment in long-term other assets. On June 7, 2007, Infinera completed its initial public offering (“IPO”) and its common stock began trading publicly on the NASDAQ Global Market.

As a result of the Infinera IPO on June 7, 2007, the Company has classified the Infinera investment on its balance sheet as a current marketable security that is available for sale, subject to compliance with applicable U.S. federal securities laws. The fair value of the Infinera common stock as of June 30, 2007 is approximately $68 million. An unrealized gain on the investment in Infinera totaling $58 million was recorded in the second quarter of 2007 and is included in Other Comprehensive Income. In connection with Infinera’s IPO, Level 3 entered into a “lock-up” agreement with Infinera’s underwriters which restricts the Company’s ability to sell the stock until December 7, 2007.

(7) Receivables

Receivables at June 30, 2007 and December 31, 2006 were as follows:

 

Communications

 

Coal

 

Total

 

 

 

(dollars in millions)

 

June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts Receivable—Trade

 

$

465

 

$

7

 

$

472

 

Allowance for Doubtful Accounts

 

(17

)

 

(17

)

Total

 

$

448

 

$

7

 

$

455

 

 

 

 

 

 

 

 

 

December 31, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts Receivable—Trade

 

$

337

 

$

6

 

$

343

 

Allowance for Doubtful Accounts

 

(17

)

 

(17

)

Total

 

$

320

 

$

6

 

$

326

 

 

The Company recognized bad debt expense in selling, general and administrative expenses of $3 million and $6 million in the three and six months ended June 30, 2007, respectively, and less than $1 million in each of the three and six month periods ended June 30, 2006, respectively. The Company reduced accounts receivable and the allowance for doubtful accounts by $7 million in the six months ended June 30, 2007 for previously reserved amounts the Company wrote off as uncollectible.

(8) Property, Plant and Equipment, net

Costs associated directly with expansions and improvements to the communications network and customer installations, including employee related costs, have been capitalized. The Company generally capitalizes costs associated with network construction, provisioning of services and software development.

Capitalized labor and related costs associated with employees and contract labor working on capital projects were approximately $28 million and $54 million for the three and six months ended June 30, 2007, respectively.

Capitalized labor and related costs associated with employees and contract labor working on capital projects were approximately $16 million and $26 million for the three and six months ended June 30, 2006, respectively.

The Company continues to develop business support systems required for its business. The external direct costs of software, materials and services, and payroll and payroll related expenses for employees directly associated with the project incurred when developing the business support systems are capitalized and included in the capitalized costs above. Upon completion of a project, the total cost of the business support system is amortized over an estimated useful life of three years.

During the second quarter of 2007, the Company received the final valuation for the ICG Communications acquisition that included revised valuations for identifiable tangible assets. As a result, the fixed assets acquired for ICG Communications

16




increased from $10 million in the preliminary valuation to $93 million in the final valuation as a result of a detailed analysis to physically identify and estimate the fair value of the fixed assets acquired.

During the second quarter of 2006, Level 3 determined that the period the Company expects to use its existing fiber is longer than the remaining useful life as originally estimated.  As a result, the Company extended the depreciable life of its existing fiber from 7 years to 12 years.  This change in estimate, effected as of April 1, 2006, was accounted for prospectively, in accordance with SFAS No. 154, “Accounting Changes and Error Corrections — A Replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”), and reduced depreciation expense by $18 million in the second quarter of 2006.  In addition, this change in estimate reduced net loss from continuing operations and net loss by $18 million, or approximately $0.02 cents per share in the second quarter of 2006.

Depreciation expense was $213 million and $410 million for the three and six months ended June 30, 2007, respectively.  Depreciation expense was $149 million and $316 million for the three and six months ended June 30, 2006, respectively.

(9) Goodwill

Goodwill at June 30, 2007 and December 31, 2006 was as follows (dollars in millions):

 

June 30,
2007

 

December 31,
2006

 

 

 

 

 

 

 

XCOM

 

$

30

 

$

30

 

McLeod

 

40

 

40

 

Progress Telecom

 

30

 

32

 

ICG Communications

 

73

 

127

 

TelCove

 

179

 

179

 

Broadwing

 

943

 

 

 

 

$

1,295

 

$

408

 

 

The Company segregates identifiable intangible assets acquired in a business combination from goodwill. Goodwill is not amortized and the carrying amount of the goodwill and indefinite-lived intangible assets must be evaluated at least annually for impairment using a fair value based test. An assessment of the carrying value of the goodwill and indefinite-lived intangible assets attributable to the communications business was performed as of December 31, 2006 and indicated that the assets were not impaired.

The final purchase price valuations for the Progress Telecom, ICG Communications and TelCove acquisitions indicated that the purchase price exceeded the fair value of the identifiable assets acquired and liabilities assumed and resulted in goodwill of $30 million, $73 million and $179 million, respectively. The final purchase price valuation for ICG Communications was received in the second quarter of 2007.  As a result of the revisions to the fixed asset and customer-related intangible asset valuations described in Note 2, the goodwill recorded in connection with the ICG Communications acquisition was reduced from $127 million based on the preliminary valuation to $73 million based on the final valuation.

The preliminary purchase price valuation for the Broadwing acquisition indicated that the purchase price exceeded the fair value of the identifiable assets acquired and liabilities assumed and resulted in goodwill of $943 million as of June 30, 2007. As described in Note 2, the Company made purchase price allocation adjustments for the Broadwing acquisition in the second quarter of 2007 that resulted in a net increase of $4 million to the goodwill recorded for Broadwing.

As also described Note 2, the Company received a revised valuation report for the CDN Business that resulted in increased valuations for patents and customer-related intangible assets and resulted in the elimination of the $110 million of goodwill preliminarily recorded for the CDN Business acquisition in the first quarter of 2007.

17




The final valuation of the assets acquired and liabilities assumed in the Looking Glass transaction indicated that the fair value of the identifiable net assets acquired exceeds the consideration paid to the former owners by $24 million which reduced the fair value of long-lived assets acquired in the transaction on a pro-rata basis. Also, during the fourth quarter of 2006 Level 3 recorded a $24 million liability for unfavorable leases attributable to Looking Glass.

(10) Other Intangibles, net

Other Intangibles, net at June 30, 2007 and December 31, 2006 were as follows (dollars in millions):

 

June 30,
2007

 

December 31,
2006

 

 

 

 

 

 

 

360networks

 

$

2

 

$

3

 

Sprint

 

 

5

 

Telverse

 

7

 

10

 

Genuity

 

3

 

6

 

WilTel

 

127

 

135

 

Progress Telecom

 

31

 

33

 

ICG Communications

 

15

 

47

 

TelCove

 

251

 

264

 

Looking Glass

 

8

 

8

 

Broadwing

 

240

 

 

CDN Business

 

126

 

 

 

 

$

810

 

$

511

 

 

On January 23, 2007, Level 3 completed the acquisition of the CDN Business. In the first quarter of 2007, the preliminary valuation of the assets acquired in the CDN Business transaction indicated a value of $23 million for patents and customer-related intangible assets. As described in Note 2, during the second quarter of 2007 the Company received a revised valuation for the CDN Business that indicated a significant increase in the value of the identifiable intangible assets, primarily patents and customer-related intangible assets. The identifiable intangible assets for the CDN Business increased from $23 million in the preliminary valuation to $133 million in the revised valuation as a result of additional analysis of the estimated cash flows expected to be generated from the patents and customers acquired in the CDN Business acquisition.  The increase in the value allocated to the identifiable intangible assets for the CDN Business eliminated the $110 million of goodwill recorded on the transaction in the first quarter of 2007. The estimated useful lives for the patent and customer-related intangible assets range from four to ten years.

On January 3, 2007, Level 3 completed the acquisition of Broadwing. A preliminary valuation of the assets acquired in the Broadwing transaction indicated a value of $254 million for wholesale and enterprise customer-related intangible assets. Level 3 had initially assigned an estimated useful life of ten years to the customer-related intangible assets. During June 2007, the Company completed a review of the estimated useful lives of the customer-related intangible assets for the Broadwing acquisition that resulted in a reduction of the estimated useful lives from ten years to six to eight years.  This change in estimate, effected as of June 1, 2007, was accounted for prospectively and increased amortization expense by approximately $1 million during the second quarter of 2007.

On August 2, 2006, Level 3 completed the acquisition of Looking Glass. The final valuation of the assets acquired in the Looking Glass transaction as of the acquisition date, indicated wholesale customer-related intangibles of approximately $9 million with an estimated useful life of eight years. During June 2007, the Company completed a review of the estimated useful life of the customer-related intangible asset for the Looking Glass acquisition that resulted in a reduction of the estimated useful life from eight years to six years. This change in estimate, effected as of June 1, 2007, was accounted for prospectively and increased amortization expense by less than $1 million during the second quarter of 2007.

On July 24, 2006, Level 3 completed the acquisition of TelCove. The final valuation of the assets acquired in the TelCove transaction as of the acquisition date, indicated wholesale and enterprise customer-related intangible assets of approximately $253 million, with lives ranging from nine to 13 years and other intangible assets of approximately $20 million with an indefinite life.  During June 2007, the Company completed a review of the estimated useful lives of the customer-related intangible assets for the TelCove acquisition that resulted in a reduction of the estimated useful lives from nine to 13 years to six

18




to eight years. This change in estimate, effected as of June 1, 2007, was accounted for prospectively and increased amortization expense by approximately $1 million during the second quarter of 2007.

On May 31, 2006, Level 3 completed the acquisition of ICG Communications. A preliminary valuation of the assets acquired in the ICG Communications transaction indicated a value of $49 million for wholesale customer-related intangible assets with an estimated useful life of 15 years.  As described in Note 2, during the second quarter of 2007 the Company received the final valuation for the ICG Communications acquisition that included revised valuations for both the identifiable tangible and intangible assets. As a result of the changes to the valuation of the fixed assets, the valuation of the identifiable intangible assets decreased from $49 million in the preliminary valuation to $18 million in the final valuation.  During June 2007, the Company completed a review of the estimated useful life of the customer-related intangible asset for the ICG Communications acquisition that resulted in a reduction in the estimated useful life from 15 years to six years. This change in estimate, effected as of June 1, 2007, was accounted for prospectively and increased amortization expense by less than $1 million during the second quarter of 2007 after taking into consideration the reduced valuation of the ICG Communications customer-related intangible assets.

On March 20, 2006, Level 3 completed the acquisition of Progress Telecom. A final valuation of the assets acquired in the Progress Telecom acquisition resulted in a value of $36 million for customer-related intangible assets with an estimated useful life of eight years.

As described above, in June 2007 the Company completed a review of the estimated useful lives used for amortization of the customer-related intangible assets for the ICG Communications, Looking Glass, TelCove and Broadwing acquisitions.  As a result of the review, the Company revised the useful lives used for amortization of customer-related intangible assets as described above.  This change in estimate, effected as of June 1, 2007, was accounted for prospectively in accordance with SFAS No. 154, and increased amortization expense in the aggregate by approximately $2 million in total during the second quarter of 2007.

Intangible asset amortization expense was $34 million and $58 million for the three and six months ended June 30, 2007, respectively.  Intangible asset amortization expense was $15 million and $35 million for the three and six months ended June 30, 2006, respectively.  The amortization expense related to intangible assets currently recorded on the Company’s books for each of the five succeeding years is estimated to be the following for the years ended December 31: second half of 2007—$66 million; 2008—$124 million; 2009—$120 million; 2010—$119 million; 2011—$118 million and thereafter—$211 million.

19




(11) Long-Term Debt

At June 30, 2007 and December 31, 2006, long-term debt was as follows:

(dollars in millions)

 

June 30,
2007

 

December 31,
2006

 

Senior Secured Term Loan due 2014 (7.605%)

 

$

1,400

 

$

 

Senior Secured Term Loan due 2011

 

 

730

 

Senior Notes due 2008 (11.0%)

 

20

 

78

 

Senior Euro Notes due 2008 (10.75%)

 

5

 

65

 

Senior Discount Notes due 2010

 

 

488

 

Senior Euro Notes due 2010

 

 

137

 

Senior Notes due 2010

 

 

96

 

Senior Notes due 2010 (11.5%)

 

13