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Section 1: 8-K/A (FORM 8-K AMENDMENT NO. 1)

Form 8-K Amendment No. 1

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

FORM 8-K/A

(Amendment No. 1)

 

 

CURRENT REPORT

Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

Date of Report (Date of earliest event reported):

November 1, 2017

 

 

 

 

LOGO

CenturyLink, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Louisiana   1-7784   72-0651161

(State or other jurisdiction

of incorporation)

 

(Commission

File Number)

 

(IRS Employer

Identification No.)

100 CenturyLink Drive

Monroe, Louisiana

  71203
(Address of principal executive offices)   (Zip Code)

(318) 388-9000

(Registrants’ telephone number, including area code)

 

 

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligations of the registrant under any of the following provisions:

 

Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (17 CFR §230.405) or Rule 12b-2 of the Securities Exchange Act of 1934 (17 CFR §240.12b-2). Emerging growth company  ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

 

 


Explanatory Note

On November 1, 2017, we filed a Current Report on Form 8-K (the “Initial Report”), which indicated that we had (i) closed our previously-announced business combination (the “Combination”) with Level 3 Communications, Inc. and (ii) elected to defer filing certain of the information required by the form, as permitted by the form’s rules. This Current Report on Form 8-K/A supplements the Initial Report to include the historical consolidated financial statements and pro forma financial information required by Items 9.01(a) and 9.01(b) of Form 8-K and should be read in conjunction with the Initial Report.

 

Item 9.01 Financial Statements and Exhibits.

 

(a) Financial statements of business acquired.

The consolidated financial statements of Level 3 Communications, Inc. (renamed Level 3 Parent, LLC as of November 1, 2017 and hereinafter referred to as “Level 3”) as of September 30, 2017 and for the periods ended September 30, 2017 and 2016, and as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014, all of which Level 3 has previously filed with the U.S. Securities and Exchange Commission, are attached as Exhibits 99.1 and 99.2, respectively, to this Current Report on Form 8-K/A.

 

(b) Pro forma financial information.

The unaudited pro forma condensed combined financial information reflecting the Combination is attached as Exhibit 99.3 to this Current Report on Form 8-K/A.

 

(d) Exhibits

The following exhibits are filed herewith:

 

Exhibit
No.

  

Description

23.1    Consent of KPMG LLP, independent registered public accounting firm for Level 3
99.1    Consolidated financial statements of Level 3 as of September 30, 2017 and for the periods ended September 30, 2017 and 2016:
  

i.       Consolidated Statements of Income for the Periods Ended September 30, 2017 and 2016 (Unaudited)

  

ii.      Consolidated Statements of Comprehensive Income for the Periods Ended September 30, 2017 and 2016 (Unaudited)

  

iii.    Consolidated Balance Sheet as of September 30, 2017 (Unaudited)

  

iv.     Consolidated Statements of Cash Flows for the Periods Ended September 30, 2017 and 2016 (Unaudited)

  

v.      Condensed Notes to Consolidated Financial Statements (Unaudited)

 

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99.2    Consolidated financial statements of Level 3 as of December 31, 2016 and 2015 and for the years ended December 31, 2016, 2015 and 2014:
  

i.       Reports of KPMG LLP, Independent Registered Public Accounting Firm

  

ii.      Consolidated Statements of Income for the Years Ended December 31, 2016, 2015 and 2014

  

iii.    Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015 and 2014

  

iv.     Consolidated Balance Sheets as of December 31, 2016 and 2015

  

v.      Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014

  

vi.     Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2016, 2015 and 2014

  

vii.   Notes to Consolidated Financial Statements

99.3    Unaudited Pro Forma Condensed Combined Financial Information

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, CenturyLink, Inc. has duly caused this Current Report on Form 8-K/A to be signed on its behalf by the undersigned officer hereunto duly authorized.

 

CENTURYLINK, INC.
By:  

/s/ Stacey W. Goff

  Stacey W. Goff
  Executive Vice President,
  Chief Administrative Officer,
  General Counsel and Secretary

Dated: January 16, 2018

 

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Section 2: EX-23.1 (EX-23.1)

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors

CenturyLink, Inc.:

We consent to the incorporation by reference, in the registration statements (No. 333-202411, No. 333-212575, and No. 333-187366) on Form S-3, the registration statements (No. 33-60061, No. 333-160391, No. 333-37148, No. 333-60806, No. 333-150157, No. 333-124854, No. 333-150188, No. 333-174571, and No. 333-221267) on Form S-8, and the registration statements (No. 33-48956, No. 333-17015, No. 333-167339, No. 333-174291, No. 333-155521, No. 333-206725, and No. 333-215121) on Form S-4 of CenturyLink, Inc., of our reports dated February 24, 2017, with respect to the consolidated balance sheets of Level 3 Communications, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, cash flows, and changes in stockholders’ equity for each of the years in the three-year period ended December 31, 2016, and the effectiveness of internal control over financial reporting as of December 31, 2016, which reports are included in the Form 8-K/A of CenturyLink, Inc.

/s/ KPMG LLP

Denver, Colorado

January 12, 2018

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Section 3: EX-99.1 (EX-99.1)

EX-99.1

Exhibit 99.1

Part I - Financial Information

ITEM 1. FINANCIAL STATEMENTS

LEVEL 3 PARENT, LLC AND SUBSIDIARIES

Consolidated Statements of Income

(unaudited)

 

    Three Months Ended     Nine Months Ended  

(dollars in millions, except per share data)

  September 30,
2017
    September 30,
2016
    September 30,
2017
    September 30,
2016
 

Revenue

  $ 2,059     $ 2,033     $ 6,168     $ 6,140  

Costs and Expenses:

       

Network access costs

    678       675       2,044       2,045  

Network related expenses

    345       337       1,018       1,014  

Depreciation and amortization

    333       319       983       930  

Selling, general and administrative expenses

    348       348       1,078       1,061  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs and Expenses

    1,704       1,679       5,123       5,050  
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income

    355       354       1,045       1,090  

Other Income (Expense):

       

Interest income

    6       1       11       3  

Interest expense

    (134     (139     (400     (414

Loss on modification and extinguishment of debt

    —         —         (44     (40

Other, net

    6       1       9       (14
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Expense

    (122     (137     (424     (465
 

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Income Taxes

    233       217       621       625  

Income Tax Expense

    (76     (74     (215     (198
 

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

  $ 157     $ 143     $ 406     $ 427  
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic Earnings per Common Share

       

Net Income Per Share

  $ 0.43     $ 0.40     $ 1.12     $ 1.19  

Weighted-Average Shares Outstanding (in thousands)

    363,471       359,561       362,413       358,097  

Diluted Earnings per Common Share

       

Net Income Per Share

  $ 0.43     $ 0.39     $ 1.11     $ 1.18  

Weighted-Average Shares Outstanding (in thousands)

    365,323       361,907       364,710       361,072  

See accompanying notes to unaudited Consolidated Financial Statements.

 

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LEVEL 3 PARENT, LLC AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

 

    Three Months Ended     Nine Months Ended  

(dollars in millions)

  September 30,
2017
    September 30,
2016
    September 30,
2017
    September 30,
2016
 

Net Income

  $ 157     $ 143     $ 406     $ 427  

Other Comprehensive Income (Loss), net of Tax:

       

Foreign currency translation adjustments, net of tax effect of ($18), $6, ($55) and $30

    44       (15     106       9  

Defined benefit pension plan adjustments, net of tax effect of ($1), ($1), ($1), and ($2)

    —         —         —         (1
 

 

 

   

 

 

   

 

 

   

 

 

 

Other Comprehensive Income (Loss), net of Tax

    44       (15     106       8  
 

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income

  $ 201     $ 128     $ 512     $ 435  
 

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited Consolidated Financial Statements.

 

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LEVEL 3 PARENT, LLC AND SUBSIDIARIES

Consolidated Balance Sheets

(unaudited)

 

(dollars in millions, except per share data)

  September 30,
2017
    December 31,
2016
 

Assets:

   

Current Assets:

   

Cash and cash equivalents

  $ 2,252     $ 1,819  

Restricted cash and securities

    5       7  

Receivables, less allowances for doubtful accounts of $32 and $29, respectively

    750       712  

Other

    136       115  
 

 

 

   

 

 

 

Total Current Assets

    3,143       2,653  

Property, Plant and Equipment, net of accumulated depreciation of $12,203 and $11,249, respectively

    10,485       10,139  

Restricted Cash and Securities

    29       31  

Goodwill

    7,741       7,729  

Other Intangibles, net

    761       915  

Deferred Tax Assets

    3,162       3,370  

Other Assets, net

    52       51  
 

 

 

   

 

 

 

Total Assets

  $ 25,373     $ 24,888  
 

 

 

   

 

 

 

Liabilities and Stockholders’ Equity:

   

Current Liabilities:

   

Accounts payable

  $ 704     $ 706  

Current portion of long-term debt

    7       7  

Accrued payroll and employee benefits

    247       195  

Accrued interest

    95       129  

Current portion of deferred revenue

    276       266  

Other

    139       168  
 

 

 

   

 

 

 

Total Current Liabilities

    1,468       1,471  

Long-Term Debt, less current portion

    10,586       10,877  

Deferred Revenue, less current portion

    1,132       1,001  

Other Liabilities

    637       622  
 

 

 

   

 

 

 

Total Liabilities

    13,823       13,971  

Commitments and Contingencies

   

Stockholders’ Equity:

   

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

    —         —    

Common stock, $.01 par value, authorized 433,333,333 shares in both periods; 362,799,950 issued and outstanding at September 30, 2017 and 360,021,098 issued and outstanding at December 31, 2016

    4       4  

Additional paid-in capital

    19,921       19,800  

Accumulated other comprehensive loss

    (281     (387

Accumulated deficit

    (8,094     (8,500
 

 

 

   

 

 

 

Total Stockholders’ Equity

    11,550       10,917  
 

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

  $ 25,373     $ 24,888  
 

 

 

   

 

 

 

See accompanying notes to unaudited Consolidated Financial Statements.

 

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LEVEL 3 PARENT, LLC AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

    Nine Months Ended  

(dollars in millions)

  September 30,
2017
    September 30,
2016
 

Cash Flows from Operating Activities:

   

Net income

  $ 406     $ 427  

Adjustments to reconcile net income to net cash provided by operating activities:

   

Depreciation and amortization

    983       930  

Non-cash compensation expense attributable to stock awards

    120       121  

Loss on modification and extinguishment of debt

    44       40  

Accretion of debt discount and amortization of debt issuance costs

    13       15  

Accrued interest on long-term debt, net

    (34     27  

Deferred income taxes

    189       163  

Loss (gain) on sale of property, plant and equipment and other assets

    6       (1

Other, net

    5       (7

Changes in working capital items:

   

Receivables

    (34     16  

Other current assets

    (38     (40

Accounts payable

    (10     99  

Deferred revenue

    134       21  

Other current liabilities

    7       (25
 

 

 

   

 

 

 

Net Cash Provided by Operating Activities

    1,791       1,786  

Cash Flows from Investing Activities:

   

Capital expenditures

    (1,018     (1,028

Change in restricted cash and securities, net

    4       11  

Purchases of marketable securities

    (1,127     —    

Maturity of marketable securities

    1,127       —    

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

    1       1  
 

 

 

   

 

 

 

Net Cash Used in Investing Activities

    (1,013     (1,016

Cash Flows from Financing Activities:

   

Long-term debt borrowings, net of issuance costs

    4,569       764  

Payments on and repurchases of long-term debt and capital leases

    (4,917     (818
 

 

 

   

 

 

 

Net Cash Used in Financing Activities

    (348     (54

Effect of Exchange Rates on Cash and Cash Equivalents

    3       (1
 

 

 

   

 

 

 

Net Change in Cash and Cash Equivalents

    433       715  

Cash and Cash Equivalents at Beginning of Period

    1,819       854  
 

 

 

   

 

 

 

Cash and Cash Equivalents at End of Period

  $ 2,252     $ 1,569  
 

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information:

   

Cash interest paid

  $ 412     $ 372  

Income taxes paid, net of refunds

  $ 47     $ 26  

See accompanying notes to unaudited Consolidated Financial Statements.

 

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LEVEL 3 PARENT, LLC AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

Effective November 1,2017, Level 3 Communications, Inc. became an indirect wholly owned subsidiary of CenturyLink, Inc. Upon completion of the acquisition, Level 3 Communications, Inc.’s name changed to Level 3 Parent, LLC. Unless the context requires otherwise, references in this report to “Level 3 Communications, Inc.,” “Level 3,” “we,” “us,” the “Company” and “our” refer to Level 3 Parent, LLC and its consolidated subsidiaries.

(1) Organization and Summary of Significant Accounting Policies

Description of Business

We are a facilities-based provider (that is, a provider that owns or leases a substantial portion of the property, plant and equipment necessary to provide our services) of a broad range of integrated communications services. We created our communications network by constructing our own assets and through a combination of purchasing other companies and purchasing or leasing facilities from others. Our network is an international, facilities-based communications network. We designed our network to provide communications services that employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.

On October 31, 2016, we entered into an agreement and plan of merger (the “Merger Agreement”) with CenturyLink, Inc., a Louisiana corporation (“CenturyLink”), Wildcat Merger Sub 1 LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink (“Merger Sub 1”), and WWG Merger Sub LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink (“Merger Sub 2”), pursuant to which, effective November 1, 2017, we were acquired by CenturyLink in a cash and stock transaction, including the assumption of our debt (the “CenturyLink Merger”). See Note 2—Events Associated with the CenturyLink Merger.

Principles of Consolidation and Basis of Presentation

The consolidated financial statements include our and our subsidiaries’ accounts in which we have a controlling interest. All significant intercompany accounts and transactions have been eliminated. The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).

As part of our consolidation policy, we consider our controlled subsidiaries, investments in businesses in which we are not the primary beneficiary or do not have effective control but have the ability to significantly influence operating and financial policies, and variable interests resulting from economic arrangements that give us rights to economic risks or rewards of a legal entity. We do not have variable interests in a variable interest entity where we are required to consolidate the entity as the primary beneficiary. Due to exchange restrictions and other conditions, effective at the end of the third quarter of 2015 we deconsolidated our Venezuelan subsidiary and began accounting for our investment in our Venezuelan subsidiary using the cost method of accounting. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the end of the third quarter of 2017.

The accompanying Consolidated Balance Sheet as of December 31, 2016, which was derived from audited Consolidated Financial Statements, and the unaudited interim Consolidated Financial Statements as of September 30, 2017 and for the three and nine months ended September 30, 2017 and 2016 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for quarterly reports on Form 10-Q and do not include all of the information and note disclosures required by GAAP for complete financial statements. These financial statements should

 

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be read in conjunction with our audited Consolidated Financial Statements and notes thereto included in our Form 10-K for the year ended December 31, 2016. In the opinion of our management, these financial statements contain all adjustments necessary for a fair presentation of financial position, results of operations and cash flows at the dates and for the interim periods presented herein. The results of operations for an interim period are not necessarily indicative of the results of operations expected for a full fiscal year.

The preparation of the Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses during the reported period. Actual results could differ from these estimates under different assumptions or conditions and such differences could be material.

Recently Issued Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (“ASC 842”), which requires entities that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. This ASU will replace most existing leasing guidance in U.S. GAAP when it becomes effective. The new standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those years. Early application is permitted. The standard requires the use of a modified retrospective transition method. We are evaluating the effect that ASU 2016-02 will have on our Consolidated Financial Statements and related disclosures, and expect the new guidance to significantly increase the reported assets and liabilities on our Consolidated Balance Sheets.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which amended the existing accounting standards for revenue recognition and requires an entity to recognize the amount of revenue it expects to be entitled to for the transfer of promised goods or services to customers. The ASU and subsequent amendments have been codified as ASC 606, Revenue from Contracts with Customers (“ASC 606”). In July 2015, the FASB deferred the effective date to annual reporting periods beginning after December 15, 2017, and interim reporting periods within those periods. Early adoption is permitted using the original effective date of annual reporting periods beginning after December 15, 2016, and interim reporting periods within those periods. The new guidance may be applied retrospectively to each prior period presented or prospectively with the cumulative effect recognized as of the date of initial adoption. We will not adopt ASC 606 early.

We have performed a comprehensive analysis of our revenue streams and contractual arrangements to identify and quantify the effects of ASC 606 on our consolidated financial statements and are developing new accounting and reporting policies, business and internal control processes and procedures to facilitate adoption of the standard. Because we currently have service contracts that contain a significant financing component that are not currently separately accounted for, we will be required to estimate and record incremental revenue and interest cost associated with these contractual terms. In addition, we will be required to capitalize, and subsequently amortize, commission costs associated with obtaining or fulfilling our customer contracts, which we do not currently defer and amortize. We will also have to comply with new revenue disclosure requirements. We are continuing to review and evaluate underlying contract information that will be used to support new accounting and disclosure requirements under ASC 606 and evaluate other matters that may result from adoption of the standard. We have not yet selected a transition method, as our method of transition may be affected by the CenturyLink Merger, which was completed effective November 1, 2017 (see Note 2—Events Associated with the CenturyLink Merger), and subsequent integration activities completed prior to the January 1, 2018 ASC 606 adoption date.

 

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(2) Events Associated with the CenturyLink Merger

On November 1, 2017, pursuant to the terms and conditions of the previously-announced Merger Agreement, dated as of October 31, 2016, among Level 3, CenturyLink, Merger Sub I and Merger Sub 2, Merger Sub 1 merged with and into Level 3 (the “Initial Merger”) and immediately thereafter Level 3 merged with and into Merger Sub 2 (the “Subsequent Merger”), with Merger Sub 2 surviving such merger as an indirect wholly owned subsidiary of CenturyLink under the name of Level 3 Parent, LLC.

In connection with the Initial Merger, each outstanding share of Level 3 Communications, Inc. common stock, par value $0.01 per share (the “LVLT Common Stock”), other than shares held by holders who have properly exercised appraisal rights and shares owned by CenturyLink, Level 3 or their respective subsidiaries, was converted into the right to receive $26.50 in cash, without interest, and 1.4286 shares of CenturyLink common stock, par value $1.00 per share (“CTL Common Stock”), with cash paid in lieu of fractional shares.

In addition, as a result of the Initial Merger, (i) each outstanding Level 3 restricted stock unit award granted prior to April 1, 2014 or granted to an outside director of Level 3 was converted into the right to receive $26.50 in cash and 1.4286 shares of CTL Common Stock (and cash in lieu of fractional shares) with respect to each Level 3 share covered by such award, less applicable tax withholdings, and (ii) each outstanding Level 3 restricted stock unit award granted on or after April 1, 2014 (other than those granted to outside directors of Level 3) was converted into a restricted stock unit award relating to such number of shares of CTL Common Stock determined in accordance with a formula set forth in the Merger Agreement (the “Continuing RSU Awards”). The Continuing RSU Awards will remain subject to the same terms and conditions applicable to the original Level 3 awards immediately prior to their conversion, subject to certain exceptions.

As a result of the Initial Merger, CenturyLink delivered to our stockholders an aggregate of approximately $9.6 billion in cash and approximately 517.3 million shares of CTL Common Stock valued at approximately $9.8 billion (excluding shares of CTL Common Stock subject to future issuance under the Continuing RSU Awards and amounts to be paid to holders of dissenting shares), based on the number of shares of LVLT Common Stock and Converted RSU Awards outstanding at the close of business on October 31, 2017 and the per share closing price of CTL Common Stock on the New York Stock Exchange on October 31, 2017.

The above-described issuance of shares of CTL Common Stock in connection with the Initial Merger was registered under the Securities Act of 1933, as amended, pursuant to a registration statement on Form S-4 (File No. 333-215121) filed by us with the U.S. Securities and Exchange Commission (the “Commission”) and declared effective on February 13, 2017. The joint proxy statement/ prospectus of CenturyLink and Level 3 included in the registration statement (the “Joint Proxy Statement/Prospectus”), including the various reports incorporated by reference therein, contains additional information about the above-described transactions.

In connection with the closing of the Merger Agreement, we invested $1.825 billion in CenturyLink in exchange for an unsecured demand note that bears interest at 3.5% per annum. The principal amount of such note is payable upon demand by Level 3 Parent but no later than November 1, 2020, and is prepayable by CenturyLink at any time.

The U.S. Department of Justice approved the acquisition subject to conditions of a consent decree on October 2, 2017, which requires the combined company to divest certain Level 3 metro network assets in the markets located in Albuquerque, New Mexico; Boise, Idaho; and Tucson, Arizona and the combined company will divest 24 strands of dark fiber connecting 30 specified city-pairs across the United States in the form of an Indefeasible Right of Use agreement. The carrying value of the metro network and dark fiber assets is not material to Level 3.

Our results of operations will be included in the consolidated results of operations of CenturyLink beginning November 1, 2017. CenturyLink will account for its acquisition of us under the acquisition method of accounting, which will result in the allocation of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition, with the excess

 

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purchase price being recognized as goodwill. None of the goodwill associated with this transaction is deductible for income tax purposes. The allocation of the purchase price to the assets acquired and liabilities assumed (and the related estimated lives of depreciable tangible and identifiable intangible assets) will require a significant amount of judgment. Such allocation of the purchase price (including the assignment of goodwill to reporting units) will be determined based upon an analysis currently being performed, which is expected to be complete no later than the fourth quarter of 2018. The recognition of assets and liabilities at fair value will be reflected in our financial statements and therefore will result in a new basis of accounting for the “successor period” beginning on November 1, 2017. This new basis of accounting means that our financial statements for the successor periods will not be comparable to our previously reported financial statements, including the financial statements in this report.

We recognized $31 million and $74 million of expenses associated with our activities surrounding the CenturyLink Merger for the three and nine months ended September 30, 2017, respectively.

(3) Earnings Per Share

We compute basic earnings per share by dividing net income for the period by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing the net income for the period by the weighted average number of shares of common stock outstanding during the period and including the dilutive effect of common stock that would be issued assuming exercise of stock-based compensation awards.

The effects of approximately 2 million total restricted stock units (“RSUs”) and performance restricted stock units (“PRSUs”) outstanding at September 30, 2017 have been included in the computation of diluted earnings per share for the three and nine months ended September 30, 2017. Less than 1 million of PRSUs granted in 2016 were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2017, as they were contingently issuable and no shares would have been issued if these periods were the end of the contingency period. The effect of approximately 2 million and 3 million total outperform stock appreciation rights (“OSOs”), RSUs and PRSUs outstanding at September 30, 2016 were included in the computation of diluted earnings per share for the three and nine months ended September 30, 2016, respectively.

 

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(4) Other Intangible Assets

Other intangible assets as of September 30, 2017 and December 31, 2016 were as follows:

 

(dollars in millions)    Gross
Carrying
Amount
     Accumulated
Amortization
     Net  

September 30, 2017

        

Finite-Lived Intangible Assets:

        

Customer Contracts and Relationships

   $ 1,973      $ (1,250    $ 723  

Trademarks

     55        (55      —    

Patents and Developed Technology

     228        (205      23  
  

 

 

    

 

 

    

 

 

 
     2,256        (1,510      746  

Indefinite-Lived Intangible Assets:

        

Trade Name

     15        —          15  
  

 

 

    

 

 

    

 

 

 
   $ 2,271      $ (1,510    $ 761  
  

 

 

    

 

 

    

 

 

 

December 31, 2016

        

Finite-Lived Intangible Assets:

        

Customer Contracts and Relationships

   $ 1,973      $ (1,113    $ 860  

Trademarks

     55        (55      —    

Patents and Developed Technology

     229        (189      40  
  

 

 

    

 

 

    

 

 

 
     2,257        (1,357      900  

Indefinite-Lived Intangible Assets:

        

Trade Name

     15        —          15  
  

 

 

    

 

 

    

 

 

 
   $ 2,272      $ (1,357    $ 915  
  

 

 

    

 

 

    

 

 

 

Finite-lived intangible asset amortization expense was $49 million and $153 million for the three and nine months ended September 30, 2017 and $53 million and $159 million for the three and nine months ended September 30, 2016.

At September 30, 2017, the weighted average remaining useful lives of our finite-lived intangible assets was 4.1 in total; 4.2 for customer contracts and relationships, and 2.1 for patents and developed technology.

As of September 30, 2017, estimated amortization expense for our finite-lived intangible assets over the next five years is as follows (dollars in millions):

 

2017 (remaining three months)

   $ 47  

2018

     190  

2019

     179  

2020

     166  

2021

     143  

2022

     21  

Thereafter

     —    
  

 

 

 
   $   746  
  

 

 

 

 

10


(5) Fair Value of Financial Instruments

Our financial instruments consist of cash, cash equivalents, restricted cash and securities, receivables, accounts payable, capital leases, other liabilities and long-term debt (including the current portion). The carrying values of cash and cash equivalents, restricted cash and securities, receivables, accounts payable, capital leases and other liabilities approximated their fair values at September 30, 2017 and December 31, 2016.

GAAP defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements and disclosures for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability, such as interest and foreign exchange rates, transfer restrictions, and risk of nonperformance.

Fair Value Hierarchy

GAAP establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value measurement of each class of assets and liabilities is dependent upon its categorization within the fair value hierarchy, based upon the lowest level of input that is significant to the fair value measurement of each class of asset and liability. GAAP establishes three levels of inputs that may be used to measure fair value:

 

Level 1  —   Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2  —   Unadjusted quoted prices for similar assets or liabilities in active markets, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
Level 3  —   Unobservable inputs for the asset or liability.

We recognize transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers within the fair value hierarchy during each of the nine months ended September 30, 2017 and September 30, 2016.

 

11


The table below presents the fair values for our long-term debt as well as the input levels used to determine these fair values as of September 30, 2017 and December 31, 2016:

 

                Fair Value Measurement Using  
    Total Carrying Value in
Consolidated Balance

Sheets
    Unadjusted Quoted Prices
in Active
Markets for Identical
Assets or Liabilities
(Level 1)
    Significant Other
Observable Inputs (Level 2)
 

(dollars in millions)

  September 30,
2017
    December 31,
2016
    September 30,
2017
    December 31,
2016
    September 30,
2017
    December 31,
2016
 

Liabilities Not Recorded at Fair Value in the Financial Statements:

           

Long-term Debt, including the current portion:

           

Term Loans

  $ 4,569     $ 4,566     $ 4,611     $ 4,671     $ —       $ —    

Senior Notes

    5,845       6,135       6,065       6,283       —         —    

Capital Leases and Other

    179       183       —         —         179       183  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Long-term Debt, including the current portion

  $ 10,593     $ 10,884     $ 10,676     $ 10,954     $ 179     $ 183  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We do not have any assets or liabilities where the fair value is measured using significant unobservable inputs (Level 3).

Term Loans

The fair value of the Term Loans referenced above was approximately $4.6 billion and $4.7 billion at September 30, 2017 and December 31, 2016, respectively. The fair value of each loan is based on quoted prices. Each loan tranche is actively traded. For additional information on the refinancing of the Term Loans, see Note 6—Long-Term Debt.

Senior Notes

The fair value of the Senior Notes referenced above was approximately $6.1 billion at September 30, 2017 and $6.3 billion at December 31, 2016, respectively, based on quoted prices for identical terms and maturities. Each series of notes is actively traded. On September 29, 2017, the $300 million aggregate principal amount plus accrued and unpaid interest due under the Floating Rate Senior Notes due 2018 was paid.

Capital Leases

The fair value of our capital leases is determined by discounting anticipated future cash flows derived from the contractual terms of the obligations and observable market interest and foreign exchange rates.

 

12


(6) Long-Term Debt

The following table summarizes our long-term debt (amounts in millions):

 

   

Date of

      September 30,
2017
    December 31,
2016
 
   

Issuance/
Amendment

 

Maturity

 

Interest
Payments

 

Interest Rate

  Amount     Amount  

Senior Secured Term Loans:

           

Borrowed by Level 3 Financing, Inc.

           

Tranche B-III 2019 Term Loan (1)(4)

  Aug 2013   —     Quarterly   LIBOR +3.00%   $ —       $ 815  

Tranche B 2020 Term Loan (1)(4)

  Oct 2013   —     Quarterly   LIBOR +3.00%     —         1,796  

Tranche B-II 2022 Term Loan (1)(4)

  May 2015   —     Quarterly   LIBOR +2.75%     —         2,000  

Tranche B 2024 Term Loan (4)(5)

  Feb 2017   Feb 2024   Quarterly   LIBOR +2.25%     4,611       —    

Senior Notes:

           

Issued by Level 3 Financing, Inc.

           

Floating Rate Senior Notes due 2018 (2)(4)

  Nov 2013   Jan 2018   May/Nov   6-Month LIBOR +3.50%     —         300  

6.125% Senior Notes due 2021 (2)

  Nov 2013   Jan 2021   Apr/Oct   6.125%     640       640  

5.375% Senior Notes due 2022 (2)

  Aug 2014   Aug 2022   May/Nov   5.375%     1,000       1,000  

5.625% Senior Notes due 2023 (2)

  Jan 2015   Feb 2023   Jun/Dec   5.625%     500       500  

5.125% Senior Notes due 2023 (2)

  Apr 2015   May 2023   Mar/Sept   5.125%     700       700  

5.375% Senior Notes due 2025 (2)

  Apr 2015   May 2025   Mar/Sept   5.375%     800       800  

5.375% Senior Notes due 2024 (2)

  Nov 2015   Jan 2024   Jan/Jul   5.375%     900       900  

5.25% Senior Notes due 2026 (2)

  Mar 2016   Mar 2026   Apr/Oct   5.250%     775       775  

Issued by Level 3 Parent, LLC

           

5.75% Senior Notes due 2022 (3)

  Dec 2014   Dec 2022   Mar/Sept   5.750%     600       600  

Capital Leases and Other Debt

            179       183  
         

 

 

   

 

 

 

Total Debt Obligations

            10,705       11,009  

Unamortized discounts

            —         (13

Unamortized debt issuance costs

            (112     (112

Current Portion

            (7     (7
         

 

 

   

 

 

 

Total Long-Term Debt

          $ 10,586     $ 10,877  
         

 

 

   

 

 

 

 

(1)  The term loans were secured obligations and guaranteed by Level 3 Communications, Inc. and Level 3 Communications, LLC and certain other subsidiaries.
(2)  The notes are fully and unconditionally guaranteed on an unsubordinated unsecured basis by Level 3 Parent, LLC and Level 3 Communications, LLC.
(3) The notes are not guaranteed by any of Level 3 Parent, LLC’s subsidiaries.
(4)  The Tranche B 2024 Term Loan had an interest rate of 3.486% as of September 30, 2017. All other term loans were refinanced on February 22, 2017 as described below. The Tranche B-III 2019 Term Loan and the Tranche B 2020 Term Loan each had an interest rate of 4.000% as of December 31, 2016. The Tranche B-II 2022 Term Loan had an interest rate of 3.500% as of December 31, 2016. The interest rate on the Tranche B-III 2019 Term Loan and the Tranche B 2020 Term Loan were set with a minimum LIBOR of 1.00%. The interest rate on the Tranche B-II 2022 Term Loan was set with a minimum LIBOR of 0.75% and the interest rate on the Tranche B 2024 Term Loan is set with a minimum LIBOR of zero percent. The Floating Rate Senior Notes due 2018 had an interest rate of 4.762% as of December 31, 2016.
(5)  The Tranche B 2024 Term Loan is a secured obligation and is guaranteed by Level 3 Parent, LLC and certain of its non-regulated subsidiaries.

Senior Secured Term Loans

As of September 30, 2017, Level 3 Financing, Inc., Level 3 Parent, LLC’s direct wholly owned subsidiary (“Level 3 Financing”) had a senior secured credit facility consisting of a $4.611 billion Tranche B Term Loan due 2024.

 

13


On February 22, 2017, we completed the refinancing of all of our then outstanding $4.611 billion senior secured term loans through the issuance of a new Tranche B 2024 Term Loan in the principal amount of $4.611 billion. The term loans refinanced were our Tranche B-III 2019 Term Loan, Tranche B 2020 Term Loan, and the Tranche B-II 2022 Term Loan. The new Tranche B 2024 Term Loan bears interest at LIBOR plus 2.25 percent, with a zero percent minimum LIBOR, and will mature on February 22, 2024. The Tranche B 2024 Term Loan was priced to lenders at par, with the payment to the lenders at closing of an upfront 25 basis point fee. We recognized a charge of approximately $44 million for modification and extinguishment in the first quarter of 2017 related to this refinancing.

As the new Tranche B 2024 Term Loan represents a new tranche to our existing credit facility, new regulatory approvals are required for Level 3 Communications, LLC and certain other regulated subsidiaries of Level 3 Financing to guarantee and to provide security for the Tranche B 2024 Term Loan. As a result, the guarantees and a portion of the collateral provided by those entities to support the term loans that were refinanced are not available to support the Tranche B 2024 Term Loan unless and until those regulatory approvals are obtained.

Senior Notes

All of the notes pay interest semiannually, and allow for the redemption of the notes at the option of the issuer upon not less than 30 or more than 60 days’ prior notice by paying the greater of 101% of the principal amount or a “make-whole” amount, plus accrued interest. In addition, the notes also have a provision that allows for an additional right of optional redemption using cash proceeds received from the sale of equity securities. For specific details of these features and requirements, including the applicable premiums and timing, refer to the indentures for the respective senior notes in connection with the original issuances.

7% Senior Notes due 2020 and 5.25% Senior Notes due 2026

On March 22, 2016, Level 3 Financing issued $775 million in aggregate principal amount of our 5.25% Senior Notes due 2026 (the “5.25% Senior Notes due 2026”). The 5.25% Senior Notes due 2026 are fully and unconditionally guaranteed on an unsubordinated unsecured basis by Level 3 Parent, LLC and Level 3 Communications, LLC.

On April 21, 2016, all of the outstanding principal amount of the 7% Senior Notes Due 2020 was redeemed at a redemption price equal to 104.138% of the principal amount, along with accrued and unpaid interest to but excluding the redemption date. To fund the redemption of these notes, Level 3 Financing used the net proceeds, along with cash on hand, from the March 22, 2016 issuance of our 5.25% Senior Notes due 2026. We recognized a charge of approximately $40 million for modification and extinguishment in the second quarter of 2016 related to this refinancing.

Floating Rate Senior Notes due 2018

On September 29, 2017, the $300 million aggregate principal amount plus accrued and unpaid interest due under the Floating Rate Senior Notes due 2018 was paid and we recognized a loss on extinguishment of less than $1 million.

Capital Leases

As of September 30, 2017, we had $179 million of capital leases. We lease property, equipment, certain dark fiber facilities and metro fiber under non-cancelable IRU agreements that are accounted for as capital leases. The weighted average interest rate on these capital leases approximated 5.8% as of September 30, 2017.

 

14


Covenant Compliance

At September 30, 2017 and December 31, 2016, we were in compliance with the financial covenants on all outstanding debt issuances.

Long-Term Debt Maturities

Aggregate future contractual maturities of long-term debt and capital leases (excluding debt issuance costs) were as follows as of September 30, 2017 (dollars in millions):

 

2017 (remaining three months)

   $ 2  

2018

     7  

2019

     7  

2020

     8  

2021

     650  

2022

     1,610  

Thereafter

     8,421  
  

 

 

 
   $ 10,705  
  

 

 

 

(7) Accumulated Other Comprehensive Loss

The accumulated balances for each classification of other comprehensive income (loss) were as follows:

 

(dollars in millions)

  Net Foreign
Currency
Translation
Adjustment
    Defined Benefit
Pension Plans
    Total  

Balance at December 31, 2015

  $ (273   $ (28   $ (301

Other comprehensive income (loss) before reclassifications, net of tax

    9       (2     7  

Amounts reclassified from accumulated other comprehensive loss

    —         1       1  
 

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

  $ (264   $ (29   $ (293
 

 

 

   

 

 

   

 

 

 

Balance at December 31, 2016

  $ (353   $ (34   $ (387

Other comprehensive income before reclassifications, net of tax

    106       1       107  

Amounts reclassified from accumulated other comprehensive loss

    —         (1     (1
 

 

 

   

 

 

   

 

 

 

Balance at September 30, 2017

  $ (247   $ (34   $ (281
 

 

 

   

 

 

   

 

 

 

 

15


(8) Stock-Based Compensation

The following table summarizes non-cash compensation expense for each of the three and nine months ended September 30, 2017 and 2016:

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
(dollars in millions)   2017     2016     2017     2016  

Outperform Stock Appreciation Rights

  $ —       $ —       $ —       $ 2  

Restricted Stock Units

    21       26       77       60  

Performance Restricted Stock Units

    5       9       17       33  

401(k) Match Expense

    7       8       26       27  
 

 

 

   

 

 

   

 

 

   

 

 

 
    33       43       120       122  

Capitalized Non-Cash Compensation

    —         —         —         (1
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 33     $ 43     $ 120     $ 121  
 

 

 

   

 

 

   

 

 

   

 

 

 

As of September 30, 2017, there were approximately 5 million total restricted stock and performance restricted stock units outstanding.

(9) Segment Information

Prior to the CenturyLink Merger, our operating revenues were generated primarily from our former segments (North America; Europe, the Middle East and Africa (“EMEA”); and Latin America), and our Chief Operating Decision Maker (“CODM”) regularly reviewed information for each of our segments to evaluate performance and to allocate resources. The accounting principles used to determine segment results were the same as those used in our consolidated financial statements.

As of November 1, 2017, the effective date of the CenturyLink Merger, our operations will be integrated into and will be reported as part of the segments of CenturyLink. CenturyLink’s CODM has become our CODM, but will review our financial information on an aggregate basis only in connection with our quarterly and annual reports.

Operating segments are defined under GAAP as components of an enterprise for which separate financial information is available and evaluated regularly by our CODM in deciding how to allocate resources and assess performance. Our former reportable segments consisted of: 1) North America; 2) EMEA; and 3) Latin America. Other separate business interests that are not segments include interest, certain corporate assets and overhead costs, and certain other general and administrative costs that were not allocated to any of the operating segments.

The CODM measured and evaluated segment performance primarily based upon revenue, revenue growth and Adjusted EBITDA. Adjusted EBITDA, as defined by us, is equal to net income from the Consolidated Statements of Income before (1) income tax benefit (expense), (2) total other income (expense), (3) non-cash impairment charges included within selling, general and administrative expenses and network related expenses, (4) depreciation and amortization expense, and (5) non-cash stock-based compensation expense included within selling, general and administrative expenses and network related expenses.

Adjusted EBITDA is not a measurement under GAAP and may not be used in the same way by other companies. Management believes that Adjusted EBITDA is an important part of our internal reporting and is a key measure used by management to evaluate our profitability and operating performance and to make resource allocation decisions. Management believes such measurement is

 

16


especially important in a capital-intensive industry such as telecommunications. Management also uses Adjusted EBITDA to compare our performance to that of our competitors and to eliminate certain non-cash and non-operating items in order to consistently measure from period to period our ability to fund capital expenditures, fund growth, service debt and determine bonuses.

Adjusted EBITDA excludes non-cash impairment charges and non-cash stock-based compensation expense because of the non-cash nature of these items. Adjusted EBITDA also excludes interest income, interest expense and income tax benefit (expense) because these items are associated with our capitalization and tax structures. Adjusted EBITDA also excludes depreciation and amortization expense because these non-cash expenses reflect the effect of capital investments which management believes are better evaluated through cash flow measures. Adjusted EBITDA excludes net other income (expense) because these items are not related to our primary operations.

There are limitations to using non-GAAP financial measures such as Adjusted EBITDA, including the difficulty associated with comparing companies that use similar performance measures whose calculations may differ from our calculations. Additionally, this financial measure does not include certain significant items such as interest income, interest expense, income tax benefit (expense), depreciation and amortization expense, non-cash impairment charges, non-cash stock-based compensation expense, and net other income (expense). Adjusted EBITDA should not be considered a substitute for other measures of financial performance reported in accordance with GAAP.

The following table presents revenue by segment:

 

    Three Months Ended     Nine Months Ended  

(dollars in millions)

  September 30,
2017
    September 30,
2016(1)
    September 30,
2017
    September 30,
2016(1)
 

Core Network Services Revenue:

       

North America

  $ 1,597     $ 1,573     $ 4,798     $ 4,779  

EMEA

    184       180       535       561  

Latin America

    182       176       541       491  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Core Network Services Revenue

    1,963       1,929       5,874       5,831  

Wholesale Voice Services Revenue:

       

North America

    90       98       279       292  

EMEA

    3       4       8       11  

Latin America

    3       2       7       6  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Wholesale Voice Services Revenue

    96       104       294       309  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue

  $ 2,059     $ 2,033     $ 6,168     $ 6,140  
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)  The 2016 results have been adjusted to reflect changes made to customer assignments between the wholesale and enterprise channels as of the beginning of 2017.

 

17


The following table presents Adjusted EBITDA by segment and reconciles Adjusted EBITDA to net income:

 

     Three Months Ended      Nine Months Ended  

(dollars in millions)

   September 30,
2017
     September 30,
2016
     September 30,
2017
     September 30,
2016
 

Adjusted EBITDA:

           

North America

   $ 817      $ 784      $ 2,441      $ 2,415  

EMEA

     64        56        189        162  

Latin America

     78        80        235        218  

Unallocated Corporate Expenses

     (238      (204      (717      (654
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

     721        716        2,148        2,141  

Income Tax Expense

     (76      (74      (215      (198

Total Other Expense

     (122      (137      (424      (465

Depreciation and Amortization

     (333      (319      (983      (930

Non-Cash Stock Compensation

     (33      (43      (120      (121
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $ 157      $ 143      $ 406      $ 427  
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents capital expenditures by segment and reconciles capital expenditures by segment to total capital expenditures:

 

     Three Months Ended      Nine Months Ended  

(dollars in millions)

   September 30,
2017
     September 30,
2016
     September 30,
2017
     September 30,
2016
 

Capital Expenditures:

           

North America

   $ 216      $ 245      $ 690      $ 677  

EMEA

     25        38        83        117  

Latin America

     48        44        126        118  

Unallocated Corporate Capital Expenditures

     33        37        119        116  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Capital Expenditures

   $ 322      $ 364      $ 1,018      $ 1,028  
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents total assets by segment:

 

(dollars in millions)

   September 30,
2017
     December 31,
2016
 

Assets:

     

North America

   $ 21,094      $ 20,818  

EMEA

     1,766        1,639  

Latin America

     2,387        2,304  

Other

     126        127  
  

 

 

    

 

 

 

Total Assets

   $ 25,373      $ 24,888  
  

 

 

    

 

 

 

The changes in the carrying amount of goodwill by segment during the nine months ended September 30, 2017 were as follows:

 

(dollars in millions)    North America      EMEA      Latin America      Total  

Balance at December 31, 2016

   $ 7,024      $ 109      $ 596      $ 7,729  

Effect of foreign currency rate change

     —          12        —          12  
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2017

   $ 7,024      $ 121      $ 596      $ 7,741  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

18


There were no events or changes in circumstances during the first three and nine months of 2017 that indicated the carrying value of goodwill may not be recoverable.

(10) Commitments, Contingencies and Other Items

We are subject to various legal proceedings and other contingent liabilities that individually or in the aggregate could materially affect our financial condition, future results of operations or cash flows. Amounts accrued for such contingencies aggregate to $93 million and are included in “Other” current liabilities and “Other Liabilities” in our Consolidated Balance Sheet at September 30, 2017. The establishment of an accrual does not mean that actual funds have been set aside to satisfy a given contingency. Thus, the resolution of a particular contingency for the amount accrued would have no effect on our results of operations but could materially adversely affect our cash flows for the affected period.

We review our accruals at least quarterly and adjust them to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. Below is a description of material legal proceedings and other contingencies pending at September 30, 2017. Although we believe we have accrued for these matters in accordance with the accounting guidance for contingencies, contingencies are inherently unpredictable and it is possible that results of operations or cash flows could be materially and adversely affected in any particular period by unfavorable developments in, or resolution or disposition of, one or more of these matters. For those contingencies in respect of which we believe it is reasonably possible that a loss may result that is materially in excess of the accrual (if any) established for the matter, we have either provided an estimate of such possible loss or range of loss or included a statement that such an estimate cannot be made. In addition to the contingencies described below, we are party to many other legal proceedings and contingencies, the resolution of which is not expected to materially affect our financial condition or future results of operations beyond the amounts accrued.

Rights-of-Way Litigation

We are party to a number of purported class action lawsuits involving our right to install fiber optic cable network in railroad right-of-ways adjacent to plaintiffs’ land. In general, we obtained the rights to construct our networks from railroads, utilities, and others, and have installed our networks along the rights-of-way so granted. Plaintiffs in the purported class actions assert that they are the owners of lands over which the fiber optic cable networks pass, and that the railroads, utilities and others who granted us the right to construct and maintain our network did not have the legal authority to do so. The complaints seek damages on theories of trespass, unjust enrichment and slander of title and property, as well as punitive damages. We have also received, and may in the future receive, claims and demands related to rights-of-way issues similar to the issues in these cases that may be based on similar or different legal theories. We have defeated motions for class certification in a number of these actions but expect that, absent settlement of these actions, plaintiffs in the pending lawsuits will continue to seek certification of statewide or multi-state classes. The only lawsuit in which a class was certified against us, absent an agreed upon settlement, occurred in Koyle, et. al. v. Level 3 Communications, Inc., et. al., a purported two state class action filed in the United States District Court for the District of Idaho. The Koyle lawsuit has been dismissed pursuant to a settlement reached in November 2010 as described further below.

We negotiated a series of class settlements affecting all persons who own or owned land next to or near railroad rights of way in which we have installed our fiber optic cable networks. The United States District Court for the District of Massachusetts in Kingsborough v. Sprint Communications Co. L.P. granted preliminary approval of the proposed settlement; however, on September 10, 2009, the court denied a motion for final approval of the settlement on the basis that the court lacked subject matter jurisdiction and dismissed the case.

In November 2010, we negotiated revised settlement terms for a series of state class settlements affecting all persons who own or owned land next to or near railroad rights of way in which we have installed our fiber optic cable networks. We are currently pursuing presentment of the settlement in applicable jurisdictions. The settlements, affecting current and former landowners, have received final federal court approval in all but one of the applicable states and the parties are actively engaged in, or have completed, the claims process for the vast majority of the applicable states, including payment of claims. We continue to seek approval in the remaining state.

 

19


Management believes that Level 3 has substantial defenses to the claims asserted in the remaining state and intends to defend them vigorously if a satisfactory settlement is not ultimately approved for the affected landowners.

Peruvian Tax Litigation

Beginning in 2005, one of our Peruvian subsidiaries received a number of assessments for tax, penalties and interest for calendar years 2001 and 2002. Peruvian tax authorities (“SUNAT”) took the position that the Peruvian subsidiary incorrectly documented its importations resulting in additional income tax withholding and value-added taxes (“VAT”). The total amount of the asserted claims, including potential interest and penalties, was $26 million, consisting of $3 million for income tax withholding in connection with the import of services for calendar years 2001 and 2002, $7 million for VAT in connection with the import of services for calendar years 2001 and 2002, and $16 million in connection with the disallowance of VAT credits for periods beginning in 2005. After taking into account the developments described below, as well as the accrued interest and foreign exchange effects, the total amount of exposure is $16 million at September 30, 2017.

We challenged the tax assessments during 2005 by filing administrative claims before SUNAT. During August 2006 and June 2007, SUNAT rejected our administrative claims, thereby confirming the assessments. Appeals were filed in September 2006 and July 2007 with the Tribunal Fiscal, the highest level of administrative review, which is not part of the Peru judiciary (the “Tribunal”). The 2001 and 2002 assessed withholding tax assessments were resolved in our favor in separate administrative resolutions; however, the penalties with respect to withholding tax remain at issue in the administrative appeals.

In October 2011, the Tribunal issued its administrative resolution with respect to the calendar year 2002 tax period regarding VAT, associated penalties and penalties associated with withholding taxes, deciding the central issue underlying the assessments in the government’s favor, while confirming the assessment in part and denying a portion of the assessment on procedural grounds. We appealed the Tribunal’s October 2011 administrative resolutions to the judicial court in Peru. In September 2014, the first judicial court rendered a decision largely in our favor on the central issue underlying the assessments. SUNAT appealed the court’s decision to the next judicial level. The court of appeal remanded the case to the first judicial court for further development of the facts and legal analysis supporting its decision. In April 2016, the first judicial level rendered a decision in our favor on the central issue underlying the assessments. SUNAT has appealed the substantive issue to the next judicial level. We also appealed certain procedural points. In May 2017, the court of appeal issued a decision reversing the favorable decision reached by the first judicial level. In June 2017, we filed an appeal of the decision to the Supreme Court of Justice, the final judicial level.

In October 2013, the Tribunal notified us of its July 2013 administrative resolution with respect to the calendar year 2001 tax period regarding VAT, associated penalties and penalties associated with withholding taxes, determining the central issue underlying the assessments in the government’s favor, while confirming the assessment in part and denying a portion of the assessment on procedural grounds. We appealed the Tribunal’s July 2013 administrative resolutions to the judicial court in Peru. In April 2015, the first judicial court rendered a decision largely in SUNAT’s favor on the central issue underlying the assessments. We appealed the court’s decision to the next judicial level. In April 2016, the court of appeal rendered a decision that declared null the April 2015 decision and remanded the case to the first judicial court for further development of the facts and legal analysis supporting its decision. In June 2017, the first judicial court issued a ruling against us primarily based on the same grounds from the original decision. In June 2017, we filed an appeal with the court of appeal. An oral hearing took place before the court of appeals on October 18, 2017. A decision on this case is pending.

 

20


In December 2013, SUNAT initiated an audit of calendar year 2001. In June 2014, we were served with SUNAT’s assessments of the 2001 VAT credits declared null by the Tribunal and the corresponding fine. In July 2014, we challenged these assessments by filing administrative claims before SUNAT. In January 2015, SUNAT rejected the administrative claims, thereby confirming the assessments. We filed an appeal with the Tribunal in February 2015. In May 2015, the Tribunal notified us of its administrative resolution declaring the assessments and corresponding fines null. The time for SUNAT to appeal this resolution has closed. Under local practice, notification of an appeal can take several months. Counsel confirmed in the first quarter of 2016 that SUNAT has not filed an appeal to the resolution. Nevertheless, SUNAT retains the right to reissue the assessments declared null or start a new audit. However, we are under no obligation to provide additional information and any fine issued by SUNAT based on the same information that it has already used in the past would be declared null. Accordingly, in March 2016, we released an accrual of approximately $15 million for an assessment and associated interest.

In addition, based on a change in legal interpretation by the Peruvian judicial courts, the statute of limitations with respect to the 2001 fines has expired. Accordingly, in the fourth quarter of 2016, we released an accrual of approximately $11 million of fines and associated interest.

Employee Severance and Contractor Termination Disputes

A number of former employees and third-party contractors have asserted a variety of claims in litigation against certain of our Latin American subsidiaries for separation pay, severance, commissions, pension benefits, unpaid vacation pay, breach of employment contracts, unpaid performance bonuses, property damages, moral damages and related statutory penalties, fines, costs and expenses (including accrued interest, attorneys’ fees and statutorily mandated inflation adjustments) as a result of their separation from us or termination of service relationships. We are vigorously defending ourselves against the asserted claims, which aggregate to approximately $30 million at September 30, 2017.

Brazilian Tax Claims

In December 2004, March 2009, April 2009 and July 2014, the São Paulo state tax authorities issued tax assessments against one of our Brazilian subsidiaries for the Tax on Distribution of Goods and Services (“ICMS”) with respect to revenue from leasing movable properties (in the case of the December 2004, March 2009 and July 2014 assessments) and revenue from the provision of Internet access services (in the case of the April 2009 and July 2014 assessments), by treating such activities as the provision of communications services, to which the ICMS tax applies. During the third quarter of 2014, we released an accrual of $6 million for tax, penalty and associated interest corresponding to the ICMS applicable on the provision of Internet access services due to the expiration of the statute of limitations for the January 2008 to June 2009 tax periods. In September 2002, July 2009 and May 2012, the Rio de Janeiro state tax authorities issued tax assessments to the same Brazilian subsidiary on similar issues. We have filed objections to these assessments, arguing that the lease of assets and the provision of Internet access are not communication services subject to ICMS. The objections to the September 2002, December 2004 and March 2009 assessments were rejected by the respective state administrative courts, and we have appealed those decisions to the judicial courts. In October 2012 and June 2014, we received favorable rulings from the lower court on the December 2004 and March 2009 assessments regarding equipment leasing, but those rulings are subject to appeal by the state. No ruling has been obtained with respect to the September 2002 assessment. The objections to the April and July 2009 and May 2012 assessments are still pending final administrative decisions. The July 2014 assessment was confirmed during the fourth quarter of 2014 at the first administrative level and we appealed this decision to the second administrative level. During the fourth quarter of 2014, we entered into an amnesty with the Rio de Janeiro state tax authorities with respect to potential ICMS liability for the 2008 tax period. As a result, we paid $5 million and released an accrual of $3 million of tax corresponding to the ICMS applicable on the provision of Internet access services in the fourth quarter of 2014.

 

21


We are vigorously contesting all such assessments in both states and, in particular, view the assessment of ICMS on revenue from leasing movable properties to be without merit. Nevertheless, we believe it is reasonably possible that these assessments could result in a loss of up to $54 million at September 30, 2017 in excess of the accruals established for these matters.

Other Matters

Level 3 has recently been notified of a qui tam action pending against Level 3 Communications, Inc., certain former employees and others in the United States District Court for the Eastern District of Virginia (United States of America ex rel., Stephen Bishop v. Level 3 Communications, Inc. et al., Case No. 1:13-cv-1453). Certain statutes permit private citizens, called “relators”, to institute civil proceedings alleging violations of those statutes. These qui tam cases are typically sealed by the court at the time of filing. The original qui tam complaint was filed under seal on November 26, 2013, and an amended complaint was filed under seal on June 16, 2014. The court unsealed the complaints on October 26, 2017.

The amended complaint alleges that Level 3, principally through two former employees, submitted false claims and made false statements to the government in connection with two government contracts. The relator seeks damages in this lawsuit of approximately $50 million, subject to trebling, plus statutory penalties, pre-and-post judgment interest, and attorney’s fees. The case is currently stayed.

As we have only recently been made aware of the content of the amended complaint, we are evaluating our defenses to the claims. At this time, we do not believe it is probable we will incur a material loss. If, contrary to our expectations, the plaintiff prevails in this matter and proves damages at or near $50 million, and is successful in having those damages trebled, the outcome could have a material adverse effect on our results of operations in the period in which a liability is recognized and on our cash flows for the period in which any damages are paid.

The two former Level 3 employees named in the qui tam amended complaint and others were also indicted in the United States District Court for the Eastern District of Virginia on October 3, 2017, and charged with, among other things, accepting kickbacks from a subcontractor, who was also indicted, for work to be performed under a prime government contract. The company is fully cooperating in the government’s investigations in this matter.

Letters of Credit

It is customary for us to use various financial instruments in the normal course of business. These instruments include letters of credit. Letters of credit are conditional commitments issued on our behalf in accordance with specified terms and conditions. As of September 30, 2017 and December 31, 2016, we had outstanding letters of credit or other similar obligations of approximately $36 million and $39 million, respectively, of which $29 million and $33 million are collateralized by cash that is reflected on the Consolidated Balance Sheets as restricted cash and securities. We do not believe exposure to loss related to our letters of credit is material.

(11) Condensed Consolidating Financial Information

Level 3 Financing, Inc., a wholly owned subsidiary, has issued Senior Notes that are unsecured obligations of Level 3 Financing, Inc.; however, they are also fully and unconditionally and jointly and severally guaranteed on an unsecured senior basis by Level 3 Parent, LLC and Level 3 Communications, LLC.

 

 

22


In conjunction with the registration of the Level 3 Financing, Inc. Senior Notes, the accompanying condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 “Financial statements of guarantors and affiliates whose securities collateralize an issue registered or being registered.”

The operating activities of the separate legal entities included in our Consolidated Financial Statements are interdependent. The accompanying condensed consolidating financial information presents the statements of comprehensive income, balance sheets and statements of cash flows of each legal entity and, on an aggregate basis, the other non-guarantor subsidiaries based on amounts incurred by such entities, and is not intended to present the operating results of those legal entities on a stand-alone basis. Level 3 Communications, LLC leases equipment and certain facilities from other wholly owned subsidiaries of Level 3 Parent, LLC. These transactions are eliminated in our consolidated results.

 

23


Condensed Consolidating Statements of Comprehensive Income (Loss)

Three Months Ended September 30, 2017

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
    (dollars in millions)  

Revenue

  $ —       $ —       $ 932     $ 1,168     $ (41   $ 2,059  

Costs and Expense:

           

Network Access Costs

    —         —         329       390       (41     678  

Network Related Expenses

    —         —         254       91       —         345  

Depreciation and Amortization

    —         —         114       219       —         333  

Selling, General and Administrative Expenses

    2       1       272       73       —         348  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs and Expenses

    2       1       969       773       (41     1,704  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income (Loss)

    (2     (1     (37     395       —         355  

Other Income (Expense):

           

Interest income

    —         —         6       —         —         6  

Interest expense

    (9     (121     —         (4     —         (134

Interest income (expense) affiliates, net

    377       562       (868     (71     —         —    

Equity in net earnings (losses) of subsidiaries

    (212     (614     215       —         611       —    

Other, net

    —         —         12       (6     —         6  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Income (Expense)

    156       (173     (635     (81     611       (122
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) before Income Taxes

    154       (174     (672     314       611       233  

Income Tax Benefit (Expense)

    3       (38     (1     (40     —         (76
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

    157       (212     (673     274       611       157  

Other Comprehensive Income (Loss), Net of

           

Income Taxes

    44       —         —         44       (44     44  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

  $ 201     $ (212   $ (673   $ 318     $ 567     $ 201  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

24


Condensed Consolidating Statements of Comprehensive Income (Loss)

Nine Months Ended September 30, 2017

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
    (dollars in millions)  

Revenue

  $ —       $ —       $ 2,785     $ 3,499     $ (116   $ 6,168  

Costs and Expense:

           

Network Access Costs

    —         —         991       1,169       (116     2,044  

Network Related Expenses

    —         —         743       275       —         1,018  

Depreciation and Amortization

    —         —         327       656       —         983  

Selling, General and Administrative Expenses

    4       3       843       228       —         1,078  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs and Expenses

    4       3       2,904       2,328       (116     5,123  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income (Loss)

    (4     (3     (119     1,171       —         1,045  

Other Income (Expense):

           

Interest income

    —         —         11       —         —         11  

Interest expense

    (27     (358     (2     (13     —         (400

Interest income (expense) affiliates, net

    1,132       1,703       (2,605     (230     —         —    

Equity in net earnings (losses) of subsidiaries

    (703     (1,892     618       —         1,977       —    

Other, net

    —         (44     16       (7     —         (35
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Income (Expense)

    402       (591     (1,962     (250     1,977       (424
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) before Income Taxes

    398       (594     (2,081     921       1,977       621  

Income Tax Benefit (Expense)

    8       (109     (2     (112     —         (215
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

    406       (703     (2,083     809       1,977       406  

Other Comprehensive Income (Loss), Net of Income Taxes

    106       —         —         106       (106     106  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

  $ 512     $ (703   $ (2,083   $ 915     $ 1,871     $ 512  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Condensed Consolidating Statements of Comprehensive Income (Loss)

Three Months Ended September 30, 2016

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
                (dollars in millions)              

Revenue

  $ —       $ —       $ 907     $ 1,160     $ (34   $ 2,033  

Costs and Expense:

           

Network Access Costs

    —         —         330       379       (34     675  

Network Related Expenses

    —         —         242       95       —         337  

Depreciation and Amortization

    —         —         100       219       —         319  

Selling, General and Administrative Expenses

    1       1       262       84       —         348  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs and Expenses

    1       1       934       777       (34     1,679  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (Loss) Income

    (1     (1     (27     383       —         354  

Other Income (Expense):

           

Interest income

    —         —         1       —         —         1  

Interest expense

    (9     (124     (1     (5     —         (139

Interest income (expense) affiliates, net

    342       526       (804     (64     —         —    

Equity in net earnings (losses) of subsidiaries

    (193     (539     169       —         563       —    

Other, net

    —         —         (1     2       —         1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Income (Expense)

    140       (137     (636     (67     563       (137
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) before Income Taxes

    139       (138     (663     316       563       217  

Income Tax Expense

    4       (55     —         (23     —         (74
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

    143       (193     (663     293       563       143  

Other Comprehensive Income (Loss), Net of

           

Income Taxes

    (15     —         —         (15     15       (15
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

  $ 128     $ (193   $ (663   $ 278     $ 578     $ 128  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Condensed Consolidating Statements of Comprehensive Income (Loss)

Nine Months Ended September 30, 2016

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
                (dollars in millions)              

Revenue

  $ —       $ —       $ 2,652     $ 3,590     $ (102   $ 6,140  

Costs and Expense:

           

Network Access Costs

    —         —         965       1,182       (102     2,045  

Network Related Expenses

    —         —         716       298       —         1,014  

Depreciation and Amortization

    —         —         280       650       —         930  

Selling, General and Administrative Expenses

    3       4       775       279       —         1,061  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs and Expenses

    3       4       2,736       2,409       (102     5,050  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (Loss) Income

    (3     (4     (84     1,181       —         1,090  

Other Income (Expense):

           

Interest income

    —         —         2       1       —         3  

Interest expense

    (27     (380     (2     (5     —         (414

Interest income (expense) affiliates, net

    1,027       1,585       (2,407     (205     —         —    

Equity in net earnings (losses) of subsidiaries

    (581     (1,568     569       —         1,580       —    

Other, net

    —         (39     2       (17     —         (54
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Income (Expense)

    419       (402     (1,836     (226     1,580       (465
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (Loss) before Income Taxes

    416       (406     (1,920     955       1,580       625  

Income Tax Expense

    11       (175     (2     (32     —         (198
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss)

    427       (581     (1,922     923       1,580       427  

Other Comprehensive Income (Loss), Net of

           

Income Taxes

    8       —         —         8       (8     8  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income (Loss)

  $ 435     $ (581   $ (1,922   $ 931     $ 1,572     $ 435  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

27


Condensed Consolidating Balance Sheets

September 30, 2017

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
    (dollars in millions)  

Assets

           

Current Assets:

           

Cash and cash equivalents

  $ 14     $ —       $ 2,141     $ 97     $ —       $ 2,252  

Restricted cash and securities

    —         —         1       4       —         5  

Receivables, less allowances for doubtful accounts

    —         —         25       725       —         750  

Due from affiliates

    18,214       22,749       —         3,253       (44,216     —    

Other

    —         —         110       26       —         136  

Total Current Assets

    18,228       22,749       2,277       4,105       (44,216     3,143  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Property, Plant, and Equipment, net

    —         —         4,204       6,281       —         10,485  

Restricted Cash and Securities

    19       —         10       —         —         29  

Goodwill and Other Intangibles, net

    —         —         352       8,150       —         8,502  

Investment in Subsidiaries

    16,947       17,141       3,626       —         (37,714     —    

Deferred Tax Assets

    58       2,577       —         527       —         3,162  

Other Assets, net

    —         —         18       34       —         52  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Assets

  $ 35,252     $ 42,467     $ 10,487     $ 19,097     $ (81,930   $ 25,373  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities and Stockholders’ Equity (Deficit)

           

Current Liabilities:

           

Accounts payable

  $ —       $ 1     $ 331     $ 372     $ —       $ 704  

Current portion of long-term debt

    —         —         2       5       —         7  

Accrued payroll and employee benefits

    —         —         216       31       —         247  

Accrued interest

    3       86       —         6       —         95  

Current portion of deferred revenue

    —         —         128       148       —         276  

Due to affiliates

    —         —         44,216       —         (44,216     —    

Other

    —         (1     92       48       —         139  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Current Liabilities

    3       86       44,985       610       (44,216     1,468  

Long-Term Debt, less current portion

    593       9,820       13       160       —         10,586  

Deferred Revenue, less current portion

    —         —         843       289       —         1,132  

Other Liabilities

    16       —         185       436       —         637  

Commitments and

           

Contingencies

           

Stockholders’ Equity (Deficit)

    34,640       32,561       (35,539     17,602       (37,714     11,550  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity (Deficit)

  $ 35,252     $ 42,467     $ 10,487     $ 19,097     $ (81,930   $ 25,373  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

28


Condensed Consolidating Balance Sheets

December 31, 2016

 

    Level 3
Parent,
LLC
    Level 3
Financing, Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
    (dollars in millions)  

Assets

           

Current Assets:

           

Cash and cash equivalents

  $ 15     $ —       $ 1,700     $ 104     $ —       $ 1,819  

Restricted cash and securities

    —         —         1       6       —         7  

Receivables, less allowances for doubtful accounts

    —         —         26       686       —         712  

Due from affiliates

    17,032       21,715       —         2,180       (40,927     —    

Other

    —         —         87       28       —         115  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Current Assets

    17,047       21,715       1,814       3,004       (40,927     2,653  

Property, Plant, and Equipment, net

    —         —         3,869       6,270       —         10,139  

Restricted Cash and Securities

    22       —         9       —         —         31  

Goodwill and Other Intangibles, net

    —         —         353       8,291       —         8,644  

Investment in Subsidiaries

    16,869       17,599       3,674       —         (38,142     —    

Deferred Tax Assets

    51       2,687       —         632       —         3,370  

Other Assets, net

    —         —         16       35       —         51  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Assets

  $ 33,989     $ 42,001     $ 9,735     $ 18,232     $ (79,069   $ 24,888  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities and Stockholders’ Equity (Deficit)

           

Current Liabilities:

           

Accounts payable

  $ —       $ —       $ 307     $ 399     $ —       $ 706  

Current portion of long-term debt

    —         —         2       5       —         7  

Accrued payroll and employee benefits

    —         —         160       35       —         195  

Accrued interest

    11       110       —         8       —         129  

Current portion of deferred revenue

    —         —         116       150       —         266  

Due to affiliates

    —         —         40,927       —         (40,927     —    

Other

    —         —         127       41       —         168  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Current Liabilities

    11       110       41,639       638       (40,927     1,471  

Long-Term Debt, less current portion

    592       10,108       13       164       —         10,877  

Deferred Revenue, less current portion

    —         —         719       282       —         1,001  

Other Liabilities

    16       —         155       451       —         622  

Commitments and Contingencies

           

Stockholders’ Equity (Deficit)

    33,370       31,783       (32,791     16,697       (38,142     10,917  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity (Deficit)

  $ 33,989     $ 42,001     $ 9,735     $ 18,232     $ (79,069   $ 24,888  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

29


Condensed Consolidating Statements of Cash Flows

Nine Months Ended September 30, 2017

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
                (dollars in millions)              

Net Cash Provided by (Used in)

           

Operating Activities

  $ (32   $ (378   $ 698     $ 1,503     $ —       $ 1,791  

Cash Flows from Investing

           

Activities:

           

Capital expenditures

    —         —         (614     (404     —         (1,018

Decrease (increase) in restricted cash and securities, net

    3       —         (1     2       —         4  

Purchases of marketable securities

    —         —         (1,127     —         —         (1,127

Maturity of marketable securities

    —         —         1,127       —         —         1,127  

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

    —         —         1       —         —         1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Cash Provided by (Used in) Investing Activities

    3       —         (614     (402     —         (1,013

Cash Flows from Financing Activities:

           

Long-term debt borrowings, net of issuance costs

    —         4,569       —         —         —         4,569  

Payments on and repurchases of long-term debt and capital leases

    —         (4,911     1       (7     —         (4,917

Increase (decrease) due from/to affiliates, net

    28       720       356       (1,104     —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Cash Provided by (Used in) Financing Activities

    28       378       357       (1,111     —         (348

Effect of Exchange Rates on Cash and Cash Equivalents

    —         —         —         3       —         3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Change in Cash and Cash Equivalents

    (1     —         441       (7     —         433  

Cash and Cash Equivalents at Beginning of Period

    15       —         1,700       104       —         1,819  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and Cash Equivalents at End of Period

  $ 14     $ —       $ 2,141     $ 97     $ —       $ 2,252  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

30


Condensed Consolidating Statements of Cash Flows

Nine Months Ended September 30, 2016

 

    Level 3
Parent,
LLC
    Level 3
Financing,
Inc.
    Level 3
Communications,
LLC
    Other Non-
Guarantor
Subsidiaries
    Eliminations     Total  
    (dollars in millions)  

Net Cash Provided by (Used in)

           

Operating Activities

  $ (35   $ (332   $ 489     $ 1,664     $ —       $ 1,786  

Cash Flows from Investing Activities:

           

Capital expenditures

    —         —         (537     (491     —         (1,028

Decrease in restricted cash and securities, net

    5       —         6       —         —         11  

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

    —         —         —         1       —         1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Cash Used in Investing Activities

    5       —         (531     (490     —         (1,016

Cash Flows from Financing Activities:

           

Long-term debt borrowings, net of issuance costs

    —         764       —         —         —         764  

Payments on and repurchases of long-term debt and capital leases

    —         (806     (1     (11     —         (818

Increase (decrease) due from/to affiliates, net

    34       368       798       (1,200     —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Cash Provided by (Used in) Financing Activities

    34       326       797       (1,211     —         (54

Effect of Exchange Rates on Cash and Cash Equivalents

    —         —         —         (1     —         (1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Change in Cash and Cash Equivalents

    4       (6     755       (38     —         715  

Cash and Cash Equivalents at Beginning of Period

    12       6       727       109       —         854  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and Cash Equivalents at End of Period

  $ 16     $ —       $ 1,482     $ 71     $ —       $ 1,569  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

31

(Back To Top)

Section 4: EX-99.2 (EX-99.2)

EX-99.2

Exhibit 99.2

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Level 3 Communications, Inc.:

We have audited the accompanying consolidated balance sheets of Level 3 Communications, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, cash flows and changes in stockholders’ equity for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Level 3 Communications, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Level 3 Communications, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Denver, Colorado

February 24, 2017

 

F-2


Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Level 3 Communications, Inc.:

We have audited Level 3 Communications, Inc.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Level 3 Communications, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Level 3 Communications, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Level 3 Communications, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, cash flows and changes in stockholders’ equity, for each of the years in the three-year period ended December 31, 2016, and our report dated February 24, 2017, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Denver, Colorado

February 24, 2017

 

F-3


LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Income

For each of the three years ended December 31,

 

(dollars in millions, except per share data)

   2016     2015     2014  

Revenue

   $ 8,172     $ 8,229     $ 6,777  

Costs and Expenses:

      

Network access costs

     2,725       2,833       2,529  

Network related expenses

     1,346       1,432       1,246  

Depreciation and amortization

     1,250       1,166       808  

Selling, general and administrative expenses

     1,407       1,467       1,181  
  

 

 

   

 

 

   

 

 

 

Total Costs and Expenses

     6,728       6,898       5,764  
  

 

 

   

 

 

   

 

 

 

Operating Income

     1,444       1,331       1,013  

Other Income (Expense):

      

Interest income

     4       1       1  

Interest expense

     (546     (642     (654

Loss on modification and extinguishment of debt

     (40     (218     (53

Venezuela deconsolidation charge

     —         (171     —    

Other, net

     (20     (18     (69
  

 

 

   

 

 

   

 

 

 

Total Other Expense

     (602     (1,048     (775
  

 

 

   

 

 

   

 

 

 

Income Before Income Taxes

     842       283       238  

Income Tax (Expense) Benefit

     (165     3,150       76  
  

 

 

   

 

 

   

 

 

 

Net Income

   $ 677     $ 3,433     $ 314  
  

 

 

   

 

 

   

 

 

 

Basic Earnings per Common Share

      

Net Income Per Share

   $ 1.89     $ 9.71     $ 1.23  

Weighted-Average Shares Outstanding (in thousands)

     358,559       353,385       254,428  

Diluted Earnings per Common Share

      

Net Income Per Share

   $ 1.87     $ 9.58     $ 1.21  

Weighted-Average Shares Outstanding (in thousands)

     361,472       358,593       258,483  

See accompanying notes to Consolidated Financial Statements.

 

F-4


LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

For each of the three years ended December 31,

 

(dollars in millions)

   2016     2015     2014  

Net Income

   $ 677     $ 3,433     $ 314  

Other Comprehensive Loss net of Tax:

      

Foreign currency translation adjustments, net of tax effect of $39, $13, and $0

     (80     (162     (178

Defined benefit pension plan adjustments, net of tax effect of $4, ($2), and $0

     (6     8       (5
  

 

 

   

 

 

   

 

 

 

Other Comprehensive Loss, net of Tax

     (86     (154     (183
  

 

 

   

 

 

   

 

 

 

Comprehensive Income

   $ 591     $ 3,279     $ 131  
  

 

 

   

 

 

   

 

 

 

See accompanying notes to Consolidated Financial Statements.

 

F-5


LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

As of December 31,

 

(dollars in millions, except share data)

   2016     2015  

Assets:

    

Current Assets:

    

Cash and cash equivalents

   $ 1,819     $ 854  

Restricted cash and securities

     7       8  

Receivables, less allowances for doubtful accounts of $29 and $32, respectively

     712       757  

Other

     115       111  
  

 

 

   

 

 

 

Total Current Assets

     2,653       1,730  

Property, Plant and Equipment, net of accumulated depreciation of $11,249 and $10,365, respectively

     10,139       9,878  

Restricted Cash and Securities

     31       42  

Goodwill

     7,729       7,749  

Other Intangibles, net

     915       1,127  

Deferred Tax Assets

     3,370       3,441  

Other Assets, net

     51       50  
  

 

 

   

 

 

 

Total Assets

   $ 24,888     $ 24,017  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity:

    

Current Liabilities:

    

Accounts payable

   $ 706     $ 629  

Current portion of long-term debt

     7       15  

Accrued payroll and employee benefits

     195       218  

Accrued interest

     129       108  

Current portion of deferred revenue

     266       267  

Other

     168       179  
  

 

 

   

 

 

 

Total Current Liabilities

     1,471       1,416  

Long-Term Debt, less current portion

     10,877       10,866  

Deferred Revenue, less current portion

     1,001       977  

Other Liabilities

     622       632  
  

 

 

   

 

 

 

Total Liabilities

     13,971       13,891  

Commitments and Contingencies

     —         —    

Stockholders’ Equity:

    

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

     —         —    

Common stock, $.01 par value, authorized 433,333,333 shares in both periods; 360,021,098 shares issued and outstanding at December 31, 2016 and 356,374,473 shares issued and outstanding at December 31, 2015

     4       4  

Additional paid-in capital

     19,800       19,642  

Accumulated other comprehensive loss

     (387     (301

Accumulated deficit

     (8,500     (9,219
  

 

 

   

 

 

 

Total Stockholders’ Equity

     10,917       10,126  
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 24,888     $ 24,017  
  

 

 

   

 

 

 

See accompanying notes to Consolidated Financial Statements.

 

F-6


LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For each of the three years ended December 31,

 

(dollars in millions)

   2016     2015     2014  

Cash Flows from Operating Activities:

      

Net income

   $ 677     $ 3,433     $ 314  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     1,250       1,166       808  

Loss on impairment

     —         —         18  

Non-cash compensation expense attributable to stock awards

     156       141       73  

Loss on modification and extinguishment of debt

     40       218       53  

Venezuela deconsolidation charge

     —         171       —    

Accretion of debt discount and amortization of debt issuance costs

     21       24       36  

Accrued interest on long-term debt, net

     21       (57     12  

Non-cash tax adjustments

     —         —         (7

Deferred income taxes

     123       (3,202     (116

(Gain) loss on sale of property, plant, and equipment and other assets

     (2     1       (3

Other, net

     (10     35       (8

Changes in working capital items:

      

Receivables

     31       (87     9  

Other current assets

     (36     (11     2  

Accounts payables

     83       4       (77

Deferred revenue

     18       88       6  

Other current liabilities

     (29     (69     41  
  

 

 

   

 

 

   

 

 

 

Net Cash Provided by Operating Activities

     2,343       1,855       1,161  

Cash Flows from Investing Activities:

      

Capital expenditures

     (1,334     (1,229     (910

Cash related to deconsolidated Venezuela operations

     —         (83     —    

Change in restricted cash and securities, net

     12       (22     (10

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

     3       4       3  

Investment in tw telecom, net of cash acquired

     —         —         (167

Other

     —         (14     (2
  

 

 

   

 

 

   

 

 

 

Net Cash Used in Investing Activities

     (1,319     (1,344     (1,086

Cash Flows from Financing Activities:

      

Long-term debt borrowings, net of issuance costs

     764       4,832       589  

Payments on and repurchases of long-term debt and capital leases

     (820     (5,051     (671
  

 

 

   

 

 

   

 

 

 

Net Cash Used in Financing Activities

     (56     (219     (82

Effect of Exchange Rates on Cash and Cash Equivalents

     (3     (18     (44
  

 

 

   

 

 

   

 

 

 

Net Change in Cash and Cash Equivalents

     965       274       (51

Cash and Cash Equivalents at Beginning of Year

     854       580       631  
  

 

 

   

 

 

   

 

 

 

Cash and Cash Equivalents at End of Year

   $ 1,819     $ 854     $ 580  
  

 

 

   

 

 

   

 

 

 

 

F-7


Supplemental Disclosure of Cash Flow Information:

        

Cash interest paid

   $ 508      $ 668      $ 598  

Income taxes paid, net of refunds

   $ 35      $ 50      $ 44  

Non-cash Investing and Financing Activities:

        

Capital lease obligations incurred

   $ 1      $ 6      $ 2  

Long-term debt conversion into equity

   $ —        $ 333      $ 142  

Accrued interest conversion into equity

   $ —        $ 10      $ 2  

Long-term debt issued and proceeds placed in escrow

   $ —        $ —        $ 3,000  

Escrowed securities used in the acquisition of tw telecom

   $ —        $ —        $ 3,014  

See accompanying notes to Consolidated Financial Statements.

 

F-8


LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity

For each of the three years ended December 31,

 

     Common Stock      Additional
Paid-in
Capital
     Accumulated
Other
Comprehensive
Income (Loss)
    Accumulated
Deficit
    Total  

(dollars in millions, except share data)

   Shares      $            

Balance at January 1, 2014

     234,688,063      $ 2      $ 14,339      $ 36     $ (12,966   $ 1,411  

Common stock:

               

Common stock issued under employee stock benefit plans and other

     4,528,559        —          78        —         —         78  

Stock-based compensation

     —          —          55        —         —         55  

tw telecom acquisition equity consideration

     96,868,883        1        4,543        —         —         4,544  

Conversion of debt to equity

     5,275,915        —          144        —         —         144  

Net Income

     —          —          —          —         314       314  

Other Comprehensive Loss

     —          —          —          (183     —         (183
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2014

     341,361,420      $ 3      $ 19,159      $ (147   $ (12,652   $ 6,363  

Common stock:

               

Common stock issued under employee stock benefit plans and other

     2,696,470        —          35        —         —         35  

Stock-based compensation

     —          —          106        —         —         106  

Conversion of debt to equity

     12,316,583        1        342        —         —         343  

Net Income

     —          —          —          —         3,433       3,433  

Other Comprehensive Loss

     —          —          —          (154     —         (154
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

     356,374,473      $ 4      $ 19,642      $ (301   $ (9,219   $ 10,126  

Common stock:

               

Common stock issued under employee stock benefit plans and other

     3,646,625        —          37        —         —         37  

Stock-based compensation

     —          —          121        —         —         121  

Net Income

     —          —                 —         677       677  

Adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting

     —          —          —          —         42       42  

Other Comprehensive Loss

     —          —          —          (86     —         (86
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2016

     360,021,098      $ 4      $ 19,800      $ (387   $ (8,500   $ 10,917  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to Consolidated Financial Statements.

 

F-9


LEVEL 3 COMMUNICATIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Organization and Summary of Significant Accounting Policies

Description of Business

Level 3 Communications, Inc. and subsidiaries is a facilities-based provider (that is, a provider that owns or leases a substantial portion of the plant, property and equipment necessary to provide our services) of a broad range of integrated communications services. We created our communications network by constructing our own assets and through a combination of purchasing other companies and purchasing or leasing facilities from others. Our network is an international, facilities-based communications network. We designed our network to provide communications services that employ and take advantage of rapidly improving underlying optical, Internet Protocol, computing and storage technologies.

On October 31, 2014, we completed the acquisition of tw telecom inc. (“tw telecom”) and tw telecom became our indirect, wholly owned subsidiary through a tax-free, stock and cash reorganization. See Note 3 - Events Associated with the Acquisition of tw telecom inc.

On October 31, 2016, we entered into an agreement and plan of merger (the “Merger Agreement”) with CenturyLink, Inc., a Louisiana corporation (“CenturyLink”), Wildcat Merger Sub 1 LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink (“Merger Sub 1”), and WWG Merger Sub LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink (“Merger Sub 2”), pursuant to which, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, we will be acquired by CenturyLink in a cash and stock transaction, including the assumption of our debt (the “CenturyLink Merger”). See Note 2 - CenturyLink Merger.

Principles of Consolidation and Basis of Presentation

The consolidated financial statements include our and our subsidiaries’ accounts in which we have a controlling interest. All significant intercompany accounts and transactions have been eliminated. The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).

As part of our consolidation policy, we consider our controlled subsidiaries, investments in businesses in which we are not the primary beneficiary or do not have effective control but have the ability to significantly influence operating and financial policies, and variable interests resulting from economic arrangements that give us rights to economic risks or rewards of a legal entity. We do not have variable interests in a variable interest entity where we are required to consolidate the entity as the primary beneficiary.

Prior to October 1, 2015, we included the results of our wholly owned Venezuelan subsidiary in our Consolidated Financial Statements using the consolidation method of accounting. Our Venezuelan subsidiary was in the Latin America segment and had total revenue of $72 million for the nine months ended September 30, 2015. For more information on our segments and non-GAAP measures see Note 16 - Segment Information.

Venezuelan exchange control regulations have resulted in an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar, and have restricted our Venezuelan operations’ ability to pay dividends and settle intercompany obligations in U.S. dollars. The severe currency controls imposed by the Venezuelan government have significantly limited the ability to realize the benefits from earnings of our Venezuelan operations and access the resulting liquidity provided by those earnings in U.S. dollars. We expect that this condition will continue for the foreseeable future.

 

F-10


Additionally, government regulations affecting our ability to manage our Venezuelan subsidiary’s capital structure, purchasing, product pricing, customer invoicing and collections, and labor relations; and the current political and economic situation within Venezuela have resulted in an acute degradation in our ability to make key operational decisions for our Venezuelan operations. The lack of exchangeability between the Venezuelan bolivar and the U.S. dollar and the degradation in our ability to control key operational decisions resulting in a lack of control over our Venezuelan subsidiary for U.S. accounting purposes, we concluded it no longer met the accounting criteria for consolidation and deconsolidated our Venezuelan subsidiary on September 30, 2015, and began accounting for our variable interest investment in our Venezuelan operations using the cost method of accounting. As a result of deconsolidating our Venezuelan subsidiary, we recorded a one-time charge of $171 million in the third quarter of 2015, which had no accompanying tax benefit. Our financial results no longer include the operating results of our Venezuelan operations. The factors that led to the deconsolidation of our Venezuelan subsidiary at the end of the third quarter of 2015 continued to exist through the end of 2016. Any dividends from our Venezuelan subsidiary are recorded as other income upon receipt of the cash in U.S. dollars. Prior period results have not been adjusted to reflect the deconsolidation of our Venezuelan subsidiary.

Foreign Currency Translation

Local currencies of foreign subsidiaries are the functional currencies for financial reporting purposes except for certain foreign subsidiaries in Latin America. For operations outside the United States that have functional currencies other than the U.S. dollar, assets and liabilities are translated to U.S. dollars at period-end exchange rates, and revenue, expenses and cash flows are translated using average exchange rates prevailing during the year. A significant portion of our non-United States subsidiaries have either the British pound, the euro or the Brazilian real as the functional currency, each of which experienced significant fluctuations against the U.S. dollar during 2016, 2015 and 2014. Foreign currency translation gains and losses are recognized as a component of accumulated other comprehensive income (loss) in stockholders’ equity and in the Consolidated Statements of Comprehensive Income in accordance with accounting guidance for foreign currency translation. We consider the majority of our investments in our foreign subsidiaries to be long-term in nature. Our non-United States exchange transaction gains (losses), including where transactions with our non-United States subsidiaries are not considered to be long-term in nature, are included within other income (expense) in Other, net on the Consolidated Statements of Income.

Reclassifications

Certain amounts in the prior year Consolidated Financial Statements and accompanying footnotes have been reclassified to conform to the current year’s presentation primarily pursuant to the adoption of Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs. As of December 31, 2015, approximately $19 million of current debt issuance costs have been reclassified from other current assets to long-term debt, less current portion and approximately $109 million of non-current debt issuance costs have been reclassified from other non-current assets to long-term debt, less current portion.

 

F-11


Use of Estimates

The preparation of the Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. The accounting estimates that require management’s judgments include revenue recognition, revenue reserves, network access costs, network access cost dispute reserves, determination of the useful lives of long-lived assets, measurement and recognition of stock-based compensation expense, valuation of long-lived assets, goodwill and indefinite-lived intangible assets for purposes of impairment testing, valuation of asset retirement obligations, allowance for doubtful accounts, measurement of the fair value of assets acquired and liabilities assumed in business combinations, accruals for estimated tax and legal liabilities, and valuation allowance for deferred tax assets. Actual results could differ from these estimates under different assumptions or conditions and such differences could be material.

Revenue

Revenue is recognized monthly as the services are provided based on contractual amounts expected to be collected. Management establishes appropriate revenue reserves at the time services are rendered based on an analysis of historical credit activity to address, where significant, situations in which collection is not reasonably assured as a result of credit risk, potential billing disputes or other reasons. Actual results may differ from these estimates under different assumptions or conditions and these differences could be material.

Intercarrier compensation revenue is recognized when an interconnection agreement is in place with another carrier, or if an agreement has expired, when the parties have agreed to continue operating under the previous agreement until a new agreement is negotiated and executed, or at rates mandated by the Federal Communications Commission (the “FCC”).

For certain sale and long-term indefeasible right of use, or IRU, contracts involving private line, wavelengths and dark fiber services, we may receive upfront payments for services to be delivered for a period of up to 25 years. In these situations, we defer the revenue and amortize it on a straight-line basis to earnings over the term of the contract.

Termination revenue is recognized when a customer discontinues service prior to the end of the contract period for which we had previously received consideration and for which revenue recognition was deferred. Termination revenue also is recognized when customers are required to make termination penalty payments to us to settle contractually committed purchase amounts that the customer no longer expects to meet or when a customer and we renegotiate a contract under which we are no longer obligated to provide services for consideration previously received and for which revenue recognition has been deferred.

We are obligated under dark fiber IRUs and other capacity agreements to maintain our network in efficient working order and in accordance with industry standards. Customers are obligated for the term of the agreement to pay for their allocable share of the costs for operating and maintaining the network. We recognize this revenue monthly as services are provided.

Our customer contracts require us to meet certain service level commitments. If we do not meet the required service levels, we may be obligated to provide credits, usually in the form of free service, for a short period of time. The credits are a reduction to revenue and, to date, have not been material.

 

F-12


Network Access Costs

Network Access Costs for the communications business include leased capacity, right-of-way costs, access charges, satellite transponder lease costs and other third party costs directly attributable to providing access to customer locations from our network, but excludes Network Related Expenses, and depreciation and amortization. Network Access Costs do not include any employee expenses or impairment expenses; these expenses are allocated to Network Related Expenses or Selling, General and Administrative Expenses.

We recognize the network access costs as they are incurred in accordance with contractual requirements. We dispute incorrect billings from our suppliers of network services. The most prevalent types of disputes include disputes for circuits that are not disconnected by the supplier on a timely basis, charges from suppliers for circuits that were not timely installed and incorrect rate or other inadequate information needed to determine the appropriate billing from the supplier. Depending on the type and complexity of the issues involved, it may and often does take several quarters to resolve the disputes. We establish appropriate network access costs reserves for disputed supplier billings based on an analysis of our historical experience in resolving disputes with our suppliers and regulatory analysis regarding certain supplier billing matters. Judgment is required in estimating the ultimate outcome of the dispute resolution process, as well as any other amounts that may be incurred to conclude the negotiations or settle any litigation. Actual results may differ from these estimates under different assumptions or conditions and these differences could be material.

Network Related Expenses

Network Related Expenses includes certain expenses associated with the delivery of services to customers and the operation and maintenance of our network, such as facility rent, utilities, maintenance and other costs, each related to the operation of our communications network, as well as salaries, wages and related benefits (including non-cash stock-based compensation expenses) associated with personnel who are responsible for the delivery of services, operation and maintenance of our communications network, and accretion expense on asset retirement obligations, but excludes depreciation and amortization.

Selling, General and Administrative Expenses

Selling, General and Administrative Expenses includes the salaries, wages and related benefits (including non-cash, stock-based compensation expenses) and the related costs of corporate and sales personnel, travel, insurance, non-network related rent, advertising, and other administrative expenses.

USF and Gross Receipts Taxes

The revenue recognition standards include guidance relating to 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, gross receipts taxes and certain state regulatory fees. We record Universal Service Fund (“USF”) contributions where we are the primary obligor for the taxes assessed in each jurisdiction where we do business on a gross basis in our Consolidated Statements of Income, but generally record gross receipts taxes and certain state regulatory fees billed to our customers on a net basis in our Consolidated Statements of Income. Total revenue and network access costs on the Consolidated Statements of Income include USF contributions totaling $357 million, $323 million and $234 million for the years ended December 31, 2016, 2015 and 2014, respectively.

 

F-13


Stock-Based Compensation

We recognize the estimated fair value of stock-based compensation costs, net of an estimated forfeiture rate, over the requisite service period of the award, which is generally the vesting term or term for restrictions on transfer that lapse, as the case may be. We estimate forfeiture rates based on our historical experience for the type of award, adjusted for expected activities as necessary.

Income Taxes

We recognize deferred tax assets and liabilities for our United States and non-U.S. operations, for operating loss and other credit carry forwards and the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. We record a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction.

Cash and Cash Equivalents

We classify investments as cash equivalents if they are readily convertible to cash and have original maturities of three months or less at the time of acquisition. Cash and cash equivalents consist primarily of highly liquid investments in government and government agency securities and government money market funds issued or managed by financial institutions in the United States, Europe and Latin America and commercial paper depending on liquidity requirements. As of December 31, 2016 and 2015, the carrying value of cash equivalents approximates fair value due to the short period of time to maturity.

Restricted Cash and Securities

Restricted cash and securities consists primarily of cash and investments that serve to collateralize our outstanding letters of credit and certain performance and operating obligations. Restricted cash and securities are recorded as current or non-current assets in the Consolidated Balance Sheets depending on the duration of the restriction and the purpose for which the restriction exists. Restricted securities are stated at cost which approximates fair value as of December 31, 2016 and 2015.

Allowance for Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and can bear interest. We establish an allowance for doubtful accounts for accounts receivable amounts that may not be collectible. We determine the allowance for doubtful accounts based on the aging of our accounts receivable balances, the credit quality of our customers and an analysis of our historical experience of bad debt write-offs. Accounts receivable balances are written off against the allowance for doubtful accounts after all means of collection have been exhausted and the potential for recovery is considered remote. We recognized bad debt expense, net of recoveries, of approximately $18 million in 2016, $23 million in 2015 and $22 million in 2014.

 

F-14


Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation and amortization for our property, plant and equipment are computed using the straight-line method based on the following estimated useful lives:

 

Facility and Leasehold Improvements

   15 - 40 years

Network Infrastructure (including fiber and conduit)

   25 - 50 years

Operating Equipment

   5 - 15 years

Furniture, Fixtures, Office Equipment and Other

   3 - 7 years

We perform internal reviews to evaluate the depreciable lives of our property, plant and equipment annually, or more frequently if new facts and circumstances arise, that may affect management’s original estimates. Due to the rapid changes in technology and the competitive environment, selecting the estimated economic life of telecommunications property, plant, and equipment requires a significant amount of judgment. Our internal reviews take into account input from our global engineering and network services personnel, actual usage, the physical condition of our property, plant, and equipment, industry data, and other relevant factors. In connection with our periodic review of the estimated useful lives of property, plant and equipment, we may determine that the period we expect to use certain assets is different than the remaining previously estimated useful lives.

Leasehold improvements are depreciated over the shorter of their estimated useful lives or lease terms that are reasonably assured.

We capitalize costs directly associated with expansions and improvements of our communications network and customer installations, including employee-related costs, and generally capitalize costs associated with network construction and provisioning of services. We amortize such costs over an estimated useful life of 3 to 5 years.

In addition, we continue to develop business support systems required for our business. The external direct costs of software, materials and services, and payroll and payroll-related expenses for employees directly associated with business support system development projects are capitalized. The total development costs of the business support system is amortized over an estimated useful life of 3 years.

Capitalized labor and related costs associated with employees and contract labor working on capital projects were approximately $271 million, $244 million and $187 million for the years ended December 31, 2016, 2015 and 2014, respectively.

Asset Retirement Obligations

We recognize a liability for the estimated fair value of legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset in the period incurred. The fair value of the obligation is also capitalized as property, plant and equipment and then amortized over the estimated remaining useful life of the associated asset. Increases to the asset retirement obligation liability due to the passage of time are recognized as accretion expense and included within network related expenses. Changes in the liability due to revisions to the amount or timing of future cash flows are recognized by increasing or decreasing the liability with the offset adjusting the carrying amount of the related long-lived asset. To the

 

F-15


extent that the downward revisions exceed the carrying amount of the related long-lived asset initially recorded when the asset retirement obligation liability was established, we record the remaining adjustment as a reduction to depreciation expense, to the extent of historical depreciation of the related long-lived asset, and then to network related expenses.

Goodwill and Indefinite-Lived Intangible Assets

Accounting guidance prohibits the amortization of goodwill and intangible assets with indefinite useful lives. We review goodwill and intangible assets with indefinite lives for impairment annually as of October 1st and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable.

Our goodwill impairment review process considers the fair value of each reporting unit relative to its carrying value. If the fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is performed. If the carrying value of the reporting unit exceeds its fair value, then a second step must be performed, and the implied fair value of the reporting unit’s goodwill must be determined and compared to the carrying value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then an impairment loss equal to the difference will be recorded. Prior to performing the two step evaluation, an assessment of qualitative factors may be performed to determine whether it is more likely than not that the fair value of a reporting unit exceeds the carrying value. If it is determined that it is unlikely that the carrying value exceeds the fair value, we are not required to complete the two step goodwill impairment evaluation.

At the time of each impairment assessment date in 2016, 2015, and 2014, our reporting units consisted of three regional operating units in: North America; Europe, the Middle East and Africa (“EMEA”); and Latin America. We conducted our annual goodwill impairment analysis as of October 1, and concluded that our goodwill was not impaired in 2016 and 2014. As a result of the deconsolidation of our Venezuelan subsidiary, we completed an assessment of the Latin American and our other reporting units’ goodwill as of September 30, 2015 and concluded there was no impairment in 2015.

Our indefinite-lived intangible assets impairment review process compares the estimated fair value of the indefinite-lived intangible assets to their respective carrying values. If the fair value of the indefinite-lived intangible assets exceeds their carrying values, then the indefinite-lived intangible assets are not impaired. If the carrying value of the indefinite-lived intangible assets exceeds their fair value, then an impairment loss equal to the difference will be recorded. In accordance with applicable accounting guidance, an entity may assess qualitative factors to determine whether it is more likely than not that the fair value exceeds the carrying value prior to performing the two step evaluation. If it is determined that it is unlikely the carrying value exceeds the fair value, then the entity is not required to complete the indefinite-lived intangible assets impairment evaluation.

Long-Lived Assets Including Finite-Lived Intangible Assets

We amortize intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from 4 to 12 years.

We evaluate long-lived assets, such as property, plant and equipment and intangible assets with finite lives, for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We assess the recoverability of the assets based on the undiscounted future cash flows the asset groups are expected to generate and recognize an impairment loss when estimated undiscounted future cash flows expected to result from the use of the assets plus net proceeds expected from disposition of the assets, if any, are less than the carrying value of the assets. If an asset is deemed to be impaired, the amount of the impairment loss is the excess of the asset’s carrying value over its estimated fair value.

 

F-16


We conducted a long-lived asset impairment analysis in 2016, 2015 and 2014 and in each case concluded that our long-lived assets, including finite-lived intangible assets, were not impaired.

Concentration of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash equivalents, accounts receivable, restricted cash and securities. We maintain our cash equivalents, restricted cash and securities with various financial institutions. These financial institutions are primarily located in the United States, Europe and Latin America and our policy is to limit exposure with any one institution. As part of our cash and risk management processes, we perform periodic evaluations of the relative credit standing of the financial institutions. We also have established guidelines relative to financial instrument credit ratings, diversification and maturities that seek to maintain safety and liquidity. Our investment strategy generally results in lower yields on investments but reduces the risk to principal in the short term prior to these funds being used in our business. Notwithstanding the devaluation of the Venezuelan bolivar, we have not experienced any material losses on financial instruments held at financial institutions.

We provide communications services to a wide range of wholesale and enterprise customers, ranging from well capitalized national carriers to small early stage companies primarily in the United States, Europe, and Latin America. Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising our customer base and their dispersion across many different industries and geographical regions. We perform ongoing credit evaluations of our customers’ financial condition and generally require no collateral from our customers, although letters of credit and deposits are required in certain limited circumstances. We have, from time to time, entered into agreements with value-added resellers and other channel partners to reach consumer and enterprise markets for voice services. We have policies and procedures in place to evaluate the financial condition of these resellers prior to initiating service to the final customer. We maintain an allowance for doubtful accounts based upon the expected collectability of accounts receivable. Due to our credit evaluation and collection process, bad debt expenses have not been significant; however, we are not able to predict changes in the financial stability of our customers. Any material change in the financial status of any one or a particular group of customers may cause us to adjust our estimate of the recoverability of receivables and could have a material effect on our results of operations. Fair values of accounts receivable approximate carrying amount due to the short period of time to collection.

A relatively small number of customers account for a significant percentage of our revenue. Our top ten customers accounted for approximately 16%, 16% and 17% of our revenue for the years ended December 31, 2016, 2015 and 2014, respectively.

Recently Adopted Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09, Improvements to Employee Share-Based Payment Accounting, as part of its simplification initiative, which involves several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted, but all of the amendments must be adopted in the same period.

We elected to early adopt ASU 2016-09 in the third quarter of 2016, which required adjustments to be reflected as of January 1, 2016, the beginning of the annual period that includes the interim period of adoption. Upon adoption, we recognized previously unrecognized excess tax benefits using the modified retrospective transition method, which resulted in a cumulative-effect adjustment of $42 million recorded to accumulated deficit as of January 1, 2016.

 

F-17


This ASU amended the definition of assumed proceeds when applying the treasury stock method of computing earnings per share to exclude the amount of excess tax benefits that would be recognized in additional paid-in capital. This amendment increased the amount of Diluted Weighted-Average Shares Outstanding, as noted in the table below.

The new presentation requirements for excess tax benefits to be shown on the statement of cash flows as an operating activity and presenting employee taxes paid where the employer withholds shares for tax-withholding purposes as a financing activity had no effect to any of the periods presented in our Consolidated Statements of Cash Flows as there had been no such activities in the Consolidated Statements of Cash Flow. We have elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period.

Adoption of the new standard also resulted in the recognition of excess tax benefits as a reduction to income tax expense of $22 million, or $0.06 per basic share, for 2016.

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which required debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. The new guidance is effective retrospectively for public companies for fiscal years beginning after December 15, 2015, and interim periods within those years. It was effective for us on January 1, 2016, and, upon adoption, debt issuance costs capitalized in other current assets and other assets in the consolidated balance sheet were reclassified and presented as a reduction to current and noncurrent long-term debt. As of December 31, 2015, debt issuance costs, net of accumulated amortization, recognized in the Consolidated Balance Sheets totaled $128 million, of which $19 million were recorded in other current assets.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, Leases (ASC 842), which requires entities that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. This ASU will replace most existing leasing guidance in U.S. GAAP when it becomes effective. The new standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those years. Early application is permitted. The standard requires the use of a modified retrospective transition method. We are evaluating the effect that ASU 2016-02 will have on our Consolidated Financial Statements and related disclosures, and expect the new guidance to significantly increase the reported assets and liabilities on our Consolidated Balance Sheets.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers, which amended the existing accounting standards for revenue recognition and requires an entity to recognize the amount of revenue it expects to be entitled to for the transfer of promised goods or services to customers. The ASU and subsequent amendments have been codified as ASC 606, Revenue from Contracts with Customers (“ASC 606”). In July 2015, the FASB deferred the effective date to annual reporting periods beginning after December 15, 2017, and interim reporting periods within those periods. Early adoption is permitted using the original effective date of annual reporting periods beginning after December 15, 2016, and interim reporting periods within those periods. The new guidance may be applied retrospectively to each prior period presented or prospectively with the cumulative effect recognized as of the date of initial adoption. We will not adopt ASC 606 early.

We are performing a comprehensive analysis of our revenue streams and contractual arrangements to identify the effects of ASC 606 on our consolidated financial statements and are developing new accounting and reporting policies, business and internal control processes and procedures to facilitate adoption of the standard. Because we currently have service contracts that contain a significant financing component that are not currently separately accounted for, we will be required to estimate and record incremental revenue and interest cost associated with these contractual terms. In addition, we will be

 

F-18


required to capitalize, and subsequently amortize, commission costs associated with obtaining or fulfilling our customer contracts, which we do not currently defer and amortize. We will also have to comply with new revenue disclosure requirements. We are continuing to review and evaluate underlying contract information that will be used to support new accounting and disclosure requirements under ASC 606 and evaluate other matters that may result from adoption of the standard. We have not yet selected a transition method, as our method of transition may be affected by the CenturyLink Merger, which we expect will be completed in the third quarter of 2017, and subsequent integration activities completed prior to the January 1, 2018 ASC 606 adoption date.

(2) CenturyLink Merger

On October 31, 2016, we entered into an agreement and plan of merger with CenturyLink, Inc., a Louisiana corporation, Wildcat Merger Sub 1 LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink, and WWG Merger Sub LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of CenturyLink, pursuant to which, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, we will be acquired by CenturyLink in a cash and stock transaction, including the assumption of our debt.

Under the Merger Agreement, at the effective time of the merger of Merger Sub 1 with and into us (the “Initial Merger”), (i) each issued and outstanding share of our common stock, will be converted into 1.4286 shares (the “Stock Consideration”) of CenturyLink’s common stock par value $1.00 per share and (ii) the right to receive $26.50 in cash (the “Cash Consideration” and, together with the Stock Consideration, the “Merger Consideration”). In addition, the Merger Agreement provides that at the effective time of the CenturyLink Merger, each issued and outstanding restricted stock unit award granted prior to April 1, 2014 and each restricted stock unit award granted to a non-employee member of our Board of Directors will be exchanged for the Merger Consideration. Further, at the effective time of the CenturyLink Merger, each issued and outstanding restricted stock unit award granted on or after April 1, 2014, other than those granted to non-employee members of our Board of Directors, will be assumed and converted automatically into a restricted stock unit award of CenturyLink common stock that will be subject to the same service-based vesting conditions as applicable to such awards prior to the transaction (but not any performance-based vesting conditions, which will be deemed satisfied based on forecasted and adjusted results through the closing of the transaction (as determined by Compensation Committee of our Board of Directors)). The CenturyLink Merger is subject to the receipt of certain regulatory approvals, including expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act, review by the U.S. Federal Communications Commission, certain state regulatory approvals and other customary closing conditions.

The transaction is also subject to the approval of CenturyLink shareholders and our stockholders. CenturyLink has entered into a voting agreement with STT Crossing Ltd. (a wholly owned subsidiary of ST Telemedia), holder of approximately 18 percent of our outstanding common stock, pursuant to which they have agreed to vote their Level 3 shares in favor of the transaction.

(3) Events Associated with the Acquisition of tw telecom inc.

On October 31, 2014, we completed our acquisition of tw telecom and tw telecom became our indirect, wholly owned subsidiary through a tax-free, stock and cash reorganization. As a result of the acquisition of tw telecom, (1) each issued and outstanding share of common stock of tw telecom was exchanged for 0.7 shares of our common stock and $10 in cash (together the “acquisition consideration”); (2) the outstanding stock options of tw telecom were canceled and the holders received the acquisition consideration, net of aggregate per share exercise price; (3) each restricted stock unit award of tw telecom was immediately vested and canceled and the holders received the acquisition consideration; and (4) each restricted stock unit of tw telecom was immediately vested and canceled and holders received the acquisition consideration.

 

F-19


In connection with the closing of the acquisition, Level 3 Financing, Inc., a wholly owned subsidiary, amended its existing credit agreement to incur an additional $2 billion of borrowings through an additional Tranche (the “Tranche B 2022 Term Loan”). The aggregate net proceeds of the Tranche B 2022 Term Loan were used to finance the cash portion of the acquisition consideration payable to tw telecom’s stockholders and to refinance certain existing indebtedness of tw telecom, including fees and premiums, in connection with the closing of the acquisition (see Note 10 - Long-Term Debt for additional information). In addition, the net proceeds from the issuance of $1 billion of 5.375% Senior Notes due 2022 raised in August 2014 (see Note 10 - Long-Term Debt) were used to finance the cash portion of the acquisition consideration payable to tw telecom stockholders and to refinance certain existing indebtedness of tw telecom, including fees and premiums, in connection with the closing of the acquisition.

On October 30, 2014, we increased the number of authorized shares of common stock to 433,333,333. As a result of the acquisition, we issued approximately 96.9 million shares of our common stock to former holders of tw telecom common shares, stock options, restricted stock awards and restricted stock units. In addition, we called for redemption and discharged or repaid approximately $1.793 billion of tw telecom’s outstanding consolidated debt including premiums of $154 million.

Based on the number of our shares issued, our closing stock price of $46.91 on October 31, 2014, the cash paid to the former holders of tw telecom common stock and the $2.1 billion of debt of tw telecom called for redemption and discharged or repaid, the aggregate consideration for acquisition accounting, including assumed capital leases of $152 million, approximated $8.1 billion.

The premium we paid in this transaction is attributable to strategic benefits, as the transaction further solidified our position as a premier global communications provider to the enterprise, government and carrier market, combining tw telecom’s extensive local operations and assets in North America with our global assets and capabilities. tw telecom’s business model is directly aligned with our initiatives for growth, which include building managed solutions to meet customer needs through an advanced IP/optical network.

The goodwill associated with this transaction is not deductible for income tax purposes except that certain deductible goodwill of tw telecom will continue to be deductible following the acquisition.

Our combined results of operations with tw telecom are included in our consolidated results of operations beginning in November 2014. The assets acquired and liabilities assumed of tw telecom were recognized at their acquisition date fair value. The purchase price allocation of acquired assets and assumed liabilities, including the assignment of goodwill to reporting units, was completed in the fourth quarter of 2015. The following is the final allocation of the purchase price.

 

F-20


     Purchase
Price
Allocation
 
     (dollars in
millions)
 

Assets:

  

Cash, Cash Equivalents and Restricted Cash

   $ 309  

Property, Plant and Equipment

     1,553  

Goodwill

     5,181  

Identifiable Intangible Assets

     1,263  

Other Assets

     140  
  

 

 

 

Total Assets

     8,446  
  

 

 

 

Liabilities:

  

Long-Term Debt

     (2,099

Deferred Revenue

     (57

Other Liabilities

     (279
  

 

 

 

Total Liabilities

     (2,435
  

 

 

 

Total Consideration to be Allocated

   $ 6,011  
  

 

 

 

As a result of new information available since the acquisition date, we made certain immaterial adjustments to the preliminary purchase price allocation during the first quarter of 2015, which have been reflected in the above table. The primary adjustment was a result of a single change in the purchase price allocation of $60 million related to the estimated value associated with the identifiable intangible assets and goodwill.

The following unaudited pro forma financial information presents our combined results with tw telecom as if the completion of the acquisition had occurred as of January 1, 2014 (dollars in millions, except per share data).

 

     Year Ended
December 31,
 
     2014  

Total Revenue

   $ 8,123  

Net Income

   $ 149  

Net Income per Share - Basic

   $ 0.44  

Net Income per Share - Diluted

   $ 0.44  

These pro forma results include certain adjustments, primarily due to increases in depreciation and amortization expense due to fair value adjustments of tangible and intangible assets, increases in interest expense due to our issuance of incremental debt to finance cash consideration, partially offset by the refinancing of tw telecom debt that had higher interest rates than the incremental financing, and to eliminate historical transactions between us and tw telecom. The unaudited pro forma information is not intended to represent or be indicative of our actual results of operations that would have been reported had the acquisition been completed on January 1, 2014, nor is it representative of our future operating results. The pro forma information does not include any operating efficiencies or cost savings that we achieved with respect to combining the companies.

Acquisition related costs include transaction costs such as legal, accounting, valuation and other professional services as well as integration costs such as severance and retention. Acquisition related

 

F-21


costs have been recorded in Network Related Expenses and Selling, General and Administrative Expenses in our Consolidated Statements of Income. We incurred total acquisition related transaction and integration costs of approximately $81 million in 2014 and $32 million in 2015.

(4) Earnings Per Share

We compute basic earnings per share by dividing net income for the period by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing the net income for the period by the weighted average number of shares of common stock outstanding during the period and including the dilutive effect of common stock that would be issued assuming conversion or exercise of outstanding convertible notes and stock-based compensation awards.

The effect of approximately 3 million total restricted stock units (“RSUs”) and performance restricted stock units (“PRSUs”) outstanding at December 31, 2016, has been included in the computation of diluted earnings per share for the year ended December 31, 2016. Less than 1 million of PRSUs granted in 2016 were excluded from the computation of diluted earnings per share for the year ended December 31, 2016, as they were contingently issuable and no shares would have been issued if this period was the end of the contingency period.

The effect of approximately 3 million and 4 million total outperform stock appreciation rights (“OSOs”) and RSUs outstanding at December 31, 2015 and 2014, respectively have been included in the computation of diluted earnings per share for the year ended December 31, 2015 and 2014, respectively. PRSUs granted in 2015 were excluded from the computation of diluted earnings per share for the year ended December 31, 2015 and PRSUs granted in 2014 were excluded from the computation of diluted earnings per share for the year ended December 31, 2014, as they were contingently issuable and no shares would have been issued if these periods were the end of the contingency period.

The effect of approximately 17 million shares issuable pursuant to the various series of convertible notes outstanding at December 31, 2014, have not been included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive to the computation.

 

F-22


(5) Property, Plant and Equipment

The components of our property, plant and equipment as of December 31, 2016 and 2015 are as follows (dollars in millions):

 

     Cost      Accumulated
Depreciation
     Net  

December 31, 2016

        

Land

   $ 179      $ —        $ 179  

Land Improvements

     77        (58      19  

Facility and Leasehold Improvements

     2,679        (1,447      1,232  

Network Infrastructure

     9,110        (3,899      5,211  

Operating Equipment

     8,846        (5,626      3,220  

Furniture, Fixtures and Office Equipment

     241        (196      45  

Other

     26        (23      3  

Construction-in-Progress

     230        —          230  
  

 

 

    

 

 

    

 

 

 
   $ 21,388      $ (11,249    $ 10,139  
  

 

 

    

 

 

    

 

 

 

December 31, 2015

        

Land

   $ 180      $ —        $ 180  

Land Improvements

     76        (53      23  

Facility and Leasehold Improvements

     2,582        (1,352      1,230  

Network Infrastructure

     8,979        (3,669      5,310  

Operating Equipment

     7,988        (5,079      2,909  

Furniture, Fixtures and Office Equipment

     242        (189      53  

Other

     28        (23      5  

Construction-in-Progress

     168        —          168  
  

 

 

    

 

 

    

 

 

 
   $ 20,243      $ (10,365    $ 9,878  
  

 

 

    

 

 

    

 

 

 

Depreciation expense was $1.039 billion in 2016, $939 million in 2015 and $713 million in 2014.

(6) Asset Retirement Obligations

Our asset retirement obligations consist of legal requirements to remove certain of our network infrastructure at the expiration of the underlying right-of-way (“ROW”) term and restoration requirements for leased facilities. We recognize our estimate of the fair value of our asset retirement obligations in the period incurred in other long-term liabilities. The fair value of the asset retirement obligation is also capitalized as property, plant and equipment and then depreciated over the estimated remaining useful life of the associated asset.

 

F-23


The following table provides asset retirement obligation activity for the years ended December 31, 2016 and 2015 (dollars in millions):

 

     2016      2015  

Asset retirement obligation at January 1

   $ 90      $ 85  

Accretion expense

     10        9  

Liabilities settled

     (9      (8

Revision in estimated cash flows

     —          5  

Effect of foreign currency rate change

     (2      (1
  

 

 

    

Asset retirement obligation at December 31

   $ 89      $ 90  
  

 

 

    

 

 

 

(7) Other Intangible Assets

Other intangible assets as of December 31, 2016 and 2015 were as follows (dollars in millions):

 

     Gross
Carrying
Amount
     Accumulated
Amortization
     Net  

December 31, 2016

        

Finite-Lived Intangible Assets:

        

Customer Contracts and Relationships

   $ 1,973      $ (1,113    $ 860  

Trademarks

     55        (55      —    

Patents and Developed Technology

     229        (189      40  
  

 

 

    

 

 

    

 

 

 
     2,257        (1,357      900  

Indefinite-Lived Intangible Assets:

        

Trade Name

     15        —          15  
     

 

 

    

 

 

 
   $ 2,272      $ (1,357    $ 915  
  

 

 

    

 

 

    

 

 

 

December 31, 2015

        

Finite-Lived Intangible Assets:

        

Customer Contracts and Relationships

   $ 1,975      $ (932    $ 1,043  

Trademarks

     55        (55      —    

Patents and Developed Technology

     230        (161      69  
     2,260        (1,148      1,112  

Indefinite-Lived Intangible Assets:

        

Trade Name

     15        —          15  
  

 

 

    

 

 

    

 

 

 
   $ 2,275      $ (1,148    $ 1,127  
  

 

 

    

 

 

    

 

 

 

During the fourth quarter of 2016 and 2015, we conducted our long-lived assets and indefinite-lived intangible assets impairment analysis and concluded that there was no impairment in 2016 and 2015.

Finite-lived intangible assets amortization expense was $211 million in 2016, $227 million in 2015 and $95 million in 2014.

At December 31, 2016, the weighted average remaining useful lives of our finite-lived intangible assets was 4.8 years in total; 4.9 years for customer contracts and relationships and 2.8 years for patents and developed technology.

 

F-24


As of December 31, 2016, estimated amortization expense for our finite-lived intangible assets over the next five years and thereafter is as follows (dollars in millions):

 

2017

   $ 196  

2018

     193  

2019

     181  

2020

     166  

2021

     143  

Thereafter

     21  
  

 

 

 
   $ 900  
  

 

 

 

(8) Restructuring Charges

Employee Separations

Changing economic and business conditions as well as organizational structure optimization efforts have caused us to initiate from time to time various workforce reductions resulting in involuntary employee terminations. We also have initiated workforce reductions resulting from the integration of previously acquired companies.

During 2015 and 2014, as part of the tw telecom acquisition and to improve organizational effectiveness, we initiated workforce reductions. Restructuring charges totaled $24 million and $45 million in 2015 and 2014, respectively, of which $8 million and $11 million in 2015 and 2014, respectively, were recorded in Network Related Expenses and $16 million and $34 million in 2015 and 2014, respectively, were recorded in Selling, General and Administrative Expenses. Workforce reductions were not material in 2016.

As of December 31, 2016 and 2015, we had $3 million and $4 million, respectively, of employee termination liabilities.

Facility Closings

We also have accrued contract termination costs of $5 million and $11 million as of December 31, 2016 and 2015, respectively, for facility lease costs that we continue to incur without economic benefit. Accrued contract termination costs are recorded in other liabilities (current and non-current) in the Consolidated Balance Sheets. We expect to pay the majority of these costs through 2020. We did not recognize any charge in 2016, and recognized a charge of approximately $3 million and a charge of less than $1 million in 2015 and 2014, respectively, as a result of facility lease costs associated with facility closing. We record charges for contract termination costs within Network Related Expenses and Selling, General and Administrative Expenses in the Consolidated Statements of Income.

(9) Fair Value of Financial Instruments

Our financial instruments consist of cash and cash equivalents, restricted cash and securities, receivables, accounts payable, capital leases, other liabilities, and long-term debt (including the current portion). The carrying values of cash and cash equivalents, restricted cash and securities, receivables, accounts payable, capital leases and other liabilities approximated their fair values at December 31, 2016 and 2015.

 

F-25


GAAP defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements and disclosures for assets and liabilities required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability, such as interest and foreign exchange rates, transfer restrictions, and risk of nonperformance.

Fair Value Hierarchy

GAAP establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value measurement of each class of assets and liabilities is dependent upon its categorization within the fair value hierarchy, based upon the lowest level of input that is significant to the fair value measurement of each class of asset and liability. GAAP establishes three levels of inputs that may be used to measure fair value:

 

Level 1—   Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—   Unadjusted quoted prices for similar assets or liabilities in active markets, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
Level 3—   Unobservable inputs for the asset or liability.

We recognize transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers within the fair value hierarchy during each of the years ended December 31, 2016 and 2015.

The table below presents the fair values for our long-term debt as well as the input levels used to determine these fair values as of December 31, 2016 and 2015:

 

                Fair Value Measurement Using  
    Total Carrying Value in
Consolidated Balance Sheets
    Unadjusted Quoted Prices
in Active

Markets for Identical Assets
or Liabilities (Level 1)
    Significant Other Observable
Inputs (Level 2)
 

(dollars in millions)

  December 31,
2016
    December 31,
2015
    December 31,
2016
    December 31,
2015
    December 31,
2016
    December 31,
2015
 

Liabilities Not Recorded at Fair Value in the Financial Statements:

           

Long-term Debt, including the current portion:

           

Term Loans

  $ 4,566     $ 4,556     $ 4,671     $ 4,570     $ —       $ —    

Senior Notes

    6,135       6,126       6,283       6,298       —         —    

Capital Leases and Other

    183       199       —         —         183       199  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Long-term Debt, including the current portion:

  $ 10,884     $ 10,881     $ 10,954     $ 10,868     $ 183     $ 199  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

We do not have any assets or liabilities where the fair value is measured using significant unobservable inputs (Level 3).

 

F-26


Term Loans

The fair value of the Term Loans referenced above was approximately $4.7 billion and $4.6 billion at December 31, 2016 and 2015, respectively. The fair value of each loan is based on quoted prices. Each loan tranche is actively traded.

Senior Notes

The fair value of the Senior Notes referenced above was approximately $6.3 billion and $6.3 billion at December 31, 2016 and 2015, respectively, based on quoted prices. Each series of notes is actively traded.

Capital Leases

The fair value of our capital leases are determined by discounting anticipated future cash flows derived from the contractual terms of the obligations and observable market interest and foreign exchange rates.

 

F-27


(10) Long-Term Debt

The following table summarizes our long-term debt (amounts in millions):

 

    

Date of

    December 31,
2016
    December 31,
2015
 
    

Issuance/

Amendment

  

Maturity

  

Interest
Payments

   Interest Rate     Amount     Amount  

Senior Secured Term Loans:

               

Borrowed by Level 3 Financing, Inc.

               

Tranche B-III 2019 Term Loan (1)(4)

   Aug 2013    Aug 2019    Quarterly      LIBOR +3.00%     $ 815     $ 815  

Tranche B 2020 Term Loan (1)(4)

   Oct 2013    Jan 2020    Quarterly      LIBOR +3.00%       1,796       1,796  

Tranche B-II 2022 Term Loan (1)(4)

   May 2015    May 2022    Quarterly      LIBOR +2.75%       2,000       2,000  

Senior Notes:

               

Issued by Level 3 Financing, Inc.

               

Floating Rate Senior Notes due 2018 (2)(4)

   Nov 2013    Jan 2018    May/Nov     

6-Month

LIBOR +3.50%

 

 

    300       300  

7% Senior Notes due 2020 (2)

   Aug 2012    Jun 2020    Jun/Dec      7.000     —         775  

6.125% Senior Notes due 2021 (2)

   Nov 2013    Jan 2021    Apr/Oct      6.125     640       640  

5.375% Senior Notes due 2022 (2)

   Aug 2014    Aug 2022    May/Nov      5.375     1,000       1,000  

5.625% Senior Notes due 2023 (2)

   Jan 2015    Feb 2023    Jun/Dec      5.625     500       500  

5.125% Senior Notes due 2023 (2)

   Apr 2015    May 2023    Mar/Sept      5.125     700       700  

5.375% Senior Notes due 2025 (2)

   Apr 2015    May 2025    Mar/Sept      5.375     800       800  

5.375% Senior Notes due 2024 (2)

   Nov 2015    Jan 2024    Jan/Jul      5.375     900       900  

5.25% Senior Notes due 2026 (2)

   Mar 2016    Mar 2026    Apr/Oct      5.250     775       —    

Issued by Level 3 Communications, Inc.

               

5.75% Senior Notes due 2022 (3)

   Dec 2014    Dec 2022    Mar/Sept      5.750     600       600  

Capital Leases and Other Debt

                183       199  
             

 

 

   

 

 

 

Total Debt Obligations

                11,009       11,025  

Unamortized discounts

                (13     (16

Unamortized debt issuance costs

                (112     (128

Current Portion

                (7     (15
             

 

 

   

 

 

 

Total Long-Term Debt

              $ 10,877     $ 10,866  
             

 

 

   

 

 

 

 

(1)  The term loans are secured obligations and guaranteed by Level 3 Communications, Inc. and Level 3 Communications, LLC and certain other subsidiaries.
(2)  The notes are fully and unconditionally guaranteed on an unsubordinated unsecured basis by Level 3 Communications, Inc. and Level 3 Communications, LLC.
(3) The notes were not guaranteed by any of Level 3 Communications, Inc.’s subsidiaries.
(4) The Tranche B-III 2019 Term Loan and the Tranche B 2020 Term Loan each had an interest rate of 4.000% as of December 31, 2016 and 2015. The Tranche B-II 2022 Term Loan had an interest rate of 3.500% as of December 31, 2016 and 2015. The Floating Rate Senior Notes due 2018 had an interest rate of 4.762% as of December 31, 2016 and 4.101% as of December 31, 2015. The interest rate on the Tranche B-III 2019 Term Loan and the Tranche B 2020 Term Loan are set with a minimum LIBOR of 1.00%, and the Tranche B-II 2022 Term Loan is set with a minimum LIBOR of 0.75%.

 

F-28


Senior Secured Term Loans

As of January 1, 2014, Level 3 Financing, Inc., our direct wholly owned subsidiary (“Level 3 Financing”) had a senior credit facility consisting of $815 million Tranche B-III Term Loan due 2019 and $1.796 billion Tranche B Term Loan due 2020.

On October 31, 2014, Level 3 Financing entered into a ninth amendment agreement to the Existing Credit Agreement to incur $2 billion in aggregate borrowings under the Existing Credit Agreement through the creation of a new Tranche B 2022 Term Loan (the “Tranche B 2022 Term Loan”). The Tranche B 2022 Term Loan included an upfront payment to the lenders of 0.75% of par and bears interest equal to LIBOR plus 3.50% with LIBOR set at a minimum of 1.00%.

On May 8, 2015, Level 3 Financing refinanced its existing $2 billion senior secured Tranche B 2022 Term Loan under a tenth amendment agreement to its Existing Credit Agreement through the creation of a new senior secured Tranche B-II 2022 term loan in the aggregate principal amount of $2 billion (the “Tranche B-II 2022 Term Loan”). The Tranche B-II 2022 Term Loan has an interest rate of LIBOR plus 2.75%, with a minimum LIBOR of 0.75%, and will mature on May 31, 2022. The Tranche B-II 2022 Term Loan was priced to lenders at par, with the payment to the lenders of an upfront fee of 25 basis points at closing. As a result of this transaction, we recognized a loss on the refinancing of approximately $27 million.

Senior Notes

We completed several offerings and refinancing of senior notes in 2016 and 2015. All of the notes pay interest semiannually, and allow for the redemption of the notes at the option of the issuer upon not less than 30 or more than 60 days’ prior notice by paying the greater of 101% of the principal amount or a “make-whole” amount, plus accrued interest. In addition, the notes also have a provision that allows for an additional right of optional redemption using cash proceeds received from the sale of equity securities. For specific details of these features and requirements, including the applicable premiums and timing, refer to the indentures for the respective senior notes in connection with the original issuances.

5.375% Senior Notes due 2022

On August 12, 2014, Level 3 Escrow II, Inc. (“Level 3 Escrow”), an indirect, wholly owned subsidiary of Level 3 Communications, Inc., issued $1.0 billion in aggregate principal amount of its 5.375% Senior Notes due 2022 (the “5.375% Senior Notes due 2022”). The 5.375% Senior Notes due 2022 were assumed by Level 3 Financing and the proceeds were used to refinance certain existing indebtedness of tw telecom.

5.75% Senior Notes due 2022

On December 1, 2014, we issued a total of $600 million aggregate principal amount of our 5.75% Senior Notes due 2022 (the “5.75% Senior Notes”). The net proceeds from the offering of the notes, together with cash on hand were used to redeem all of the outstanding 11.875% Senior Notes due 2019 issued by Level 3 Financing, including the payment of accrued interest and applicable premiums, and in connection with that redemption, the indenture relating to the 11.875% Senior Notes due 2019 was discharged on December 31, 2014. Level 3 Financing redeemed its 11.875% Senior Notes due 2017 at a price of 106.859% of the principal amount and recognized a loss on extinguishment of debt of $53 million.

 

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5.625% Senior Notes due 2023