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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 1-3040
U S WEST Communications, Inc.
A Colorado Corporation IRS Employer No. 84-0273800
1801 California Street, Denver, Colorado 80202
Telephone Number (303) 896-3099
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF U S WEST, INC., MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) and (b) OF FORM 10-Q AND
IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO
GENERAL INSTRUCTION H(2).
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No __
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Form 10-Q - Part I U S WEST Communications, Inc.
FORM 10-Q
TABLE OF CONTENTS
Item Page
- ---- ----
PART I - FINANCIAL INFORMATION
1. Financial Statements
Consolidated Statements of Operations -
Three and Six Months Ended June 30, 1997 and 1996 3
Consolidated Balance Sheets -
June 30, 1997 and December 31, 1996 4
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
2. Management's Analysis of the Results of Operations - (Reduced
disclosure format pursuant to General Instruction H(2)) 10
PART II - OTHER INFORMATION
1. Legal Proceedings 20
6. Exhibits and Reports on Form 8-K 20
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF
OPERATIONS (Unaudited) U S WEST COMMUNICATIONS, INC.
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
Dollars in millions 1997 1996 1997 1996
- ------------------------------------------- ---------- --------- ---------- ----------
Operating revenues:
Local service $ 1,151 $ 1,179 $ 2,382 $ 2,324
Interstate access service 678 626 1,365 1,248
Intrastate access service 200 189 400 379
Long-distance network services 240 278 490 568
Other services 219 168 398 329
---------- --------- ---------- ----------
Total operating revenues 2,488 2,440 5,035 4,848
Operating expenses:
Employee-related expenses 842 864 1,648 1,677
Other operating expenses 374 373 824 762
Taxes other than income taxes 95 97 200 192
Depreciation and amortization 524 513 1,046 1,024
---------- --------- ---------- ----------
Total operating expenses 1,835 1,847 3,718 3,655
---------- --------- ---------- ----------
Income from operations 653 593 1,317 1,193
Interest expense 93 101 189 204
Gains on sales of rural telephone exchanges 29 49 47 49
Other income (expense) - net (18) 2 (40) (15)
---------- --------- ---------- ----------
Income before income taxes and cumulative
effect of change in accounting principle 571 543 1,135 1,023
Provision for income taxes 218 208 433 391
---------- --------- ---------- ----------
Income before cumulative effect of change
in accounting principle 353 335 702 632
Cumulative effect of change in accounting
principle - net of tax - - - 34
---------- --------- ---------- ----------
NET INCOME $ 353 $ 335 $ 702 $ 666
========== ========= ========== ==========
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS
(Unaudited) U S WEST COMMUNICATIONS, INC.
June 30, December 31,
Dollars in millions 1997 1996
- ----------------------------------------- --------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 98 $ 92
Accounts and notes receivable - net 1,537 1,550
Inventories and supplies 131 109
Deferred tax asset 177 152
Prepaid and other 64 57
--------- -------------
Total current assets 2,007 1,960
--------- -------------
Gross property, plant and equipment 32,583 32,451
Less accumulated depreciation 18,954 18,522
--------- -------------
Property, plant and equipment - net 13,629 13,929
Other assets 821 743
--------- -------------
Total assets $ 16,457 $ 16,632
--------- -------------
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS
(Unaudited), continued U S WEST COMMUNICATIONS, INC.
June 30, December 31,
Dollars in millions 1997 1996
- -------------------------------------------------- ---------- --------------
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities:
Short-term debt $ 159 $ 834
Accounts payable 1,036 998
Employee compensation 268 308
Dividends payable 354 307
Advanced billing and customer deposits 278 250
Other 1,026 754
---------- --------------
Total current liabilities 3,121 3,451
---------- --------------
Long-term debt 5,320 5,375
Postretirement and other postemployment
benefit obligations 2,349 2,347
Deferred income taxes 827 807
Deferred credits and other 569 592
Contingencies (See Note C to the Consolidated
Financial Statements)
Shareowner's equity:
Common shares - one share without par value,
owned by parent 7,888 7,677
Cumulative deficit (3,617) (3,617)
---------- --------------
Total shareowner's equity 4,271 4,060
---------- --------------
Total liabilities and shareowner's equity $ 16,457 $ 16,632
========== ==============
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF
CASH FLOWS (Unaudited) U S WEST COMMUNICATIONS, INC.
Six Months Ended Six Months Ended
June 30, June 30,
Dollars in millions 1997 1996
- ---------------------------------------------------------- ------------------ ------------------
OPERATING ACTIVITIES
Net income $ 702 $ 666
Adjustments to net income:
Depreciation and amortization 1,046 1,024
Gains on sales of rural telephone exchanges (47) (49)
Cumulative effect of change in accounting principle - (34)
Deferred income taxes and amortization
of investment tax credits (14) (4)
Changes in operating assets and liabilities:
Restructuring payments (45) (74)
Postretirement medical and life costs, net
of cash fundings 5 (30)
Accounts receivable 12 45
Inventories, supplies and other current assets (40) (23)
Accounts payable and accrued liabilities 310 (83)
Other adjustments - net 77 18
------------------ ------------------
Cash provided by operating activities 2,006 1,456
------------------ ------------------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (831) (1,259)
Proceeds from sales of rural telephone exchanges 28 111
Proceeds from (payments on) disposals of property,
plant, and equipment 4 (7)
------------------ ------------------
Cash (used for) investing activities (799) (1,155)
------------------ ------------------
FINANCING ACTIVITIES
Net (repayments of) proceeds from short-term debt (669) 302
Repayments of long-term debt (85) (245)
Dividends paid on common stock (656) (630)
Equity infusions from U S WEST Communications Group 209 148
------------------ ------------------
Cash (used for) financing activities (1,201) (425)
------------------ ------------------
CASH AND CASH EQUIVALENTS
Increase (decrease) 6 (124)
Beginning balance 92 191
------------------ ------------------
Ending balance $ 98 $ 67
================== ==================
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended June 30, 1997 and 1996
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies
Basis of Presentation. U S WEST Communications, Inc. (the "Company") is
incorporated under the laws of the State of Colorado and is an indirect,
wholly owned subsidiary of U S WEST, Inc. ("U S WEST").
The Consolidated Financial Statements have been prepared by the Company,
pursuant to the interim reporting rules and regulations of the Securities and
Exchange Commission ("SEC"). Certain information and footnote disclosures
normally accompanying financial statements prepared in accordance with
generally accepted accounting principles ("GAAP") have been condensed or
omitted pursuant to such SEC rules and regulations. In the opinion of the
Company's management, the Consolidated Financial Statements include all
adjustments, consisting of only normal recurring adjustments, necessary to
present fairly the financial information set forth therein. It is suggested
that the Consolidated Financial Statements be read in conjunction with the
financial statements and notes thereto included in the Company's Form 10-K for
the year ended December 31, 1996.
Financial Instruments. Synthetic instrument accounting is used for interest
rate and foreign currency swaps if the index, maturity, and amount of the
instrument match the terms of the underlying debt. Net interest accrued is
recognized over the life of the instruments as an adjustment to interest
expense and is a component of cash provided by operating activities. Any gain
or loss on the termination of an instrument, which qualifies for synthetic
instrument accounting, would be deferred and amortized over the remaining life
of the original instrument.
Hedge accounting is used for forward contracts which qualify as hedges of
future debt issues. To qualify for hedge accounting, the contracts must have
a high inverse correlation to the exposure being hedged, and reduce the risk
or volatility associated with changes in interest rates. Qualified contracts
are carried at market value with gains and losses recorded with the related
debt and amortized as yield adjustments. Any gain or loss on the termination
of a contract, which qualifies for hedge accounting, would be deferred and
accounted for with the related transaction. The Company does not use
derivative financial instruments for trading purposes.
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
New Accounting Standards. In 1998, U S WEST will adopt Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" and
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 130 requires that the components of and the total
amount for comprehensive income be displayed in the financial statements.
Comprehensive income includes net income and all changes in equity during a
period that arise from nonowner sources, such as foreign currency items and
unrealized gains and losses on certain investments in equity securities.
Among other things, SFAS No. 131 requires detailed operating segment
information of an enterprise on an annual and interim period basis. The
effects of adopting both SFAS No. 130 and 131 are being evaluated.
B. Rural Telephone Exchanges Held for Sale
In conjunction with its rural telephone exchange sales program, the Company
sold certain rural telephone exchanges for pretax gains of $47. The carrying
value of the remaining rural telephone exchanges held for sale approximates
$75 at June 30, 1997. The remaining rural telephone exchanges held for sale
are expected to be disposed of in the latter half of 1997 and first-quarter
1998. In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company
has stopped depreciating the exchanges held for sale.
C. Contingencies
There are pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both.
On May 1, 1996, the Oregon Public Utilities Commission ("OPUC") approved a
stipulation terminating prematurely the Company's alternative form of
regulation ("AFOR") plan, and it then undertook a review of the Company's
earnings. In May 1997, the OPUC ordered the Company to reduce its annual
revenues by $97, effective May 1, 1997, and to issue a one-time refund,
including interest, of approximately $102 to reflect the revenue reduction for
the period May 1, 1996 through April 30, 1997. The one-time refund is for
interim rates which became subject to refund when the Company's AFOR plan was
terminated on May 1, 1996.
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
The Company filed an appeal of the order and asked for an immediate stay of
the refund with the Oregon Circuit Court for the County of Marion ("Oregon
Circuit Court"). On June 26, 1997, the Oregon Circuit Court granted the
Company's request for a stay, pending a full review of the OPUC's order. The
Oregon Circuit Court is scheduled to hear arguments on the appeal in December
1997.
The one-time refund and cumulative amount of revenues collected subject to
refund, including interest, as of June 30, 1997, totals approximately $121.
In 1996, the Washington State Utilities and Transportation Commission ("WUTC")
acted on the Company's 1995 rate request. The Company had sought to increase
revenues by raising rates primarily for basic residential services over a
four-year period. Instead of granting the Company's request, the WUTC ordered
$91.5 in annual net revenue reductions, effective May 1, 1996.
Based on the WUTC ruling, the Company filed a lawsuit with the King County
Superior Court (the "Court") for an appeal of the order, a temporary stay of
the ordered rate reduction and an authorization to implement a revenue
increase. The Court declined to change the WUTC order. The Company appealed
the Court's decision to the Washington State Supreme Court (the "State Supreme
Court") which, on January 22, 1997, granted a stay of the order, pending the
State Supreme Court's full review of the appeal. Oral arguments were heard in
June 1997. The Company is waiting a decision by the State Supreme Court.
Effective May 1, 1996, the Company began collecting revenues subject to
refund. The cumulative amount of revenues collected subject to refund as of
June 30, 1997, including interest, is approximately $135.
In another proceeding, the Utah Supreme Court remanded a Utah Public Service
Commission ("PSC") order to the PSC for hearing, thereby establishing two
exceptions to the rule against retroactive ratemaking: 1) unforeseen and
extraordinary events, and 2) misconduct. The PSC's initial order denied a
refund request from interexchange carriers and other parties related to the
Tax Reform Act of 1986. The potential exposure, including interest, at June
30, 1997, is approximately $160.
The Company has accrued $113 at June 30, 1997, which represents its estimated
liability for state regulatory proceedings. It is possible that the ultimate
liability could exceed the recorded liability by an amount up to $300. The
Company continues to monitor and evaluate the risks associated with its state
regulatory environment, and will adjust estimates as new information becomes
available.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions)
Some of the information presented in or in connection with this report
constitutes "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Although the Company believes that
its expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that
actual results will not differ materially from its expectations. Factors that
could cause actual results to differ from expectations include: (i) different
than anticipated competition from new entrants into the local exchange and
intraLATA toll markets, (ii) changes in demand for the Company's products and
services, including optional custom calling features, (iii) different than
anticipated employee levels, capital expenditures, and operating expenses as a
result of unusually rapid, in-region growth, (iv) the gain or loss of
significant customers, (v) pending regulatory actions in state jurisdictions,
and (vi) regulatory changes affecting the telecommunications industry,
including changes that could have an impact on the competitive environment in
the local exchange market.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1997 COMPARED WITH 1996
Following are details of the Company's reported net income, normalized to
exclude the effects of certain nonoperating items.
Six Six
Months Months
Ended Ended Increase Increase
June 30, June 30, (Decrease) (Decrease)
1997 1996 Dollars Percent
---------- ---------- ----------- ----------
Reported net income $ 702 $ 666 $ 36 5.4
Adjustments to reported net income:
Gains on sales of rural telephone
exchanges (29) (30) 1 (3.3)
Cumulative effect of change in
accounting principle (1)<F1> - (34) 34 -
Current year effect of change in
accounting principle (1)<F1> - (10) 10 -
---------- ---------- ----------- ----------
Normalized income $ 673 $ 592 $ 81 13.7
========== ========== =========== ==========
<FN>
<F1>
(1) Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of."
</FN>
During 1997, the Company's normalized income increased $81, or 13.7 percent,
to $673. Earnings before interest, taxes, depreciation, amortization and
other ("EBITDA") increased $146, or 6.6 percent, to $2,363. EBITDA excludes
gains on sales of certain rural telephone exchanges. The Company believes
EBITDA is an important indicator of the operational performance of its
businesses. EBITDA, however, should not be considered as an alternative to
operating or net income as an indicator of the performance of the Company's
business or as an alternative to cash flows from operating activities as a
measure of liquidity, in each case determined in accordance with GAAP.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
The increases are primarily due to higher demand for services and continued
cost control efforts which accelerated in the latter half of 1996. These
increases were partially offset by an accrual to recognize the Company's
estimated state regulatory liabilities. (See "Contingencies") The Company
anticipates net income growth will continue to be partially offset by
increased costs related to growth initiatives and interconnection
requirements, and the impacts of access reform and price cap regulation. (See
"Regulatory Environment")
Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," which, among other things, requires that companies no longer record
depreciation expense on assets held for sale. Adoption of SFAS No. 121
resulted in a 1996 one-time gain of $34 (net of tax of $22), related to the
cumulative effect of change in accounting principle.
Operating Revenues
An analysis of operating revenues follows:
Six Six
Months Months
Ended Ended Increase Increase
June 30, June 30, Price Lower (Decrease) (Decrease)
1997 1996 Demand Changes Refunds Other Dollars Percent
Local service $ 2,382 $ 2,324 $ 198 $ (14) $ 17 $ (143) $ 58 2.5
Interstate access 1,365 1,248 138 (10) 3 (14) 117 9.4
Intrastate access 400 379 25 5 - (9) 21 5.5
Long-distance network 490 568 (47) (5) - (26) (78) (13.7)
Other services 398 329 - - - 69 69 21.0
--------- --------- -------- --------- -------- ------- ----------- ----------
Total $ 5,035 $ 4,848 $ 314 $ (24) $ 20 $ (123) $ 187 3.9
========= ========= ======== ========= ======== ======= =========== ==========
Local Services Revenues. Local service revenues increased $58, or 2.5
percent, to $2,382, primarily as a result of access line growth and increased
demand for new product and service offerings, and existing central office
features. Total reported access lines increased 616,000, or 4.1 percent,
during the past 12 months, of which 249,000 was attributable to second lines.
Second line installations increased 26.7 percent. Access lines grew 686,000,
or 4.6 percent, when adjusted for sales of approximately 70,000 rural
telephone access lines during the past twelve months.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Partially offsetting the increase is a $91 accrual to recognize the Company's
estimated state regulatory liabilities. (See "Contingencies") Also partially
offsetting the increase was a $30 reclassification of public telephone
revenues to other services revenues. The reclassification was in conjunction
with the Federal Communications Commission's ("FCC") payphone orders, which
took effect April 15, 1997, as mandated by the Telecommunications Act of 1996
(the "Telecommunications Act"). Lower wireless interconnection access prices,
also mandated by the Telecommunications Act, reduced local service revenues by
$27.
Excluding the non-recurring effects of the regulatory accrual and the public
telephone revenues reclassification, local service revenues increased 6.8
percent. (See "Contingencies")
Interstate Access Revenues. Higher interstate access revenues resulted from
increased demand for private line services, access line growth and an increase
of 6.3 percent in billed interstate access minutes of use. The increase was
partially offset by the effects of price reductions and accruals of $22 for
refunds to interexchange carriers. The refunds relate to a one-time $22
exogenous cost adjustment ordered by the FCC as a condition of granting the
Company's waiver from price cap sharing rules for the first half of 1997. (See
"Regulatory Environment") True-ups of $18 to the 1996 price cap sharing
accruals partially offset the one-time $22 exogenous cost adjustment.
The Company anticipates future interstate access revenue growth will be
negatively impacted by the FCC's recent orders to restructure the access
charge system and its current price cap plan. (See "Regulatory Environment")
Intrastate Access Revenues. Intrastate access revenues increased largely as a
result of an increase of 10.5 percent in billed intrastate minutes of use and
increased demand for private line services.
Long-distance Network Service Revenues. Long-distance network service
revenues decreased 13.7 percent primarily due to the effects of competition
and the implementation of multiple toll carrier plans ("MTCPs") in Iowa and
Nebraska in 1996, and in Iowa, Oregon and Washington in first-quarter 1997.
The MTCPs essentially allow independent telephone companies to act as toll
carriers. During 1997, the MTCPs reduced long-distance revenues by $29, which
was offset by increased intrastate access revenues of $3, and decreased other
operating expenses (i.e., access expense) of $23.
Excluding the effects of the MTCPs, long-distance network service revenues
decreased by 8.6 percent. Erosion of long-distance network service revenues
will continue due to the loss of exclusivity of 1+ dialing in Minnesota and
Arizona, effective in February and April 1996, respectively, and continued
dial-around activity in other states within the Company's 14 state region.
The Company is responding to competitive losses through competitive pricing
of intraLATA long-distance services and increased promotional efforts to
retain customers.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Other Services Revenues. Other services revenues increased largely due to the
second-quarter 1997 $30 reclassification of public telephone revenues from
local service revenues. Also contributing to the increase was interim
compensation revenue from interexchange carriers as a result of the FCC's
payphone orders which took effect April 15, 1997. The amount of interim
compensation may change as a result of the District of Columbia Court of
Appeals recent review and remand of the FCC's payphone orders. Increases in
voice messaging, inside wire maintenance and billing and collection services
revenues also contributed to higher other services revenues.
Future revenues may be affected by pending regulatory actions in federal and
local regulatory jurisdictions.
Costs and Expenses
Six Six
Months Months Increase Increase
Ended Ended (Decrease) (Decrease)
June 30, June 30, Dollars) Percent
1997 1996
Employee-related expenses $ 1,648 $ 1,677 (29) (1.7)
Other operating expenses 824 762 62 8.1
Taxes other than income taxes 200 192 8 4.2
Depreciation and amortization 1,046 1,024 22 2.1
Interest expense 189 204 (15) (7.4)
Gains on sales of rural telephone exchanges 47 49 (2) (4.1)
Other expense 40 15 25 -
- ------------------------------------------- --------- --------- ---------- ----------
Employee-Related Expenses. Employee-related expenses decreased $29, or 1.7
percent, primarily due to lower salaries and wages, overtime, and conference
and travel expenses. Salaries and wages decreased primarily as a result of
employee reductions totaling 3,795 during the last twelve months. However,
this decrease was largely offset by the effects of inflation-driven wage
increases. The reduction in overtime, and conference and travel expenses is
primarily the result of continued cost control efforts which accelerated in
the latter half of 1996. Partially offsetting the decreases were higher
contract labor costs and an increase in the postretirement benefits accrual.
The increase in contract labor is primarily due to additional costs for system
development work and the launch of new products and services, and sales
efforts associated with a first-quarter 1997 promotion of caller
identification.
Other Operating Expenses. Other operating expenses increased $62, or 8.1
percent. The increase was predominantly a result of higher advertising costs,
of which approximately $30 is attributable to a advertising promotion of
caller identification in first-quarter 1997, and a reserve adjustment
associated with billing and collection activities performed for interexchange
carriers. Also contributing to the increase was additional network software
purchases, increased professional
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
fees and repair costs associated with flooding in North Dakota. Costs related
to the growth initiatives also contributed to the increase. Partially
offsetting the increases were lower materials and supplies as a result of
continued cost control efforts and reduced access expense (primarily related
to the implementation of the MTCPs in 1996 and 1997).
Taxes Other Than Income Taxes. Taxes other than income taxes increased
primarily due to increased use and gross receipt taxes. Partially offsetting
were decreased property taxes due to favorable tax valuations and mill levies,
as compared with 1996.
Depreciation and Amortization. Increased depreciation and amortization
expense was attributable to the effects of a higher depreciable asset base
partially offset by lower depreciation rates for certain classes of plant.
Interest Expense. Interest expense decreased primarily due to lower average
debt levels and interest rates as compared to 1996. Partially offsetting
the decrease in interest expense was a decrease in the amount of
interest capitalized resulting from a lower average balance of
telecommunications plant under construction.
Gains on Sales of Rural Telephone Exchanges. During 1997, the Company sold
selected rural telephone exchanges in Iowa, South Dakota, Nebraska and Idaho
for a pretax gain of $47 and an after tax gain of $29. The 1996 gains were a
result of sales in North and South Dakota.
Other Expense. Other expense increased primarily due to additional interest
expense associated with the Company's interstate sharing liabilities and state
regulatory liabilities.
Provision for Income Taxes
Six Six
Months Months
Ended Ended
June 30, June 30, Percent
1997 1996 Change
---------- ---------- -------
Provision for income taxes $ 433 $ 391 10.7
Effective tax rate 38.1% 38.2% -
- -------------------------- ---------- ---------- -------
The increase in the provision for income taxes resulted primarily from higher
pretax earnings and lower amortization of the investment tax credit.
Restructuring Charge
During the six-month period ended June 30, 1997, the restructuring reserve
decreased $45 to a balance of $78. Reserve usage is primarily a result of
expenditures for 380 employee separations during the first half of 1997 and
systems development costs. The restructuring plan is expected to be
substantially complete by the end of 1997. Management continues to evaluate
the remaining reserve balance and employee separations.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
CONTINGENCIES
There are pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both.
On May 1, 1996, the Oregon Public Utilities Commission ("OPUC") approved a
stipulation terminating prematurely the Company's alternative form of
regulation ("AFOR") plan, and it then undertook a review of the Company's
earnings. In May 1997, the OPUC ordered the Company to reduce its annual
revenues by $97, effective May 1, 1997, and to issue a one-time refund,
including interest, of approximately $102 to reflect the revenue reduction for
the period May 1, 1996 through April 30, 1997. The one-time refund is for
interim rates which became subject to refund when the Company's AFOR plan was
terminated on May 1, 1996.
The Company filed an appeal of the order and asked for an immediate stay of
the refund with the Oregon Circuit Court for the County of Marion ("Oregon
Circuit Court"). On June 26, 1997, the Oregon Circuit Court granted the
Company's request for a stay, pending a full review of the OPUC's order. The
Oregon Circuit Court is scheduled to hear arguments on the appeal in December
1997.
The one-time refund and cumulative amount of revenues collected subject to
refund, including interest, as of June 30, 1997, totals approximately $121.
In 1996, the Washington State Utilities and Transportation Commission ("WUTC")
acted on the Company's 1995 rate request. The Company had sought to increase
revenues by raising rates primarily for basic residential services over a
four-year period. Instead of granting the Company's request, the WUTC ordered
$91.5 in annual net revenue reductions, effective May 1, 1996.
Based on the WUTC ruling, the Company filed a lawsuit with the King County
Superior Court (the "Court") for an appeal of the order, a temporary stay of
the ordered rate reduction and an authorization to implement a revenue
increase. The Court declined to change the WUTC order. The Company appealed
the Court's decision to the Washington State Supreme Court (the "State Supreme
Court") which, on January 22, 1997, granted a stay of the order, pending the
State Supreme Court's full review of the appeal. Oral arguments were heard in
June 1997. The Company is waiting a decision by the State Supreme Court.
Effective May 1, 1996, the Company began collecting revenues subject to
refund. The cumulative amount of revenues collected subject to refund as of
June 30, 1997, including interest, is approximately $135.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
In another proceeding, the Utah Supreme Court remanded a Utah Public Service
Commission ("PSC") order to the PSC for hearing, thereby establishing two
exceptions to the rule against retroactive ratemaking: 1) unforeseen and
extraordinary events, and 2) misconduct. The PSC's initial order denied a
refund request from interexchange carriers and other parties related to the
Tax Reform Act of 1986. The potential exposure, including interest, at June
30, 1997, is approximately $160.
The Company has accrued $113 at June 30, 1997, which represents its estimated
liability for state regulatory proceedings. It is possible that the ultimate
liability could exceed the recorded liability by an amount up to $300. The
Company continues to monitor and evaluate the risks associated with its state
regulatory environment, and will adjust estimates as new information becomes
available.
REGULATORY ENVIRONMENT
The Telecommunications Act of 1996
The Telecommunications Act of 1996 (the "Telecommunications Act") replaces the
Modification of Final Judgment, the antitrust consent decree entered into in
1984 in connection with the divestiture by AT&T of its local telephone
business and the formation of U S WEST and the other Regional Bell Operating
Companies ("RBOCs"). The Telecommunications Act permits local telephone
companies, long-distance carriers and cable television companies to enter each
others' lines of business. Among other things, the RBOCs will be permitted to
provide interLATA long-distance services by opening their local networks to
facilities-based competition and satisfying a detailed list of requirements,
including providing interconnection and number portability. The
Telecommunications Act also reaffirms the concept of universal service and
directs the FCC and state regulators to determine universal service funding
policy. The FCC and state regulators have been given the responsibility to
interpret and oversee implementation of large portions of the
Telecommunications Act.
On August 8, 1996, the FCC issued an order (the "FCC Order") establishing a
framework of minimum national rules that would enable the states and the FCC
to begin implementing the local competition provisions of the
Telecommunications Act. Among other things, the FCC Order established rigid
costing and pricing rules which, from U S WEST's perspective, significantly
impede negotiations with new entrants to the local exchange market, state
public utility commission ("PUC") interconnection rulemakings, and
interconnection arbitration proceedings.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
On July 18, 1997, the Eighth Circuit Court of Appeals ("Eighth Circuit")
vacated significant portions of the FCC Order. Most significantly, the Eighth
Circuit ruled that jurisdiction over local interconnection prices rests with
the states, not the FCC. The effect of the Eighth Circuit's decision is to
have interconnection and network unbundled element pricing be resolved through
negotiations or state PUC arbitration proceedings. Some of the FCC's
unbundling rules, as well as its "pick and choose" provision, were also
vacated by the Eighth Circuit Court.
On May 7, 1997, the FCC announced three decisions that will establish rules to
implement the Universal Service provision of the Telecommunications Act of
1996 (the "Universal Service Order"), as well as rules to restructure the
access charge system (the "Access Reform Order") and the FCC's current price
cap plan (the "Price Cap Order").
UNIVERSAL SERVICE
Under the Universal Service Order, all providers of interstate
telecommunications services will contribute to universal service funding,
which will be based on retail telecommunications revenues. The Universal
Service Order deferred defining a new explicit mechanism to support high-cost
service in areas served by non-rural telephone companies such as the Company
until January 1, 1999. Until the explicit mechanism is put in place, the
existing universal service support mechanisms were left intact, except to the
extent modified by the FCC's Access Reform and Price Cap Orders discussed
below.
The FCC's Universal Service Order also includes the establishment of two
separate funds to help connect eligible schools and libraries, and rural
health care providers, to the global telecommunications network. These funds
are capped at $2.25 billion and $400, respectively.
On July 17, 1997, U S WEST filed a petition with the FCC for reconsideration
and clarification of certain issues in the Universal Service Order. Among
other things, U S WEST requested the FCC to reconsider: 1) establishing a
national fund to ensure high-cost support is sufficient, and 2) assessing
contributions as explicit end-user surcharges. Appeals of the Universal
Service Order have been filed by various other companies.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
FEDERAL ACCESS REFORM
The FCC has ordered a substantial restructuring of interstate access pricing.
A significant portion of the pricing that has been charged using
minutes-of-use pricing will now be charged using a combination of
minutes-of-use rates, presubscribed interexchange carrier charges ("PICCs")
and subscriber line charges ("SLCs"). Although an increase in the SLC to
multi-line business users occurred on July 1, 1997, the bulk of the mandated
pricing changes will occur on January 1, 1998. Additional mandated pricing
changes will also occur on January 1, 1998 through 2001. The net effect of
these changes will be to decrease minutes-of-use charges by over 60 percent
and increase flat-rate charges (i.e., PICCs and SLCs). The Access Reform
Order also continued in place the current rules by which incumbent local
exchange carriers ("LECs") may not assess interstate access charges on
information service providers and purchasers of unbundled network elements.
The FCC will separately address issues surrounding information service
providers' usage of the public switched network in a related notice of
inquiry. The impacts of access reform will occur over a number of years and
cannot be evaluated until the FCC resolves all remaining issues. Generally,
however, the Access Reform Order will reduce the revenues the Company derives
from interstate access charges. Competition from new entrant LECs will also
affect the Company's access revenues.
U S WEST has appealed the Access Reform Order. U S WEST's primary challenge
is that the FCC acted unlawfully by exempting purchasers of unbundled network
elements from payment of interstate access charges.
PRICE CAP ORDER
The FCC's Price Cap Order requires LECs that are subject to price cap
regulation to increase their price cap index productivity factor to 6.5
percent. The order eliminates the lower productivity factor options (i.e.,
4.0 percent and 4.7 percent) that required sharing of earnings above a
specified level and will require LECs to set their 1997 price cap index
assuming that the 6.5 percent factor had been in effect at the time of the
1996 tariff filing.
Under the FCC's previous price cap plan, the Company had elected the lowest
productivity factor, 4.0 percent, in its 1996 annual interstate tariff filing.
As a result, the Company remained subject to the sharing requirements for the
first half of 1997. In May 1997, the Company requested a waiver of the price
cap sharing rules for the first half of 1997. On June 26, 1997, the FCC
granted the waiver, resulting in the Company making a one-time exogenous cost
adjustment of $22. The adjustment is reflected in the 1997 second-quarter
interstate access revenues results (See "Operating Revenues"). The $22
adjustment was reflected in lower interstate access rates over twelve months
beginning July 1, 1997.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
As mandated by the Price Cap Order, the price cap index in the Company's 1997
interstate access tariff filing was established assuming that the 6.5 percent
productivity factor had been in effect at the time of the 1996 tariff filing.
The access rate reductions have an on-going revenue impact of approximately
$165 which will be reflected through lower interstate rates over twelve months
beginning July 1, 1997.
On June 23, 1997, U S WEST petitioned the Tenth Circuit Court of Appeals
("Tenth Circuit") for a review of the Access Reform Order and Price Cap Order.
Among other things, the petition requested the Tenth Circuit to review the use
of a 6.5 percent productivity factor and the retroactive application of the
6.5 percent productivity factor to July 1, 1996 when determining the price cap
index for the 1997 price cap filing. Through the federal court multi-district
litigation forum selection process, the Access Reform Order will be reviewed
by the Eighth Circuit. The Tenth Circuit has now transferred review of the
Price Cap Order to the District of Columbia Court of Appeals.
Form 10-Q - Part II U S WEST Communications, Inc.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company and its subsidiaries are subject to claims and proceedings arising
in the ordinary course of business. While complete assurance cannot be given
as to the outcome of any contingent liabilities, in the opinion of the
Company, any financial impact to which the Company and its subsidiaries are
subject is not expected to be material in amount to the Company's operating
results or its financial position.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No.
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12 Statement regarding computation of earnings to fixed charges ratio of
U S WEST Communications, Inc.
27 Financial Data Schedule
(b) Reports on Form 8-K Filed During the Second Quarter of 1997:
No reports on Form 8-K have been filed for the Company during the second
quarter of 1997.
Form 10-Q - Part II U S WEST Communications, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
August 13, 1997
/s/ Allan R. Spies
-----------------------
U S WEST Communications, Inc.
Allan R. Spies
Vice President and Chief Financial Officer