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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 September 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 Nine Months Ended September 30, 1997 and 1996 3
Consolidated Balance Sheets -
September 30, 1997 and December 31, 1996 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 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 18
6. Exhibits and Reports on Form 8-K 18
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF U S WEST COMMUNICATIONS, INC.
OPERATIONS (Unaudited)
Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
September September September September
30, 30, 30, 30,
Dollars in millions 1997 1996 1997 1996
Operating revenues:
Local service $ 1,314 $ 1,208 $ 3,739 $ 3,532
Interstate access service 663 606 2,028 1,854
Intrastate access service 208 192 608 571
Long-distance network services 231 272 721 840
Other services 193 178 548 507
---------- ---------- ---------- ----------
Total operating revenues 2,609 2,456 7,644 7,304
Operating expenses:
Employee-related expenses 850 848 2,498 2,525
Other operating expenses 479 386 1,303 1,148
Taxes other than income taxes 100 92 300 284
Depreciation and amortization 528 541 1,574 1,565
---------- ---------- ---------- ----------
Total operating expenses 1,957 1,867 5,675 5,522
---------- ---------- ---------- ----------
Income from operations 652 589 1,969 1,782
Interest expense 93 104 282 308
Gains on sales of rural telephone exchanges 30 2 77 51
Other expense 11 10 51 25
---------- ---------- ---------- ----------
Income before income taxes and cumulative
effect of change in accounting principle 578 477 1,713 1,500
Provision for income taxes 220 183 653 574
---------- ---------- ---------- ----------
Income before cumulative effect of change
in accounting principle 358 294 1,060 926
Cumulative effect of change in accounting
principle - net of tax - - - 34
---------- ---------- ---------- ----------
NET INCOME $ 358 $ 294 $ 1,060 $ 960
---------- ---------- ---------- ----------
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS U S WEST COMMUNICATIONS, INC.
(Unaudited)
September 30, December 31,
Dollars in millions 1997 1996
ASSETS
Current assets:
Cash and cash equivalents $ 172 $ 92
Accounts and notes receivable - net 1,513 1,550
Inventories and supplies 147 109
Deferred tax asset 145 152
Prepaid and other 55 57
-------------- -------------
Total current assets 2,032 1,960
-------------- -------------
Gross property, plant and equipment 32,831 32,451
Less accumulated depreciation 19,120 18,522
-------------- -------------
Property, plant and equipment - net 13,711 13,929
Other assets 834 743
-------------- -------------
Total assets $ 16,577 $ 16,632
-------------- -------------
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS U S WEST COMMUNICATIONS, INC.
(Unaudited), continued
September 30, December 31,
Dollars in millions 1997 1996
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities:
Short-term debt $ 423 $ 834
Accounts payable 1,219 998
Employee compensation 291 308
Dividends payable 357 307
Advanced billing and customer deposits 286 250
Other 865 754
--------------- --------------
Total current liabilities 3,441 3,451
--------------- --------------
Long-term debt 5,023 5,375
Postretirement and other postemployment
benefit obligations 2,294 2,347
Deferred income taxes 841 807
Deferred credits and other 614 592
Contingencies (See Note C to the Consolidated
Financial Statements)
Shareowner's equity:
Common shares - one share without par value,
owned by parent 7,981 7,677
Cumulative deficit (3,617) (3,617)
--------------- --------------
Total shareowner's equity 4,364 4,060
--------------- --------------
Total liabilities and shareowner's equity $ 16,577 $ 16,632
--------------- --------------
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF U S WEST COMMUNICATIONS, INC.
CASH FLOWS (Unaudited)
Nine Nine
Months Months
Ended Ended
September September
30, 30,
Dollars in millions 1997 1996
OPERATING ACTIVITIES
Net income $ 1,060 $ 960
Adjustments to net income:
Depreciation and amortization 1,574 1,565
Gains on sales of rural telephone exchanges (77) (51)
Cumulative effect of change in accounting principle - (34)
Deferred income taxes and amortization
of investment tax credits 1 (8)
Changes in operating assets and liabilities:
Restructuring payments (55) (114)
Postretirement medical and life costs, net
of cash fundings 8 (28)
Accounts receivable 37 5
Inventories, supplies and other current assets (55) (2)
Accounts payable and accrued liabilities 302 83
Other adjustments - net 111 9
----------- -----------
Cash provided by operating activities 2,906 2,385
----------- -----------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (1,291) (1,883)
Purchase of PCS wireless licenses (57) -
Proceeds from sales of rural telephone exchanges 51 130
Proceeds from (payments on) disposals of property,
plant, and equipment 27 (1)
----------- -----------
Cash (used for) investing activities (1,270) (1,754)
----------- -----------
FINANCING ACTIVITIES
Net (repayments of) proceeds from short-term debt (700) 257
Proceeds from issuance of long-term debt - 16
Repayments of long-term debt (107) (271)
Dividends paid on common stock (1,009) (965)
Equity infusions from U S WEST Communications Group 260 235
----------- -----------
Cash (used for) financing activities (1,556) (728)
----------- -----------
CASH AND CASH EQUIVALENTS
Increase (decrease) 80 (97)
Beginning balance 92 191
----------- -----------
Ending balance $ 172 $ 94
----------- -----------
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 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") and a major component
of U S WEST Communications Group ("Communications Group").
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.
B. U S WEST Split
On October 27, 1997, U S WEST announced its intention to split Communications
Group and U S WEST Media Group ("Media Group") into separate public companies.
Communications Group will be renamed U S WEST, Inc. ("new U S WEST") and Media
Group will be renamed MediaOne Group, Inc. ("MediaOne Group"). Under the terms
of the proposed transaction, new U S WEST will include the telephone, data and
wireless operations of the Communications Group, as well as the Yellow Pages
and electronic directory businesses of U S WEST Dex, Inc. ("Dex"). Dex is
currently part of the Media Group and will be transferred to the
Communications Group as part of the proposed transaction (the "Dex Transfer").
MediaOne Group will include the cable/broadband, wireless and domestic and
international investments of the Media Group.
Under the terms of the proposed split, Communications Group shareowners will
receive one share of new U S WEST common stock for each share of
Communications Group common stock. Media Group shareowners will receive one
share of MediaOne Group common stock for each share of Media Group common
stock. In addition, Media Group shareowners will receive shares of new U S
WEST common stock for each share of Media Group common stock which represents
their interest in Dex, totaling approximately $850. Under the terms of the
Dex Transfer, Media Group debt will be reduced and Communications Group debt
will be increased by $3.9 billion.
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
B. U S WEST Split (continued)
The transaction is subject to a number of approvals, including approvals by
regulators and both shareowner groups, and receipt of a favorable ruling from
the Internal Revenue Service. The split is expected to be complete in the
second half of 1998.
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.
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 September 30, 1997, totals approximately
$150.
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.
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
C. Contingencies (continued)
Effective May 1, 1996, the Company began collecting revenues subject to
refund. The cumulative amount of revenues collected subject to refund as of
September 30, 1997, including interest, is approximately $155.
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
September 30, 1997, is approximately $160.
The Company has accrued $125 at September 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
approximately $340. 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 - NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH
1996
Following are details of the Company's reported net income, normalized to
exclude the effects of certain nonoperating items.
Nine Nine
Months Months
Ended Ended
September September Increase Increase
30, 30, (Decrease) (Decrease)
1997 1996 Dollars Percent
Reported net income $ 1,060 $ 960 $ 100 10.4
Adjustments to reported net income:
Gains on sales of rural telephone (48) (31) (17) (54.8)
exchanges
Cumulative effect of change in
accounting principle (1)<F1> - (34) 34 -
Current year effect of change in
accounting principle (1)<F1> - (13) 13 -
----------- ----------- ----------- ----------
Normalized income $ 1,012 $ 882 $ 130 14.7
----------- ----------- ----------- ----------
<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 $130, or 14.7 percent,
primarily due to higher demand for services and continued cost control efforts
in the core business which accelerated in the latter half of 1996. Additional
expenses related to interconnection and accruals to recognize the Company's
estimated state regulatory liability partially offset the increase. (See Note
C - Contingencies - to the Consolidated Financial Statements.) The Company
anticipates that spending increases related to interconnection requirements
and entry into wireless personal communications services ("PCS") markets,
combined with rate reductions resulting from the Federal Communications
Commission's (the "FCC") price cap regulation, will partially offset future
net income growth.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
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 income tax expenses of $22),
related to the cumulative effect of change in accounting principle.
Operating Revenues
Nine Nine
Months Months
Ended Ended
September September Increase Increase
30, 30, (Decrease (Decrease)
1997 1996 Dollars Percent
Local service $ 3,739 $ 3,532 $ 207 5.9
Interstate access service 2,028 1,854 174 9.4
Intrastate access service 608 571 37 6.5
Long-distance network services 721 840 (119) (14.2)
Other services 548 507 41 8.1
---------- ---------- ----------- ----------
Total $ 7,644 $ 7,304 $ 340 4.7
---------- ---------- ----------- ----------
Local Service Revenues. Local service revenues increased predominately 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 576,000, or 3.8 percent, during the past 12 months, of which 274,000
was attributable to second lines. Second-line installations increased 28
percent during the past 12 months. Access lines grew 663,000, or 4.3 percent,
when adjusted for sales of approximately 87,000 rural telephone access lines
during the past 12 months. Also contributing to the revenue increase were
rate increases in various states and interim compensation revenue from
interexchange carriers as a result of the FCC's payphone orders which took
effect in April 1997.
Partially offsetting the increase were accruals of approximately $100 to
recognize the Company's estimated state regulatory liabilities (See Note C -
Contingencies - to the Consolidated Financial Statements) and lower wireless
interconnection access prices mandated by the Telecommunications Act of 1996
(the "Telecommunications Act").
Interstate Access Service Revenues. Higher interstate access service
revenues resulted from increased demand for private line services, access line
growth and a 6.2 percent increase in billed interstate access minutes of use.
Also contributing to the increase were the effects of sharing-related accruals
for refunds to interexchange carriers recorded in 1996. These increases were
partially offset by 1997 price reductions. Beginning July 1, 1997, the Company
reduced prices for interstate services as a result of the FCC's current price
cap plan. The access rate reductions have an on-going annual revenue impact of
approximately $165 which is reflected in lower interstate 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
Intrastate Access Service Revenues. Intrastate access service revenues
increased largely as a result of an 11.4 percent increase in billed intrastate
minutes of use and increased demand for private line services.
Long-Distance Network Service Revenues. Long-distance network service
revenues decreased 14.2 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 several states in 1997. The MTCPs essentially allow
independent telephone companies to act as toll carriers and are net income
neutral with the reduction in toll revenues largely offset by increased
intrastate access revenues and lower access expense.
Excluding the effects of the MTCPs, long-distance network service revenues
decreased 9.4 percent. The Company believes that 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 competitive dial-around activity in other states
within the Company's 14 state region. The Company is responding to competition
through competitive pricing of intraLATA long-distance services and increased
promotional efforts to retain customers.
Other Services Revenues. Other services revenues increased primarily as a
result of continued market penetration of voice messaging services and greater
sales of inside wire maintenance.
Revenue growth may be affected by pending regulatory actions in federal and
local regulatory jurisdictions.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Costs and Expenses
Nine Nine
Months Months
Ended Ended
September September Increase Increase
30, 30, (Decrease) (Decrease)
1997 1996 Dollars Percent
Employee-related expenses $ 2,498 $ 2,525 $ (27) (1.1)
Other operating expenses 1,303 1,148 155 13.5
Taxes other than income taxes 300 284 16 5.6
Depreciation and amortization 1,574 1,565 9 0.6
Interest expense 282 308 (26) (8.4)
Gains on sales of rural
telephone exchanges 77 51 26 51.0
Other expense 51 25 26 -
Employee-Related Expenses. Employee-related expenses decreased $27, or 1.1
percent, primarily as a result of lower salaries and wages related to employee
reductions totaling 4,180 during the last 12 months (which includes the
transfer of 1,200 employees during third-quarter 1997 to an unregulated
affiliate). Lower overtime costs and lower conference and travel expenses were
largely offset by higher contract labor costs. The contract labor increase
reflects increased marketing and sales efforts, systems development work
(which include expenses related to interconnection), and the launch of new
products and services. Further offsetting the decrease in employee-related
expenses were increases in certain employee-related benefit costs.
Other Operating Expenses. Other operating expenses increased $155, or 13.5
percent, predominantly as a result of increased network software purchases
(which include expenses related to interconnection), advertising costs and
professional fees. Additionally, operating expenses increased as a result of a
reserve adjustment associated with billing and collection activities performed
for interexchange carriers, increased affiliate expense as a result of
transferring 1,200 employees to an unregulated affiliate in third-quarter 1997
and repair costs associated with flooding in North Dakota. Partially
offsetting the increases were reduced access expenses (primarily related to
the implementation of the MTCPs in 1996 and 1997), lower materials and
supplies, and a 1996 charge to discontinue the Omaha broadband video service
trial.
Taxes Other Than Income Taxes. Taxes other than income taxes increased $16, or
5.6 percent, as a result of increased 1997 use taxes and property tax true-ups
in 1996.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA").
EBITDA increased 5.9 percent, to $3,543, primarily due to higher demand for
services and continued cost control efforts in the core business which
accelerated in the latter half of 1996. Additional expenses related to
interconnection and accruals to recognize the Company's estimated state
regulatory liability partially offset the increase. (See Note C -
Contingencies - to the Consolidated Financial Statements.) 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.
Depreciation and Amortization. Depreciation expense increased during the
nine-month period. The effects of a higher depreciable asset base were
partially offset by a third-quarter 1996 depreciation adjustment.
Interest Expense. Interest expense decreased $26, or 8.4 percent, primarily a
result of lower average debt levels as compared to 1996. Partially offsetting
the decrease was a reduction 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 the nine-month period,
the Company sold selected rural telephone exchanges in Iowa, South Dakota,
Nebraska, Idaho, and Minnesota for pretax gains of $77. The 1996 gains were a
result of sales in Utah, North Dakota and South Dakota.
Other Expense. Other expense increased primarily due to additional interest
expense associated with the Company's interstate sharing and state regulatory
liabilities.
Provision for Income Taxes
Nine Nine
Months Months
Ended Ended
September 30, September 30, Percent
1997 1996 Change
Provision for income taxes $ 653 $ 574 13.8
Effective tax rate 38.1% 38.3% -
The increase in the provision for income taxes resulted primarily from higher
pretax earnings and lower amortization of investment tax credits.
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Restructuring Charge
During the nine-month period ended September 30, 1997, the restructuring
reserve decreased $55 to a balance of $68. Reserve usage is primarily a
result of expenditures for 492 employee separations during the first nine
months 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.
Other Items
In connection with U S WEST's announcement of its intention to split the
Communications Group and the Media Group into separate public companies,
Standard & Poor's placed the Company's senior unsecured debt rating on credit
watch with positive implications and reaffirmed the Company's commercial paper
ratings. Duffs & Phelps reaffirmed the Company's senior unsecured debt and
commercial paper ratings. The Company's senior unsecured debt rating remains
under review by Moody's, which may result in a downgrading.
CONTINGENCIES
There are pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both. For a discussion of the specific
pending regulatory items, see Note C - Contingencies - to the Consolidated
Financial Statements.
The Company has accrued $125 at September 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
approximately $340. 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
INTERCONNECTION
In August 1996, the FCC issued an order (the "FCC Order") establishing a
framework of mandatory 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
impeded 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 (the "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 unbundled network 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.
On October 14, 1997, the Eighth Circuit clarified that incumbent
telecommunications providers are not required to make rebundled service
offerings available to competitors at unbundled element pricing. This decision
substantially reduces new entrants' ability to arbitrage between resale of
finished services and the pricing of unbundled network elements.
The Eighth Circuit is reviewing the FCC's August 1997 order that required
shared transport be made available in combination with local switching as an
unbundled element. This review is still pending.
NUMBER PORTABILITY
Among other things, the Telecommunications Act requires all local exchange
carriers ("LECs") to provide permanent number portability to facilitate local
exchange competition. The FCC has established a schedule for deployment of
number portability during 1998. This schedule includes 10 markets in the
Company's 14 state region. The FCC, however, has not issued cost recovery
rules as required by the Telecommunications Act. On October 23, 1997, U S
WEST filed a petition in the Tenth Circuit Court of Appeals (the "Tenth
Circuit"), seeking an order which would require the FCC to issue its cost
recovery rules. The Company will also seek cost recovery through state
ratemaking proceedings and interconnection cost recovery dockets. The Company
expects its estimated costs to deploy number portability will be significant
over the next few years. Due to legal and regulatory uncertainties, the
Company cannot provide assurance the one-time costs of deploying number
portability will ultimately be recovered.
UNIVERSAL SERVICE, ACCESS REFORM AND PRICE CAP
On May 7, 1997, the FCC announced three decisions that will establish rules to
implement the Universal Service provision of the Telecommunications Act (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
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 other issues
addressed by 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 services that have 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, 1999 through 2001. The net effect of
these changes will be to decrease minutes-of-use charges up to 60 percent and
increase flat-rate charges (i.e. PICCs and SLCs). Although the effects of the
mandated pricing changes beginning January 1, 1998 will initially be revenue
neutral, the Access Reform Order coupled with the Price Cap Order, will over
time reduce the revenues the Company derives from interstate access charges.
Competition from competitive LECs will also affect the Company's access
revenues.
U S WEST and other incumbent LECs have 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, while not providing for the immediate replacement of subsidies
contained within those same access charges. This case is pending in the
Eighth Circuit and will be heard in January 1998.
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 eliminated the lower productivity factor options (i.e. 4.0
percent and 4.7 percent) that required sharing of earnings above a specified
level and required 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.
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 annual revenue impact of
approximately $165 which are being reflected through lower interstate rates
over twelve months beginning July 1, 1997.
On June 23, 1997, U S WEST petitioned the Tenth Circuit for a review of the
Price Cap Order. The Tenth Circuit has transferred review of the Price Cap
Order to the District of Columbia Court of Appeals. Among other things, U S
WEST and other appellants are requesting the District of Columbia Court of
Appeals 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. This case
will be heard in 1998.
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 Third Quarter of 1997:
No reports on Form 8-K have been filed for the Company during the third
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.
November 13, 1997 /s/ Allan R. Spies
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U S WEST Communications, Inc.
Allan R. Spies
Vice President and Chief
Financial Officer