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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 1-8611
U S WEST, Inc.
A Delaware Corporation IRS Employer No. 84-0926774
7800 East Orchard Road, Englewood, Colorado 80111-2526
Telephone Number 303-793-6500
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 __
The number of shares of each class of U S WEST, Inc.'s common stock
outstanding (net of shares held in treasury), at July 31, 1997, was:
U S WEST Communications Group Common Stock - 483,129,022 shares;
U S WEST Media Group Common Stock - 606,683,005 shares
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U S WEST, Inc.
Form 10-Q
TABLE OF CONTENTS
Item Page
- ---- ----
PART I - FINANCIAL INFORMATION
1. U S WEST, Inc. Financial Information
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 5
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1997 and 1996 7
Notes to Consolidated Financial Statements 8
2. U S WEST, Inc. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
1. U S WEST Communications Group Financial Information
Combined Statements of Operations -
Three and Six Months Ended June 30, 1997 and 1996 34
Combined Balance Sheets -
June 30, 1997 and December 31, 1996 35
Combined Statements of Cash Flows -
Six Months Ended June 30, 1997 and 1996 37
Notes to Combined Financial Statements 38
2. U S WEST Communications Group Management's Discussion and
Analysis of Financial Condition and Results of Operations 42
1. U S WEST Media Group Financial Information
Combined Statements of Operations -
Three and Six Months Ended June 30, 1997 and 1996 55
Combined Balance Sheets -
June 30, 1997 and December 31, 1996 56
Combined Statements of Cash Flows -
Six Months Ended June 30, 1997 and 1996 58
Notes to Combined Financial Statements 59
2. U S WEST Media Group Management's Discussion and
Analysis of Financial Condition and Results of Operations 66
PART II - OTHER INFORMATION
1. Legal Proceedings 81
4. Submission of Matters to a Vote of Security Holders 81
6. Exhibits and Reports on Form 8-K 82
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF OPERATIONS
U S WEST, Inc.
(Unaudited)
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
--------- --------- --------- ---------
Sales and other revenues $ 3,787 $ 3,124 $ 7,553 $ 6,174
Operating expenses:
Employee-related expenses 1,215 1,098 2,363 2,141
Other operating expenses 820 609 1,662 1,200
Taxes other than income taxes 115 111 239 218
Depreciation and amortization 830 588 1,660 1,172
--------- --------- --------- ---------
Total operating expenses 2,980 2,406 5,924 4,731
--------- --------- --------- ---------
Income from operations 807 718 1,629 1,443
Interest expense 266 136 544 271
Equity losses in unconsolidated ventures 153 77 318 143
Gains on sales of investments 44 - 95 -
Gains on sales of rural telephone exchanges 29 49 47 49
Guaranteed minority interest expense 22 12 44 24
Other expense - net 24 23 50 46
--------- --------- --------- ---------
Income before income taxes, extraordinary
item and cumulative effect of change in
accounting principle 415 519 815 1,008
Provision for income taxes 180 206 350 398
--------- --------- --------- ---------
Income before extraordinary item and
cumulative effect of change in accounting
principle 235 313 465 610
Extraordinary item:
Early extinguishment of debt - net of tax 3 - 3 -
--------- --------- --------- ---------
Income before cumulative effect of change in
accounting principle 238 313 468 610
Cumulative effect of change in accounting
principle - net of tax - - - 34
--------- --------- --------- ---------
NET INCOME $ 238 $ 313 $ 468 $ 644
========= ========= ========= =========
Dividends on preferred stock 12 1 25 2
--------- --------- --------- ---------
EARNINGS AVAILABLE FOR
COMMON STOCK $ 226 $ 312 $ 443 $ 642
========= ========= ========= =========
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF OPERATIONS
U S WEST, Inc.
(Unaudited), continued
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
In thousands (except per share amounts) 1997 1996 1997 1996
---------- ---------- ---------- ----------
COMMUNICATIONS GROUP EARNINGS
PER COMMON SHARE:
Income before cumulative effect of change
in accounting principle $ 0.69 $ 0.68 $ 1.39 $ 1.30
Cumulative effect of change in accounting
principle - - - 0.07
---------- ---------- ---------- ----------
COMMUNICATIONS GROUP EARNINGS
PER COMMON SHARE $ 0.69 $ 0.68 $ 1.39 $ 1.37
========== ========== ========== ==========
COMMUNICATIONS GROUP
DIVIDENDS $ 0.535 $ 0.535 $ 1.07 $ 1.07
========== ========== ========== ==========
PER COMMON SHARE
COMMUNICATIONS GROUP AVERAGE
COMMON SHARES OUTSTANDING 482,542 476,803 481,945 475,929
========== ========== ========== ==========
MEDIA GROUP LOSS PER COMMON
SHARE $ (0.17) $ (0.03) $ (0.38) $ (0.02)
========== ========== ========== ==========
MEDIA GROUP AVERAGE COMMON
SHARES OUTSTANDING 606,446 473,593 606,486 473,298
========== ========== ========== ==========
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS
U S WEST, Inc.
(Unaudited)
June 30, December 31,
Dollars in millions 1997 1996
--------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 244 $ 201
Accounts and notes receivable - net 2,104 2,113
Inventories and supplies 218 159
Deferred directory costs 252 259
Deferred tax asset 237 213
Prepaid and other 104 167
--------- -------------
Total current assets 3,159 3,112
--------- -------------
Gross property, plant and equipment 38,546 37,756
Accumulated depreciation 20,260 19,475
--------- -------------
Property, plant and equipment - net 18,286 18,281
Investment in Time Warner Entertainment 2,483 2,477
Net investment in international ventures 1,322 1,548
Intangible assets - net 12,516 12,595
Net investment in assets held for sale 416 409
Other assets 2,184 2,433
--------- -------------
Total assets $ 40,366 $ 40,855
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See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS
U S WEST, Inc.
(Unaudited), continued
June 30, December 31,
Dollars in millions 1997 1996
---------- --------------
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities:
Short-term debt $ 1,443 $ 1,051
Accounts payable 1,250 1,316
Due to Continental Cablevision shareowners - 1,150
Employee compensation 387 470
Dividends payable 266 263
Other 2,315 1,824
---------- --------------
Total current liabilities 5,661 6,074
---------- --------------
Long-term debt 14,135 14,300
Postretirement and other postemployment
benefit obligations 2,492 2,479
Deferred income taxes 4,343 4,349
Deferred credits and other 989 973
Contingencies (See Note G to the Consolidated
Financial Statements)
Company-obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely
Company-guaranteed debentures 1,080 1,080
Preferred stock subject to mandatory redemption 100 51
Shareowners' equity:
Preferred stock 921 920
Common shares 10,776 10,741
Retained earnings (deficit) (17) 18
LESOP guarantee (72) (91)
Foreign currency translation adjustments (42) (39)
---------- --------------
Total shareowners' equity 11,566 11,549
---------- --------------
Total liabilities and shareowners' equity $ 40,366 $ 40,855
========== ==============
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF CASH FLOWS U S
WEST, Inc.
(Unaudited)
Six Six
Months Months
Ended Ended
June 30, June 30,
Dollars in millions 1997 1996
---------- ----------
OPERATING ACTIVITIES
Net income $ 468 $ 644
Adjustments to net income:
Depreciation and amortization 1,660 1,172
Equity losses in unconsolidated ventures 318 143
Gains on sales of investments (95) -
Gains on sales of rural telephone exchanges (47) (49)
Cumulative effect of change in accounting principle - (34)
Deferred income taxes and amortization of investment (85) (50)
tax credits
Changes in operating assets and liabilities:
Restructuring payments (50) (82)
Postretirement medical and life costs, net of cash fundings 10 (24)
Accounts and notes receivable (11) 21
Inventories, supplies and other current assets (91) (45)
Accounts payable and accrued liabilities 384 (55)
Other adjustments - net 117 (10)
---------- ----------
Cash provided by operating activities 2,578 1,631
---------- ----------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (1,558) (1,509)
Payment to Continental Cablevision shareowners (1,150) -
Investment in international ventures (44) (139)
Proceeds from sale of Time Warner, Inc. shares 220 -
Proceeds from sales of investments 355 -
Proceeds from disposals of property, plant and equipment 32 104
Cash from net investment in assets held for sale 50 93
Other - net (141) (74)
---------- ----------
Cash (used for) investing activities (2,236) (1,525)
---------- ----------
FINANCING ACTIVITIES
Net proceeds from (repayments of ) short-term debt (3,714) 340
Proceeds from issuance of long-term debt 4,110 330
Repayments of long-term debt (193) (476)
Dividends paid on common and preferred stock (498) (469)
Proceeds from issuance of common stock 49 104
Purchases of treasury stock (53) -
---------- ----------
Cash (used for) financing activities (299) (171)
---------- ----------
CASH AND CASH EQUIVALENTS
Increase (decrease) 43 (65)
Beginning balance 201 192
---------- ----------
Ending balance $ 244 $ 127
========== ==========
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 1997
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies
Basis of Presentation. The Consolidated Financial Statements have been
prepared by U S WEST, Inc. ("U S WEST" or 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 U S WEST'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 these
Consolidated Financial Statements be read in conjunction with the 1996 U S
WEST Consolidated Financial Statements and notes thereto included in U S
WEST's proxy statement mailed to all shareowners on April 7, 1997.
Financial Instruments. Synthetic instrument accounting is used for interest
rate swaps, interest rate caps 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 foreign currency forward and zero-cost
combination contracts which qualify for and are designated as hedges of firm
equity investment commitments and for options and 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 foreign exchange
or interest rates. Qualified contracts are carried at market value with gains
and losses recorded in equity until sale of the investment or are associated
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.
Market value accounting is used for derivative contracts which do not qualify
for synthetic instrument or hedge accounting. Market value accounting is also
used for foreign exchange contracts designated as hedges of foreign
denominated receivables and payables. These contracts are carried at market
value in other assets or liabilities with gains and losses recorded as other
income (expense). U S WEST does not use derivative financial instruments for
trading purposes.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies (continued)
New Accounting Standards. In fourth-quarter 1997, U S WEST will adopt
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." This standard specifies new computation, presentation and disclosure
requirements for earnings per share. Among other things, SFAS No. 128
requires presentation of basic and diluted earnings per share on the face of
the income statement. Adoption of the new standard is not expected to have a
material impact on Communications Group or Media Group earnings per share.
In 1998, U S WEST will adopt 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. AirTouch Transaction
During 1994, U S WEST entered into a definitive agreement with AirTouch
Communications, Inc. ("AirTouch") to combine their domestic cellular
properties into a partnership in a multi-phased transaction (the "AirTouch
Joint Venture"). During Phase I, which commenced on November 1, 1995, the
cellular properties are owned separately. A wireless management company has
been formed and is providing services to both companies, as requested, on a
contract basis.
In February 1997, the King County Superior Court in Washington state ruled
that a subsidiary of Media Group violated the terms of its partnership
agreement with its minority partners in the Seattle cellular partnership by
entering into the AirTouch Joint Venture. The Company currently is complying
with the Court's order which requires the Company to issue a right of first
refusal to the minority partners with respect to the subsidiary's limited
partnership interest. The Court has also authorized the limited partners to
take legally appropriate steps by August 15, 1997, to secure unanimous
agreement for a substitute for the Company as the general partner. The
Company retains its right to appeal unfavorable rulings before transferring
any partnership interest in the Seattle cellular partnership. Similar
litigation has been filed in other jurisdictions regarding other cellular
partnerships by the same minority partner that brought the Seattle litigation.
The Company is also seeking declaratory relief from the Delaware Chancery
Court. The Company believes it will ultimately be successful in all
litigation asserting that the Company's entering into the AirTouch Joint
Venture violated its partnership agreements with its minority partners.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
B. AirTouch Transaction (continued)
In May 1997, Media Group and AirTouch entered into a definitive agreement to
merge Media Group's domestic cellular business and its interest in PrimeCo
Personal Communications ("PrimeCo") into AirTouch (the "AirTouch Merger").
Completing the AirTouch Merger, on a tax-free basis depended among other
things, upon the final status of the "Morris Trust" provision of the recent
tax legislation. Since the enacted legislation eliminated the "Morris Trust"
provision and did not provide transitional relief for the AirTouch Merger, the
Company will continue with the original AirTouch Joint Venture transaction.
Media Group and AirTouch have agreed not to proceed to Phase II of the
AirTouch Joint Venture before May 5, 1998. In Phase II of the AirTouch Joint
Venture, the partners will combine those domestic properties for which
authorizations and partnership approvals have been obtained. Media Group has
the right under Phase III of the AirTouch Joint Venture agreement to convert
its joint venture interest into AirTouch stock.
C. Dex Transfer
In May 1997, U S WEST announced its intention to transfer its domestic
directory business from the Media Group to the Communications Group (the "Dex
Transfer"). Under the terms of the Dex Transfer, $3.9 billion of U S WEST
debt will be reallocated from the Media Group to the Communications Group and
the Communications Group will issue shares of Communications Group common
stock to Media Group shareowners totaling $850. Contingent upon receiving
favorable federal income tax treatment, the Company intends to pursue the Dex
Transfer.
D. Asset Sales and Restructurings
Marketable Securities and Investments. During the second quarter of 1997,
Media Group sold an additional 2 million shares of Teleport Communications
Group, Inc. ("TCG") for proceeds of $58, bringing the total number of TCG
shares sold in 1997 to 6,075,000 for total proceeds of $178. In connection
with the November 15, 1996 merger of Continental Cablevision, Inc. into a
wholly owned subsidiary of U S WEST (the "Continental Merger"), Media Group
is required by a consent decree with the United States Department of Justice
to dispose of its interest in TCG by December 31, 1998. The share sales have
reduced Media Group's interest in TCG from
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
D. Asset Sales and Restructurings (continued)
11 percent at December 31, 1996, to approximately 7 percent at June 30, 1997.
Also during the second quarter of 1997, Media Group sold its shares of Time
Warner, Inc., acquired in the Continental Merger, for proceeds of $220 and a
pretax gain of $44.
During the first quarter of 1997, Media Group reached a settlement to transfer
its investment in Optus Vision, an Australian cable and telecommunications
venture acquired in the Continental Merger, to Optus Communications Pty Ltd,
an Australian telecommunications carrier. Upon satisfaction of various
pre-conditions, Media Group will receive convertible notes which can be
converted to shares of Optus Communications upon public offering of its
shares. The settlement released the Company from litigation and future
claims.
Each of the partners of PRIMESTAR Partners L.P., including Media Group, have
entered into an agreement whereby each partner's direct broadcast satellite
customers and certain assets will be contributed to a newly formed company,
PRIMESTAR, Inc. In exchange, each partner, including Media Group, will
receive a combination of cash and stock in PRIMESTAR, Inc. The transaction is
subject to various approvals and is expected to close in early 1998. In a
related transaction, an agreement has been entered into whereby the satellite
assets controlled by News Corp. and its partner MCI Communications Corporation
will be purchased by PRIMESTAR, Inc. in exchange for nonvoting convertible
securities. The transaction is subject to regulatory and other approvals.
Cable Systems. As a result of the Continental Merger, Media Group must
dispose of its wholly owned cable systems located within the telephone service
areas of U S WEST Communications, Inc. ("U S WEST Communications"). Media
Group has reached definitive agreements to sell its cable systems in Minnesota
and Idaho. The Minnesota systems are being sold for proceeds of approximately
$600 and serve 290,000 subscribers. The Idaho systems are being sold for
approximately $26 and serve 16,000 subscribers. In accordance with SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," U S WEST has stopped depreciation and amortization
related to these assets. In each case, the sale proceeds approximate the
carrying value of the cable systems. These systems contributed $6 and $7 in
operating income during the three- and six-month periods ended June 30, 1997,
respectively. The cable system sales are subject to federal and local
regulatory approvals, including the transfer of franchises, and are expected
to close in early 1998.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
D. Asset Sales and Restructurings (continued)
Rural Telephone Exchanges Held for Sale. In conjunction with its rural
telephone exchange sales program, U S WEST Communications sold certain rural
telephone exchanges for pretax gains of $29 and $47 during the three- and
six-month periods ended June 30, 1997, respectively. 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, the Company has stopped depreciating the
exchanges held for sale.
International Directories. On June 4, 1997, Media Group sold Thomson
Directories, its directory operation in the United Kingdom, for $121. Also,
in July 1997, Media Group entered into an agreement to sell U S WEST Polska,
its directory operation in Poland. The sale is awaiting approval from
Poland's Office of Competition and Consumer Protection. These transactions
will result in the disposition of Media Group's wholly owned international
directory operations.
E. Series E Preferred Stock Subject to Mandatory Redemption
On June 30, 1997, Media Group acquired cable systems serving 40,000
subscribers in the state of Michigan for cash of $25 and 994,082 shares of
nonvoting, Series E Convertible Preferred Stock (the "Preferred Stock") issued
by U S WEST. Dividends are payable quarterly at the annual rate of 6.34
percent. The Preferred Stock is recorded at the market value of $50.00 per
share at June 30, 1997, which is equal to its liquidation value. Upon
redemption, the preferred stockholders may elect to receive cash or convert
their Preferred Stock into Media Group common stock. Cash redemption is equal
to the Preferred Stock's liquidation value of $50.00 per share, plus accrued
dividends. The number of shares of Media Group common stock to be received
upon conversion is $47.50 per share divided by the then current market price
of Media Group common stock. The conversion rate is subject to adjustment by
U S WEST under certain circumstances.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
E. Series E Preferred Stock Subject to Mandatory Redemption (continued)
The Preferred Stock is redeemable as follows: (a) U S WEST may call for
redemption all or any part of the Preferred Stock beginning on June 30, 2002;
(b) on a yearly basis beginning August 1, 2007, and continuing through August
1, 2016, U S WEST will redeem 49,704 shares of Preferred Stock, and on June
30, 2017, all of the remaining outstanding shares of Preferred Stock; or (c)
all of the outstanding Preferred Stock shall be redeemed upon the occurrence
of certain events, including the dissolution or sale of Media Group.
The Preferred Stock ranks senior to all classes of U S WEST common stock, is
subordinated to any senior debt and ranks on equal terms with all other
preferred securities.
F. Subsequent Events
In July 1997, Media Group entered into an agreement to purchase up to the
remaining 50 percent of Fintelco, S.A., ("Fintelco"), a cable and
telecommunications venture with approximately 660,000 cable subscribers
located in Argentina. This additional interest could bring Media Group's
ownership in Fintelco up to 100 percent. Closing is contingent upon various
regulatory approvals, which are expected during the third quarter of 1997.
On August 6, 1997, Media Group announced it will relocate the corporate
offices of its domestic cable operations, MediaOne, Inc., from Boston to
Denver. Approximately 150 employees will be asked to relocate to Denver. The
move is designed to improve operations through better alignment and focus, and
will occur in phases between September 1997 and June 1998. In addition,
several changes in the senior management of MediaOne were announced. The
Media Group anticipates incurring a pretax charge of approximately $30 in
third-quarter 1997 for costs related to the move and management changes.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
G. Contingencies
At U S WEST Communications 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 U S WEST Communications' alternative form
of regulation ("AFOR") plan, and it then undertook a review of U S WEST
Communication's earnings. In May 1997, the OPUC ordered U S WEST
Communications 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 U S WEST Communications' AFOR plan was terminated on May 1, 1996.
U S WEST Communications 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 U S WEST Communications' 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 U S WEST Communications' 1995 rate request. U S WEST
Communications had sought to increase revenues by raising rates primarily for
basic residential services over a four-year period. Instead of granting U S
WEST Communications' request, the WUTC ordered $91.5 in annual net revenue
reductions, effective May 1, 1996.
Based on the WUTC ruling, U S WEST Communications 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. U S WEST
Communications 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. U S WEST Communications is waiting a
decision by the State Supreme Court.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
G. Contingencies (continued)
Effective May 1, 1996, U S WEST Communications 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 Communications Group 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 Communications Group continues to monitor and evaluate the risks
associated with its state regulatory environment, and will adjust estimates as
new information becomes available.
H. Net Investment in Assets Held for Sale
The capital assets segment is being accounted for in accordance with Staff
Accounting Bulletin No. 93, issued by the SEC, which requires discontinued
operations not disposed of within one year of the measurement date to be
accounted for prospectively in continuing operations as "net investment in
assets held for sale." The net realizable value of the assets is being
evaluated on an ongoing basis with adjustments to the existing reserve, if
any, being charged to continuing operations. No such adjustment has been
required. Prior to January 1, 1995, the entire capital assets segment was
accounted for as discontinued operations in accordance with Accounting
Principles Board Opinion No. 30.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
H. Net Investment in Assets Held for Sale (continued)
The components of net investment in assets held for sale follow:
June 30, December 31,
Dollars in millions 1997 1996
--------- -------------
ASSETS
Cash and cash equivalents $ 22 $ 21
Finance receivables - net 820 869
Investment in real estate - net of valuation allowance 184 182
Bonds, at market value 145 146
Investment in FSA 339 326
Other assets 173 165
--------- -------------
Total assets $ 1,683 $ 1,709
========= =============
LIABILITIES
Debt $ 442 $ 481
Deferred income taxes 681 671
Accounts payable, accrued liabilities and other 133 137
Minority interests 11 11
--------- -------------
Total liabilities 1,267 1,300
--------- -------------
Net investment in assets held for sale $ 416 $ 409
========= =============
Building sales and operating revenues of the capital assets segment were $21
and $78 for the three- and six-month periods ended June 30, 1997,
respectively, and $21 and $51 for the three- and six-month periods ended June
30, 1996, respectively.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
H. Net Investment in Assets Held for Sale (continued)
Revenues of U S WEST Financial Services, Inc., a member of the capital assets
segment, were $6 and $11 for the three- and six-month periods ended June 30,
1997, respectively, and $7 and $14 for the three- and six-month periods ended
June 30, 1996, respectively. Selected financial data for U S WEST Financial
Services follows:
June 30, December 31,
1997 1996
--------- -------------
Net finance receivables $ 861 $ 859
Total assets 1,066 1,058
Total debt 246 236
Total liabilities 996 998
Equity 70 60
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
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) greater
than anticipated competition from new entrants into the local exchange,
intraLATA toll, cable, telephony, wireless and directories 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 at the Communications Group as a
result of unusually rapid, in-region growth, (iv) the gain or loss of
significant customers, (v) pending regulatory actions in state jurisdictions,
(vi) regulatory changes affecting the cable and telecommunications industries,
including changes that could have an impact on the competitive environment in
the local exchange market, (vii) a change in economic conditions in the
various markets served by the Company's operations that could adversely affect
the level of demand for cable, wireless, directories or other services offered
by the Company, (viii) greater than anticipated competitive activity requiring
new pricing for services, (ix) higher than anticipated start-up costs
associated with new business opportunities, (x) increases in fraudulent
activity with respect to wireless services, or (xi) delays in the development
of anticipated technologies, or the failure of such technologies to perform
according to expectations.
RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED JUNE 30, 1997 COMPARED WITH
1996
NET INCOME (LOSS)
Three Three Increase Increase Six Six Increase Increase
Months Months (Decrease) (Decrease) Months Months (Decrease) (Decrease)
Ended Ended Ended Ended
June 30, June 30, Dollars Percent June 30, June 30, Dollars Percent
1997 1996 1997 1996
---------- ----------
Communications Group $ 332 $ 324 $ 8 2.5 $ 671 $ 652 $ 19 2.9
Media Group (94) (11) (83) - (203) (8) (195) -
---------- ---------- ----------- ---------- ---------- ---------- ----------- ----------
Total net income $ 238 $ 313 $ (75) (24.0) $ 468 $ 644 $ (176) (27.3)
========== ========== =========== ========== ========== ========== =========== ==========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions, except per share amounts),
continued
Communications Group Net Income
Three Three Six Six
Months Months Increase Increase Months Months Increase
Ended Ended (Decrease) (Decrease) Ended Ended (Decrease)
Net Income: June 30, June 30, June 30, June 30,
1997 1996 Dollars Percent 1997 1996 Dollars
Reported net income $ 332 $ 324 $ 8 2.5 $ 671 $ 652 $ 19
Adjustments to reported net
income:
Gains on sales of rural
telephone exchanges (18) (30) 12 (40.0) (29) (30) 1
Cumulative effect of change in
accounting principle (1)<F1> - - - - - (34) 34
Current year effect of change
in accounting - (5) 5 - - (10) 10
---------- ---------- ----------- ---------- ---------- ---------- -----------
principle (1)<F1>
Normalized income $ 314 $ 289 $ 25 8.7 $ 642 $ 578 $ 64
========== ========== =========== ========== ========== ========== ===========
Increase
(Decrease)
Net Income:
Percent
Reported net income 2.9
Adjustments to reported net
income:
Gains on sales of rural
telephone exchanges (3.3)
Cumulative effect of change in
accounting principle (1)<F1> -
Current year effect of change
in accounting -
----------
principle (1)<F1>
Normalized income 11.1
==========
Three Three Six Six
Months Months Months Months
Ended Ended Increase Increase Ended Ended Increase
June 30, June 30, (Decrease) (Decrease) June 30, June 30, (Decrease)
Earnings per Share: 1997 1996 Dollars Percent 1997 1996 Dollars
Reported earnings per share $ 0.69 $ 0.68 $ 0.01 1.5 $ 1.39 $ 1.37 $ 0.02
Adjustments to reported
earnings per share:
Gains on sales of rural
telephone exchanges (0.04) (0.06) 0.02 (33.3) (0.06) (0.06) -
Cumulative effect of change in
accounting principle (1)<F1> - - - - - (0.07) 0.07
Current year effect of change
in accounting - (0.01) 0.01 - - (0.02) 0.02
---------- ---------- ----------- ---------- ---------- ---------- -----------
principle (1)<F1>
Normalized earnings per share $ 0.65 $ 0.61 $ 0.04 6.6 $ 1.33 $ 1.22 $ 0.11
========== ========== =========== ========== ========== ========== ===========
Increase
(Decrease)
Earnings per Share: Percent
Reported earnings per share 1.5
Adjustments to reported
earnings per share:
Gains on sales of rural
telephone exchanges -
Cumulative effect of change in
accounting principle (1)<F1> -
Current year effect of change
in accounting -
----------
principle (1)<F1>
Normalized earnings per share 9.0
==========
<FN>
<F1>
(1) Effective January 1, 1996, U S WEST 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>
The Communications Group's normalized income increased $25, or 8.7 percent, to
$314, and $64, or 11.1 percent to $642, for the three- and six-month periods
ended June 30, 1997, respectively. Normalized earnings per share were $0.65
per Communications share, an increase of $0.04, or 6.6 percent, and $1.33 per
Communications share, an increase of $0.11, or 9.0 percent for the three- and
six-month periods, respectively.
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 U S WEST
Communications' estimated state regulatory liabilities. (See "Contingencies")
The Communications Group anticipates net income growth will continue
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions, except per share amounts),
continued
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, U S WEST adopted SFAS No. 121 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), or $0.07 per Communications share, related to
the cumulative effect of change in accounting principle.
Media Group Net Loss
Media Group net loss increased to $94, or $0.17 per Media share, for the
three-month period, and to $203, or $0.38 per Media share, for the six-month
period. Excluding the after tax effects of the gains on sales of investments
totaling $25 ($0.04 per Media share) during the second quarter of 1997, and
$31 ($0.05 per Media share) during the first quarter of 1997, Media Group net
loss increased $108 and $251, for the three- and six-month periods ended June
30, 1997, respectively. The Continental Merger contributed approximately $73
of the loss during the three-month period ended June 30, 1997 and $183 of the
loss during the six-month period ended June 30, 1997. The merger resulted in
significant increases in interest and depreciation and amortization charges.
The remaining increase in net loss is due to greater losses from
unconsolidated ventures, partially offset by an increase in earnings from
domestic cellular and directories operations.
SALES AND OTHER REVENUES
Three Three Proforma Proforma
Months Months Increase Increase Increase Increase
Ended Ended (Decrease) (Decrease) Proforma (Decreases) (Decreases)
June 30, June 30,
1997 1996 Dollars Percent 1996 Dollars Percent
Communications Group $ 2,543 $ 2,500 $ 43 1.7 $ 2,500 $ 43 1.7
Media Group 1,277 658 619 94.1 1,132 145 12.8
Intergroup eliminations (33) (34) 1 (2.9) (34) 1 (2.9)
---------- ---------- ----------- ---------- ---------- ------------ -----------
Total $ 3,787 $ 3,124 $ 663 21.2 $ 3,598 $ 189 5.2
========== ========== =========== ========== ========== ============ ===========
Six Six Proforma Proforma
Months Months Increase Increase Increase Increase
Ended Ended (Decrease) (Decrease) Proforma (Decreases) (Decreases)
June 30, June 30,
1997 1996 Dollars Percent 1996 Dollars Percent
Communications Group $ 5,130 $ 4,965 $ 165 3.3 $ 4,965 $ 165 3.3
Media Group 2,484 1,271 1,213 95.4 2,207 277 12.6
Intergroup eliminations (61) (62) 1 (1.6) (62) 1 (1.6)
---------- ---------- ----------- ---------- ---------- ------------ -----------
Total $ 7,553 $ 6,174 $ 1,379 22.3 $ 7,110 $ 443 6.2
========== ========== =========== ========== ========== ============ ===========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Communications Group Sales and Other Revenues
Lower Increase Increase
Price (Higher) (Decrease) (Decrease)
1997 1996 Demand Changes Refunds Other Dollars Percent
Local service
Second quarter $1,151 $1,179 $ 97 $ (4) $ 8 $ (129) $ (28) (2.4)
Six months 2,382 2,324 198 (14) 17 (143) 58 2.5
Interstate access
Second quarter 678 626 74 (5) (7) (10) 52 8.3
Six months 1,365 1,248 138 (10) 3 (14) 117 9.4
Intrastate access
Second quarter 200 189 16 3 - (8) 11 5.8
Six months 400 379 25 5 - (9) 21 5.5
Long-distance
network
Second quarter 240 278 (25) (4) - (9) (38) (13.7)
Six months 490 568 (47) (5) - (26) (78) (13.7)
Other services
Second quarter 274 228 - - - 46 46 20.2
Six months 493 446 - - - 47 47 10.5
Total revenues
Second quarter 2,543 2,500 162 (10) 1 (110) 43 1.7
Six months $5,130 $4,965 $ 314 $ (24) $ 20 $ (145) $ 165 3.3
====== ====== ======== ========= ========= ======= =========== ==========
Local Services Revenues. Local service revenues decreased $28, or 2.4
percent, during the three-month period ended June 30, 1997. The decrease is
largely the result of an $84 accrual to recognize U S WEST Communications'
estimated state regulatory liabilities. (See "Contingencies") Also
contributing to the decrease 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
$11.
Partially offsetting these decreases were 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 Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Local service revenues increased $58, or 2.5 percent, during the six-month
period primarily as a result of access line growth and increased demand for
new product and service offerings, and existing central office features.
Partially offsetting the increase is a $91 accrual to recognize U S WEST
Communications' estimated state regulatory liabilities. Lower wireless
interconnection access prices and the reclassification of public telephone
revenues, both mandated by the Telecommunications Act, further reduced local
service revenues for the six-month period by $27 and $30, respectively.
Excluding the non-recurring effects of the regulatory accrual and the public
telephone revenues reclassification, local service revenues increased 6.4
percent and 6.8 percent, during the three- and six-month periods ended June
30, 1997, respectively. (See "Contingencies")
Interstate Access Revenues. Higher interstate access revenues resulted from
increased demand for private line services and access line growth. Also
contributing were increases of 6.1 and 6.3 percent in billed interstate access
minutes of use for the three- and six-month periods, respectively. The
increases were partially offset by the effects of price reductions and
accruals of $14 and $22 for refunds to interexchange carriers, during the
three- and six-month periods, respectively. The refunds relate to a one-time
$22 exogenous cost adjustment ordered by the FCC as a condition of granting U
S WEST Communications' 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
in the six-month period.
The Communications Group 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 increases of 12.5 and 10.5 percent in billed intrastate minutes of
use for the three- and six-month periods, respectively, and increased demand
for private line services.
Long-distance Network Service Revenues. Long-distance network service
revenues decreased 13.7 percent for the three- and six-month periods 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 the three- and six-month
periods ended June 30, 1997, the MTCPs reduced long-distance revenues by $12
and $29, which was offset by increased intrastate access revenues of $1 and
$3, and decreased other operating expenses (i.e., access expense) of $9 and
$23, respectively.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Excluding the effects of the MTCPs, long-distance network service revenues
decreased by 9.4 and 8.6 percent for the three- and six-month periods,
respectively. 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 Communications Group's 14
state region. The Communications Group is responding to competitive losses
through competitive pricing of intraLATA long-distance services and increased
promotional efforts to retain customers.
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 were almost entirely offset by a reduction in contract revenues due
to the completion of a large federal government telephony project in 1996.
Future revenues at U S WEST Communications may be affected by pending
regulatory actions in federal and local regulatory jurisdictions.
Media Group Sales and Other Revenues
Pro forma
Percent Pro forma Percent
Three Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $ 585 $ 59 - $ 533 9.8
International 4 - - - -
------ ----- -------- ---------- ----------
589 59 - 533 10.5
Wireless communications:
Domestic:
Cellular service 327 267 22.5 267 22.5
Cellular equipment 36 23 56.5 23 56.5
------ ----- -------- ---------- ----------
363 290 25.2 290 25.2
Directory and information services:
Domestic 296 279 6.1 279 6.1
International 23 25 (8.0) 25 (8.0)
------ ----- -------- ---------- ----------
319 304 4.9 304 4.9
Other 6 5 20.0 5 20.0
------ ----- -------- ---------- ----------
Sales and other revenues $1,277 $ 658 94.1 $ 1,132 12.8
====== ===== ======== ========== ==========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Media Group Sales and Other Revenues (continued)
Pro forma
Percent Pro forma Percent
Six Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $1,137 $ 116 - $ 1,052 8.1
International 8 - - - -
------ ------ ------- ---------- ---------
1,145 116 - 1,052 8.8
Wireless communications:
Domestic:
Cellular service 630 506 24.5 506 24.5
Cellular equipment 68 48 41.7 48 41.7
------ ------ ------- ---------- ---------
698 554 26.0 554 26.0
Directory and information services:
Domestic 583 550 6.0 550 6.0
International 45 42 7.1 42 7.1
------ ------ ------- ---------- ---------
628 592 6.1 592 6.1
Other 13 9 44.4 9 44.4
------ ------ ------- ---------- ---------
Sales and other revenues $2,484 $1,271 95.4 $ 2,207 12.6
====== ====== ======= ========== =========
Media Group sales and other revenues increased 94.1 percent, to $1,277, and
95.4 percent, to $2,484, for the three- and six-month periods, respectively.
On a pro forma basis, which gives effect to the Continental Merger as though
it had occurred as of January 1, 1996, Media Group sales and other revenues
increased 12.8 percent and 12.6 percent, respectively. The increases were
primarily a result of growth in cellular service revenue and domestic cable
and telecommunications revenue.
Cable and Telecommunications. On a pro forma basis, domestic cable and
telecommunications revenue increased 9.8 percent, to $585, and 8.1 percent, to
$1,137, for the three- and six-month periods, respectively. The increases
resulted primarily from price increases of approximately 6 to 8 percent, the
addition of new channels and basic subscriber increases of 1.8 percent, on a
same property basis. Increases in pay-per-view and direct broadcast satellite
("DBS") service revenues also contributed to the increase in revenue. DBS
service revenues increased primarily as a result of a 53.4 percent increase in
DBS customers in 1997 compared with 1996.
Wireless Communications. Cellular service revenues increased 22.5 percent, to
$327, and 24.5 percent, to $630, for the three- and six-month periods,
respectively. These increases are a result of a 33 percent increase in
subscribers during the last twelve months, partially offset by an 8.8 percent
drop in average revenue per subscriber to $48.00 per month. The increase in
subscribers relates to continued growth in demand for wireless services.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Cellular equipment revenues increased 56.5 percent, to $36, and 41.7 percent,
to $68, for the three- and six-month periods, respectively. These increases
are primarily a result of an increase in unit sales associated with a 68
percent increase in gross customer additions in the first six months of 1997,
partially offset by a decrease in selling price per unit.
In May 1997, Media Group and AirTouch entered into a definitive agreement to
merge Media Group's domestic cellular business and its interest in PrimeCo
into AirTouch. Completing the AirTouch Merger, on a tax-free basis depended
among other things, upon the final status of the "Morris Trust" provision of
the recent tax legislation. Since the enacted legislation eliminated the
"Morris Trust" provision and did not provide transitional relief for the
AirTouch Merger, the Company will continue with the original AirTouch Joint
Venture transaction. See Note B - AirTouch Transaction - to the Consolidated
Financial Statements.
Directory and Information Services. Revenues related to Yellow Pages
directory advertising represent 98 percent of domestic directory and
information services. Yellow Pages directory advertising revenues increased
6.6 percent, to $291, and 6.9 percent, to $575, during the three- and
six-month periods ended June 30, 1997, respectively. The increases are
largely a result of a 7.4 percent increase in revenue per local advertiser
primarily resulting from price increases of 4.6 percent and an increase in
volume and complexity of advertisements sold. These increases are offset by
decreased revenue associated with exited product lines which were nonstrategic
to the directories business.
On June 4, 1997, Media Group sold Thomson Directories, its directory operation
in the United Kingdom, for $121. Also, in July 1997, Media Group entered into
an agreement to sell U S WEST Polska, its directory operation in Poland. The
sale is awaiting approval from Poland's Office of Competition and Consumer
Protection. These transactions will result in the disposition of Media
Group's wholly owned international directory operations.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
OPERATING INCOME
Three Three
Months Months Proforma Proforma
Ended Ended Increase Increase ProForma Increase Increase
June 30, June 30,
1997 1996 Dollars Percent 1996 Dollars Percent
Communications Group $ 620 $ 574 $ 46 8.0 $ 574 $ 46 8.0
Media Group 187 144 43 29.9 135 52 38.5
--------- --------- --------- -------- --------- --------- --------
Total operating income $ 807 $ 718 $ 89 12.4 $ 709 $ 98 13.8
========= ========= ========= ======== ========= ========= ========
Six Six
Months Months Proforma Proforma
Ended Ended Increase Increase ProForma Increase Increase
1997 1996 Dollars Percent 1996 Dollars Percent
Communications Group $ 1,264 $ 1,170 $ 94 8.0 $ 1,170 $ 94 8.0
Media Group 365 273 92 33.7 247 118 47.8
------- ------- --------- -------- --------- --------- --------
Total operating income $ 1,629 $ 1,443 $ 186 12.9 $ 1,417 $ 212 15.0
======= ======= ========= ======== ========= ========= ========
Communications Group Operating Income
The Communications Group's operating income increased 8.0 percent, to $620 and
$1,264, during the three and six-month periods, respectively. The increase in
operating income is primarily due to revenue increases as a result of higher
demand for services, and continued cost control efforts which accelerated in
the latter half of 1996. Partially offsetting the increase was an accrual to
recognize U S WEST Communications' estimated state regulatory liabilities (See
"Contingencies"). For a further discussion of Communications Group's costs
and expenses, see Management's Discussion and Analysis of Financial Condition
and Results of Operations - "Cost and Expenses."
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Media Group Operating Income (Loss)
Pro forma
Percent Pro forma Percent
Three Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $ - $ 4 - $ (5) -
International (3) - - - -
------ ------ -------- ----------- ----------
(3) 4 - (5) (40.0)
Wireless communications:
Domestic 100 59 69.5 59 69.5
International (6) - - - -
------ ------ -------- ----------- ----------
94 59 59.3 59 59.3
Directory and information services:
Domestic 132 115 14.8 115 14.8
International (2) (3) (33.3) (3) (33.3)
------ ------ -------- ----------- ----------
130 112 16.1 112 16.1
Other (see Note 1) (34) (31) 9.7 (31) 9.7
------ ------ -------- ----------- ----------
Operating income $ 187 $ 144 29.9 $ 135 38.5
====== ====== ======== =========== ==========
Pro forma
Percent Pro forma Percent
Six Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $ (19) $ 8 - $ (18) 5.6
International (7) - - - -
------ ------ -------- ----------- ----------
(26) 8 - (18) 44.4
Wireless communications:
Domestic 195 109 78.9 109 78.9
International (9) - - - -
------ ------ -------- ----------- ----------
186 109 70.6 109 70.6
Directory and information services:
Domestic 262 225 16.4 225 16.4
International (9) (11) (18.2) (11) (18.2)
------ ------ -------- ----------- ----------
253 214 18.2 214 18.2
Other (see Note 1) (48) (58) (17.2) (58) (17.2)
------ ------ -------- ----------- ----------
Operating income $ 365 $ 273 33.7 $ 247 47.8
Note 1 - Primarily includes headquarters expenses for shared services and
divisional expenses associated with equity investments.
Media Group's operating income increased $43, or 29.9 percent, to $187, and
$92, or 33.7 percent, to $365, during the three- and six-month periods,
respectively. On a pro forma basis, operating income increased 38.5 and 47.8
percent, respectively. The increases were primarily due to strong growth in
domestic wireless communications operations.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Cable and Telecommunications. On a pro forma basis, cable and
telecommunications operating loss decreased $2, to $3, for the three-month
period. Revenue increases were partially offset by higher programming fees
associated with rate increases, subscriber growth and special events, and
costs associated with changing the domestic cable brand name to "MediaOne".
Media Group expects to incur additional costs related to the brand name change
during the remainder of 1997, as well as for the deployment of new products
and services. The remaining decline is attributed to the third-quarter 1996
consolidation of the Media Group's cable operation in the Czech Republic
("Kabel Plus").
For the six-month period, on a pro forma basis, cable and telecommunications
operating loss increased $8 to $26. The slight increase in domestic cable and
telecommunications operating loss was a result of revenue increases being more
than offset by the expense increases mentioned above. The remainder of the
decline is due to the third-quarter 1996 consolidation of Kabel Plus.
On August 6, 1997, Media Group announced it will relocate the corporate
offices of its domestic cable operations, MediaOne, Inc., from Boston to
Denver. Approximately 150 employees will be asked to relocate to Denver. The
move is designed to improve operations through better alignment and focus, and
will occur in phases between September 1997 and June 1998. In addition,
several changes in the senior management of MediaOne were announced. The
Media Group anticipates incurring a pretax charge of approximately $30 in
third-quarter 1997 for costs related to the move and management changes.
Wireless Communications. Domestic wireless communications operating income
increased 69.5 percent, to $100, and 78.9 percent, to $195, for the three- and
six-month periods, respectively. These increases are a result of revenue
increases associated with the rapidly expanding subscriber base combined with
efficiency gains. On a per subscriber basis, the 1997 decline in revenue of
8.8 percent has been more than offset by the 21.9 percent decrease in the
costs to acquire and support customers. Increased depreciation expense,
largely a result of network upgrades, partially offset the increase in
operating income.
Directory and Information Services During the three- and six-month periods,
operating income related to domestic Yellow Pages directory advertising
increased 5.3 percent, to $140, and 5.7 percent, to $277, respectively.
Revenue increases and cost savings associated with headcount reductions were
partially offset by increased printing, paper and sales support costs. These
cost increases were primarily associated with an increase in the volume and
complexity of advertisements sold. Operating losses associated with ongoing
product development activities, which include development costs for internet
content services, are included in domestic directory and information services
operating income. Such operating losses decreased by $10 and $22, during the
three- and six-month periods, respectively, primarily as a result of
discontinuing various product development activities in 1996.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Other. During the three-month period, other operating loss increased $3, to
$34, primarily due to a shift in the timing of billing U S WEST corporate
costs to the Media Group. The increased costs were partially offset by staff
reductions at international headquarters. During the six-month period, other
operating losses decreased $10, to $48, primarily attributable to cost savings
related to international staff reductions.
INTEREST EXPENSE AND OTHER
Three Three Six Six
Month Months Months Months
Ended Ended Increase Increase Ended Ended Increase Increase
June 30, June 30, (Decrease) (Decrease) June 30, June 30, (Decrease) (Decrease)
1997 1996 Dollars Percent 1997 1996 Dollars Percent
Interest expense $ 266 $ 136 $ 130 95.6 $ 544 $ 271 $ 273 -
Equity losses in
unconsolidated ventures 153 77 76 98.7 318 143 175 -
Gains on sales of investments 44 - 44 - 95 - 95 -
Gains on sales of rural
telephone exchanges 29 49 (20) (40.8) 47 49 (2) (4.1)
Guaranteed minority interest
expense 22 12 10 83.3 44 24 20 83.3
Other expense 24 23 1 4.3 50 46 4 8.7
Interest expense increased $130 and $273 during the three- and six-month
periods, respectively, primarily as a result of the Continental Merger. U S
WEST assumed Continental debt totaling $6,525 (at market value) and incurred
debt of $1,150 to finance the cash portion of the Merger consideration.
Equity losses increased $76 and $175 for the three- and six-month periods,
respectively, due to greater losses from international ventures and from the
domestic investment in PrimeCo. The increase in international losses relates
to: (1) expansion of the network and financing activities at Telewest
Communications, plc ("Telewest"), (2) costs associated with the significant
increase in customers and network coverage at One 2 One, and (3) the
amortization of license fees related to the wireless investment in India.
Domestically, PrimeCo launched service in November 1996, and losses associated
with this venture have increased as a result of start-up and other costs.
Media Group expects equity losses will continue to be significant as venture
expansion activities continue.
During the second quarter of 1997, Media Group sold its shares of Time Warner,
Inc. acquired in the Continental Merger, for proceeds of $220 and a pretax
gain of $44. In addition, during the first quarter of 1997, Media Group sold
its 5 percent interest in a wireless venture in France for proceeds of $82,
and a pretax gain of $51.
During the six-month period ended June 30, 1997, the Communications Group 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. Certain Iowa, South
Dakota and Idaho rural telephone exchanges were sold
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
during second-quarter 1997 for a pretax gain of $29 and an after tax gain of
$18. The 1996 gains were a result of sales in North and South Dakota.
Guaranteed minority interest expense increased $10 and $20 for the three- and
six-month periods, respectively. The increases were a result of the October
1996 issuance of Company-obligated mandatorily redeemable preferred securities
of subsidiary trust holding solely Company-guaranteed debentures ("Preferred
Securities") totaling $480.
The slight increases in other expense are primarily due to foreign currency
losses and additional interest expense associated with the Communication
Group's interstate sharing liabilities and state regulatory liabilities.
These increases were largely offset by a 1996 pretax charge of $31 associated
with the sale of Media Group's cable television interests in Norway, Sweden
and Hungary.
Income Tax Provision
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, Percent June 30, June 30, Percent
1997 1996 Change 1997 1996 Change
Provision for income taxes $ 180 $ 206 (12.6) $ 350 $ 398 (12.1)
Effective tax rate - - - 42.9 39.5 -
The increase in the effective tax rate is primarily a result of lower pretax
earnings and additional goodwill amortization associated with the Continental
Merger.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Six Months Ended Six Months Ended
June 30, June 30,
1997 1996
Communications Group $ 2,002 $ 1,429
Media Group 576 202
----------------- -----------------
Total cash provided by operating activities $ 2,578 $ 1,631
================= =================
Cash provided by operating activities increased $947 in the first half of
1997, compared with 1996, primarily due to growth in Communications Group
operations. The increase in Communications Group's operating cash flow
reflects continued cost control efforts, lower tax payments and restructuring
expenditures, and a decrease in the cash funding of postretirement benefits
10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
during 1997. Operating cash flow at the Media Group increased primarily due
to the Continental Merger and growth in operations from the domestic cellular
business. Partially offsetting the increase was higher financing costs
resulting from greater debt levels associated with the Continental Merger.
Investing Activities
Six Months Six Month
Ended Ended
June 30, June 30,
1997 1996
Communications Group $ (809) $ (1,162)
Media Group (1,427) (363)
------------ -----------
Total cash (used for) investing activities $ (2,236) $ (1,525)
============ ===========
Investing activities at the Communications Group consists primarily of capital
expenditures of $841 for the first six months of 1997. The majority of the
1997 expenditures were for access line growth, continued improvement of the
telecommunications network and for interconnection costs related to the
Telecommunications Act. The decline in cash used for investing activities is
primarily due to lower capital expenditures as a result of timing and tighter
control efforts over spending. The Communications Group anticipates capital
expenditures will accelerate during the remainder of 1997 and will include
expenditures for wireless personal communications services, interconnection
requirements related to the Telecommunications Act and interLATA long-distance
service.
Investing activities of the Media Group include capital expenditures of $717
for the first six months of 1997. The majority of expenditures in 1997 were
devoted to upgrading the domestic cable network and expanding the domestic
cellular network. Media Group also invested $44 in international ventures
during 1997, primarily capital contributions to a wireless venture in India.
Other investing activities include an investment in Continental of $1,150
which represents payment of the cash portion of the Merger consideration.
During 1997, Media Group received proceeds totaling $625 related to asset
sales as follows: (a) $220 from the sale of Time Warner, Inc. shares acquired
in the Continental Merger, (b) $178 from the sale of 6,075,000 shares of
Teleport Communications Group stock, (c) $121 from the sale of Thomson
Directories, (d) partial proceeds of $29 from the sale of Media Group's 5
percent interest in a wireless venture in France, (e) $50 from the capital
assets segment, which is held for sale, and (f) $27 from other miscellaneous
sales.
10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
In July 1997, Media Group entered into an agreement to purchase up to the
remaining 50 percent of Fintelco, S.A., ("Fintelco"), a cable and
telecommunications venture with approximately 660,000 cable subscribers
located in Argentina. This additional interest could bring Media Group
ownership in Fintelco up to 100 percent. Closing is contingent upon various
regulatory approvals, which are expected during the third quarter of 1997.
Financing Activities
Six Months Ended Six Months Ended
June 30, June 30,
1997 1996
Communications Group $ (1,184) $ (384)
Media Group 885 213
------------------ ------------------
Total cash (used for) financing activities $ (299) $ (171)
================== ==================
Total debt at June 30, 1997 was $15,578, an increase of $227 compared with
December 31, 1996. The Company incurred additional debt in 1997 to finance
the cash portion of the Continental Merger consideration which totaled $1,150.
In January 1997, the Company issued medium- and long-term debt totaling $4.1
billion, at a weighted average rate of 7.47 percent. The proceeds were used
to refinance debt incurred in conjunction with the Continental Merger.
Increases in debt at the Media Group were partially offset by a decrease in
debt of $713 at the Communications Group. The Communications Group's debt
decrease was partially driven by lower capital expenditures and increased
operating cash flows.
In connection with the recent regulatory rulings (See "Contingencies"), U S
WEST Communication's senior unsecured debt rating is under review by Moody's.
The review may result in a downgrading.
During the second quarter of 1997, U S WEST called a 10 5/8 percent senior
subordinated note, due June 15, 2002. The debt had a recorded value of $110,
including a premium of $10. This extinguishment resulted in a pretax gain of
$5, ($3 after tax).
On June 30, 1997, Media Group acquired cable systems serving 40,000
subscribers in the state of Michigan for cash of $25 and approximately $50 of
Preferred Stock issued by U S WEST. The Preferred Stock is redeemable at U S
WEST's option starting five years from the acquisition date, or upon
dissolution of Media Group. The stockholders have the right to elect cash
upon redemption, or to convert their Preferred Stock into Media Group common
stock. (See Note E - Series E Preferred Stock Subject to Mandatory Redemption
- - to the Consolidated Financial Statements.)
10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
On July 30, 1997, U S WEST announced that it will call its Liquid Yield Option
Notes effective August 29, 1997. At June 30, 1997, the notes had a carrying
value of $565.
Excluding debt associated with the capital assets segment, the Company's
percentage of debt to total capital at June 30, 1997 was 55.0 percent compared
with 54.8 percent at December 31, 1996. Including debt associated with the
capital assets segment, Preferred Securities and mandatorily redeemable
preferred stock, the Company's percentage of debt to total capital was 59.8
percent at June 30, 1997, compared with 59.5 percent at December 31, 1996.
The percentage of debt to total capital has increased as a result of higher
debt associated with the Continental Merger.
U S WEST from time to time engages in preliminary discussions regarding
restructurings, dispositions and other similar transactions. Any such
transaction may include, among other things, the transfer of certain assets,
businesses or interests, or the incurrence or assumption of indebtedness, and
could be material to the financial condition and results of operations of U S
WEST. There is no assurance that any such discussions will result in the
consummation of any such transaction.
CONTINGENCIES
For a discussion of contingencies at the Communications Group, see
Management's Discussion and Analysis of Financial Condition and Results of
Operations - "Contingencies."
REGULATORY ENVIRONMENT
For a discussion of Communications Group's regulatory environment, see
Management's Discussion and Analysis of Financial Condition and Results of
Operations - "Regulatory Environment."
Form 10-Q - Part I
COMBINED STATEMENTS OF U S WEST COMMUNICATIONS
GROUP
OPERATIONS (Unaudited)
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
Dollars in millions (except per share amounts) 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 274 228 493 446
---------- --------- ---------- ----------
Total operating revenues 2,543 2,500 5,130 4,965
Operating expenses:
Employee-related expenses 904 921 1,768 1,788
Other operating expenses 391 387 836 775
Taxes other than income taxes 98 100 205 197
Depreciation and amortization 530 518 1,057 1,035
---------- --------- ---------- ----------
Total operating expenses 1,923 1,926 3,866 3,795
---------- --------- ---------- ----------
Income from operations 620 574 1,264 1,170
Interest expense 100 110 203 221
Gains on sales of rural telephone exchanges 29 49 47 49
Other income (expense) - net (19) 4 (41) (12)
---------- --------- ---------- ----------
Income before income taxes and cumulative
effect of change in accounting principle 530 517 1,067 986
Provision for income taxes 198 193 396 368
---------- --------- ---------- ----------
Income before cumulative effect of change
in accounting principle 332 324 671 618
Cumulative effect of change in accounting
principle - net of tax - - - 34
---------- --------- ---------- ----------
NET INCOME $ 332 $ 324 $ 671 $ 652
========== ========= ========== ==========
EARNINGS PER COMMON SHARE:
Income before cumulative effect of
change in accounting principle $ 0.69 $ 0.68 $ 1.39 $ 1.30
Cumulative effect of change in
accounting principle - - - 0.07
---------- --------- ---------- ----------
EARNINGS PER COMMON SHARE $ 0.69 $ 0.68 $ 1.39 $ 1.37
========== ========= ========== ==========
DIVIDENDS PER COMMON SHARE $ 0.535 $ 0.535 $ 1.07 $ 1.07
========== ========= ========== ==========
AVERAGE COMMON SHARES
OUTSTANDING (thousands) 482,542 476,803 481,945 475,929
========== ========= ========== ==========
See Notes to Combined Financial Statements.
Form 10-Q - Part I
COMBINED BALANCE SHEETS U S WEST COMMUNICATIONS GROUP
(Unaudited)
June 30, December 31,
Dollars in millions 1997 1996
ASSETS
Current assets:
Cash and cash equivalents $ 89 $ 80
Accounts and notes receivable - net 1,605 1,622
Inventories and supplies 182 144
Deferred tax asset 197 171
Prepaid and other 73 65
--------- -------------
Total current assets 2,146 2,082
--------- -------------
Gross property, plant and equipment 32,787 32,645
Less accumulated depreciation 19,082 18,639
--------- -------------
Property, plant and equipment - net 13,705 14,006
Other assets 910 827
--------- -------------
Total assets $ 16,761 $ 16,915
========= =============
See Notes to Combined Financial Statements.
Form 10-Q - Part I
COMBINED BALANCE SHEETS U S WEST COMMUNICATIONS GROUP
(Unaudited), continued
June 30, December 31,
Dollars in millions 1997 1996
LIABILITIES AND EQUITY
Current liabilities:
Short-term debt $ 166 $ 834
Accounts payable 1,029 989
Employee compensation 301 342
Dividends payable 258 257
Advanced billing and customer deposits 278 250
Other 1,091 795
--------- -------------
Total current liabilities 3,123 3,467
--------- -------------
Long-term debt 5,619 5,664
Postretirement and other postemployment
benefit obligations 2,393 2,387
Deferred income taxes 766 749
Deferred credits and other 710 731
Contingencies (See Note D to the Combined
Financial Statements)
Communications Group equity 4,150 3,917
--------- -------------
Total liabilities and equity $ 16,761 $ 16,915
========= =============
See Notes to Combined Financial Statements.
Form 10-Q - Part I
COMBINED STATEMENTS OF U S WEST COMMUNICATIONS GROUP
CASH FLOWS (Unaudited)
Six Months Six Months
Ended Ended
June 30, June 30,
Dollars in millions 1997 1996
OPERATING ACTIVITIES
Net income $ 671 $ 652
Adjustments to net income:
Depreciation and amortization 1,057 1,035
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 (17) (3)
Changes in operating assets and liabilities:
Restructuring payments (45) (74)
Postretirement medical and life costs, net
of cash fundings 3 (30)
Accounts receivable 17 57
Inventories, supplies and other current assets (58) (35)
Accounts payable and accrued liabilities 336 (62)
Other adjustments - net 85 (28)
------------ ------------
Cash provided by operating activities 2,002 1,429
------------ ------------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (841) (1,266)
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 (809) (1,162)
------------ ------------
FINANCING ACTIVITIES
Net (repayments of) proceeds from short-term debt (662) 260
Repayments of long-term debt (85) (253)
Dividends paid on common stock (475) (467)
Proceeds from issuance of common stock 38 76
------------ ------------
Cash (used for) financing activities (1,184) (384)
------------ ------------
CASH AND CASH EQUIVALENTS
Increase (decrease) 9 (117)
Beginning balance 80 172
------------ ------------
Ending balance $ 89 $ 55
============ ============
See Notes to Combined Financial Statements.
Form 10-Q - Part I
U S WEST COMMUNICATIONS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 1997 and 1996
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies
Basis of Presentation. The Combined Financial Statements have been prepared
by U S WEST, Inc. ("U S WEST" or 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 U S WEST's management, the Combined
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 these Combined Financial Statements
be read in conjunction with the 1996 U S WEST Consolidated Financial
Statements, the U S WEST Communications Group Combined Financial Statements
and the U S WEST Media Group Combined Financial Statements and notes thereto
included in U S WEST's proxy statement mailed to all shareowners on April 7,
1997.
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. U S WEST does not use derivative
financial instruments for trading purposes.
New Accounting Standards. In fourth-quarter 1997, U S WEST will adopt
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." This standard specifies new computation, presentation and disclosure
requirements for earnings per share. Among other things, SFAS No. 128
requires presentation of basic and diluted earnings per share on the face of
the income statement. Adoption of the new standard is not expected to have a
material impact on Communications Group's earnings per share.
Form 10-Q - Part I
U S WEST COMMUNICATIONS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies (continued)
In 1998, U S WEST will adopt 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. Dex Transfer
In May 1997, U S WEST announced its intention to transfer its domestic
directory business from the Media Group to the Communications Group (the "Dex
Transfer"). Under the terms of the Dex Transfer, $3.9 billion of U S WEST debt
will be reallocated from the Media Group to the Communications Group and the
Communications Group will issue shares of Communications Group common stock to
Media Group shareowners totaling $850. Contingent upon receiving favorable
federal income tax treatment, the Company intends to pursue the Dex Transfer.
C. Rural Telephone Exchanges Held for Sale
In conjunction with its rural telephone exchange sales program, U S WEST
Communications, Inc. ("U S WEST Communications") sold certain rural telephone
exchanges for pretax gains of $29 and $47, during the three- and six-month
periods ended June 30, 1997, respectively. 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.
Form 10-Q - Part I
U S WEST COMMUNICATIONS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
D. Contingencies
At U S WEST Communications 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 U S WEST Communications' alternative form
of regulation ("AFOR") plan, and it then undertook a review of U S WEST
Communication's earnings. In May 1997, the OPUC ordered U S WEST
Communications 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 U S WEST Communications' AFOR plan was terminated on May 1, 1996.
U S WEST Communications 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 U S WEST Communications' 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 U S WEST Communications' 1995 rate request. U S WEST
Communications had sought to increase revenues by raising rates primarily for
basic residential services over a four-year period. Instead of granting U S
WEST Communications' request, the WUTC ordered $91.5 in annual net revenue
reductions, effective May 1, 1996.
Based on the WUTC ruling, U S WEST Communications 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. U S WEST
Communications 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. U S WEST Communications is waiting a
decision by the State Supreme Court.
Form 10-Q - Part I
U S WEST COMMUNICATIONS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
D. Contingencies (continued)
Effective May 1, 1996, U S WEST Communications 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 Communications Group 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 Communications Group 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 Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions, except per share amounts)
RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED JUNE 30, 1997 COMPARED WITH
1996
Following are details of the Communications Group's reported net income and
earnings per common share ("earnings per share"), normalized to exclude the
effects of certain nonoperating items.
Three Three Increase Increase Six Six Increase
Months Months (Decrease) (Decrease) Months Months (Decrease)
Ended Ended Ended Ended
June 30, June 30, June 30, June 30
Net Income: 1997 1996 Dollars Percent 1997 1996 Dollars
Reported net income $ 332 $ 324 $ 8 2.5 $ 671 $ 652 $ 19
Adjustments to reported net income:
Gains on sales of rural
telephone exchanges (18) (30) 12 (40.0) (29) (30) 1
Cumulative effect of change in
accounting principle (1)<F1> - - - - - (34) 34
Current year effect of change
in accounting - (5) 5 - - (10) 10
---------- ---------- ----------- ---------- ---------- --------- -----------
principle (1)<F>
Normalized income $ 314 $ 289 $ 25 8.7 $ 642 $ 578 $ 64
========== ========== =========== ========== ========== ========= ===========
Increase
(Decrease)
Net Income: Percent
Reported net income 2.9
Adjustments to reported net income:
Gains on sales of rural
telephone exchanges (3.3)
Cumulative effect of change in
accounting principle (1)<F1> -
Current year effect of change
in accounting -
----------
principle (1)<F>
Normalized income 11.1
==========
Three Three Increase Increase Six Six Increase
Months Months (Decrease) (Decrease) Months Months (Decrease)
Ended Ended Ended Ended
June 30, June 30, June 30, June 30
Earnings per Share: 1997 1996 Dollars Percent 1997 1996 Dollars
Reported earnings per share $ 0.69 $ 0.68 $ 0.01 1.5 $ 1.39 $ 1.37 $ 0.02
Adjustments to reported
earnings per share:
Gains on sales of rural
telephone exchanges (0.04) (0.06) 0.02 (33.3) (0.06) (0.06) -
Cumulative effect of change in
accounting principle (1)<F1> - - - - - (0.07) 0.07
Current year effect of change
in accounting - (0.01) 0.01 - - (0.02) 0.02
---------- ---------- ----------- ---------- ---------- --------- -----------
principle (1)<F1>
Normalized earnings per share $ 0.65 $ 0.61 $ 0.04 6.6 $ 1.33 $ 1.22 $ 0.11
========== ========== =========== ========== ========== ========= ===========
Increase
(Decrease)
Earnings per Share: Percent
Reported earnings per share 1.5
Adjustments to reported
earnings per share:
Gains on sales of rural
telephone exchanges -
Cumulative effect of change in
accounting principle (1)<F1> -
Current year effect of change
in accounting -
----------
principle (1)<F1>
Normalized earnings per share 9.0
==========
<FN>
<F1>
(1) Effective January 1, 1996, U S WEST 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>
The Communications Group's normalized income increased $25, or 8.7 percent, to
$314, and $64, or 11.1 percent to $642, for the three- and six-month periods
ended June 30, 1997, respectively. Normalized earnings per share were $0.65,
an increase of $0.04, or 6.6 percent, and $1.33, an increase of $0.11, or 9.0
percent for the three- and six-month periods, respectively. Earnings before
interest, taxes, depreciation, amortization and other ("EBITDA") increased 5.3
percent, to $1,150, and $2,321 for the three- and six-month periods,
respectively. EBITDA excludes gains on sales of certain rural telephone
exchanges.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions, except per share amounts),
continued
The Communications Group 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 Communications Group'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.
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 U S WEST
Communication's estimated state regulatory liabilities. (See "Contingencies")
The Communications Group 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, U S WEST 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), or $0.07 per
share, related to the cumulative effect of change in accounting principle.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Operating Revenues
An analysis of operating revenues follows:
Lower Increase Increase
Price (Higher) (Decrease) (Decrease)
1997 1996 Demand Changes Refunds Other Dollars Percent
Local service
Second quarter $1,151 $1,179 $ 97 $ (4) $ 8 $ (129) $ (28) (2.4)
Six months 2,382 2,324 198 (14) 17 (143) 58 2.5
Interstate access
Second quarter 678 626 74 (5) (7) (10) 52 8.3
Six months 1,365 1,248 138 (10) 3 (14) 117 9.4
Intrastate access
Second quarter 200 189 16 3 - (8) 11 5.8
Six months 400 379 25 5 - (9) 21 5.5
Long-distance network
Second quarter 240 278 (25) (4) - (9) (38) (13.7)
Six months 490 568 (47) (5) - (26) (78) (13.7)
Other services
Second quarter 274 228 - - - 46 46 20.2
Six months 493 446 - - - 47 47 10.5
------ ------ -------- --------- --------- ------- ----------- ----------
Total revenues
Second quarter 2,543 2,500 162 (10) 1 (110) 43 1.7
Six months $5,130 $4,965 $ 314 $ (24) $ 20 $ (145) $ 165 3.3
====== ====== ======== ========= ========= ======= =========== ==========
Local Services Revenues. Local service revenues decreased $28, or 2.4
percent, during the three-month period ended June 30, 1997. The decrease is
largely the result of an $84 accrual to recognize U S WEST Communications'
estimated state regulatory liabilities. (See "Contingencies") Also
contributing to the decrease 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
$11.
Partially offsetting these decreases was 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 Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Local service revenues increased $58, or 2.5 percent, during the six-month
period primarily as a result of access line growth and increased demand for
new product and service offerings, and existing central office features.
Partially offsetting the increase is a $91 accrual to recognize U S WEST
Communication's estimated state regulatory liabilities. Lower wireless
interconnection access prices and the reclassification of public telephone
revenues, both mandated by the Telecommunications Act, further reduced local
service revenues for the six-month period by $27 and $30, respectively.
Excluding the non-recurring effects of the regulatory accrual and the public
telephone revenues reclassification, local service revenues increased 6.4
percent and 6.8 percent, during the three- and six-month periods ended June
30, 1997, respectively. (See "Contingencies")
Interstate Access Revenues. Higher interstate access revenues resulted from
increased demand for private line services and access line growth. Also
contributing were increases of 6.1 and 6.3 percent in billed interstate
access minutes of use for the three- and six-month periods, respectively. The
increases were partially offset by the effects of price reductions and
accruals of $14 and $22 for refunds to interexchange carriers, during the
three- and six-month periods, respectively. The refunds relate to a one-time
$22 exogenous cost adjustment ordered by the FCC as a condition of granting U
S WEST Communications' 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
in the six-month period.
The Communications Group 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 increases of 12.5 and 10.5 percent in billed intrastate minutes of
use for the three- and six-month periods, respectively, and increased demand
for private line services.
Long-distance Network Service Revenues. Long-distance network service
revenues decreased 13.7 percent for the three- and six-month periods 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 the three- and six-month
periods ended June 30, 1997, the MTCPs reduced long-distance revenues by
$12 and $29, which was offset by increased intrastate access revenues of $1
and $3, and decreased other operating expenses (i.e., access expense) of
$9 and $23, respectively.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Excluding the effects of the MTCPs, long-distance network service revenues
decreased by 9.4 and 8.6 percent for the three- and six-month periods,
respectively. 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 Communications Group's 14
state region. The Communications Group is responding to competitive losses
through competitive pricing of intraLATA long-distance services and increased
promotional efforts to retain customers.
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 were almost entirely offset by a reduction in contract revenues due
to the completion of a large federal government telephony project in 1996.
Future revenues at U S WEST Communications may be affected by pending
regulatory actions in federal and local regulatory jurisdictions.
Costs and Expenses
Three Three Increase Increase Six Six Increase Increase
Months Months (Decrease) (Decrease) Months Months (Decrease) (Decrease)
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
1997 1996 Dollars Percent 1997 1996 Dollars Percent
Employee-related expenses $ 904 $ 921 (17) (1.8) $ 1,768 $ 1,788 (20) (1.1)
Other operating expenses 391 387 4 1.0 836 775 61 7.9
Taxes other than income taxes 98 100 (2) (2.0) 205 197 8 4.1
Depreciation and amortization 530 518 12 2.3 1,057 1,035 22 2.1
Interest expense 100 110 (10) (9.1) 203 221 (18) (8.1)
Gains on sales of rural telephone
exchanges 29 49 (20) (40.8) 47 49 (2) (4.1)
Other income (expense) - net (19) 4 (23) - (41) (12) 29 -
Employee-Related Expenses. Employee-related expenses decreased $17, or 1.8
percent, and $20, or 1.1 percent, for the three- and six-month periods,
respectively. The decreases are 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 4,051 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.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
The increase in contract labor is primarily due to additional costs for system
development work and the launch of new products and services. The contract
labor increase during the six-month period also includes marketing and sales
efforts associated with a first-quarter 1997 promotion of caller
identification.
Other Operating Expenses. The increase in other operating expenses of $4, or
1.0 percent, during the three-month period, was partially attributed to
additional repair costs associated with flooding in North Dakota. Also
contributing to the increase was a reserve adjustment associated with billing
and collection activities performed for interexchange carriers, increased
professional fees and costs related to growth initiatives. The increases were
partially offset by lower materials and supplies as a result of continued cost
control efforts and lower costs due to the completion of a large federal
government telephony project in 1996. Reduced access expense (primarily
related to the implementation of the MTCPs in 1996 and 1997) also decreased
operating expenses.
During the six-month period, other operating expenses increased $61, or 7.9
percent. The increase was predominantly a result of higher advertising costs,
of which approximately $30 is attributable to an 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 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 lower
costs due to the completion of a large federal government telephony project in
1996. Reduced access expense (primarily related to the implementation of the
MTCPs in 1996 and 1997) also decreased operating expenses.
Taxes Other Than Income Taxes. Taxes other than income taxes decreased $2, or
2.0 percent, and increased $8, or 4.1 percent, for the three- and six-month
periods, respectively. Decreased property taxes due to favorable tax
valuations and mill levies, as compared with 1996, were partially offset for
the three-month period, and more than offset for the six-month period, by
increased use and gross receipt taxes.
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 $10, or 9.1 percent, and $18, or
8.1 percent, for the three- and six-month periods, respectively, 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.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Gains on Sales of Rural Telephone Exchanges. During the six-month period
ended June 30, 1997, the Communications Group 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. Certain Iowa, South Dakota and Idaho rural
telephone exchanges were sold during second-quarter 1997 for a pretax gain of
$29 and an after tax gain of $18. The 1996 gains were a result of sales in
North and South Dakota.
Other Income (Expense). Other expense increased primarily due to additional
interest expense associated with the Communications Group's interstate sharing
liabilities and state regulatory liabilities.
Provision for Income Taxes
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, Percent June 30, June 30, Percent
1997 1996 Change 1997 1996 Change
Provision for income taxes $ 198 $ 193 2.6 $ 396 $ 368 7.6
Effective tax rate - - - 37.1 37.3 -
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.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash provided by operations increased $573, to $2,002, in the first half of
1997 compared with 1996. The increase in operating cash flow is primarily due
to business growth and continued cost control efforts. Lower tax payments,
along with a decrease in the cash funding of postretirement benefits and lower
restructuring expenditures, also contributed to the increase.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Investing Activities
Communications Group capital expenditures were $841 during the first six
months of 1997. The majority of the 1997 expenditures were for access line
growth, continued improvement of the telecommunications network and for
interconnection costs related to the Telecommunications Act. The decline of
$425 in capital expenditures as compared with 1996 is primarily due to timing
and tighter control efforts over spending. The Communications Group
anticipates capital expenditures will accelerate during the remainder of 1997
and will include expenditures for wireless personal communications service
("PCS"), interconnection requirements related to the Telecommunications Act
and interLATA long-distance service.
In January 1997, the Company purchased PCS licenses in the FCC's block auction
of D and E spectrum. The licenses were granted to the Company in June 1997.
The purchase price of approximately $57 was paid in July 1997.
Financing Activities
During the first half of 1997, debt decreased $713 and the percentage of debt
to total capital decreased from 62.4 at December 31, 1996, to 58.2 percent, at
June 30, 1997. The decrease in the percentage of debt to total capital is
primarily a result of lower debt levels, partially driven by lower capital
expenditures and increased operating cash flows.
In connection with the recent regulatory rulings (See "Contingencies"), U S
WEST Communication's senior unsecured debt rating is under review by Moody's.
The review may result in a downgrading.
Under the terms of the Dex Transfer, $3.9 billion of U S WEST debt will be
reallocated from the Media Group to the Communications Group and the
Communications Group will issue shares of Communications Group common stock to
Media Group shareowners totaling $850. Contingent upon receiving favorable
federal income tax treatment, the Company intends to pursue the Dex Transfer.
On July 30, 1997, U S WEST announced that it will call its Liquid Yield Option
Notes effective August 29, 1997. At June 30, 1997, the notes had a carrying
value of $300.
Communications Group from time to time engages in preliminary discussions
regarding restructurings, dispositions and other similar transactions. Any
such transaction may include, among other things, the transfer of certain
assets, businesses or interest, or the incurrence or assumption of
indebtedness, and could be material to the financial condition and results of
operations of U S WEST and the Communications Group. There is no assurance
that any such discussions will result in the consummation of any such
transaction.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
CONTINGENCIES
At U S WEST Communications, Inc. 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 U S WEST Communications' alternative form
of regulation ("AFOR") plan, and it then undertook a review of U S WEST
Communication's earnings. In May 1997, the OPUC ordered U S WEST
Communications 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 U S WEST Communications' AFOR plan was terminated on May 1, 1996.
U S WEST Communications 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 U S WEST Communications' 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 U S WEST Communications' 1995 rate request. U S WEST
Communications had sought to increase revenues by raising rates primarily for
basic residential services over a four-year period. Instead of granting U S
WEST Communications' request, the WUTC ordered $91.5 in annual net revenue
reductions, effective May 1, 1996.
Based on the WUTC ruling, U S WEST Communications 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. U S WEST
Communications 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. U S WEST Communications is waiting a
decision by the State Supreme Court.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Effective May 1, 1996, U S WEST Communications 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 Communications Group 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 Communications Group 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.
<page
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
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 U S WEST
Communications 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, the Company 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 Discussion and Analysis of Financial Condition and
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 inrease flat-rate charges (i.e. PICCs and SLCs). The Access Reform Order
generally removes non-traffic sensitive costs from minutes-of-use access
charges. The FCC concluded these non-traffic sensitive costs should be
generally recovered through flat-rate charges against interexchange carriers,
multi-line business users and additional residential lines. 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, U S WEST Communications had elected
the lowest productivity factor, 4.0 percent, in its 1996 annual interstate
tariff filing. As a result, U S WEST Communications remained subject to the
sharing requirements for the first half of 1997. In May 1997, U S WEST
Communications 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 U S
WEST Communications 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 Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
As mandated by the Price Cap Order, the price cap index in U S WEST
Communications' 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 I
COMBINED STATEMENTS OF OPERATIONS U S WEST MEDIA GROUP
(Unaudited)
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June 30, June 30, June 30, June 30,
Dollars in millions (except per share amounts) 1997 1996 1997 1996
Sales and other revenues:
Cable and telecommunications $ 589 $ 59 $ 1,145 $ 116
Wireless communications 363 290 698 554
Directory and information services 319 304 628 592
Other 6 5 13 9
---------- ---------- ---------- ----------
Total sales and other revenues 1,277 658 2,484 1,271
Operating expenses:
Cost of sales and other revenues 430 206 836 405
Selling, general and administrative expenses 360 238 680 456
Depreciation and amortization 300 70 603 137
---------- ---------- ---------- ----------
Total operating expenses 1,090 514 2,119 998
---------- ---------- ---------- ----------
Income from operations 187 144 365 273
Interest expense 166 26 341 50
Equity losses in unconsolidated ventures 153 77 318 143
Gains on sales of investments 44 - 95 -
Guaranteed minority interest expense 22 12 44 24
Other expense - net 5 27 9 34
---------- ---------- ---------- ----------
Income (loss) before income taxes and
extraordinary item (115) 2 (252) 22
Provision (benefit) for income taxes (18) 13 (46) 30
---------- ---------- ---------- ----------
Loss before extraordinary item (97) (11) (206) (8)
Extraordinary item:
Early extinguishment of debt, net of tax 3 - 3 -
---------- ---------- ---------- ----------
NET LOSS $ (94) $ (11) $ (203) $ (8)
========== ========== ========== ==========
Dividends on preferred stock 12 1 25 2
---------- ---------- ---------- ----------
LOSS AVAILABLE FOR
COMMON STOCK $ (106) $ (12) $ (228) $ (10)
========== ========== ========== ==========
LOSS PER COMMON SHARE $ (0.17) $ (0.03) $ (0.38) $ (0.02)
========== ========== ========== ==========
AVERAGE COMMON SHARES
OUTSTANDING (thousands) 606,446 473,593 606,486 473,298
See Notes to Combined Financial Statements.
Form 10-Q - Part I
COMBINED BALANCE SHEETS U S WEST
MEDIA GROUP
(Unaudited)
June 30, December 31,
Dollars in millions 1997 1996
ASSETS
Current assets:
Cash and cash equivalents $ 155 $ 121
Accounts and notes receivable - net 514 508
Deferred directory costs 252 259
Receivable from Communications Group 96 92
Marketable securities - 58
Other 107 101
--------- -------------
Total current assets 1,124 1,139
--------- -------------
Gross property, plant and equipment 5,759 5,111
Accumulated depreciation 1,178 836
--------- -------------
Property, plant and equipment - net 4,581 4,275
Investment in Time Warner Entertainment 2,483 2,477
Net investment in international ventures 1,322 1,548
Intangible assets - net 12,461 12,595
Net investment in assets held for sale 416 409
Other assets 1,340 1,618
--------- -------------
Total assets $ 23,727 $ 24,061
========= =============
See Notes to Combined Financial Statements.
Form 10-Q - Part I
COMBINED BALANCE SHEETS U S WEST
MEDIA GROUP
(Unaudited), Continued
June 30, December 31,
Dollars in millions 1997 1996
LIABILITIES AND EQUITY
Current liabilities:
Short-term debt $ 1,277 $ 217
Due to Continental Cablevision shareowners - 1,150
Accounts payable 320 425
Deferred revenue and customer deposits 127 129
Other 925 795
--------- -------------
Total current liabilities 2,649 2,716
--------- -------------
Long-term debt 8,516 8,636
Deferred income taxes 3,577 3,600
Deferred credits and other 389 346
Company-obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely
Company-guaranteed debentures 1,080 1,080
Preferred stock subject to mandatory redemption 100 51
Media Group equity 7,416 7,632
--------- -------------
Total liabilities and equity $ 23,727 $ 24,061
========= =============
See Notes to Combined Financial Statements.
Form 10-Q - Part I
COMBINED STATEMENTS OF CASH FLOWS U S WEST MEDIA GROUP
(Unaudited)
Dollars in millions
Six Months Ended June 30, 1997 1996
OPERATING ACTIVITIES
Net loss $ (203) $ (8)
Adjustments to net loss:
Depreciation and amortization 603 137
Equity losses in unconsolidated ventures 318 143
Gains on sales of investments (95) -
Deferred income taxes (69) (47)
Provision for uncollectibles 44 30
Changes in operating assets and liabilities:
Accounts and notes receivable (30) (48)
Deferred directory costs and other (34) (10)
Accounts payable and accrued liabilities 51 (11)
Other adjustments - net (9) 16
-------- ------
Cash provided by operating activities 576 202
-------- ------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (717) (243)
Payment to Continental Cablevision shareowners (1,150) -
Investment in international ventures (44) (139)
Proceeds from sale of Time Warner, Inc. shares 220 -
Proceeds from sales of investments 355 -
Cash from net investment in assets held for sale 50 93
Other - net (141) (74)
-------- ------
Cash (used for) investing activities (1,427) (363)
-------- ------
FINANCING ACTIVITIES
Proceeds from (repayments of) short-term debt - net (3,052) 80
Proceeds from issuance of long-term debt 4,110 330
Repayments of long-term debt (108) (223)
Dividends paid on preferred stock (23) (2)
Proceeds from issuance of common stock 11 28
Purchases of treasury stock (53) -
-------- ------
Cash provided by financing activities 885 213
-------- ------
CASH AND CASH EQUIVALENTS
Increase 34 52
Beginning balance 121 20
-------- ------
Ending balance $ 155 $ 72
======== ======
See Notes to Combined Financial Statements.
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 1997 and 1996
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies
Basis of Presentation. The Combined Financial Statements have been prepared
by U S WEST, Inc. ("U S WEST" or 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 U S WEST's management, the Combined
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 these Combined Financial Statements
be read in conjunction with the 1996 U S WEST Consolidated Financial
Statements, the U S WEST Media Group Combined Financial Statements and the U S
WEST Communications Group Combined Financial Statements and notes thereto
included in U S WEST's proxy statement mailed to all shareowners on April 7,
1997.
Certain reclassifications within the Combined Financial Statements have been
made to conform to the current year presentation.
Financial Instruments. Synthetic instrument accounting is used for interest
rate swaps and interest rate caps 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 foreign currency forward and zero-cost
combination contracts which qualify for and are designated as hedges of firm
equity investment commitments and for options and 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 foreign exchange
or interest rates. Qualified contracts are carried at market value with gains
and losses recorded in equity until sale of the investment or are associated
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.
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies (continued)
Market value accounting is used for derivative contracts which do not qualify
for synthetic instrument or hedge accounting. Market value accounting is also
used for foreign exchange contracts designated as hedges of foreign
denominated receivables and payables. These contracts are carried at market
value in other assets or liabilities with gains and losses recorded as other
income (expense). U S WEST does not use derivative financial instruments for
trading purposes.
New Accounting Standards. In fourth-quarter 1997, U S WEST will adopt
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." This standard specifies new computation, presentation and disclosure
requirements for earnings per share. Among other things, SFAS No. 128
requires presentation of basic and diluted earnings per share on the face of
the income statement. Adoption of the new standard is not expected to have a
material impact on Media Group earnings per share.
In 1998, U S WEST will adopt 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. AirTouch Transaction
During 1994, U S WEST entered into a definitive agreement with AirTouch
Communications, Inc. ("AirTouch") to combine their domestic cellular
properties into a partnership in a multi-phased transaction (the "AirTouch
Joint Venture"). During Phase I, which commenced on November 1, 1995, the
cellular properties are owned separately. A wireless management company has
been formed and is providing services to both companies, as requested, on a
contract basis.
In February 1997, the King County Superior Court in Washington state ruled
that a subsidiary of Media Group violated the terms of its partnership
agreement with its minority partners in the Seattle cellular partnership by
entering into the AirTouch Joint Venture. The Company currently is complying
with the Court's order which requires the Company to issue a right of first
refusal to the minority partners with respect to the subsidiary's limited
partnership interest. The Court has also authorized the limited partners to
take legally appropriate steps by August 15, 1997, to secure
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
B. AirTouch Transaction (continued)
unanimous agreement for a substitute for the Company as the general partner.
The Company retains its right to appeal unfavorable rulings before
transferring any partnership interest in the Seattle cellular partnership.
Similar litigation has been filed in other jurisdictions regarding other
cellular partnerships by the same minority partner that brought the Seattle
litigation. The Company is also seeking declaratory relief from the Delaware
Chancery Court. The Company believes it will ultimately be successful in all
litigation asserting that the Company's entering into the AirTouch Joint
Venture violated its partnership agreements with its minority partners.
In May 1997, Media Group and AirTouch entered into a definitive agreement to
merge Media Group's domestic cellular business and its interest in PrimeCo
Personal Communications ("PrimeCo") into AirTouch (the "AirTouch Merger").
Completing the AirTouch Merger, on a tax-free basis depended among other
things, upon the final status of the "Morris Trust" provision of the recent
tax legislation. Since the enacted legislation eliminated the "Morris Trust"
provision and did not provide transitional relief for the AirTouch Merger, the
Company will continue with the original AirTouch Joint Venture transaction.
Media Group and AirTouch have agreed not to proceed to Phase II of the
AirTouch Joint Venture before May 5, 1998. In Phase II of the AirTouch Joint
Venture, the partners will combine those domestic properties for which
authorizations and partnership approvals have been obtained. Media Group has
the right under Phase III of the AirTouch Joint Venture agreement to convert
its joint venture interest into AirTouch stock.
C. Dex Transfer
In May 1997, U S WEST announced its intention to transfer its domestic
directory business from the Media Group to the Communications Group (the "Dex
Transfer"). Under the terms of the Dex Transfer, $3.9 billion of U S WEST
debt will be reallocated from the Media Group to the Communications Group and
the Communications Group will issue shares of Communications Group common
stock to Media Group shareowners totaling $850. Contingent upon receiving
favorable federal income tax treatment, the Company intends to pursue the Dex
Transfer.
D. Asset Sales and Restructurings
Marketable Securities and Investments. During the second quarter of 1997,
Media Group sold an additional 2 million shares of Teleport Communications
Group, Inc. ("TCG") for proceeds of $58, bringing the total number of TCG
shares sold in 1997 to 6,075,000 for total proceeds of $178. In connection
with the November 15, 1996 merger of Continental Cablevision, Inc. into a
wholly owned subsidiary of U S WEST (the "Continental Merger"), Media Group
is required by a consent decree with the United States Department of Justice
to dispose of its interest in TCG by
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
D. Asset Sales and Restructurings (continued)
December 31, 1998. The share sales have reduced Media Group's interest in TCG
from 11 percent at December 31, 1996, to approximately 7 percent at June 30,
1997. Also during the second quarter of 1997, Media Group sold its shares of
Time Warner, Inc., acquired in the Continental Merger, for proceeds of $220
and a pretax gain of $44.
During the first quarter of 1997, Media Group reached a settlement to transfer
its investment in Optus Vision, an Australian cable and telecommunications
venture acquired in the Continental Merger, to Optus Communications Pty Ltd,
an Australian telecommunications carrier. Upon satisfaction of various
pre-conditions, Media Group will receive convertible notes which can be
converted to shares of Optus Communications upon public offering of its
shares. The settlement released the Company from litigation and future
claims.
Each of the partners of PRIMESTAR Partners L.P., including Media Group, have
entered into an agreement whereby each Partner's direct broadcast satellite
customers and certain assets will be contributed to a newly formed company,
PRIMESTAR, Inc. In exchange, each Partner, including Media Group, will
receive a combination of cash and stock in PRIMESTAR, Inc. The transaction is
subject to various approvals and is expected to close in early 1998. In a
related transaction, an agreement has been entered into whereby the satellite
assets controlled by News Corp. and its partner MCI Communications Corporation
will be purchased by PRIMESTAR, Inc. in exchange for nonvoting convertible
securities. The transaction is subject to regulatory and other approvals.
Cable Systems. As a result of the Continental Merger, Media Group must
dispose of its wholly owned cable systems located within the telephone service
areas of U S WEST Communications, Inc. Media Group has reached definitive
agreements to sell its cable systems in Minnesota and Idaho. The Minnesota
systems are being sold for proceeds of approximately $600 and serve 290,000
subscribers. The Idaho systems are being sold for approximately $26 and serve
16,000 subscribers. In accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
Media Group has stopped depreciation and amortization related to these assets.
In each case, the sale proceeds approximate the carrying value of the cable
systems. These systems contributed $6 and $7 in operating income during the
three- and six-month periods ended June 30, 1997, respectively. The cable
system sales are subject to federal and local regulatory approvals, including
the transfer of franchises, and are expected to close in early 1998.
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
D. Asset Sales and Restructurings (continued)
International Directories. On June 4, 1997, Media Group sold Thomson
Directories, its directory operation in the United Kingdom, for $121. Also,
in July 1997, Media Group entered into an agreement to sell U S WEST Polska,
its directory operation in Poland. The sale is awaiting approval from
Poland's Office of Competition and Consumer Protection. These transactions
will result in the disposition of Media Group's wholly owned international
directory operations.
E. Series E Preferred Stock Subject to Mandatory Redemption
On June 30, 1997, Media Group acquired cable systems serving 40,000
subscribers in the state of Michigan for cash of $25 and 994,082 shares of
nonvoting, Series E Convertible Preferred Stock (the "Preferred Stock") issued
by U S WEST. Dividends are payable quarterly at the annual rate of 6.34
percent. The Preferred Stock is recorded at the market value of $50.00 per
share at June 30, 1997, which is equal to its liquidation value. Upon
redemption, the preferred stockholders may elect to receive cash or convert
their Preferred Stock into Media Group common stock. Cash redemption is equal
to the Preferred Stock's liquidation value of $50.00 per share, plus accrued
dividends. The number of shares of Media Group common stock to be received
upon conversion is $47.50 per share divided by the then current market price
of Media Group common stock. The conversion rate is subject to adjustment by
U S WEST under certain circumstances.
The Preferred Stock is redeemable as follows: (a) U S WEST may call for
redemption all or any part of the Preferred Stock beginning on June 30, 2002;
(b) on a yearly basis beginning August 1, 2007, and continuing through August
1, 2016, U S WEST will redeem 49,704 shares of Preferred Stock, and on June
30, 2017, all of the remaining outstanding shares of Preferred Stock; or (c)
all of the outstanding Preferred Stock shall be redeemed upon the occurrence
of certain events, including the dissolution or sale of Media Group.
The Preferred Stock ranks senior to all classes of U S WEST common stock, is
subordinated to any senior debt and ranks on equal terms with all other
preferred securities.
F. Subsequent Events
In July 1997, Media Group entered into an agreement to purchase up to the
remaining 50 percent of Fintelco, S.A., ("Fintelco"), a cable and
telecommunications venture with approximately 660,000 cable subscribers
located in Argentina. This additional interest could bring Media Group's
ownership in Fintelco up to 100 percent. Closing is contingent upon various
regulatory approvals, which are expected during the third quarter of 1997.
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
F. Subsequent Events (continued)
On August 6, 1997, Media Group announced it will relocate the corporate
offices of its domestic cable operations, MediaOne, Inc., from Boston to
Denver. Approximately 150 employees will be asked to relocate to Denver. The
move is designed to improve operations through better alignment and focus, and
will occur in phases between September 1997 and June 1998. In addition,
several changes in the senior management of MediaOne were announced. The
Media Group anticipates incurring a pretax charge of approximately $30 in
third-quarter 1997 for costs related to the move and management changes.
G. Net Investment in Assets Held for Sale
The capital assets segment is being accounted for in accordance with Staff
Accounting Bulletin No. 93, issued by the SEC, which requires discontinued
operations not disposed of within one year of the measurement date to be
accounted for prospectively in continuing operations as "net investment in
assets held for sale." The net realizable value of the assets is being
evaluated on an ongoing basis with adjustments to the existing reserve, if
any, being charged to continuing operations. No such adjustment has been
required. Prior to January 1, 1995, the entire capital assets segment was
accounted for as discontinued operations in accordance with Accounting
Principles Board Opinion No. 30.
Form 10-Q - Part I
U S WEST MEDIA GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
G. Net Investment in Assets Held for Sale (continued)
The components of net investment in assets held for sale follow:
June 30, December 31,
Dollars in millions 1997 1996
ASSETS
Cash and cash equivalents $ 22 $ 21
Finance receivables - net 820 869
Investment in real estate - net of valuation allowance 184 182
Bonds, at market value 145 146
Investment in FSA 339 326
Other assets 173 165
--------- -------------
Total assets $ 1,683 $ 1,709
========= =============
LIABILITIES
Debt $ 442 $ 481
Deferred income taxes 681 671
Accounts payable, accrued liabilities and other 133 137
Minority interests 11 11
--------- -------------
Total liabilities 1,267 1,300
--------- -------------
Net investment in assets held for sale $ 416 $ 409
========= =============
Building sales and operating revenues of the capital assets segment were $21
and $78 for the three- and six-month periods ended June 30, 1997,
respectively, and $21 and $51 for the three- and six-month periods ended June
30, 1996, respectively.
Revenues of U S WEST Financial Services, Inc., a member of the capital assets
segment, were $6 and $11 for the three- and six-month periods ended June 30,
1997, respectively, and $7 and $14 for the three- and six-month periods ended
June 30, 1996, respectively. Selected financial data for U S WEST Financial
Services follows:
June 30, December 31,
1997 1996
Net finance receivables $ 861 $ 859
Total assets 1,066 1,058
Total debt 246 236
Total liabilities 996 998
Equity 70 60
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions)
The following discussion is based on the U S WEST Media Group Combined
Financial Statements prepared in accordance with GAAP. The discussion should
be read in conjunction with the U S WEST, Inc. Consolidated Financial
Statements. Pro forma discussions give effect to the Continental Merger as
though it had occurred as of January 1, 1996. A discussion of the Media
Group's operations on a proportionate basis follows the GAAP discussion.
RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED JUNE 30, 1997 COMPARED WITH
1996
Sales and Other Revenues
Pro forma
Percent Pro forma Percent
Three Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $ 585 $ 59 - $ 533 9.8
International 4 - - - -
------ ----- -------- ---------- ----------
589 59 - 533 10.5
Wireless communications:
Domestic:
Cellular service 327 267 22.5 267 22.5
Cellular equipment 36 23 56.5 23 56.5
------ ----- -------- ---------- ----------
363 290 25.2 290 25.2
Directory and information services:
Domestic 296 279 6.1 279 6.1
International 23 25 (8.0) 25 (8.0)
------ ----- -------- ---------- ----------
319 304 4.9 304 4.9
Other 6 5 20.0 5 20.0
------ ----- -------- ---------- ----------
Sales and other revenues $1,277 $ 658 94.1 $ 1,132 12.8
====== ===== ======== ========== ==========
Pro forma
Percent Pro forma Percent
Six Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $1,137 $ 116 - $ 1,052 8.1
International 8 - - - -
------ ------ ------- ---------- ---------
1,145 116 - 1,052 8.8
Wireless communications:
Domestic:
Cellular service 630 506 24.5 506 24.5
Cellular equipment 68 48 41.7 48 41.7
------ ------ ------- ---------- ---------
698 554 26.0 554 26.0
Directory and information services:
Domestic 583 550 6.0 550 6.0
International 45 42 7.1 42 7.1
------ ------ ------- ---------- ---------
628 592 6.1 592 6.1
Other 13 9 44.4 9 44.4
------ ------ ------- ---------- ---------
Sales and other revenues $2,484 $1,271 95.4 $ 2,207 12.6
====== ====== ======= ========== =========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Media Group sales and other revenues increased 94.1 percent, to $1,277, and
95.4 percent, to $2,484, for the three- and six-month periods ended June 30,
1997, respectively. On a pro forma basis, Media Group sales and other
revenues increased 12.8 percent and 12.6 percent, for the three- and six-month
periods ended June 30, 1997, respectively. The increases were primarily a
result of growth in cellular service revenue and domestic cable and
telecommunications revenue.
Cable and Telecommunications On a pro forma basis, cable and
telecommunications revenue increased 9.8 percent, to $585, and 8.1 percent, to
$1,137, for the three- and six-month periods ended June 30, 1997,
respectively. The increases resulted primarily from price increases of
approximately 6 to 8 percent, the addition of new channels and basic
subscriber increases of 1.8 percent, on a same property basis. Increases in
pay-per-view and direct broadcast satellite ("DBS") service revenues also
contributed to the increase in revenue. DBS service revenues increased
primarily as a result of a 53.4 percent increase in DBS customers in 1997
compared with 1996.
Results for 1997 international cable and telecommunications revenues reflect
the consolidation of Kabel Plus a.s. ("Kabel Plus"), Media Group's cable
operation in the Czech Republic, effective the third quarter of 1996.
Wireless Communications Cellular service revenues increased 22.5 percent, to
$327, and 24.5 percent, to $630, for the three- and six-month periods ended
June 30, 1997, respectively. These increases are a result of a 33 percent
increase in subscribers during the last twelve months, partially offset by an
8.8 percent drop in average revenue per subscriber to $48.00 per month. The
increase in subscribers relates to continued growth in demand for wireless
services.
Cellular equipment revenues increased 56.5 percent, to $36, and 41.7 percent,
to $68, for the three- and six-month periods ended June 30, 1997,
respectively. These increases are primarily a result of an increase in unit
sales associated with a 68 percent increase in gross customer additions in the
first six months of 1997, partially offset by a decrease in selling price per
unit.
In May 1997, Media Group and AirTouch entered into a definitive agreement to
merge Media Group's domestic cellular business and its interest in PrimeCo
into AirTouch. Completing the AirTouch Merger, on a tax-free basis depended
among other things, upon the final status of the "Morris Trust" provision of
the tax legislation. Since the enacted legislation eliminated the "Morris
Trust" provision and did not provide transitional relief for the AirTouch
Merger, the Company will continue with the original AirTouch Joint Venture
transaction. See Note B - AirTouch Transaction - to the U S WEST Media Group
Combined Financial Statements.
Directory and Information Services Revenues related to Yellow Pages directory
advertising represent 98 percent of domestic directory and information
services. Yellow Pages directory advertising revenues increased 6.6 percent,
to $291, and 6.9 percent, to $575, during the three-
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
and six-month periods ended June 30, 1997, respectively. The increases are
largely a result of a 7.4 percent increase in revenue per local advertiser
primarily resulting from price increases of 4.6percent and an increase in
volume and complexity of advertisements sold. These increases are offset by
decreased revenue associated with exited product lines which were nonstrategic
to the directory business. Revenues related to interactive and other services
comprise the remaining domestic directory and information services revenues
and totaled $5 and $8 for the three- and six-month periods ended June 30,
1997, respectively.
In May 1997, U S WEST announced its intention to transfer its domestic
directory business from the Media Group to the Communications Group. See Note
C - Dex Transfer - to the U S WEST Media Group Combined Financial Statements.
On June 4, 1997, Media Group sold Thomson Directories, its directory operation
in the United Kingdom, for $121. Also, in July 1997, Media Group entered into
an agreement to sell U S WEST Polska, its directory operation in Poland. The
sale is awaiting approval from Poland's Office of Competition and Consumer
Protection. These transactions will result in the disposition of Media
Group's wholly owned international directory operations.
Operating Income (Loss)
Pro forma
Percent Pro forma Percent
Three Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $ - $ 4 - $ (5) -
International (3) - - - -
------ ------ -------- ----------- ----------
(3) 4 - (5) (40.0)
Wireless communications:
Domestic 100 59 69.5 59 69.5
International (6) - - - -
------ ------ -------- ----------- ----------
94 59 59.3 59 59.3
Directory and information services:
Domestic 132 115 14.8 115 14.8
International (2) (3) (33.3) (3) (33.3)
------ ------ -------- ----------- ----------
130 112 16.1 112 16.1
Other (see Note 1) (34) (31) 9.7 (31) 9.7
------ ------ -------- ----------- ----------
Operating income $ 187 $ 144 29.9 $ 135 38.5
====== ====== ======== =========== ==========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Operating Income (Loss) (continued)
Pro forma
Percent Pro forma Percent
Six Months Ended June 30, 1997 1996 Change 1996 Change
Cable and telecommunications:
Domestic $ (19) $ 8 - $ (18) 5.6
International (7) - - - -
------ ------ -------- ----------- ----------
(26) 8 - (18) 44.4
Wireless communications:
Domestic 195 109 78.9 109 78.9
International (9) - - - -
------ ------ -------- ----------- ----------
186 109 70.6 109 70.6
Directory and information services:
Domestic 262 225 16.4 225 16.4
International (9) (11) (18.2) (11) (18.2)
------ ------ -------- ----------- ----------
253 214 18.2 214 18.2
------ ------ -------- ----------- ----------
Other (see Note 1)<F1> (48) (58) (17.2) (58) (17.2)
------ ------ -------- ----------- ----------
Operating income $ 365 $ 273 33.7 $ 247 47.8
====== ====== ======== =========== ==========
<FN>
<F1>
Note 1 - Primarily includes headquarters expenses for shared services and divisional
expenses associated with equity investments.
During the three- and six-month periods ended June 30, 1997, Media Group
operating income increased 29.9 percent and 33.7 percent, to $187 and $365,
respectively. On a pro forma basis, operating income increased 38.5 percent
and 47.8 percent, for the three- and six-month periods ended June 30, 1997,
respectively. The increases were primarily due to strong growth in domestic
wireless communications operations.
Media Group EBITDA more than doubled in 1997, to $487 and $968, for the three-
and six-month periods ended June 30, 1997, respectively, due primarily to the
Continental Merger. On a pro forma basis, Media Group EBITDA increased 16.2
percent and 19.4 percent, for the three- and six-month periods ended June 30,
1997, respectively, due primarily to domestic wireless operations. The Media
Group considers EBITDA an important indicator of the operational strength and
performance of its businesses. EBITDA, however, should not be considered an
alternative to operating or net income as an indicator of the performance of
the Media Group's businesses, or as an alternative to cash flows from
operating activities as a measure of liquidity, in each case determined in
accordance with GAAP.
Cable and Telecommunications On a pro forma basis, cable and
telecommunications operating loss decreased $2, to $3, and increased $8, to
$26, for the three- and six-month periods ended June 30, 1997, respectively.
International cable and telecommunications results contributed operating
losses of $3 and $7, for the three- and six-month periods ended June 30, 1997,
respectively, due to the third-quarter 1996 consolidation of Kabel Plus.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
The domestic cable and telecommunications operating loss decreased $5 for the
three-month period ended June 30, 1997, compared with 1996, on a pro forma
basis. The decrease in the operating loss was a result of an $8 increase in
EBITDA, to $237, offset by a $3 increase in depreciation and amortization
expense. For the six-month period ended June 30, 1997, domestic cable and
telecommunications operating loss was virtually unchanged compared with 1996,
on a pro forma basis. The $12 increase in EBITDA, to $460, was more than
offset by a $13 increase in depreciation and amortization expense. The
increases in EBITDA are primarily a result of higher revenues associated with
price increases of 6 to 8 percent combined with subscriber growth of 1.8
percent, on a same property basis. The revenue increases were partially
offset by higher programming fees, primarily a result of rate increases and
secondarily a result of subscriber growth and special events, and costs
associated with changing the domestic cable brand name to "MediaOne". Media
Group expects to incur additional costs related to the brand name change
during the remainder of 1997, as well as for the deployment of new products
and services.
On August 6, 1997, Media Group announced it will relocate the corporate
offices of its domestic cable operations, MediaOne, Inc., from Boston to
Denver. Approximately 150 employees will be asked to relocate to Denver. The
move is designed to improve operations through better alignment and focus, and
will occur in phases between September 1997 and June 1998. In addition,
several changes in the senior management of MediaOne were announced. The
Media Group anticipates incurring a pretax charge of approximately $30 in
third-quarter 1997 for costs related to the move and management changes.
Wireless Communications Domestic wireless communications operating income
increased 69.5 percent, to $100, and 78.9 percent, to $195, for the three- and
six-month periods ended June 30, 1997, respectively. These increases are a
result of revenue increases associated with the rapidly expanding subscriber
base combined with efficiency gains. On a per subscriber basis, the 1997
decline in revenue of 8.8 percent has been more than offset by the 21.9
percent decrease in the costs to acquire and support customers. Domestic
cellular EBITDA increased 51.0 percent, to $145, and 56.7 percent, to $282,
for the same periods. The efficiencies have contributed to an increase in
1997 domestic cellular service EBITDA margin to 44.3 percent and 44.8 percent
for the three- and six-month periods, respectively, compared with 35.8 percent
and 35.5 percent in 1996.
Domestic cellular depreciation increased 25.0 percent, to $45, and 24.3
percent, to $87, respectively, for the three- and six-month periods ended June
30, 1997. These increases are largely a result of network upgrades.
International wireless communications operating losses of $6 and $9 for the
three- and six-month periods ended June 30, 1997, respectively, reflects the
third-quarter 1996 consolidation of Russian Telecommunications Development
Corporation, a Russian venture, which holds wireless investments.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Directory and Information Services During the three- and six-month periods
ended June 30, 1997, operating income related to domestic Yellow Pages
directory advertising increased 5.3 percent, to $140, and 5.7 percent, to
$277, respectively. Revenue increases and cost savings associated with
headcount reductions were partially offset by increased printing, paper and
sales support costs. These cost increases were primarily associated with an
increase in the volume and complexity of advertisements sold.
Operating losses associated with ongoing product development activities, which
include development costs for internet content services, are included in
domestic directory and information services operating income. Such operating
losses decreased $10, to $8, and decreased $22, to $15, for the three- and
six-month periods ended June 30, 1997, respectively. The reduction in these
operating losses is primarily the result of discontinuing various product
development activities in 1996.
EBITDA related to domestic Yellow Pages directory advertising service
increased 8.8 percent, to $149, and 9.3 percent, to $295, for the three- and
six-month periods ended June 30, 1997, respectively. The EBITDA margin for
both the three- and six-month periods ended June 30, 1997 was 51 percent
compared to 50 percent for same periods in 1996.
Other During the three-month period ended June 30, 1997, other operating loss
increased $3, to $34. The increase was due primarily to a shift in the timing
of billing U S WEST corporate costs to the Media Group. The increased costs
were partially offset by staff reductions at international headquarters of $5.
During the six-month period ended June 30, 1997, other operating losses
decreased $10, to $48. The decrease is primarily attributable to cost savings
of $11 related to international staff reductions.
Interest Expense and Other
Proforma
Percent Proforma Percent
Three Months Ended June 30, 1997 1996 Change 1996 Change
Interest expense $ 166 $ 26 - $ 170 (2.4)
Equity losses in unconsolidated ventures 153 77 98.7 91 68.1
Gains on sales of investments 44 - - - -
Guaranteed minority interest expense 22 12 83.3 12 83.3
Other expense - net 5 27 (81.5) 29 (82.8)
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Interest Expense and Other (continued)
Proforma
Percent Proforma Percent
Six Months Ended June 30, 1997 1996 Change 1996 Change
Interest expense $ 341 $ 50 - $ 340 0.3
Equity losses in unconsolidated ventures 318 143 - 166 91.6
Gains on sales of investments 95 - - - -
Guaranteed minority interest expense 44 24 83.3 24 83.3
Other expense - net 9 34 (73.5) 40 (77.5)
Interest expense increased $140 and $291 during the three- and six-month
periods ended June 30, 1997, respectively, primarily as a result of the
Continental Merger. U S WEST assumed Continental debt totaling $6,525 (at
market value) and incurred debt of $1,150 to finance the cash portion of the
Continental Merger consideration.
Equity losses increased $76 and $175 for the three- and six-month periods
ended June 30, 1997, respectively, due to greater losses from international
ventures and from the domestic investment in PrimeCo. The increase in
international losses relates to: (1) expansion of the network and financing
activities at Telewest Communications, plc ("Telewest"), (2) costs associated
with the significant increase in customers and network coverage at One 2 One,
and (3) the amortization of license fees related to the wireless investment in
India. Domestically, PrimeCo launched service in November 1996, and losses
associated with this venture have increased as a result of start-up and other
costs. Media Group expects equity losses will continue to be significant as
venture expansion activities continue.
During the second quarter of 1997, Media Group sold its shares of Time Warner,
Inc. acquired in the Continental Merger, for proceeds of $220 and a pretax
gain of $44. In addition, during the first quarter of 1997, Media Group sold
its 5 percent interest in a wireless venture in France for proceeds of $82,
and a pretax gain of $51.
Guaranteed minority interest expense increased $10 and $20 for the three- and
six-month periods ended June 30, 1997, respectively. The increases were a
result of the October 1996 issuance of Company-obligated mandatorily
redeemable preferred securities of subsidiary trust holding solely
Company-guaranteed debentures ("Preferred Securities") totaling $480.
Other expense decreased $22, to $5, and $25, to $9, for the three- and
six-month periods ended June 30, 1997, respectively. The decrease is
primarily a result of a second-quarter 1996 pretax charge of $31 associated
with the sale of the Media Group's cable television interests in Norway,
Sweden and Hungary. This decrease was partially offset by increased foreign
currency losses in the second quarter of 1997.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions, except per share amounts),
continued
Income Tax Provision (Benefit)
Pro forma Pro forma
Three Months Ended June 30, 1997 1996 (Decrease) 1996 (Decrease)
Income tax provision (benefit) $ (18) $ 13 $ (31) $ (48) $ (30)
Pro forma Pro forma
Six Months Ended June 30, 1997 1996 (Decrease) 1996 (Decrease)
Income tax provision (benefit) $ (46) $ 30 $ (76) $ (93) $ (47)
Effective tax rate 18.3 136.4 - 28.8 -
The decrease in the effective tax rate is primarily a result of a shift from
pretax earnings to pretax losses and additional goodwill amortization
associated with the Continental Merger.
Net Loss
Media Group net loss increased to $94, or $0.17 per share, for the three-month
period ended June 30, 1997, and to $203, or $0.38 per share, for the six-month
period ended June 30, 1997. Excluding the after tax effects of the gains on
sales of investments totaling $25 ($0.04 per share) during the second quarter
of 1997, and $31 ($0.05 per share) during the first quarter of 1997, Media
Group net loss increased $108 and $251 for the three- and six-month periods
ended June 30, 1997, respectively. The Continental Merger contributed
approximately $73 of the loss during the three-month period ended June 30,
1997, and $183 during the six-month period ended June 30, 1997. The
Continental Merger resulted in significant increases in interest and
depreciation and amortization charges. The remaining increase in net loss is
due to greater losses from unconsolidated ventures, partially offset by an
increase in earnings from domestic cellular and directories operations.
Liquidity and Capital Resources
Operating Activities
Cash provided by operating activities of the Media Group increased $374 in the
first six months of 1997, compared with 1996. The Continental Merger and
growth in operations from the domestic cellular business contributed to the
increase. Also contributing were decreased tax payments during 1997.
Partially offsetting the increase were higher financing costs resulting from
greater debt levels associated with the Continental Merger.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Investing Activities
Media Group capital expenditures were $717 for the first six months of 1997.
The majority of expenditures in 1997 were devoted to upgrading the domestic
cable network and expanding the domestic cellular network. Media Group also
invested $44 in international ventures during 1997, primarily capital
contributions to a wireless venture in India. Other investing activities
include an investment in Continental of $1,150 which represents payment of the
cash portion of the Continental Merger consideration.
During 1997, Media Group received proceeds totaling $625 related to asset
sales as follows: (a) $220 from the sale of Time Warner, Inc. shares acquired
in the Continental Merger, (b) $178 from the sale of 6,075,000 shares of
Teleport Communications Group stock, (c) $121 from the sale of Thomson
Directories, (d) partial proceeds of $29 from the sale of Media Group's 5
percent interest in a wireless venture in France, (e) $50 from the capital
assets segment, which is held for sale, and (f) $27 from other miscellaneous
sales.
In July 1997, Media Group entered into an agreement to purchase up to the
remaining 50 percent of Fintelco, a cable and telecommunications venture with
approximately 660,000 cable subscribers located in Argentina. This additional
interest could bring Media Group ownership in Fintelco up to 100 percent.
Closing is contingent upon various regulatory approvals, which are expected
during the third quarter of 1997.
Financing Activities
Media Group debt at June 30, 1997 was $9,793, an increase of $940 compared
with December 31, 1996. In 1997, Media Group incurred additional debt to
finance the cash portion of the Continental Merger consideration which totaled
$1,150. In January 1997, the Company issued medium- and long-term debt
totaling $4.1 billion, at a weighted average rate of 7.47 percent. The
proceeds were used to refinance debt incurred in conjunction with the
Continental Merger.
During the second quarter of 1997, U S WEST called a 10 5/8 percent senior
subordinated note, due June 15, 2002. The debt had a recorded value of $110,
including a premium of $10. This extinguishment resulted in a pretax gain of
$5, ($3 after tax).
On June 30, 1997, Media Group acquired cable systems serving 40,000
subscribers in the state of Michigan for cash of $25 and approximately $50 of
Preferred Stock issued by U S WEST. The Preferred Stock is redeemable at U S
WEST's option starting five years from the acquisition date, or upon
dissolution of Media Group. The stockholders have the right to elect cash
upon redemption, or to convert their Preferred Stock into Media Group common
stock. (See Note E - Series E Preferred Stock Subject to Mandatory Redemption
- - to the U S WEST Media Group Combined Financial Statements.)
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
On July 30, 1997, U S WEST announced that it will call its Liquid Yield Option
Notes effective August 29, 1997. At June 30, 1997, the notes had a carrying
value of $265.
Excluding debt associated with the capital assets segment, the Media Group's
percentage of debt to total capital at June 30, 1997, was 53.3 percent
compared with 50.3 percent at December 31, 1996. Including debt associated
with the capital assets segment, Preferred Securities and mandatorily
redeemable preferred stock, the Media Group's percentage of debt to total
capital was 60.6 percent at June 30, 1997, compared with 57.8 percent at
December 31, 1996. The percentage of debt to total capital has increased as a
result of higher debt associated with the Continental Merger.
Under the terms of the Dex Transfer, $3.9 billion of U S WEST debt will be
reallocated from the Media Group to the Communications Group and the
Communications Group will issue shares of Communications Group common stock to
Media Group shareowners totaling $850. Contingent upon receiving favorable
federal income tax treatment, the Company intends to pursue the Dex Transfer.
Due to the significant capital requirements associated with the domestic cable
upgrade, Media Group expects that cash from operations will not be adequate to
fund expected cash requirements in the next several years. Additional
financing will come primarily from new debt.
Media Group from time to time engages in preliminary discussions regarding
restructurings, dispositions and other similar transactions. Any such
transaction may include, among other things, the transfer of certain assets,
businesses or interests, or the incurrence or assumption of indebtedness, and
could be material to the financial condition and results of operations of U S
WEST and Media Group. There is no assurance that any such discussions will
result in the consummation of any such transaction.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Selected Proportionate Data
The following table and discussion is not required by GAAP or intended to
replace the Combined Financial Statements prepared in accordance with GAAP.
It is presented supplementally because the Media Group believes that
proportionate financial and operating data facilitate the understanding and
assessment of its Combined Financial Statements. The table does not reflect
financial data of the capital assets segment, which had net assets of $416 and
$409 at June 30, 1997 and December 31, 1996, respectively. The financial
information included below departs materially from GAAP because it aggregates
the revenues and operating income of entities not controlled by the Media
Group with those of the consolidated operations of the Media Group.
Pro forma Percent
Six Months Ended June 30, 1997 1996 Change
(1)<F1>
REVENUES
Cable and telecommunications:
Domestic (2) $2,496 $ 2,351 6.2
International 226 165 37.0
Wireless communications:
Domestic 652 501 30.1
International 324 187 73.3
Directory and information services:
Domestic 584 550 6.2
International 76 77 (1.3)
Corporate and other 7 6 16.7
------- ----------- --------
Total revenues $4,365 $ 3,837 13.8
======= =========== ========
EBITDA (3)<F3>
Cable and telecommunications:
Domestic (2)<F2> $ 792 $ 741 6.9
International 20 (5) -
Wireless communications:
Domestic 212 147 44.2
International (3) - -
Directory and information services:
Domestic 277 241 14.9
International 2 - -
Corporate and other (23) (25) (8.0)
------- ----------- --------
Total EBITDA $1,277 $ 1,099 16.2
======= =========== ========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Selected Proportionate Data, continued
Pro forma Percent
Six Months Ended June 30, 1997 1996 Change
(1)<F1>
OPERATING INCOME
Cable and telecommunications:
Domestic (2) $ 119 $ 97 22.7
International (78) (66) 18.2
Wireless communications:
Domestic 115 81 42.0
International (93) (41) -
Directory and information services:
Domestic 257 226 13.7
International (6) (7) (14.3)
Corporate and other (28) (30) (6.7)
------ ----------- --------
Total operating income $ 286 $ 260 10.0
====== =========== ========
NET INCOME (LOSS)
Cable and telecommunications:
Domestic (2) $(207) $ (230) (10.0)
International (120) (106) 13.2
Wireless communications:
Domestic 48 42 14.3
International (66) (42) 57.1
Directory and information services:
Domestic 154 134 14.9
International (8) (12) (33.3)
Corporate and other (4) (16) (75.0)
------ ----------- --------
Total net loss $(203) $ (230) (11.7)
====== =========== ========
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
Selected Proportionate Data, continued
Six Months Ended June 30, Pro forma Percent
(in thousands) 1997 1996 Change
(1)<F1>
SUBSCRIBERS/ADVERTISERS:
Cable and telecommunications:
Domestic (2) 7,674 7,362 4.2
International 1,199 919 30.5
Wireless communications:
Domestic 2,119 1,557 36.1
International 760 370 105.4
Directory and information services:
Domestic 482 481 0.2
International 88 274 (67.9)
------ --------- --------
Total subscribers/advertisers 12,322 10,963 12.4
====== ========= ========
<FN>
<F1>
(1) 1996 pro forma proportionate results reflect the following for the six
months: (i) Media Group historical proportionate results; (ii) the
Continental Merger; (iii) Continental's acquisition of the remaining interest
in Meredith/New Heritage; (iv) the reclassification of the Teleport
Communications Group investment to equity method; and (v) Continental's cable
investments in Argentina and Singapore.
<F2>
(2) The proportionate results are based on the Media Group's 25.51 percent pro
rata priority and residual equity interests in reported Time Warner
Entertainment Company L.P. ("TWE") results. The reported TWE results are
prepared in accordance with GAAP and have not been adjusted to report TWE
results on a proportionate basis.
<F3>
(3) Proportionate EBITDA represents the Media Group's equity interest in the
entities multiplied by the entity's EBITDA. As such, proportionate EBITDA
does not represent cash available to the Media Group.
</FN>
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
PROPORTIONATE RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1997 COMPARED
WITH 1996
Proportionate Media Group revenues increased 13.8 percent, to $4.4 billion,
EBITDA increased 16.2 percent, to $1.3 billion, and subscribers/advertisers
increased 12.4 percent, to 12.3 million. Strong growth in domestic and
international wireless and cable and telecommunications operations contributed
to the increase in proportionate revenue and growth in subscribers. Strong
growth in domestic wireless and cable contributed to the increase in
proportionate EBITDA.
Cable and Telecommunications During the first six months of 1997,
proportionate revenues for the domestic cable and telecommunications
operations increased 6.2 percent, to $2.5 billion. This is a result of
increases in subscribers and revenue per subscriber mainly due to price
increases. Proportionate EBITDA increased 6.9 percent, to $792. Proportionate
EBITDA related to TWE operations increased 13.3 percent. TWE's results
benefited from improved operations and gains realized by asset sales.
During the first six months of 1997, international cable and
telecommunications proportionate revenues increased 37.0 percent, to $226, and
proportionate EBITDA increased $25, to $20. Customer growth at Telewest and
new investments in Malaysia and Indonesia contributed to the increase in
proportionate revenue. A reduction in Media Group international staff costs
as well as improved operations at Telewest and Malaysia contributed to the
increase in proportionate EBITDA.
Proportionate international cable subscribers total approximately 1.2 million
at June 30, 1997, a 12 percent increase, on a comparable basis. Telewest's
cable television subscribers increased 31 percent compared to last year.
Wireless Communications During the first six months of 1997, domestic
wireless proportionate revenues increased 30.1 percent, to $652, and
proportionate EBITDA increased 44.2 percent, to $212. Excluding losses
generated by the start-up of PrimeCo Personal Communications L.P., domestic
cellular proportionate EBITDA increased 58.4 percent. The increase in EBITDA
is a result of revenue increases associated with the strong domestic cellular
subscriber growth combined with efficiency gains.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Dollars in millions), continued
During the first six months of 1997, proportionate revenues for the
international wireless operations increased 73.3 percent, to $324, and
proportionate EBITDA decreased $3 to ($3). The increase in proportionate
revenue is the result of the international wireless subscriber base more than
doubling to 760,000. EBITDA losses increased primarily as a result of costs
associated with increasing the subscriber base at One 2 One, a personal
communications services venture in the United Kingdom, and start-up costs
associated with providing digital wireless services in Poland.
Directory and Information Services Proportionate revenues for domestic
directory and information services increased 6.2 percent, to $584, and
proportionate EBITDA increased 14.9 percent, to $277. The increases are due to
price and volume increases, reduction in new product development activities
and employee reductions. Proportionate EBITDA of $277 was reduced by start-up
losses associated with internet content and other product development
activities of $11.
On June 4, 1997, Media Group sold its directory operation in the United
Kingdom, Thomson Directories. In July 1997, Media Group entered into an
agreement to sell its directory operation in Poland. These two operations
comprise the majority of international directories results.
Form 10-Q - Part II
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
U S WEST 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 U S WEST, any
financial impact to which U S WEST and its subsidiaries are subject is not
expected to be material in amount to U S WEST's operating results or its
financial position.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's annual meeting of shareholders on June 6, 1997, shareholders
voted as follows for the purpose of electing three individuals as directors of
the Company:
Directors Votes in Favor Votes Withheld
- ----------------- -------------- --------------
CLASS III
- -----------------
Allan D. Gilmour 673,620,126 20,097,093
Frank Popoff 673,643,182 20,074,037
Jerry O. Williams 673,621,484 20,095,735
Arthur Andersen LLP was confirmed as the Company's independent auditors with
680,823,708 votes in favor, 8,288,423 votes against and 4,605,088 votes
abstaining.
The shareholders voted as follows to approve to amend the U S WEST
Communications Group Long-Term Incentive Plan:
In Favor Against Abstained
- ----------- ---------- ----------
624,621,235 56,316,308 12,779,676
The shareholders voted as follows to amend the U S WEST 1994 Stock Plan:
In Favor Against Abstained
- ----------- ---------- ----------
622,975,100 57,539,474 13,202,645
Form 10-Q - Part II
Item 4. Submission of Matters to a Vote of Security Holders (continued)
The shareholders also considered and rejected the following two shareholder
proposals at the annual meeting:
Proposal In Favor Against Abstained Not Voted
- ------------------------------- ----------- ----------- ---------- ----------
Elimination of Classified Board 215,980,774 370,842,175 17,464,205 89,430,065
Initiation of Cumulative Voting 159,767,734 427,714,915 16,806,728 89,427,842
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number
3(i)(a) Certificate of Designation for Series D Convertible Preferred Stock as filed on
November 14, 1996.
3(i)(b) Certificate of Correction for Series D Convertible Preferred Stock as filed on
December 11, 1996.
3(i)(c) Certificate of Designation for Series E Convertible Preferred Stock as filed on
June 13, 1997.
11 Statement regarding computation of earnings per share of U S WEST, Inc.
12 Statement regarding computation of earnings to fixed charges ratio of
U S WEST, Inc. and U S WEST Financial Services, Inc.
27 Financial Data Schedule
(b) Reports on Form 8-K filed during the Second Quarter of 1997
(i) Form 8-K report dated April 30, 1997 concerning the releases of earnings
issued on April 25, 1997 by U S WEST Communications Group and on
April 29, 1997 by U S WEST Media Group, for the first quarter ended
March 31, 1997.
Form 10-Q - Part II
Item 6. Exhibits and Reports on Form 8-K (continued)
(ii) Form 8-K report dated May 16, 1997 concerning the definitive agreement to
merge the domestic cellular business of Media Group and its interest in
PrimeCo Personal Communications into AirTouch Communications. In
addition, on May 16, 1997, U S WEST, Inc. issued a press release announcing
its intention to transfer its domestic directory publishing business - known as
U S WEST Dex - from its Media Group to its Communications Group in
connection with a merger of its domestic wireless interest into AirTouch
Communications.
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.
/S/ Michael P. Glinsky
August 13, 1997
U S WEST, Inc.
Michael P. Glinsky
Executive Vice President and
Chief Financial Officer