1
EXHIBIT 13
SELECTED PORTIONS OF QWEST'S 2000 ANNUAL REPORT TO SHAREHOLDERS
Following are portions of the financial section of Qwest's 2000 Annual
Report. Our 2000 Annual Report will be available on the Internet beginning March
20, 2001. To view the annual report online, visit our website at
www.qwest.com/shareholder2001.
You may also request that a printed copy be mailed to you in one of two
ways:
(1) by completing the literature request form at
www.qwest.com/about/investor and then select "request materials"
or
(2) by writing to Investor Relations, Qwest Communications
International Inc., 1801 California Street, 51st Floor, Denver,
Colorado 80202.
FINANCIAL CONTENTS
<Table>
<Caption>
F-2 F-3 F-4 F-8 F-31
QUANTITATIVE INDEPENDENT FINANCIAL NOTES TO MARKET FOR
AND QUALITATIVE AUDITORS' REPORT STATEMENTS CONSOLIDATED REGISTRANT'S COMMON
DISCLOSURES ABOUT FINANCIAL STOCK AND RELATED
MARKET RISK STATEMENTS STOCKHOLDER MATTERS
</Table>
2
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks arising from changes in interest
rates. The objective of Qwest's interest rate risk management program is to
manage the level and volatility of its interest expense. The Company may employ
derivative financial instruments to manage its interest rate risk exposure.
Qwest has also employed financial derivatives to hedge foreign currency
exposures associated with particular debt issues.
As of December 31, 2000 and 1999, approximately $2.4 billion and $2.3
billion, respectively, of floating-rate debt was exposed to changes in interest
rates. This exposure was primarily linked to commercial paper rates and changes
in 3-month London Interbank Offered Rates ("LIBOR"). A hypothetical increase of
one-percentage point in commercial paper rates and 3-month LIBOR would increase
annual pre-tax interest expenses by $24 million. As of December 31, 2000 and
1999, the Company also had approximately $1.2 billion and $522 million,
respectively, of long-term fixed rate debt obligations maturing in the following
12 months. Any new debt obtained to refinance this debt would be exposed to
changes in interest rates. A hypothetical 10 percent change in the interest
rates on this debt would not have had a material effect on the Company's 2000
earnings.
As of December 31, 2000 and 1999, Qwest had outstanding cross-currency
swaps with notional amounts of $133 million. The cross-currency swaps
synthetically transform 93 million and 94 million of Swiss Franc borrowings at
December 31, 2000 and 1999, respectively, into U.S. dollar obligations. Any
gains (losses) on the cross-currency swaps would be offset by losses (gains) on
the Swiss Franc debt obligations.
As of December 31, 2000 and 1999, Qwest had entered into equity swaps with
a notional amount of $761 million and $1.140 billion, respectively, relating to
24 million shares of Global Crossing common stock previously owned by the
Company. In connection with the equity swaps, the Company entered into equity
collars on 12 million shares and swaps without collars on the remaining 12
million shares. The equity collars restrict the magnitude of any gains or losses
generated by the equity swaps on the collared shares. A hypothetical 10 percent
reduction in the market price of Global Crossing common shares, based upon a
market value per share of $14.25 on December 31, 2000, would decrease the market
value of the Company's net position by $17 million. A hypothetical increase of
one-percentage point in interest rates would decrease the market value of the
Company's net position by $2 million. The swaps mature in three equal increments
in February, May and August 2001.
Other assets at December 31, 2000 included marketable equity securities
recorded at a fair value of $58 million net of unrealized losses of $32 million.
The securities have exposure to price risk. The estimated potential loss in fair
value resulting from a hypothetical 10 percent decrease in prices quoted by
stock exchanges would decrease the fair value of the Company's marketable equity
securities by $6 million.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 requires, among other things,
that all derivative instruments be recognized at fair value as assets or
liabilities on the balance sheet and that changes in fair value generally be
recognized currently in earnings unless specific hedge accounting criteria are
met. The adoption of SFAS No. 133 on January 1, 2001 did not have a material
impact on the Company's consolidated financial statements.
F-2
3
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Qwest Communications International Inc.:
We have audited the accompanying consolidated balance sheets of Qwest
Communications International Inc. and subsidiaries as of December 31, 2000 and
1999, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2000. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Qwest Communications
International Inc. and subsidiaries as of December 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
/s/ Arthur Andersen LLP
Denver, Colorado
January 24, 2001.
F-3
4
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
---------- -------- --------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE AMOUNTS)
Revenues:
Commercial services....................................... $ 7,424 $ 4,689 $ 4,390
Consumer and small business services...................... 6,372 5,571 5,146
Directory services........................................ 1,530 1,436 1,318
Switched access services.................................. 1,284 1,486 1,541
---------- -------- --------
Total revenues.................................... 16,610 13,182 12,395
---------- -------- --------
Operating expenses:
Cost of services.......................................... 5,433 3,990 3,564
Selling, general and administrative....................... 4,260 3,488 3,583
Depreciation.............................................. 2,617 2,348 2,198
Amortization.............................................. 725 19 1
Merger -- related and other charges....................... 1,752 -- --
---------- -------- --------
Total operating expenses.......................... 14,787 9,845 9,346
---------- -------- --------
Operating income............................................ 1,823 3,337 3,049
---------- -------- --------
Other expense (income):
Interest expense -- net................................... 1,041 736 543
Decline in market value of financial instruments.......... 917 56 --
Expenses related to terminated merger..................... -- 282 --
(Gain) loss on sale of investments........................ (327) 367 --
Other expense (income) -- net............................. 66 (6) 87
---------- -------- --------
Total other expense -- net........................ 1,697 1,435 630
---------- -------- --------
Income before income taxes and cumulative effect of change
in accounting principle................................... 126 1,902 2,419
Provision for income taxes.................................. 207 800 911
---------- -------- --------
(Loss) income before cumulative effect of change in
accounting principle...................................... (81) 1,102 1,508
Cumulative effect of change in accounting principle -- net
of tax.................................................... -- 240 --
---------- -------- --------
Net (loss) income........................................... $ (81) $ 1,342 $ 1,508
========== ======== ========
Basic (loss) earnings per share:
(Loss) income before cumulative effect of change in
accounting principle................................... $ (0.06) $ 1.26 $ 1.76
Cumulative effect of change in accounting principle....... -- 0.28 --
---------- -------- --------
Basic (loss) earnings per share............................. $ (0.06) $ 1.54 $ 1.76
========== ======== ========
Diluted (loss) earnings per share:
(Loss) income before cumulative effect of change in
accounting principle................................... $ (0.06) $ 1.25 $ 1.75
Cumulative effect of change in accounting principle....... -- 0.27 --
---------- -------- --------
Diluted (loss) earnings per share........................... $ (0.06) $ 1.52 $ 1.75
========== ======== ========
Basic weighted average shares outstanding (in 000's)........ 1,272,088 872,309 854,967
========== ======== ========
Diluted weighted average shares outstanding (in 000's)...... 1,272,088 880,753 862,581
========== ======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
5
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
---------------------
2000 1999
--------- ---------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE
AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 154 $ 78
Accounts receivable, net of allowances of $301 and $88,
respectively........................................... 4,235 2,455
Receivable from sale of investments....................... -- 1,140
Inventories and supplies.................................. 275 272
Deferred tax assets....................................... 72 46
Prepaids and other........................................ 640 201
------- -------
Total current assets........................................ 5,376 4,192
Property, plant and equipment -- net........................ 25,583 16,404
Goodwill and other intangible assets -- net................. 32,327 501
Investments................................................. 8,186 1,290
Other assets................................................ 2,029 885
------- -------
Total assets...................................... $73,501 $23,272
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current borrowings........................................ $ 3,645 $ 2,882
Accounts payable.......................................... 2,049 1,700
Accrued expenses and other current liabilities............ 3,806 1,840
Advance billings and customer deposits.................... 393 344
------- -------
Total current liabilities................................... 9,893 6,766
Long-term borrowings........................................ 15,421 10,189
Post-retirement and other post-employment benefit
obligations............................................... 2,735 2,890
Deferred income taxes....................................... 1,768 1,191
Deferred credits and other.................................. 2,380 981
Commitments and contingencies (Note 9)
Stockholders' equity:
Preferred stock -- $1.00 par value, 200,000,000 shares
authorized, none issued and outstanding................ -- --
Common stock -- $0.01 par value, 5 billion shares
authorized, 1,672,218,763 and 875,995,661 issued,
1,672,218,763 and 875,469,943 outstanding.............. 17 9
Additional paid-in capital................................ 41,289 647
Retained earnings......................................... 24 377
Accumulated other comprehensive (loss) income............. (26) 222
------- -------
Total stockholders' equity........................ 41,304 1,255
------- -------
Total liabilities and stockholders' equity........ $73,501 $23,272
======= =======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
6
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999 1998
------- ------- -------
(DOLLARS IN MILLIONS)
OPERATING ACTIVITIES
Net (loss) income......................................... $ (81) $ 1,342 $ 1,508
Adjustments to net (loss) income:
Depreciation and amortization.......................... 3,342 2,367 2,199
Loss on investments and derivatives.................... 590 423 --
Provision for bad debts................................ 484 158 141
Asset impairment charge................................ 340 -- 35
Cumulative effect of change in accounting principle.... -- (240) --
Deferred income taxes.................................. 219 225 106
Changes in operating assets and liabilities:
Accounts receivable.................................... (899) (284) (167)
Inventories, supplies and other current assets......... (184) (106) (12)
Accounts payable, accrued expenses and advance
billings............................................. 106 345 (13)
Other.................................................. (236) 316 130
------- ------- -------
Cash provided by operating activities..................... 3,681 4,546 3,927
------- ------- -------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment............ (6,597) (3,944) (2,672)
Cash acquired in connection with Merger................... 407 -- --
Proceeds from sale of equity securities................... 868 -- --
Proceeds from 1999 sale of Global Crossing securities..... 1,140 -- --
Purchases of securities................................... (510) (2,464) --
Other..................................................... (102) (54) (97)
------- ------- -------
Cash used for investing activities........................ (4,794) (6,462) (2,769)
------- ------- -------
FINANCING ACTIVITIES
Net (repayments of) proceeds from current borrowings...... (2,200) 1,304 887
Proceeds from long-term borrowings........................ 4,266 2,062 3,781
Repayments of long-term borrowings........................ (655) (336) (442)
Dividends paid on common stock............................ (542) (1,187) (1,056)
Proceeds from issuance of common stock.................... 320 102 88
Cash paid in connection with Separation................... -- -- (4,348)
Purchases of treasury stock............................... -- -- (46)
------- ------- -------
Cash provided by (used for) financing activities.......... 1,189 1,945 (1,136)
------- ------- -------
CASH AND CASH EQUIVALENTS
Increase (decrease)....................................... 76 29 22
Beginning balance......................................... 78 49 27
------- ------- -------
Ending balance............................................ $ 154 $ 78 $ 49
======= ======= =======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
7
QWEST COMMUNICATIONS INTERNATIONAL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
QWEST PRE- OTHER
COMMON SEPARATION COMMON RETAINED COMPREHENSIVE
STOCK EQUITY STOCK EARNINGS INCOME TOTAL
---------- ---------- ------- -------- ------------- -------
(SHARES IN (DOLLARS IN MILLIONS)
THOUSANDS)
BALANCE, DECEMBER 31, 1997........ 837,881 $ 4,367 $ -- $ -- $ 4,367
Net income from January 1, 1998 to
June 12, 1998................... -- 747 -- -- $ 747 747
Dividends declared on common
stock........................... -- (528) -- -- (528)
Pre-Separation transfers to
Parent.......................... -- (146) -- -- (146)
Common stock issuances............ 1,902 55 -- -- 55
Treasury stock purchases.......... (992) (32) -- -- (32)
Other............................. -- 2 -- -- 2
June 12, 1998 Separation.......... -- (4,465) 4,465 -- --
Dex Indebtedness.................. -- -- (3,829) -- (3,829)
Issuance of common stock at
Separation...................... 28,786 -- 850 -- 850
Distribution to MediaOne
stockholders for Dex............ -- -- (850) -- (850)
Cost of debt refinancing upon
Separation...................... -- -- (140) -- (140)
Common stock issuances............ 2,630 -- 58 -- 58
Treasury stock purchases.......... (527) -- (15) -- (15)
Net income from June 13, 1998 to
December 31, 1998............... -- -- -- 761 761 761
------
Total comprehensive income........ -- -- -- -- $1,508 --
======
Dividends declared on common
stock........................... -- -- -- (538) (538)
Other............................. -- -- (7) -- (7)
--------- ------- ------- ------- ------ -------
BALANCE, DECEMBER 31, 1998........ 869,680 -- 532 223 755
Net income........................ -- -- -- 1,342 $1,342 1,342
Other comprehensive income, net of
taxes........................... -- -- -- 222 222 222
------
Total comprehensive income........ -- -- -- -- $1,564 --
======
Dividends declared on common
stock........................... -- -- -- (1,188) (1,188)
Common stock issuances............ 5,790 -- 124 -- 124
--------- ------- ------- ------- ------ -------
BALANCE, DECEMBER 31, 1999........ 875,470 -- 656 599 1,255
Net loss.......................... -- -- -- (81) $ (81) (81)
Other comprehensive loss, net of
taxes........................... -- -- -- (248) (248) (248)
------
Total comprehensive loss.......... -- -- -- -- $ (329) --
======
Issuance of shares in connection
with Merger..................... 775,175 -- 40,020 -- 40,020
Dividends declared on common
stock........................... -- -- -- (272) (272)
Common stock issuances............ 21,574 -- 630 -- 630
--------- ------- ------- ------- ------ -------
BALANCE, DECEMBER 31, 2000........ 1,672,219 $ -- $41,306 $ (2) $41,304
========= ======= ======= ======= ====== =======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
8
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998
NOTE 1: BUSINESS AND BACKGROUND
Qwest Communications International Inc. ("Qwest" or the "Company") is a
leading broadband Internet communications company incorporated under the laws of
the State of Delaware.
Merger. On June 30, 2000, Qwest completed its merger (the "Merger") with U
S WEST, Inc. ("U S WEST"). U S WEST was deemed the accounting acquirer and its
historical financial statements have been carried forward as those of the newly
combined company. In connection with the Merger, each outstanding share of U S
WEST common stock was converted into the right to receive 1.72932 shares of
Qwest common stock. In addition, all outstanding U S WEST stock options were
converted into options to acquire Qwest common stock. All share and per share
amounts have been restated to give retroactive effect to the exchange ratio.
The Merger has been accounted for as a reverse acquisition under the
purchase method of accounting with U S WEST being deemed the accounting acquirer
and Qwest the acquired entity. The total value of the consideration was
approximately $40 billion, which has been allocated to the identifiable tangible
and intangible assets and liabilities of Qwest. The preliminary purchase price
allocation was as follows: (i) $8.0 billion to tangible assets and liabilities,
net; (ii) $4.1 billion to identified intangibles, including product technology,
customer lists, tradenames and assembled workforce; and (iii) $27.9 billion to
goodwill. The amounts allocated to identifiable intangible assets and goodwill
are being amortized over periods ranging from 3 to 40 years. The allocation of
purchase price is preliminary and may change upon completion of an appraisal
currently being performed on the acquired assets and liabilities of Qwest. The
effect of any such change is not expected to be material.
The results of operations for Qwest prior to the Merger are not reflected
in the accompanying consolidated statements of operations. Following is the
results of operations for Qwest for the periods prior to the Merger:
<Table>
<Caption>
YEAR ENDED
DECEMBER 31, JANUARY 1, THRU
--------------- JUNE 30,
1998 1999 2000
------ ------ ---------------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE AMOUNT)
Revenues.............................................. $2,243 $3,928 $2,499
Operating expenses:
Operating expenses.................................. 1,948 3,168 2,007
Depreciation and amortization....................... 202 404 247
Merger costs........................................ 847 32 87
------ ------ ------
Total operating expenses.................... 2,997 3,604 2,341
------ ------ ------
(Loss) earnings from operations....................... (754) 324 158
Other expense (income) -- net......................... 96 (260) 36
------ ------ ------
(Loss) earnings before income taxes................... (850) 584 122
Income tax (benefit) expense.......................... (6) 125 102
------ ------ ------
Net (loss) income..................................... $ (844) $ 459 $ 20
====== ====== ======
(Loss) earnings per share:
Basic............................................... $(1.51) $ 0.63 $ 0.03
Diluted............................................. $(1.51) $ 0.60 $ 0.03
</Table>
F-8
9
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following unaudited pro forma results of operations are presented
assuming the Merger had been completed on January 1, 1999:
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
----------------------
2000 1999
--------- ---------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE
AMOUNTS)
Revenues.................................................... $18,954 $16,594
Net (loss) income........................................... (531) 492
Diluted (loss) earnings per share........................... $ (0.32) $ 0.30
</Table>
Pro forma diluted loss per share for the year ended December 31, 2000
excludes approximately 38 million incremental shares attributable to options due
to their anti-dilutive effect as a result of the pro forma loss for that period.
For the year ended December 31, 2000, Qwest incurred Merger-related and
other charges totaling $1.752 billion. A breakdown of these costs is as follows:
<Table>
<Caption>
2000
---------------------
(DOLLARS IN MILLIONS)
Contractual settlements and terminations........... $ 654
Merger bonuses and severance costs................. 443
Write-off of access lines.......................... 226
Termination of software development projects....... 114
Post-retirement benefit plan curtailment gain...... (106)
Other Merger-related costs and charges............. 421
------
Total Merger-related and other charges... $1,752
======
</Table>
Contractual settlements and termination losses of $654 million represent
the costs incurred to cancel various commitments no longer deemed necessary as a
result of the Merger and to settle various claims related to the Merger.
In connection with the Merger, management identified a workforce reduction
of over 4,500 employees primarily to eliminate duplicate functions. These
employees were terminated prior to December 31, 2000. Of these, 1,078 employees
voluntarily separated without receiving benefit packages. A severance charge of
$341 million relates to the employees involuntarily separated during fiscal
2000. Merger bonuses of $102 million represent bonus payments triggered by the
successful completion of the Merger.
The Company leases dedicated special-purpose access lines to Competitive
Local Exchange Carriers ("CLECs"). Given current industry conditions and
regulatory changes affecting CLECs, the Company evaluated those leased assets
for impairment. The Company concluded that the fair value of those assets was
minimal and took a $226 million charge. The assets are operated by the Company's
wholesale services segment.
Following the Merger, management reviewed all internal software projects in
process, and determined that certain projects should no longer be pursued.
Because the projects were incomplete and abandoned, the fair value of such
incomplete software was determined to be zero and $114 million of capitalized
software costs were written off. The abandoned projects included a significant
billing system replacement and a customer database system.
Other costs of $421 million include legal charges related to the Merger,
professional fees, re-branding costs, relocation costs and other costs related
to the integration of the two companies.
F-9
10
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Offsetting the Merger-related costs was a $106 million post-retirement
benefit plan curtailment gain. This gain resulted from the post-Merger
termination of retiree medical benefits for all former U S WEST employees that
did not have 20 years of service by December 31, 2000, or would not be service
pension eligible by December 31, 2003.
A summary of Merger-related costs accrued at June 30, 2000, and subsequent
charges against those accruals follows:
<Table>
<Caption>
JANUARY 1, DECEMBER 31,
2000 CURRENT CURRENT 2000
BALANCE PROVISION UTILIZATION BALANCE
---------- --------- ----------- ------------
(DOLLARS IN MILLIONS)
Contractual settlements and terminations...... $-- $ 654 $359 $295
Merger bonuses and severance costs............ 443 313 130
Other accrued costs........................... -- 185 87 98
--- ------ ---- ----
Total accrued costs at Merger
date.............................. $-- 1,282 $759 $523
=== ==== ====
Asset impairment charges...................... 340
Charges incurred subsequent to the Merger..... 130
------
Total Merger-related and other
charges........................... $1,752
======
</Table>
Management anticipates that the majority of the Merger-related accruals
will be paid by June 30, 2001.
In connection with the Merger, U S WEST and Global Crossing Ltd. ("Global
Crossing") agreed to terminate their merger agreement. In consideration for
terminating the merger agreement, U S WEST paid Global Crossing $140 million in
cash and 2,231,076 shares (that U S WEST previously purchased in the open
market) of Global Crossing common stock for which U S WEST paid $140 million.
These termination payments, together with costs of approximately $2 million,
were charged to other expense in 1999. Qwest also agreed to purchase $140
million in services from Global Crossing over four years at the best
commercially available prices offered by Global Crossing. As of December 31,
2000, Qwest had purchased $135 million in services under this agreement.
U S WEST Separation. On June 12, 1998, U S WEST's former parent company
(the "Parent"), separated into two independent companies (the "Separation").
Prior to the Separation, the Parent conducted its business through two groups:
(i) the U S WEST Communications Group (the "Communications Group"), which
included the communications businesses of U S WEST, and (ii) the U S WEST Media
Group (the "Media Group"), which included the multimedia and directories
businesses. As part of the Separation, the Parent contributed to U S WEST the
businesses of the Communications Group and the domestic directories business of
the Media Group known as U S WEST Dex, Inc. ("Dex"). The Parent continued to
operate as an independent public company comprised of the businesses of the
Media Group other than Dex and was renamed MediaOne, Inc.
In connection with the transfer of Dex to U S WEST: (i) the Parent
distributed to holders of Media Group common stock, approximately 28,786,000
shares of U S WEST common stock with an aggregate value of $850 million; and
(ii) U S WEST refinanced $3.9 billion of debt formerly allocated to the Media
Group (the "Dex Indebtedness").
Certain financial effects of the Separation, including interest expense
associated with refinancing the Dex Indebtedness and the dilutive effect of the
issuance of shares to Media Group shareholders for Dex, are not reflected in the
accompanying historical consolidated statements of operations prior to the
Separation. In addition, for the period from January 1, 1998 to June 12, 1998,
the consolidated financial statements include an allocation of certain costs,
expenses, assets and liabilities from the Parent to U S WEST. The amount of
costs allocated were not necessarily indicative of the costs that would have
been incurred if U S WEST had operated as a stand-alone company.
F-10
11
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The accompanying consolidated financial statements
include the accounts of the Company and all material majority-owned
subsidiaries. All significant intercompany amounts and transactions have been
eliminated.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts and disclosures reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Reclassifications. Certain prior year balances have been reclassified to
conform to the current year presentation.
Change in Accounting Principle. Prior to 1999, Qwest Dex, Inc. ("Qwest
Dex") recognized revenues and expenses related to publishing directories using
the "deferral method," under which revenues and expenses were recognized over
the lives of the directories, generally one year. Effective in the fourth
quarter of 1999, Qwest Dex changed to the "point of publication method" of
accounting, under which the Company recognizes revenues and expenses at the time
the directory is published. This change in methodology was made to better align
Qwest Dex's revenue and expense recognition with the earnings process and to
better reflect the operating activity of the business. The change in accounting
principle resulted in a one-time increase in net income of $240 million (net of
income tax of $153 million), or $0.27 per diluted share, which is reported as
the cumulative effect (as of January 1, 1999) of a change in accounting
principle. The Company restated its 1999 quarterly results of operations to give
effect to the point of publication method which increased net income by $13
million, or $0.01 per diluted share. On a restated basis, use of the point of
publication method would have increased net income in 1998 by $12 million, or
$0.01 per diluted share.
Revenue Recognition. Revenues are recognized when services are provided.
Payments received in advance are deferred until the service is provided.
Up-front fees received are deferred and recognized over the longer of the
contractual period or the expected customer relationship, generally 2 to 10
years. The fees include activation fees and installation charges.
Occasionally, the Company sells capacity on its network to other
telecommunication providers. Sales of capacity are accounted for as either
sales-type leases, operating leases or service agreements depending upon the
terms of the transaction. Revenues related to sales of capacity that meet the
criteria of a sales-type lease are recognized at the time of delivery of the
capacity to the customer. If title is not transferred or if the other
requirements for sales-type lease accounting are not met, revenue is recognized
ratably over the term of the agreement.
Advertising Costs. Costs related to advertising are generally expensed as
incurred. Advertising expense was $470 million, $308 million and $263 million in
2000, 1999 and 1998, respectively.
Income Taxes. The provision for income taxes consists of an amount for
taxes currently payable and an amount for tax consequences deferred to future
periods.
Unrealized Holding Gain (Loss) on Equity Securities. The Company's equity
investments in certain publicly traded companies are recorded at fair market
value. Realized gains and losses on securities are determined on the specific
identification method.
Cash and Cash Equivalents. Cash and cash equivalents include highly liquid
investments with original maturities of three months or less that are readily
convertible into cash and are not subject to significant risk from fluctuations
in interest rates. Fair values of cash, cash equivalents and current amounts
receivable and payable approximate carrying values due to their short-term
nature.
F-11
12
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Inventories. Inventories held for sale (primarily wireless handsets) are
carried at the lower of cost or market on a first-in, first-out basis.
Inventories used internally are carried at average cost, except for significant
individual items that are valued based upon specific costs.
Property, Plant and Equipment. Property, plant and equipment is carried at
cost and is depreciated using straight-line group methods. Generally, under the
group method, when an asset is sold or retired, the cost is deducted from
property, plant and equipment and charged to accumulated depreciation without
recognition of a gain or loss. Leasehold improvements are amortized over the
lesser of the useful lives of the assets or the lease term. Expenditures for
maintenance and repairs are expensed as incurred. Network construction costs,
including interest during construction, are capitalized.
Valuation of Long-Lived Assets. The Company assesses the impairment of
long-lived assets whenever changes in circumstances indicate that their carrying
value may not be recoverable. If the total expected future cash flows or salvage
value is less than the carrying value of the asset, the asset is written down to
its fair value.
Customer Acquisition Costs. The Company defers the initial direct cost of
obtaining a customer to the extent there is sufficient revenue guaranteed under
the arrangement to ensure the realizability of the capitalized costs. Deferred
customer acquisition costs are amortized over the expected life of the customer
relationship.
Intangibles. Intangible assets arising from business combinations are
amortized on a straight-line basis over their estimated useful lives. The
components of intangibles are as follows:
<Table>
<Caption>
DECEMBER 31,
--------------
ESTIMATED LIFE 2000 1999
-------------- ------- ----
(DOLLARS IN MILLIONS)
Goodwill.............................................. 40 years $27,923 $ --
Product technology.................................... 10 years 2,200 --
Customer list......................................... 10 years 1,200 --
Assembled workforce................................... 3 years 100 --
Tradename............................................. 40 years 600 --
Other................................................. 5 to 40 years 950 533
------- ----
32,973 533
Less: accumulated amortization........................ (646) (32)
------- ----
Goodwill and other intangible assets -- net........... $32,327 $501
======= ====
</Table>
Computer Software. Internally used software, whether purchased or
developed, is capitalized and amortized over an estimated useful life of 5
years. Capitalized computer software costs of $1.173 billion and $618 million at
December 2000 and 1999, respectively, are recorded in Other Assets. Amortization
of capitalized computer software costs totaled $269 million, $108 million and
$84 million in 2000, 1999 and 1998, respectively. During 2000, $114 million of
capitalized computer software costs were written-off due primarily to the
abandonment of a significant billing system replacement project and a customer
database system project. This charge is included in Merger-related and other
charges.
F-12
13
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accrued Expenses and Other Current Liabilities. Accrued expenses and other
current liabilities consist of the following:
<Table>
<Caption>
DECEMBER 31,
---------------------
2000 1999
--------- ---------
(DOLLARS IN MILLIONS)
Accrued interest............................................ $ 318 $ 207
Employee compensation....................................... 644 439
Accrual for Merger-related costs............................ 523 --
Dividends payable........................................... -- 271
Accrued property taxes...................................... 79 218
Other....................................................... 2,242 705
------ ------
Total accrued expenses and other current
liabilities..................................... $3,806 $1,840
====== ======
</Table>
Derivative Instruments. The Company, from time to time, enters into
derivative financial instruments. The objective of the Company's interest rate
risk management program is to obtain the minimum total cost of debt over time
consistent with an acceptable level of interest rate volatility. This objective
was achieved in 2000 through the type of debt issued and cross-currency swaps
that convert foreign-denominated debt to U.S. dollar-denominated debt.
Under a cross-currency swap, the Company agrees with another party to
exchange U.S. dollars for foreign currency based on a notional amount, at
specified intervals over a defined term. Cross-currency swaps are accounted for
using synthetic instrument accounting if the index, maturity and amount of the
instruments match the terms of the underlying debt. Under synthetic instrument
accounting, the cross-currency swaps and the foreign currency debt are combined
and accounted for as if U.S. dollar-denominated debt was issued directly.
Beginning January 1, 2001, the Company began accounting for cross-currency swaps
under Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities." Under SFAS No. 133, the
Company will carry the swap at fair market value on the balance sheet. Future
changes in the fair value of the cross-currency swaps that meet the criteria for
hedge accounting will be recorded in accumulated other comprehensive income.
The Company also entered into equity swaps to modify its risk exposure to
changes in the market price of the Global Crossing common stock previously owned
by the Company. Under these equity swaps, the Company agreed with another party
to exchange payments based on a notional amount at specific intervals over a
defined term. In exchange for making payments based upon an interest rate index,
the Company received (rendered) payments based upon increases (decreases) in the
market price of Global Crossing common stock. Qwest sold its remaining shares of
Global Crossing in 2000; however, the equity swaps remained outstanding as of
December 31, 2000. These swaps, which mature in 2001, are carried at fair value
on the balance sheet with any change in fair value recognized in earnings.
F-13
14
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the terms of outstanding cross-currency and
equity swaps at December 31, 2000 and 1999. Cross-currency swaps are tied to the
Swiss Franc and have a fair value (liability) of $(40) million and $(36) million
at December 31, 2000 and 1999, respectively. Amounts received on the equity
swaps are tied to changes in the market price of Global Crossing common shares
and paid rates are tied to one- and three-month London Interbank Offered Rates.
Equity collars have also been entered into in conjunction with the equity swaps
to limit the magnitude of any gains or losses on the equity swaps.
<Table>
<Caption>
DECEMBER 31, 2000 DECEMBER 31, 1999
----------------------------------------- -----------------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
RATE RATE
NOTIONAL ----------------- NOTIONAL -----------------
AMOUNT MATURITIES RECEIVE PAY AMOUNT MATURITIES RECEIVE PAY
-------- ---------- -------- ------ -------- ---------- -------- ------
(DOLLARS IN MILLIONS)
Cross-currency........... $133 2001 -- 6.51% $ 133 2001 -- 6.51%
Equity................... 761 2001 -- 7.17% 1,140 2001 -- 6.41%
</Table>
In the event Qwest is owed money under the swap agreements, the Company
could be exposed to risk in the event of nonperformance by counterparties. Qwest
does not require any collateral from these counterparties. The Company manages
this exposure by monitoring the credit standing of the counterparties and
establishing dollar and term limitations that correspond to the respective
credit rating of each counterparty.
At December 31, 2000, deferred credits of $7 million and deferred charges
of $48 million on closed forward contracts are included as part of the carrying
value of the underlying debt. The deferred credits and charges are recognized as
yield adjustments over the life of the debt that matures at various dates
through 2043.
Stock Options. Stock incentive plans are accounted for using the intrinsic
value method under which no compensation expense is recognized for options
granted to employees with a strike price that equals or exceeds the value of the
underlying security on the measurement date.
Comprehensive Income. Comprehensive income includes the following
components:
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
-------------
2000 1999
----- -----
(DOLLARS IN
MILLIONS)
Unrealized (losses) gains on marketable securities, net of
reclassification adjustments.............................. $(397) $ 366
Foreign translation losses.................................. (7) --
Income tax benefit (provision) related to items of other
comprehensive income...................................... 156 (144)
----- -----
Other comprehensive (loss) income........................... $(248) $ 222
===== =====
</Table>
Reclassification adjustments for gains and losses included in income
consisted of the following:
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
-------------
2000 1999
----- -----
(DOLLARS IN
MILLIONS)
Realized net gains (losses) included in income.............. $ 292 $(454)
Other than temporary loss charged to income................. (480) --
Income tax benefit related to items reclassified into
income.................................................... 66 176
----- -----
Total reclassification adjustments................ $(122) $(278)
===== =====
</Table>
F-14
15
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Earnings Per Share. The following reflects the computation of diluted
shares outstanding for 2000, 1999 and 1998. Diluted shares outstanding for the
year ended December 31, 2000 excludes approximately 21 million incremental
shares related to stock options. These shares were excluded due to their
anti-dilutive effect as a result of Qwest's net loss for the year ended December
31, 2000.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
--------- ------- -------
(SHARES IN THOUSANDS)
Basic weighted average shares.......................... 1,272,088 872,309 854,967
Stock options.......................................... -- 8,444 7,614
--------- ------- -------
Diluted weighted average shares........................ 1,272,088 880,753 862,581
========= ======= =======
</Table>
New Accounting Standards. On June 15, 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS No. 133 requires, among other things, that all
derivative instruments be recognized at fair value as assets or liabilities in
the consolidated balance sheets with changes in fair value recognized currently
in earnings unless specific hedge accounting criteria are met. The adoption of
SFAS No. 133 on January 1, 2001 did not have a material impact on the Company's
financial statements.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." SAB No. 101 requires, in certain cases, nonrefundable up-front fees
for services to be deferred and recognized over the expected period of
performance. SAB No. 101 also permits the direct costs incurred in obtaining the
customer to be deferred and recognized over the expected life of the customer
relationship. The Company adopted SAB No. 101 in the fourth quarter of fiscal
2000, with effect from January 1, 2000. There was no cumulative effect on
earnings from the adoption of SAB No. 101.
NOTE 3: INVESTMENTS
Investment in Qwest Digital Media, LLC. In September 1999, Qwest and
Anschutz Digital Media, Inc. ("ADMI"), an affiliate of Qwest's principal
stockholder, Anschutz Company, entered into an agreement to form a venture named
Qwest Digital Media, LLC ("QDM," formerly known as Slingshot Networks, LLC) to
provide advanced digital production, post-production and transmission
facilities, digital media storage and distribution services, telephony-based
data storage and enhanced services, access and routing services. Qwest has
contributed an $85 million promissory note payable over nine years at an annual
interest rate of 6 percent and purchased a 25 percent interest in QDM from ADMI
for a $43 million, 8 percent note payable in January 2001. In January 2001,
Qwest repaid the $43 million note and obtained control over QDM. Qwest will
consolidate QDM beginning in fiscal 2001.
Investment in KPNQwest, N.V. In April 1999, Qwest and KPN Telecom B.V.
("KPN") formed a joint venture ("KPNQwest") to create a pan-European IP-based
fiber optic network, linked to Qwest's network in North America, for data and
multimedia services. Qwest and KPN each initially owned 50 percent of KPNQwest.
On November 12, 1999, KPNQwest consummated an initial public offering
("KPNQwest's IPO") whereby 50.6 million shares of common stock were issued
generating approximately $1.0 billion in proceeds. As a result of KPNQwest's
IPO, the public owns approximately 11 percent of KPNQwest's shares and the
remainder are owned equally by Qwest and KPN. Qwest's investment in KPNQwest is
accounted for under the equity method.
F-15
16
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Below are the summarized financial results for KPNQwest as of and for the
year ended December 31, 2000 and as of and for the nine months ended December
31, 1999.
<Table>
<Caption>
DECEMBER 31,
----------------------
2000 1999
--------- ---------
(DOLLARS IN MILLIONS)
Total assets................................................ $2,717 $2,575
Total liabilities........................................... 1,506 1,170
Revenue..................................................... 425 199
Loss from operations........................................ 201 76
Net loss.................................................... $ 128 $ 62
</Table>
The Company's share of KPNQwest's losses was $34 million in 2000. At
December 31, 2000, KPNQwest had a market capitalization of $8.55 billion.
Other. The Company's equity investments in other publicly traded companies
consisted of the following (dollars in millions):
<Table>
<Caption>
DECEMBER 31, 2000 DECEMBER 31, 1999
------------------------------------------- -------------------------------------------
UNREALIZED UNREALIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
---- ---------- ---------- ---------- ---- ---------- ---------- ----------
$90 $30 $(62) $58 $842 $533 $(167) $1,208
=== === ==== === ==== ==== ===== ======
</Table>
NOTE 4: PROPERTY, PLANT AND EQUIPMENT
The components of property, plant and equipment are as follows:
<Table>
<Caption>
DECEMBER 31,
DEPRECIABLE ---------------------
LIVES 2000 1999
----------- --------- ---------
(DOLLARS IN MILLIONS)
Land and buildings.......................................... 30-38 years $ 3,473 $ 2,535
Communications equipment.................................... 2-14 years 18,319 15,828
Other network equipment..................................... 8-57 years 19,273 15,021
General purpose computers and other......................... 5-11 years 3,755 3,396
Construction in progress.................................... -- 3,498 1,346
-------- --------
48,318 38,126
Less: accumulated depreciation.............................. (22,735) (21,722)
-------- --------
Property, plant and equipment -- net........................ $ 25,583 $ 16,404
======== ========
</Table>
Capitalized Interest. Interest related to qualifying construction projects
is capitalized and included in the depreciable basis of the asset being built.
Amounts capitalized were $151 million, $27 million and $25 million in 2000, 1999
and 1998, respectively.
Leasing Arrangements. Certain office facilities, real estate and equipment
are subject to operating leases. Rent expense under operating leases for 2000,
1999 and 1998 was $528 million, $269 million and $210 million, respectively. At
December 31, 2000, the future minimum rental payments under noncancelable
operating leases for the years 2001 through 2005 and thereafter are $316
million, $242 million, $219 million, $227 million, $195 million and $959
million, respectively.
Assets Held for Sale. During 1999 and 2000, the Company committed to sell
approximately 800,000 access lines within the 14-state local service area. In
1999, definitive sales agreements were reached for the sale of 570,000 lines for
approximately $1.8 billion in cash, subject to adjustment. In 2000, the sale of
20,000 access
F-16
17
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
lines in North Dakota and South Dakota were consummated resulting in proceeds of
$19 million and gains of $11 million. The transfer of ownership of the remaining
access lines, which will occur on a state-by-state basis, is expected to be
completed by the first quarter of 2002. The pending sales are subject to
regulatory approvals and other customary closing conditions.
The Company has also identified bandwidth capacity on its existing network
that is held for sale or lease to telecommunications providers and others. This
capacity was recorded at fair value, less estimated costs to sell, in connection
with the Merger.
NOTE 5: BORROWINGS
Current Borrowings
Current borrowings consist of:
<Table>
<Caption>
DECEMBER 31,
----------------------
2000 1999
--------- ---------
(DOLLARS IN MILLIONS)
Commercial paper............................................ $2,106 $1,265
Short-term notes and current portion of long-term
borrowings................................................ 1,539 1,617
------ ------
Total current borrowings.......................... $3,645 $2,882
====== ======
</Table>
The weighted average interest rate on commercial paper was 7.33 percent and
6.53 percent at December 31, 2000 and 1999, respectively.
Qwest maintains commercial paper programs to finance the purchase of
telecommunications assets. The Company also enters into lines of credit as
backup facilities in issuing commercial paper. At December 31, 2000, Qwest had a
$4.0 billion syndicated credit facility that expires in May of 2001. As of
December 31, 2000, there was no outstanding balance. The syndicated credit
facility agreement requires Qwest to pay a quarterly fee based upon the
Company's long-term debt agency ratings. The facility fee on the total credit
facility available ranges from 0.07 percent to 0.08 percent.
Long-term Borrowings
Long-term borrowings consist principally of debentures and medium-term
notes with the following interest rates and maturities at December 31:
<Table>
<Caption>
MATURITIES
------------------------------------------
INTEREST RATES 2002 2003 2004 2005 THEREAFTER TOTAL 2000 TOTAL 1999
- -------------- ------ ------ ---- ---- ---------- ---------- ----------
(DOLLARS IN MILLIONS)
Up to 5%......................... $ 100 $ 50 $ -- $ -- $ -- $ 150 $ 150
Above 5% to 6%................... -- -- 100 41 390 531 579
Above 6% to 7%................... 750 43 -- 899 3,579 5,271 6,611
Above 7% to 8%................... 299 1,062 750 -- 5,979 8,090 2,367
Above 8% to 9%................... -- -- -- -- 630 630 243
Above 9% to 10%.................. -- -- -- -- 473 473 --
Above 10% to 11%................. -- -- -- -- 162 162 --
------ ------ ---- ---- ------- ------- -------
$1,149 $1,155 $850 $940 $11,213 15,307 9,950
====== ====== ==== ==== =======
Capital lease obligations........ 224 115
Other............................ (110) 124
------- -------
Total.................. $15,421 $10,189
======= =======
</Table>
F-17
18
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's borrowings have a fair value of $18.4 billion and $12.1
billion at December 31, 2000 and 1999, respectively. The fair values of the
Company's borrowings are based on quoted market prices where available or, if
not available, based on discounting future cash flows using current interest
rates.
Interest paid by the Company, net of amounts capitalized, was $964 million,
$595 million and $640 million in 2000, 1999 and 1998, respectively.
Indentures for certain notes contain covenants that, among other things,
limit the ability of the Company and certain of its subsidiaries (the
"Restricted Subsidiaries") to issue preferred stock, pay dividends or make other
distributions, repurchase capital stock or subordinated indebtedness, create
liens, enter into transactions with affiliates, sell assets of the Company or
its Restricted Subsidiaries, issue or sell capital stock of the Company's
Restricted Subsidiaries or enter into mergers and consolidations.
NOTE 6: EMPLOYEE BENEFITS
Pension, Post-retirement and Other Post-employment Benefits
Qwest has a noncontributory defined benefit pension plan (the "Pension
Plan") for substantially all management and occupational employees and
post-retirement healthcare and life insurance plans for retirees. The Company
also provides post-employment benefits for certain former employees.
Prior to the Separation, U S WEST participated in the defined benefit
pension plan and post-retirement healthcare and life insurance plans sponsored
by its Parent. Accordingly, the Company's financial statements for periods prior
to the Separation reflect an allocation of costs from the Parent for its
employees and retirees. On June 12, 1998, U S WEST assumed sponsorship of the
Parent's benefit plans.
In conjunction with the Merger, the Company made the following changes to
its employee benefit plans. Effective September 7, 2000, employees will not be
eligible to receive retiree medical and life benefits unless they had either at
least 20 years of service by December 31, 2000 or will be service pension
eligible by December 31, 2003. The elimination of the retiree medical benefits
decreased the other post-employment benefits expense for 2000 by approximately
$17 million. In addition, the elimination is accounted for as a plan
curtailment, resulting in a one-time gain of approximately $106 million. This
gain was recorded as an offset to Merger-related costs. The plan was also
changed for all future retirees. Employees who retained the benefits will begin
paying contributions in 2004 except for those employees who retired prior to
September 7, 2000.
Qwest also modified the pension plan benefits, effective January 1, 2001,
for all former U S WEST management employees who did not have 20 years of
service by December 31, 2000, or who will not be service pension eligible by
December 31, 2003. For employees who do not meet this criteria, the years of
service credited under the defined lump sum formula were frozen; the benefit
will be adjusted for future compensation levels. Future benefits will equal 3
percent of pay, plus a return as defined in the plan. All management employees,
other than those who remain eligible under the previous formulas, will be
eligible to participate in the 3-percent-of-pay plan.
Effective August 11, 2000, the Pension Plan was amended to provide
additional pension benefits to plan participants who are involuntarily separated
from the Company between August 11, 2000, and June 30, 2001. The amount of the
benefit is based on pay and service and ranges from a minimum of four months up
to a maximum of one year of an employee's base pay.
Pension benefits for management employees prior to January 1, 2001 were
based upon their salary and years of service while occupational employee
benefits were generally based upon job classification and years of service.
Pension and post-retirement costs are recognized over the period in which the
employee renders services and becomes eligible to receive benefits as determined
by using the projected unit credit method. Qwest's funding policy is to make
contributions with the objective of accumulating sufficient assets to pay all
benefits when due. No pension funding was required in 2000, 1999 or 1998.
F-18
19
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the pension and post-retirement benefit (credit) cost are
as follows:
<Table>
<Caption>
PENSION COST YEAR POST-RETIREMENT BENEFIT COST
ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------- ------------------------------
2000 1999 1998 2000 1999 1998
------- ----- ----- -------- -------- --------
(DOLLARS IN MILLIONS)
Service cost.......................... $ 182 $ 203 $ 189 $ 49 $ 70 $ 72
Interest cost......................... 702 658 639 337 326 319
Expected return on plan assets........ (1,068) (935) (852) (271) (229) (213)
Amortization of transition asset...... (79) (79) (79) -- -- --
Amortization of prior service cost.... 2 2 2 12 20 19
Plan curtailment...................... -- -- -- (106) -- --
Recognized net actuarial gain......... (58) -- -- (107) (28) (30)
------- ----- ----- ----- ----- -----
Net (credit) cost..................... $ (319) $(151) $(101) $ (86) $ 159 $ 167
======= ===== ===== ===== ===== =====
</Table>
The actuarial assumptions used to compute the pension and post-retirement
benefit (credit) cost are as follows:
<Table>
<Caption>
PENSION POST-RETIREMENT
YEAR ENDED BENEFITS YEAR ENDED
DECEMBER 31, DECEMBER 31,
------------------ ---------------------
2000 1999 1998 2000 1999 1998
---- ---- ---- ----- ----- -----
(IN PERCENT)
Weighted average discount rate................ 8.00% 6.75% 7.00% 8.00% 6.75% 7.00%
Weighted average rate of compensation
increase.................................... 4.65% 4.65% 5.50% N/A N/A N/A
Expected long-term rate of return on plan
assets...................................... 9.40% 8.80% 8.50% 9.40% 8.80% 8.50%
</Table>
Following is a reconciliation of the benefit obligation for the pension and
post-retirement plans:
<Table>
<Caption>
POST-RETIREMENT
PENSION COST YEAR BENEFIT COST YEAR
ENDED DECEMBER 31, ENDED DECEMBER 31,
------------------ ------------------
2000 1999 2000 1999
------ ------ ------ ------
(DOLLARS IN MILLIONS)
Benefit obligation at beginning of year..... $8,877 $9,622 $4,344 $4,825
Service cost................................ 182 203 49 70
Interest cost............................... 702 658 337 326
Actuarial loss (gain)....................... 513 (884) 301 (690)
Plan amendments............................. -- -- (169) 4
Special termination benefits................ 27 -- -- --
Plan curtailment............................ -- -- (106) --
Benefits paid............................... (831) (722) (256) (191)
------ ------ ------ ------
Benefit obligation at end of year........... $9,470 $8,877 $4,500 $4,344
====== ====== ====== ======
</Table>
F-19
20
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following is a reconciliation of the change in the fair value of plan
assets for the pension and post-retirement plans:
<Table>
<Caption>
POST-RETIREMENT
PENSION YEAR ENDED BENEFIT YEAR ENDED
DECEMBER 31, DECEMBER 31,
------------------- ------------------
2000 1999 2000 1999
-------- -------- ------- -------
(DOLLARS IN MILLIONS)
Fair value of plan assets at beginning of
year.......................................... $14,593 $12,925 $2,886 $2,604
Actual return on plan assets.................... (78) 2,509 (68) 575
Net employer withdrawals........................ -- -- (245) (212)
Divestitures.................................... -- (8) -- (1)
Section 420 transfer............................ (90) (111) 90 111
Benefits paid................................... (831) (722) (256) (191)
------- ------- ------ ------
Fair value of plan assets at year end........... $13,594 $14,593 $2,407 $2,886
======= ======= ====== ======
</Table>
In December 2000 and 1999, under provisions of Section 420 of the Internal
Revenue Code, $90 million and $111 million, respectively, of pension assets were
transferred to the post-retirement benefit plan to pay for current year retiree
health care benefits. In 2000 and 1999, $300 million and $230 million,
respectively, of Life Insurance and Welfare Trust assets were transferred to the
Company to pay for employee welfare benefits.
The following table represents the funded status of the pension and
post-retirement plans:
<Table>
<Caption>
POST-RETIREMENT
PENSION YEAR ENDED BENEFIT YEAR ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
(DOLLARS IN MILLIONS)
Funded (unfunded) status........................ $ 4,124 $ 5,716 $(2,093) $(1,458)
Unrecognized net actuarial gain................. (2,922) (4,640) (730) (1,479)
Unamortized prior service (benefit) cost........ -- 2 (58) 125
Balance of unrecognized transition asset........ (308) (387) -- --
------- ------- ------- -------
Prepaid (accrued) benefit cost.................. $ 894 $ 691 $(2,881) $(2,812)
======= ======= ======= =======
</Table>
The actuarial assumptions used to compute the funded (unfunded) status for
the plans are as follows:
<Table>
<Caption>
POST-RETIREMENT
PENSION YEAR BENEFIT YEAR
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------ ----------------
2000 1999 2000 1999
---- ---- ------ ------
(IN PERCENT)
Weighted average discount rate.......................... 7.75% 8.00% 7.75% 8.00%
Weighted average rate of compensation increase.......... 4.65% 4.65% N/A N/A
</Table>
F-20
21
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For measurement purposes, an 8 percent annual rate of increase in the
healthcare cost trend rate for 2000 is assumed. The healthcare cost trend rate
is assumed to gradually decline to an ultimate rate of 5 percent in 2011. A one
percent change in the assumed healthcare cost trend rate would have had the
following effects in 2000:
<Table>
<Caption>
ONE PERCENT CHANGE
---------------------
INCREASE DECREASE
--------- ---------
(DOLLARS IN MILLIONS)
Effect on the aggregate of the service and interest cost
components of net periodic post-retirement benefit cost... $ 30 $ (26)
Effect on accumulated post-retirement benefit obligation.... 257 (240)
</Table>
On January 5, 2001, Qwest announced an agreement with its major unions, the
Communications Workers of America and the International Brotherhood of
Electrical Workers, to extend the existing union contracts for another two
years, through August of 2003. The extensions include a 3.5 percent wage
increase in 2001, a 5 percent wage increase in 2002, a 6 percent pension
increase in 2002, and a 10 percent pension increase in 2003. These changes are
not reflected in either the pension or post-retirement benefit computations for
the periods December 31, 2000, 1999 and 1998 presented above.
NOTE 7: INCOME TAXES
The components of the provision for income taxes are as follows:
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
---------------------
2000 1999 1998
----- ----- -----
(DOLLARS IN MILLIONS)
FEDERAL:
Current................................................... $(23) $530 $685
Deferred.................................................. 196 156 90
---- ---- ----
173 686 775
STATE AND LOCAL:
Current................................................... 11 45 108
Deferred.................................................. 23 69 28
---- ---- ----
34 114 136
---- ---- ----
Provision for income taxes.................................. $207 $800 $911
==== ==== ====
</Table>
Qwest paid $115 million, $472 million and $678 million for income taxes in
2000, 1999 and 1998, respectively.
F-21
22
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The effective tax rate differs from the statutory tax rate as follows:
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
-------------------
2000 1999 1998
----- ---- ----
Federal statutory tax rate.................................. 35.0% 35.0% 35.0%
State income taxes -- net of federal effect................. 3.4 3.5 3.7
Goodwill amortization....................................... 107.4 -- --
Non-deductible Merger-related charges....................... 46.2 5.7 --
KPNQwest loss............................................... 10.7 -- --
ESOP dividend............................................... (9.4) (0.9) (0.6)
Other....................................................... (29.0) (1.2) (0.4)
----- ---- ----
Effective tax rate.......................................... 164.3% 42.1% 37.7%
===== ==== ====
</Table>
The components of the net deferred tax liability are as follows:
<Table>
<Caption>
DECEMBER 31,
---------------------
2000 1999
-------- --------
(DOLLARS IN MILLIONS)
Property, plant and equipment............................... $1,677 $1,955
Intangible assets........................................... 1,447 --
State deferred taxes -- net of federal effect............... 406 293
Investments................................................. -- 128
Revenue recognition......................................... 447 208
Other....................................................... 135 35
------ ------
Deferred tax liabilities.................................. 4,112 2,619
------ ------
Net operating loss carryforward............................. 933 --
Investments................................................. 25 --
Post-retirement benefits -- net of pension.................. 717 776
State deferred taxes -- net of federal effect............... 243 165
Other....................................................... 498 533
------ ------
Deferred tax assets....................................... 2,416 1,474
------ ------
Net deferred tax liability.................................. $1,696 $1,145
====== ======
</Table>
As of December 31, 2000, Qwest had operating loss carryforwards of $2.7
billion that will expire between 2003 and 2020. Management believes it is more
likely than not that future taxable income will be sufficient to fully recover
the existing net deferred tax asset associated with the net operating loss
carryforward.
The Company's investment in its foreign corporate joint venture, KPNQwest,
is essentially permanent in duration. As a result, Qwest has not recorded
deferred income taxes related to its investment in KPNQwest. The amount of
unrecorded deferred income taxes at December 31, 2000, was $2.8 billion. The
temporary differences would become taxable upon the sale of KPNQwest or if
earnings were repatriated into the United States.
The Company had unamortized investment tax credits of $154 million and $160
million as of December 31, 2000 and 1999.
F-22
23
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8: STOCKHOLDERS' EQUITY
Common Stock ($0.01 par value). In conjunction with the Separation on June
12, 1998, the Parent redeemed each issued and outstanding share of
Communications Group stock (other than shares of Communications Group stock held
as treasury stock) for one share of U S WEST common stock. Each share of
Communications Group stock held as treasury stock by the Parent was cancelled.
For presentation purposes, Communications Group stock shares outstanding prior
to June 12, 1998, are shown as U S WEST shares. Also for presentation purposes,
in connection with the Merger, shares outstanding have been adjusted to reflect
the conversion rate of 1.72932 Qwest shares for every U S WEST share.
Preferred Stock. Under the Company's charter, the Board of Directors has
the authority, without shareholder approval, to create one or more classes or
series within a class of preferred stock, to issue shares of preferred stock in
such class or series up to the maximum number of shares of the relevant class or
series of preferred stock authorized, and to determine the preferences, rights,
privileges and restrictions of any such class or series, including the dividend
rights, voting rights, the rights and terms of redemption, the rights and terms
of conversion, liquidation preferences, the number of shares constituting any
such class or series and the designation of such class or series. Acting under
this authority, the Company's Board of Directors could create and issue a class
or series of preferred stock with rights, privileges or restrictions, and adopt
a shareholder rights plan, having the effect of discriminating against an
existing or prospective holder of securities as a result of such shareholder
beneficially owning or commencing a tender offer for a substantial amount of the
Company's common stock. One of the effects of authorized but unissued and
unreserved shares of capital stock may be to render more difficult or discourage
an attempt by a potential acquirer to obtain control of the Company by means of
a merger, tender offer, proxy contest or otherwise, and thereby protect the
continuity of the Company's management. The issuance of such shares of capital
stock may have the effect of delaying, deferring or preventing a change in
control of the Company without any further action by the shareholders of the
Company. The Company has no present intention to adopt a shareholder rights
plan, but could do so without shareholder approval at any future time.
As of December 31, 2000, there were no shares of preferred stock issued and
outstanding.
Dividends. Qwest declared dividends of $0.31 and $1.36 per share of common
stock during 2000 and 1999, respectively.
Stock Options. Prior to the Merger, U S WEST adopted stock plans under
which the Company could grant awards in the form of stock options, stock
appreciation rights, restricted stock and phantom units, as well as substitute
stock options and restricted stock awards. In connection with the Merger, all
outstanding options prior to the Merger announcement have vested. Options
granted after that date and prior to June 30, 2000 continue to vest according to
the vesting requirements in the plan.
F-23
24
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Summarized below is the activity of the U S WEST plans prior to the Merger:
<Table>
<Caption>
NUMBER OF WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
(IN THOUSANDS)
Outstanding January 1, 1998............................... 30,469 $18.06
Granted................................................. 16,582 29.38
Exercised............................................... (4,289) 13.32
Canceled or expired..................................... (1,211) 21.39
------ ------
Outstanding December 31, 1998............................. 41,551 22.23
Granted................................................. 21,736 31.20
Exercised............................................... (5,205) 18.62
Canceled or expired..................................... (2,056) 23.38
------ ------
Outstanding December 31, 1999............................. 56,026 25.52
Granted................................................. 10,830 41.20
Exercised............................................... (7,586) 18.80
Canceled or expired..................................... (6,822) 36.27
------ ------
Outstanding June 30, 2000 (Merger date)................... 52,448 $29.64
====== ======
</Table>
Options to purchase 33.9 million shares, 22.7 million shares and 10.2
million shares of U S WEST (accounting acquirer) common stock at weighted
average per share exercise prices of $26.67, $19.94 and $17.43, were exercisable
at June 30, 2000, December 31, 1999 and December 31, 1998, respectively.
On June 23, 1997, Qwest adopted the Equity Incentive Plan, which was
amended and restated on June 1, 1998. This plan permits the grant of
non-qualified stock options, incentive stock options, stock appreciation rights,
restricted stock, stock units and other stock grants. The maximum number of
shares of common stock that may be issued under the Equity Incentive Plan at any
time pursuant to awards is equal to 10% of the aggregate number of common shares
issued and outstanding (determined as of the close of trading on the New York
Stock Exchange on the preceding trading day). As of December 31, 2000, the
maximum number of shares available was 167 million.
The Company's Compensation Committee determines the exercise price for each
option; however, stock options must have an exercise price that is at least
equal to the fair market value of the common stock on the date the stock option
is granted, subject to certain restrictions. Stock option awards generally vest
in equal increments over a five-year period, and awards granted under the Equity
Incentive Plan will immediately vest upon any change in control of the Company,
as defined, unless provided otherwise by the Compensation Committee at the time
of grant. Options granted in 2000, 1999 and 1998 have terms ranging from six to
ten years.
F-24
25
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Summarized below is the activity of the Qwest (acquired entity for
accounting purposes) plans prior to the Merger and combined Qwest activity
subsequent to the Merger:
<Table>
<Caption>
NUMBER OF WEIGHTED AVERAGE
SHARES EXERCISE PRICE
-------------- ----------------
(IN THOUSANDS)
Outstanding January 1, 1998............................. 27,892 $ 7.95
Granted............................................... 26,278 16.84
Assumed in connection with LCI merger................. 31,540 8.32
Exercised............................................. (23,314) 6.83
Canceled or expired................................... (2,094) 13.29
------- ------
Outstanding December 31, 1998........................... 60,302 12.02
Granted............................................... 35,262 31.69
Exercised............................................. (13,827) 9.68
Canceled or expired................................... (12,826) 17.12
------- ------
Outstanding December 31, 1999........................... 68,911 21.48
Granted............................................... 41,698 45.52
U S WEST options converted upon Merger................ 52,448 29.64
Exercised............................................. (20,834) 16.21
Canceled or expired................................... (12,145) 34.65
------- ------
Outstanding December 31, 2000........................... 130,078 $32.19
======= ======
</Table>
Options to purchase 22.7 million and 10.2 million shares of Qwest common
stock (the acquired entity for accounting purposes) at weighted average exercise
prices of $19.94 and $17.43 were exercisable at December 31, 1999 and 1998,
respectively.
The outstanding options at December 31, 2000 have the following
characteristics (shares in thousands):
<Table>
<Caption>
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
------------------------------------ ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE(YEARS) PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
$ 0.00-$19.00.................... 22,640 6.35 $12.06 16,470 $12.28
$19.01-$29.00.................... 27,648 7.83 25.75 14,082 23.62
$29.01-$33.00.................... 20,322 8.18 30.49 12,403 30.14
$33.01-$42.00.................... 28,605 8.90 38.73 9,536 38.09
$42.01-$49.00.................... 20,369 9.62 46.43 224 45.07
$49.01-$60.00.................... 10,494 9.50 50.40 18 49.92
------- ---- ------ ------ ------
Total.................. 130,078 8.28 $32.19 52,733 $24.33
======= ==== ====== ====== ======
</Table>
F-25
26
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Had the Company accounted for employee stock option grants under the fair
value method prescribed by SFAS No. 123, "Accounting for Stock-Based
Compensation," the pro forma results would have been as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999 1998
------- ------- -------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE AMOUNTS)
Net (loss) income:
As reported............................................... $ (81) $1,342 $1,508
Pro forma................................................. (167) 1,293 1,479
(Loss) earnings per share:
As reported -- basic...................................... $(0.06) $ 1.54 $ 1.76
As reported -- diluted.................................... (0.06) 1.52 1.75
Pro forma -- basic........................................ (0.13) 1.48 1.73
Pro forma -- diluted...................................... (0.13) 1.47 1.71
</Table>
Following are the weighted average assumptions used with the Black-Scholes
option-pricing model to estimate the fair value of options granted during 2000,
1999 and 1998:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------
2000 1999 1998
------ ------ -----
Risk-free interest rate................................... 6.0% 5.6% 5.5%
Expected dividend yield................................... 1.0% 0.0% 4.2%
Expected option life (years).............................. 4.7 4.0 4.0
Expected stock price volatility........................... 52.6% 57.0% 22.9%
Weighted average grant date fair value.................... $23.03 $27.87 $8.75
</Table>
Approximately 31 million shares of common stock were available for grant at
December 31, 2000. Approximately 75 million shares of common stock were reserved
for issuance at December 31, 2000.
Employee Stock Purchase Plan. In October 1998, Qwest (the acquired entity
for accounting purposes) instituted an Employee Stock Purchase Plan ("ESPP").
The Company is authorized to issue approximately 1.6 million shares of Qwest
common stock to eligible employees. Under the terms of the ESPP, eligible
employees may authorize payroll deductions of up to 15% of their base
compensation, as defined, to purchase Qwest common stock at a price of 85% of
the fair market value of the Qwest common stock on the last trading day of the
month in which the Qwest common stock is purchased. Shares purchased prior to
the Merger were 253,766 in 2000; 443,242 in 1999 and 21,134 in 1998. Shares
purchased subsequent to the Merger were 349,868 in 2000.
Growth Share Plan. Qwest (the acquired entity for accounting purposes) had
a Growth Share Plan for certain of its employees and directors. A "Growth Share"
is a unit of value based on the increase in value of Qwest over a specified
measurement period. Upon vesting, settlement of each Growth Share is made in
Qwest common stock. All Growth Share grants have been made based on a beginning
Qwest value that was greater than or equal to the fair value of Qwest at the
grant date.
Prior to the Merger, Qwest recognized approximately $3.5 million, $6
million and $9 million of expense for the Growth Share Plan in 2000, 1999 and
1998, respectively. Subsequent to the Merger, the Company recognized $3.5
million of expense in 2000.
F-26
27
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the activity of the number of shares of
Qwest common stock allocated for the settlement of outstanding Growth Shares:
<Table>
<Caption>
NUMBER OF
SHARES
---------
December 31, 1997 outstanding balance..................... 625,426
1998 settlements........................................ (65,472)
--------
December 31, 1998 outstanding balance..................... 559,954
1999 settlements........................................ (37,516)
--------
December 31, 1999 outstanding balance..................... 522,438
2000 settlements........................................ (165,715)
--------
December 31, 2000 outstanding balance..................... 356,723
========
</Table>
Due to the Merger, all Growth Shares were vested at December 31, 2000 and
approximately $29 million was included in other liabilities related to
outstanding Growth Shares. In the first quarter of 2001, the Company issued
approximately 357,000 shares of Qwest common stock in settlement of all
remaining vested Growth Shares.
NOTE 9: COMMITMENTS AND CONTINGENCIES
Commitments
Take-or-Pay Contracts. In July 1999, the Company and Global Crossing
entered into a purchase agreement under which Qwest agreed to purchase services
from Global Crossing over a four-year period in a total amount of $140 million.
This agreement was entered into in connection with the termination of the
U S WEST and Global Crossing merger. At the end of the two-year period following
the signing of the agreement, Qwest must pay Global Crossing an amount equal to
the difference between $140 million and the amount of services purchased under
the agreement at that time. The amount of the differential payment will be
credited by Global Crossing against all purchases by Qwest of services from
Global Crossing during the remaining two years of the agreement. Under the
agreement, Qwest is entitled to purchase services on any of Global Crossing's
network segments at the most favorable commercially available prices offered by
Global Crossing. As of December 31, 2000, Qwest had purchased $135 million in
services under this agreement.
Qwest CyberCenters (SM). In March 2000, Qwest and IBM Global Services
("IBM") formed a strategic business alliance to deliver next-generation
e-business services and applications through the construction and activation of
CyberCenters throughout North America. IBM, as the contractor, will build and
provide operational support for 28 CyberCenters for Qwest. IBM will lease
hosting space in these CyberCenters and will purchase telecommunications
services from Qwest, with the total revenue expected to be approximately $2.5
billion over the seven-year term of the agreement. Under this alliance, Qwest
agreed to purchase equipment and services from IBM, as contractor, over a
seven-year period, which combined with the construction services, is expected to
be approximately $2.5 billion. As of December 31, 2000, Qwest had purchased $26
million in equipment and services under this agreement.
Minimum Usage Requirements. The Company has agreements with certain
telecommunications inter-exchange carriers ("IXCs") and third party vendors that
require the Company to maintain minimum monthly and/or annual billings based on
usage. The Company has historically met all requirements and believes the
minimum usage commitments will continue to be met.
Contingencies
Litigation. In January 2001, an amended purported class action complaint
was filed against Qwest and certain current and former officers and directors on
behalf of stockholders of U S WEST. The complaint alleges
F-27
28
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
that Qwest has a duty to pay a quarterly dividend to U S WEST stockholders of
record as of June 30, 2000. Plaintiffs further claim that the defendants'
efforts to close the Merger in advance of the record date and the defendants'
failure to pay the dividend breaches fiduciary duties owed to stockholders of U
S WEST. Qwest has filed a motion to dismiss the complaint, which is pending.
Through December 2000, seven purported class action complaints have been
filed in various state courts against Qwest and U S WEST on behalf of customers
in the states of Arizona, Colorado, Minnesota, New Mexico, Oregon, Utah and
Washington. The complaints allege, among other things, that from 1993 to the
present, U S WEST, in violation of alleged statutory and common law obligations,
willfully delayed the provision of local telephone service to the purported
class members. In addition, the complaints allege that U S WEST misrepresented
the date on which such local telephone service was to be provided to the
purported class members. The complaints seek compensatory damages for purported
class members, disgorgement of profits and punitive damages. As of November 11,
2000, the parties have signed agreements to settle the complaints. The
agreements are subject to a variety of conditions, including court approval.
In April 1999, CSX Transportation, Inc. filed a complaint in federal
district court in Jacksonville, Florida against Qwest claiming breach of a 1995
contract. Discovery in the case is ongoing and the trial is scheduled to
commence in October 2001.
Through December 2000, several purported class actions have been filed in
various state courts against Qwest on behalf of landowners in Georgia, Indiana,
Kansas, Louisiana, Missouri, Oregon, Tennessee and Texas. The complaints
challenge Qwest's right to install its fiber optic cable network in railroad
rights-of-way. The complaints allege that the railroads own a limited property
right-of-way that did not include the right to permit Qwest to install its fiber
optic cable network on the plaintiffs' property. The Indiana action purports to
be on behalf of a national class of landowners adjacent to railroad
rights-of-way over which the Qwest network passes; the Georgia, Kansas,
Louisiana, Missouri, Oregon, Tennessee and Texas actions purport to be on behalf
of a class of such landowners in Georgia, Kansas, Louisiana, Missouri, Oregon,
Tennessee and Texas, respectively. The complaints seek damages on theories of
trespass and unjust enrichment, as well as punitive damages. The Company
received, and may in the future receive, additional claims and demands that may
be based on similar or different legal theories.
From March 2, 2000 to March 9, 2000, five purported class action complaints
were filed against Qwest in state court in Delaware on behalf of Qwest
stockholders. The complaints allege that Qwest and its directors breached their
fiduciary duty by entering into the Merger and by agreeing not to solicit
alternative transactions. Since the filing of the complaints, there has been no
discovery or other activity in the cases.
On March 17, 2000, and March 20, 2000, two class action complaints were
filed in federal district court in Delaware against Qwest and Joseph Nacchio on
behalf of U S WEST stockholders. The complaints allege, among other things, that
Qwest and Mr. Nacchio made material false statements regarding Qwest's intent to
solicit an alternative transaction to the Merger. Since the filing of the
complaints, there has been no discovery or other activity in the cases.
In 1999, 12 purported class action complaints were filed against U S WEST
and its directors on behalf of U S WEST stockholders. Each of the complaints
allege that the defendants breached their fiduciary duties to the class members
by refusing to seek all bona fide offers for U S WEST and refusing to consider
the Qwest proposal. Since the filing of the complaints, there has been no
discovery or other activity in the cases.
Various other litigation matters have been filed against Qwest. Management
intends to vigorously defend these outstanding claims.
Qwest has provided for the above matters in its financial statements as of
December 31, 2000. The Company does not expect any material adverse impacts in
excess of such provision as a result of the ultimate resolution of these
matters.
F-28
29
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intellectual Property. Qwest frequently receives offers to take licenses
for patent and other intellectual rights, including rights held by competitors
in the telecommunications industry, in exchange for royalties or other
substantial consideration. Qwest also regularly receives allegations that Qwest
products or services infringe upon various intellectual property rights,
together with demands that Qwest discontinue the alleged infringement. The
Company normally investigates such offers and allegations and responds
appropriately, including defending itself vigorously when appropriate. There can
be no assurance that, if one or more of these allegations proved to have merit
and involved significant rights or royalties, it would not have a material
adverse effect on Qwest.
Contingent Payment Arrangements. In connection with the Merger, Qwest was
required to divest transport services between local access and transport areas
("LATAs") within U S WEST's 14-state region local service area. In June 2000,
the Company sold its interLATA customer base, along with other assets. Under the
terms of the agreement, the purchase price paid is subject to adjustment for
revenue fluctuations during the 90 days subsequent to the agreement date.
Depending on certain circumstances, the revenue adjustment may not be settled
until the end of the first quarter 2001. Qwest does not expect the adjustment,
if any, to have a material adverse impact on its consolidated results of
operations or financial position.
Regulatory Matters. Qwest has pending regulatory actions in local
regulatory jurisdictions which call for price decreases, refunds or both. These
actions are generally routine and incidental to Qwest's business.
From time to time, Qwest receives complaints and becomes subject to
investigations regarding tarriffs, "slamming" (the practice of changing
long-distance carriers without the customer's consent) and other matters. In
2000, the California Public Utilities Commission opened an investigation
relating to certain slamming complaints. A purported class action complaint was
filed in federal court in Connecticut containing slamming allegations. The
Attorney General of Connecticut has also filed a similar complaint in state
court in Connecticut. Qwest may receive complaints or become subject to
investigations in the future. Such complaints or investigations could result in
the imposition of certain fines and other penalties.
NOTE 10: SEGMENT INFORMATION
Qwest operates in four segments: retail services, wholesale services,
network services and directory services. The retail services segment provides
local telephone services, long-distance services, wireless services and data
services. The wholesale services segment provides (i) exchange access services
that connect customers to the facilities of IXCs and (ii) interconnection to the
Qwest telecommunications network to CLECs. The network services segment provides
access to the Qwest telecommunications network, including Qwest's information
technologies, primarily to the Company's retail services and wholesale services
segments. The directory services segment publishes White and Yellow Pages
telephone directories and provides electronic directory and other information
services. Qwest provides the majority of its services to more than 25 million
residential and business customers in Arizona, Colorado, Idaho, Iowa, Minnesota,
Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah,
Washington and Wyoming.
Following is a breakout of the Company's segments. The accounting policies
used are the same as those used in the consolidated financial statements. The
"other" category includes unallocated corporate expenses and
F-29
30
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
revenues. Beginning in fiscal 2000, Qwest internally tracks only the assets and
capital expenditures of its Directory Services segment. Reconciling items
include unallocated assets and capital expenditures.
<Table>
<Caption>
TOTAL
COMMUNICATIONS
RETAIL WHOLESALE NETWORK AND RELATED DIRECTORY RECONCILING
SERVICES SERVICES SERVICES SERVICES SERVICES OTHER ITEMS COMBINED
-------- --------- -------- -------------- --------- ----- ----------- --------
(DOLLARS IN MILLIONS)
2000
External revenues...... $11,913 $3,194 $ 353 $15,460 $1,546 $ -- (396) $16,610
Intersegment
revenues............. 121 -- 99 220 15 -- (235) --
EBITDA(1).............. 7,236 2,523 (2,962) 6,797 896 (322) -- 7,371
Assets................. -- -- -- -- 829 -- 72,672 73,501
Capital expenditures... -- -- -- -- 41 -- 6,556 6,597
1999
External revenues...... 9,022 2,871 242 12,135 1,446 -- (399) 13,182
Intersegment
revenues............. 87 -- 60 147 10 -- (157) --
EBITDA................. 6,111 2,157 (2,793) 5,475 741 (116) -- 6,100
Assets................. -- -- -- -- 819 -- 22,453 23,272
Capital expenditures... 587 111 3,199 3,897 48 (1) -- 3,944
1998
External revenues...... 8,556 2,590 214 11,360 1,277 -- (242) 12,395
Intersegment
revenues............. 28 -- 70 98 10 -- (108) --
EBITDA................. 6,194 1,908 (2,776) 5,326 657 (234) -- 5,749
Assets................. -- -- -- -- 524 -- 17,883 18,407
Capital expenditures... 362 -- 2,143 2,505 42 125 -- 2,672
</Table>
- ---------------
(1) Earnings before interest, income taxes, depreciation and amortization
("EBITDA") does not include non-recurring and non-operating items such as
Merger costs, asset write-offs and impairments, gains/losses on the sale of
investments and fixed assets, changes in the market values of investments,
one-time legal charges, in-region long-distance activity, Qwest construction
activity, Separation charges, regulatory accruals and sales of local
telephone exchanges. EBITDA does not represent cash flow for the periods
presented and should not be considered as an alternative to net earnings
(loss) as an indicator of the Company's operating performance or as an
alternative to cash flows as a source of liquidity, and may not be
comparable with EBITDA as defined by other companies.
A reconciliation from Segment EBITDA to pre-tax income follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------
2000 1999 1998
------ ------ ------
(DOLLARS IN MILLIONS)
Segment EBITDA............................................. $7,371 $6,100 $5,749
Less:
Separation costs........................................... -- -- 129
Merger-related and other charges........................... 1,752 -- --
Other expense -- net....................................... 1,697 1,435 630
Taxes other than income taxes.............................. 454 396 372
Depreciation and amortization.............................. 3,342 2,367 2,199
------ ------ ------
Pre-tax income............................................. $ 126 $1,902 $2,419
====== ====== ======
</Table>
F-30
31
QWEST COMMUNICATIONS INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11: QUARTERLY FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
QUARTERLY FINANCIAL DATA
-------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(DOLLARS IN MILLIONS)
2000
Revenues.................................................. $3,377 $3,450 $4,765 $5,018
Net income (loss)......................................... 404 (121) (248) (116)
Earnings (loss) per share:
Basic................................................... 0.46 (0.14) (0.15) (0.07)
Diluted................................................. 0.45 (0.14) (0.15) (0.07)
1999
Revenues.................................................. $3,168 $3,227 $3,296 $3,491
Net income................................................ 634 406 136 166
Earnings per share:
Basic................................................... 0.73 0.47 0.16 0.19
Diluted................................................. 0.72 0.46 0.15 0.19
</Table>
NOTE 12: SUBSEQUENT EVENTS
In January 2001, Qwest repurchased 22.22 million shares of its common stock
from BellSouth Corporation ("BellSouth") for $1.0 billion in cash. The
repurchased shares will be available to satisfy the Company's obligations under
its employee benefits and options programs. As part of the transaction,
BellSouth agreed to purchase $250 million in services from Qwest over the next
five years. BellSouth will pay for these services in shares of Qwest common
stock.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The United States market for trading in Qwest common stock is the New York
Stock Exchange. As of March 5, 2001, the Company's common stock was held by
approximately 491,036 stockholders of record.
<Table>
<Caption>
MARKET PRICE
----------------------------------
PER SHARE MARKET AND DIVIDEND DATA HIGH LOW CLOSE DIVIDENDS(1)
---------------------------------- -------- ------------ -------- ------------
2000
First quarter........................... $79.0000 $65.1250 $72.6250 $0.5350
Second quarter(2)....................... 91.0000 66.0000 85.7500 0.0000
Third quarter........................... 57.8750 43.5000 48.1250 0.0000
Fourth quarter.......................... 51.4375 32.3750 40.8750 0.0000
1999
First quarter........................... $65.6250 $53.3125 $55.0625 $0.5350
Second quarter.......................... 62.2500 51.5625 58.7500 0.7500
Third quarter........................... 60.2500 51.7500 57.0625 0.5350
Fourth quarter.......................... 73.0000 57.0000 72.0000 0.5350
</Table>
- ---------------
(1) The decrease in 2000 dividends was due to a change in the Company's dividend
policy after the merger between Qwest and U S WEST
(2) The merger between Qwest and U S WEST was effective June 30, 2000. The stock
prices prior to June 30, 2000 reflect the price of U S WEST common stock. On
June 30, 2000, each share of U S WEST common stock was converted into the
right to receive 1.72932 shares of Qwest common stock and cash in lieu of
fractional shares.
F-31