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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-3040
U S WEST COMMUNICATIONS, INC.
A COLORADO CORPORATION IRS EMPLOYER NO.
84-0273800
1801 CALIFORNIA STREET, DENVER, COLORADO 80202
TELEPHONE NUMBER (303) 896-3099
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Securities registered pursuant to Section 12 (b) of the Act:
None
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Securities registered pursuant to Section 12 (g) of the Act:
None
THE REGISTRANT, AN INDIRECT, WHOLLY-OWNED SUBSIDIARY OF U S WEST, INC.,
MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1) (a) AND (b) OF FORM
10-K AND IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT
TO GENERAL INSTRUCTION I(2).
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. ***
*** Not applicable in that registrant is an indirect, wholly owned subsidiary.
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U S WEST COMMUNICATIONS, INC.
FORM 10-K
TABLE OF CONTENTS
ITEM DESCRIPTION PAGE
------------------------------------------------------------------------------ ----
PART I
1. Business.................................................................. 1
2. Properties................................................................ 1
3. Legal Proceedings......................................................... 2
4. Submission of Matters to a Vote of Security Holders....................... 2
PART II
5. Market for the Registrant's Common Equity and Related Stockholder
Matters................................................................. 2
6. Selected Financial Data................................................... 2
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 2
7A. Quantitative and Qualitative Disclosures About Market Risk................ 2
8. Consolidated Financial Statements and Supplementary Data.................. 2
9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.............................................................. 2
PART III
10. Directors and Executive Officers of the Registrant........................ 2
11. Executive Compensation.................................................... 2
12. Security Ownership of Certain Beneficial Owners and Management............ 2
13. Certain Relationships and Related Transactions............................ 2
PART IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........... 3
i
U S WEST COMMUNICATIONS, INC.
FORM 10-K
PART I
ITEM 1. BUSINESS.
GENERAL
U S WEST Communications, Inc. (the "Company") is incorporated under the laws
of the State of Colorado and has its principal offices at 1801 California
Street, Denver, Colorado 80202, telephone number (303) 896-3099. The Company is
an indirect, wholly owned subsidiary of U S WEST, Inc. ("U S WEST").
COMPANY OPERATIONS
The Company primarily provides telecommunications services to more than 25
million residential and business customers in the Company's 14 state region (the
"Region"). The Region includes the states of Arizona, Colorado, Idaho, Iowa,
Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota,
Utah, Washington and Wyoming.
The principal types of telecommunications services offered by the Company
are: (i) local exchange telephone services, (ii) exchange access services (which
connects customers to the facilities of carriers, including long-distance
providers and wireless operators), and (iii) long-distance services within Local
Access and Transport Areas ("LATAs") in the Region. For the year ended December
31, 1997, local service, exchange access service and intraLATA long-distance
network service accounted for 50 percent, 34 percent and 9 percent,
respectively, of the total operating revenues of the Company. At December 31,
1997, the Company had approximately 16,033,000 telephone network access lines in
service, a 3.9 percent increase over year-end 1996. Excluding the effect of the
sales of approximately 74,000 rural telephone access lines during 1997, access
lines increased 4.4 percent over year-end 1996. In 1997, revenues from a single
customer, AT&T Corp. ("AT&T"), accounted for 10 percent of the total operating
revenues of the Company. In addition, the Company is constructing wireless
networks in its principal markets within the Company's Region and began offering
wireless personal communications services ("PCS") in various markets in 1997.
ITEM 2. PROPERTIES.
The properties of the Company do not lend themselves to description by
character and location of principal units. At December 31, 1997, the percentage
distribution of total net telephone plant by major category for the Company was
as follows:
a. Connecting lines not on customers' premises.................... 39%
Telephone network equipment (primarily central office
b. equipment)................................................... 40%
c. Land and buildings (occupied principally by central offices)... 12%
d. General purpose computers and other............................ 9%
At December 31, 1997, substantially all of the installations of central
office equipment were located in buildings owned by the Company situated on land
which it owns in fee, while many garages, and administrative and business
offices were in leased quarters.
Total investment in telephone plant increased to $33.2 billion at December
31, 1997, from $32.5 billion at December 31, 1996, after giving effect to
retirements, but before deducting accumulated depreciation. The Company's 1997
capital expenditures of $2.6 billion were substantially devoted to the continued
modernization of telephone plant, to improve customer services, to accommodate
additional line capability
1
in several states and to enter the wireless business. 1998 capital expenditures
are anticipated to be $2.6 billion and the majority of these are expected to be
financed through internally generated funds.
ITEM 3. LEGAL PROCEEDINGS.
With respect to lawsuits, proceedings and other claims pending at year end,
it is the opinion of management that after final disposition, any monetary
liability or financial impact to the Company beyond that provided at year end,
would not be material to the consolidated financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Not applicable.
ITEM 6. SELECTED FINANCIAL DATA.
Omitted pursuant to General Instruction I(2).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Omitted pursuant to General Instruction I(2). See "Management's Analysis of
the Results of Operations." Reference is made to the information set forth on
pages 6 through 13.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
See "Management's Analysis of Results of Operation -- Other Items -- Risk
Management." Reference is made to the information set forth on page 11.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Reference is made to the information set forth on pages 16 through 30.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Omitted pursuant to General Instruction I(2).
ITEM 11. EXECUTIVE COMPENSATION.
Omitted pursuant to General Instruction I(2).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Omitted pursuant to General Instruction I(2).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Omitted pursuant to General Instruction I(2).
2
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report
PAGE
----------------
(1) Reports of Independent Accountants................................................ 14 through 15
(2) Consolidated Financial Statements and Supplementary Data
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995............................................ 16
Consolidated Balance Sheets as of December 31, 1997 and 1996...................... 17
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995............................................ 18
Notes to Consolidated Financial Statements........................................ 19 through 30
(3) Consolidated Financial Statement Schedule
II -- Valuation and Qualifying Accounts........................................... 31
Financial statement schedules other than those listed above have been omitted because the required information
is contained in the Consolidated Financial Statements and notes thereto, or because such schedules are not
required or applicable.
(b) Reports on Form 8-K:
U S WEST Communications filed the following reports on Form 8-K during
the fourth quarter of 1997:
(1) None.
(c) Exhibits:
Exhibits identified in parentheses below, on file with the United States
Securities and Exchange Commission ("SEC"), are incorporated herein by
referenced as exhibits hereto.
EXHIBIT
NUMBER
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(2a) Articles of Merger including the Plan of Merger between The Mountain States Telephone and
Telegraph Company (renamed U S WEST Communications, Inc.) and Northwestern Bell Telephone Company.
(Incorporated herein by this reference to Exhibit 2a to Form SE filed on January 8, 1991, File No.
1-3040).
(2b) Articles of Merger including the Plan of Merger between The Mountain States Telephone and
Telegraph Company (renamed U S WEST Communications, Inc.) and Pacific Northwest Bell Telephone
Company. (Incorporated herein by this reference to Exhibit 2b to Form SE filed on January 8, 1991,
File No. 1-3040).
3a Restated Articles of Incorporation of the Registrant.
3b Bylaws of the Registrant, as amended.
4 No instrument which defines the rights of holders of long and intermediate term debt of the
Registrant is filed herewith pursuant to Regulation S-K, Item 601(b) (4) (iii) (A). Pursuant to
this regulation, the Registrant hereby agrees to furnish a copy of any such instrument to the SEC
upon request.
3
EXHIBIT
NUMBER
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(10a) Reorganization and Divestiture Agreement dated as of November 1, 1983, between American Telephone
and Telegraph Company, U S WEST Inc., and certain of their affiliated companies, including The
Mountain States Telephone and Telegraph Company, Northwestern Bell Telephone Company, Pacific
Northwest Bell Telephone Company and NewVector Communications, Inc. (Exhibit 10a to Form 10-K for
the period ended December 31, 1983, File No. 1-3040).
(10b) Shared Network Facilities Agreement dated as of January 1, 1984, between American Telephone and
Telegraph Company, AT&T Communications of the Midwest, Inc. and The Mountain States Telephone and
Telegraph Company. (Exhibit 10b to Form 10-K for the period ended December 31, 1983, File No.
1-3040).
(10c) Agreement Concerning Termination of the Standard Supply Contract effective December 31, 1983,
between American Telephone and Telegraph Company, Western Electric Company, Incorporated, The
Mountain States Telephone and Telegraph Company and Central Services Organization (Exhibit 10d to
Form 10-K for the period ended December 31, 1983, File No. 1-3040).
(10d) Agreement Concerning Certain Centrally Developed Computer Systems effective December 31, 1983,
between American Telephone and Telegraph Company, Western Electric Company, Incorporated, The
Mountain States Telephone and Telegraph Company and Central Services Organization (Exhibit 10e to
Form 10-K for the period ended December 31, 1983, File No. 1-3040).
(10e) Agreement Concerning Patents, Technical Information and Copyrights effective December 31, 1983,
between American Telephone and Telegraph Company and U S WEST, Inc. (Exhibit 10f to Form 10-K for
the period ended December 31, 1983, File No. 1-3040).
(10f) Agreement Concerning Liabilities, Tax Matters and Termination of Certain Agreements dated as of
November 1, 1983, between American Telephone and Telegraph Company, U S WEST, Inc., The Mountain
States Telephone and Telegraph Company and certain of their affiliates (Exhibit 10g to Form 10-K
for the period ended December 31, 1983, File No. 1-3040).
(10g) Agreement Concerning Trademarks, Trade Names and Service Marks effective December 31, 1983,
between American Telephone and Telegraph Company, American Information Technologies Corporation,
Bell Atlantic Corporation, BellSouth Corporation, Cincinnati Bell, Inc., NYNEX Corporation,
Pacific Telesis Group, The Southern New England Telephone Company, Southwestern Bell Corporation
and U S WEST, Inc. (Exhibit 10i to Form 10-K for the period ended December 31, 1984, File No.
1-3040).
(10h) Shareholders' Agreement dated as of January 1, 1988, between Ameritech Services, Inc., Bell
Atlantic Management Services, Inc., BellSouth Services, Incorporated, NYNEX Service Company,
Pacific Bell, Southwestern Bell Telephone Company, The Mountain States Telephone and Telegraph
Company, Northwestern Bell Telephone Company and Pacific Northwest Bell Telephone Company (Exhibit
10h to Form SE dated March 5, 1992, File No. 1-3040).
12 Computation of Ratio of Earnings to Fixed Charges.
23 Consent of Independent Accountants.
24 Power of Attorney.
27 Financial Data Schedule.
4
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Denver,
State of Colorado, on March 25, 1998.
U S WEST COMMUNICATIONS, INC.
By: /s/ ALLAN R. SPIES
-----------------------------------------
Allan R. Spies
VICE PRESIDENT AND CHIEF
FINANCIAL OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in capacities and on the date indicated.
PRINCIPAL EXECUTIVE OFFICER:
/s/ Solomon D. Trujillo* President and Chief
Executive Officer
PRINCIPAL FINANCIAL OFFICER:
/s/ Allan R. Spies Vice President and Chief
Financial Officer
CONTROLLER:
/s/ Oscar X. Munoz* Vice President --
Controller
DIRECTORS:
/s/ Michael P. Glinsky*
/s/ Allan R. Spies
/s/ Solomon D. Trujillo*
*By /s/ THOMAS O. MCGIMPSEY
-------------------------
Thomas O. McGimpsey
(AS ATTORNEY-IN-FACT)
Dated: March 25, 1998
5
U S WEST COMMUNICATIONS, INC.
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS
(DOLLARS IN MILLIONS)
Some of the information presented in or in connection with this report
constitutes "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Although the Company believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. Factors that could
cause actual results to differ from expectations include: (i) greater than
anticipated competition from new entrants into the local exchange, intraLATA
toll and wireless markets; (ii) changes in demand for the Company's products and
services, including optional custom calling features; (iii) higher than
anticipated employee levels, capital expenditures, and operating expenses (such
as costs associated with year 2000 remediation); (iv) the loss of significant
customers; (v) pending regulatory actions in state jurisdictions; (vi)
regulatory changes affecting the telecommunications industry, including changes
that could have an impact on the competitive environment in the local exchange
market; (vii) a change in economic conditions in the various markets served by
the Company's operations; (viii) greater than anticipated competitive activity
requiring new pricing for services; (ix) higher than anticipated start-up costs
associated with new business opportunities; or (x) delays in the development of
anticipated technologies, or the failure of such technologies to perform
according to expectations.
THE RECAPITALIZATION
In 1995, U S WEST divided its businesses into two groups: U S WEST
Communications Group (the "Communications Group") and U S WEST Media Group (the
"Media Group") and created two separate classes of common stock under a
recapitalization plan. One class of stock, U S WEST Communications Group Common
Stock (the "Communications Stock"), reflects the performance of the
communications businesses comprising the Communications Group, and the other
class of stock, U S WEST Media Group Common Stock (the "Media Stock"), reflects
the performance of the multimedia businesses comprising the Media Group.
Effective November 1, 1995, each share of common stock of U S WEST was converted
into one share each of Communications Stock and Media Stock.
THE SEPARATION
On October 25, 1997, the Board of Directors of U S WEST adopted a proposal
to separate U S WEST into two independent companies (the "Separation"). As a
result of the Separation, the Communications Group will become an independent
public company and will be renamed "U S WEST, Inc." ("New U S WEST"). In
addition, the Media Group's directory business known as U S WEST Dex, Inc.
("Dex") will be aligned with New U S WEST (the "Dex Alignment"). The assets of
New U S WEST will be accounted for at the historical values at which they were
carried by U S WEST prior to the Separation. Following the Separation, U S WEST
will continue as an independent public company comprised of the current
businesses of Media Group other than Dex and will be renamed "MediaOne Group,
Inc." ("MediaOne").
The Separation will be implemented pursuant to the terms of a separation
agreement between U S WEST and New U S WEST (the "Separation Agreement"). Under
the Separation Agreement, U S WEST will redeem each issued and outstanding share
of Communications Stock (other than shares of Communications Stock held as
treasury stock by U S WEST) for one share of New U S WEST Common Stock, and each
outstanding share of Media Stock will remain outstanding and will thereafter
represent one share of MediaOne Common Stock. Each share of Media Stock held as
treasury stock by U S WEST will remain outstanding as one share of MediaOne
Common Stock held as treasury stock by MediaOne.
6
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (CONTINUED)
In connection with the Dex Alignment, (i) U S WEST will distribute, as a
dividend, an aggregate of $850 in value of New U S WEST Common Stock to holders
of Media Stock and (ii) $3.9 billion of U S WEST debt, currently allocated to
Media Group, will be refinanced by New U S WEST.
The transaction is subject to a number of approvals, including approvals by
regulators and both shareowner groups, and receipt of a favorable ruling from
the Internal Revenue Service. The Separation is expected to be complete sometime
after mid-1998.
RESULTS OF OPERATIONS -- 1997 COMPARED WITH 1996
Following are details of the Company's reported net income for 1997 and
1996, normalized to exclude the effects of certain nonoperating items.
INCREASE (DECREASE)
--------------------
1997 1996 $ %
--------- --------- --------- ---------
Reported net income.......................................................... $ 1,252 $ 1,267 $ (15) (1.2)
Adjustments to reported net income:
Gains on sales of rural telephone exchanges................................ (48) (36) (12) (33.3)
Gain on sale of investment in Bellcore..................................... (32) -- (32) --
Cumulative effect of change in accounting principle(1)..................... -- (34) 34 --
Current year effect of change in accounting principle(1)................... -- (15) 15 --
--------- --------- --------- ---------
Normalized income............................................................ $ 1,172 $ 1,182 $ (10) (0.8)
--------- --------- --------- ---------
--------- --------- --------- ---------
- ------------------------------
(1) Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" which, among
other things, requires that companies no longer record depreciation expense
on assets held for sale.
In 1997, normalized income decreased to $1,172 from $1,182 in 1996. The
decrease is primarily due to a $152 after-tax regulatory charge ($250 pretax) in
the fourth quarter of 1997. The charge primarily relates to a liability for
revenues that were collected subject to refund (with interest) in the state of
Washington from May 1, 1996 through December 31, 1997. The liability was
recognized in light of the Washington State Supreme Court's ruling on December
24, 1997 that upheld a Washington State Utilities and Transportation Commission
("WUTC") 1996 rate order (the "Washington Rate Order"). Absent the effects of
the charge, the Company's adjusted income was $1,324, an increase of 12.0
percent as compared to 1996. The prospective revenue reduction as a result of
the Washington Rate Order approximates $115 annually. In a separate action in
January 1998 the WUTC authorized a rate increase of approximately $60 annually.
Tariffs implementing both orders became effective February 1, 1998. See
"Contingencies."
Income in 1997 was favorably impacted by strong demand for services.
Partially offsetting the effects of increased demand were higher expenses
related to interconnection, provisions for estimated regulatory liabilities
other than Washington, and start-up costs associated with growth initiatives,
including PCS.
7
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (CONTINUED)
OPERATING REVENUES
INCREASE (DECREASE)
--------------------
1997 1996 $ %
--------- --------- --------- ---------
Local service................................................................ $ 5,016 $ 4,770 $ 246 5.2
Interstate access service.................................................... 2,666 2,507 159 6.3
Intrastate access service.................................................... 761 770 (9) (1.2)
Long-distance network services............................................... 885 1,100 (215) (19.5)
Other services............................................................... 755 684 71 10.4
--------- --------- --------- ---------
Total........................................................................ $ 10,083 $ 9,831 $ 252 2.6
--------- --------- --------- ---------
--------- --------- --------- ---------
Approximately 67 percent of the Company's revenues are derived from the
states of Arizona, Colorado, Minnesota, Oregon and Washington. The primary
factors that influence changes in revenues are customer demand for products and
services, price changes (including those related to regulatory proceedings) and
refunds. Approximately 30 percent of the access lines in service at December 31,
1997 are devoted to providing services to business customers. The access line
growth rate for business customers, who tend to be heavier users of the network,
has consistently exceeded the growth rate of residential customers. During 1997,
business access lines grew 5.8 percent while residential access lines increased
3.9 percent, when adjusted for the 1997 sales of rural telephone access lines.
During 1997, the Company's operating revenues increased 2.6 percent, to
$10,083. Revenue growth was impacted by the $250 regulatory charge in the fourth
quarter of 1997. The regulatory charge was allocated among local service
revenues, interstate and intrastate access service revenues, long-distance
network services revenues, and interest expense. Absent the effects of the
charge, revenues were $10,313, an increase of 4.9 percent compared to 1996.
LOCAL SERVICE REVENUES. Local service revenues include local telephone
exchange, local private line and public telephone services. During 1997, local
service revenues increased 5.2 percent, or $246, as compared with 1996. Local
service revenue growth of 5.2 percent declined from 9.8 percent in 1996 due to
the effects of an $86 accrual recognized during fourth-quarter 1997 as part of
the Washington Rate Order and additional provisions of approximately $95 during
the year for other estimated state regulatory liabilities. See "Contingencies."
Lower wireless interconnection access prices mandated by the Telecommunications
Act of 1996 and the effects of rural exchange sales also impacted local service
revenue growth in 1997.
The increase in local service revenues is primarily attributable to access
line growth and increased demand for new product and service offerings and
existing central office features. Total reported access lines increased 609,000
during 1997, or 3.9 percent, of which 294,000 is attributed to second lines.
Second line installations increased 28.2 percent compared with 1996. Access
lines grew 683,000, or 4.4 percent, when adjusted for sales of approximately
74,000 rural telephone access lines during 1997. Also contributing to the
revenues increase were rate increases of $37 in various states and interim
compensation revenues from interexchange carriers ("IXCs") as a result of the
Federal Communications Commission ("FCC") payphone orders which took effect in
April 1997.
INTERSTATE ACCESS SERVICE REVENUES. Access charges are collected primarily
from IXCs for their use of the local exchange network. For interstate access
services there is also a fee collected directly from telephone customers.
Approximately 28 percent of access revenues and 10 percent of total revenues are
derived from providing access services to AT&T.
8
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (CONTINUED)
During 1997, interstate access service revenues increased $159, or 6.3
percent, to $2,666. The increase in interstate access service revenues resulted
primarily from greater demand for private line services, access line growth and
an increase of 6.4 percent in billed interstate access minutes of use. Also
contributing to the increase were the effects of higher accruals for refunds to
IXCs in 1996. Lower prices under the FCC's current price cap plan and a $25
charge during fourth-quarter 1997 for an FCC-ordered refund to IXCs for access
revenues collected during the last half of 1997 partially offset the effects of
greater demand for interstate access services. The Company reduced prices for
interstate access services, effective July 1, 1997, as a result of the FCC's
current price cap plan. The access rate reductions, which are being reflected
through lower interstate rates over twelve months beginning July 1, 1997, have
an on-going revenue impact of approximately $160. The rate of growth in
interstate access service revenues could decline in 1998 as a result of the
FCC's May 1997 decisions that established rules to restructure the access charge
system and the current price cap plan. See "Competitive and Regulatory
Environment."
INTRASTATE ACCESS SERVICE REVENUES. The decrease of $9, or 1.2 percent, in
intrastate access service revenues is primarily due to the effects of a $68
accrual recognized during fourth-quarter 1997 as part of the Washington Rate
Order. A 12.2 percent increase in billed intrastate minutes of use, higher
demand for private line services and $7 of rate increases in local jurisdictions
largely offset the effects of the charge.
LONG-DISTANCE NETWORK SERVICES REVENUES. Long-distance network services
revenues are derived from calls which both originate and terminate within LATA
boundaries of the Region. In 1997, long-distance network services revenues
decreased $215, or 19.5 percent, as compared with 1996. The decline is partially
due to the effects of a $51 accrual recognized during fourth-quarter 1997 as
part of the Washington Rate Order. The decrease in long-distance network
services revenues is also due to the effects of competition and the
implementation of multiple toll carrier plans ("MTCPs") in various jurisdictions
in 1997 and 1996. The MTCPs essentially allow independent telephone companies to
act as toll carriers and are net income neutral with the reduction in toll
revenues largely offset by increased intrastate access service revenues and
lower access expense. Rate decreases of $20 in local jurisdictions also
contributed to the decrease in long-distance network services revenues.
Long-distance network services revenues have declined over the last several
years as customers have migrated to IXCs that have the ability to offer
long-distance services on both an intraLATA and interLATA basis. A portion of
revenues lost to competition, however, is recovered through access charges paid
by the IXCs. The Company believes that erosion of long-distance network services
revenues will continue due to the loss of exclusivity of 1+ dialing in Minnesota
and Arizona in February and April of 1996, respectively, and in New Mexico and
Wyoming in September and December of 1997, respectively, and the effects of
continued competitive dial-around activity in other states within the Region.
The Company is responding to competition through competitive pricing of
intraLATA long-distance network services and increased promotional efforts to
retain customers.
OTHER SERVICES REVENUES. Revenues from other services primarily consist of
voice messaging services, inside wire installation and maintenance services, and
billing and collection services. Other services revenues increased $71, or 10.4
percent, as compared with 1996, primarily as a result of continued market
penetration of voice messaging services and greater sales of inside wire
maintenance. Also contributing to the increase were revenues from the launch of
PCS services.
9
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (CONTINUED)
COSTS AND EXPENSES
INCREASE (DECREASE)
--------------------
1997 1996 $ %
--------- --------- --------- ---------
Employee-related expenses....................................................... $ 3,344 $ 3,377 $ (33) (1.0)
Other operating expenses........................................................ 1,894 1,574 320 20.3
Taxes other than income taxes................................................... 406 379 27 7.1
Depreciation and amortization................................................... 2,103 2,101 2 0.1
Interest expense................................................................ 374 414 (40) (9.7)
Gains on sales of rural telephone exchanges..................................... 77 59 18 30.5
Gain on sale of investment in Bellcore.......................................... 53 -- 53 --
Other expense -- net............................................................ 74 44 30 68.2
EMPLOYEE-RELATED EXPENSES. Employee-related expenses include salaries and
wages (including both basic and performance-based pay), overtime, benefits
(including pension, postretirement and health care), payroll taxes and contract
labor. During 1997, total employee-related expenses decreased $33, or 1.0
percent, to $3,344, primarily due to lower salaries and wages related to
headcount reductions, lower conference and travel expenses and decreases in
overtime costs. The headcount reductions include the transfer of approximately
1,200 employees during third-quarter 1997 to an unregulated affiliate. Partially
offsetting these decreases were higher contract labor costs, predominately a
result of increased systems development work (which includes expenses related to
interconnection and year 2000 costs) and marketing and sales efforts, and
increases in certain employee-related benefits costs.
At December 31, 1997, approximately 74 percent of the Company's employees
were represented by unions. The Company's principal collective bargaining
agreements expire in August 1998. Negotiations with respect to future collective
bargaining agreements are underway.
OTHER OPERATING EXPENSES. Other operating expenses include access charges
paid to independent local exchange carriers (incurred for the routing of
long-distance traffic through their facilities), network software expenses and
other general and administrative costs. During 1997, other operating expenses
increased $320, or 20.3 percent, to $1,894, primarily due to a $92 increase in
advertising costs, interconnection expenses and increased affiliate expense as a
result of the above referenced transfer of employees to an unregulated
affiliate. Costs associated with strategic and growth initiatives (primarily
PCS), and increased equipment rentals also contributed to the increase.
Partially offsetting these cost increases were reduced access expenses
(primarily related to the implementation of the MTCPs in 1997 and 1996), lower
material and supplies expense and a 1996 charge of $11 to discontinue the Omaha
broadband video service trial.
TAXES OTHER THAN INCOME TAXES. Taxes other than income taxes, which consist
primarily of property taxes, increased $27, or 7.1 percent, to $406, primarily
due to the effects of property tax adjustments in 1996 and increased 1997 use
taxes. Partially offsetting the increases were the effects of favorable tax
valuations and mill levies on 1997 property taxes as compared with 1996.
INTEREST EXPENSE. Interest expense decreased $40, or 9.7 percent, to $374,
primarily as a result of lower average debt levels as compared to 1996.
Partially offsetting the decrease was a reduction in the amount of interest
capitalized resulting from a lower average balance of telecommunications plant
under construction.
10
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (CONTINUED)
GAINS ON SALES OF RURAL TELEPHONE EXCHANGES. During 1997, the Company sold
selected rural telephone exchanges in Iowa, South Dakota, Nebraska, Idaho and
Minnesota for pretax gains of $77. The 1996 gains were a result of sales in
Utah, North Dakota, South Dakota, Idaho and New Mexico.
GAIN ON SALE OF INVESTMENT IN BELLCORE. During 1997, the Company and the
other Regional Bell Operating Companies ("RBOCs") sold their equity interests in
Bell Communications Research, Inc. ("Bellcore"). As a result of the sale, the
Company recorded a pretax gain of $53 ($32 after tax).
OTHER EXPENSE--NET. Other expense increased primarily due to additional
interest expense associated with the Company's state regulatory and interstate
sharing liabilities.
RESTRUCTURING CHARGE
In 1993, the Company incurred an $880 restructuring charge (pretax). The
related restructuring plan was designed to provide faster, more responsive
customer services, while reducing the costs of providing these services. During
1997, the restructuring reserve decreased $67, to $56. Reserve usage was
primarily a result of 645 employee separations and systems development costs
during 1997. The restructuring plan is substantially complete as of December 31,
1997.
OTHER ITEMS
U S WEST COMMUNICATIONS CREDIT RATINGS
During the first quarter of 1997, Standard & Poor's lowered the Company's
senior unsecured debt rating from A+ to A as a result of a modified rating
criteria implemented by Standard & Poor's to reflect the increased competitive
telecommunications environment. During the second quarter of 1997, Moody's
placed the Company's senior unsecured debt under review in connection with the
Company's regulatory rulings, which may result in a downgrading. See
"Contingencies."
The Company's senior unsecured debt and commercial paper ratings by Moody's,
Standard & Poor's and Duff & Phelps were Aa3, A and AA-, and P1, A1 and D1+,
respectively, at December 31, 1997.
In connection with U S WEST's announcement of the Separation, Standard &
Poor's placed the Company's senior unsecured debt on credit watch with positive
implications and reaffirmed the Company's commercial paper ratings, and Duff &
Phelps reaffirmed the Company's senior unsecured debt and commercial paper
ratings.
RISK MANAGEMENT
The Company is exposed to market risks arising from changes in interest
rates. Derivative financial instruments are used to selectively manage this
risk. The Company does not use derivative financial instruments for trading
purposes.
The objective of the interest rate risk management program is to minimize
the total cost of debt over time and the interest rate variability. This is
achieved through the use of interest rate swaps, which adjust the ratio of
fixed- to variable-rate debt.
Approximately $60 of the Company's floating rate debt is exposed to changes
in interest rates. Such exposure is primarily linked to the 30-day commercial
paper rate. A hypothetical 10 percent change in the 30-day commercial paper rate
would not have a material effect on the annual earnings of the Company.
11
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (Continued)
CONTINGENCIES
There are pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both.
WASHINGTON. In 1996, the WUTC acted on the Company's 1995 rate request. The
Company had sought to increase revenues by raising rates primarily for basic
residential services over a four-year period. Instead of granting the Company's
request, the WUTC ordered $91.5 in annual net revenue reductions, effective May
1, 1996.
On December 24, 1997, the Washington State Supreme Court upheld the WUTC
ruling. The Washington State Supreme Court's ruling resulted in an estimated
liability for the revenues that were collected subject to refund from May 1,
1996 through December 31, 1997, including interest, in the amount of $225. The
prospective revenue reduction as a result of this ruling approximates $115
annually, which includes the effects of business growth. In a separate action,
the WUTC authorized a rate increase of approximately $60 annually that partially
mitigates the effect of the Washington State Supreme Court's ruling. Tariffs
implementing both orders became effective February 1, 1998.
OREGON. On May 1, 1996, the Oregon Public Utilities Commission ("OPUC")
approved a stipulation terminating prematurely the Company's alternative form of
regulation ("AFOR") plan, and it then undertook a review of the Company's
earnings. In May 1997, the OPUC ordered the Company to reduce its annual
revenues by $97, effective May 1, 1997, and to issue a one-time refund,
including interest, of approximately $102 to reflect the revenue reduction for
the period May 1, 1996 through April 30, 1997. The one-time refund is for
interim rates which became subject to refund when the Company's AFOR plan was
terminated on May 1, 1996.
The Company filed an appeal of the order and asked for an immediate stay of
the refund with the Oregon Circuit Court for the County of Marion (the "Oregon
Circuit Court") which granted the Company's request for a stay, pending a full
review of the OPUC's order. On February 19, 1998, the Oregon Circuit Court
entered a judgment in the Company's favor on most of the appealed issues. The
OPUC has announced its intent to appeal. The potential exposure, including
interest, at December 31, 1997, is not expected to exceed $180.
UTAH. In another proceeding, the Utah Supreme Court has remanded a Utah
Public Service Commission ("UPSC") order to the UPSC for hearing, thereby
establishing two exceptions to the rule against retroactive ratemaking: 1)
unforeseen and extraordinary events, and 2) misconduct. The UPSC's initial order
denied a refund request from IXCs and other parties related to the Tax Reform
Act of 1986. The potential exposure, including interest, at December 31, 1997,
is not expected to exceed $160.
STATE REGULATORY ACCRUALS. The Company has accrued $348 at December 31,
1997, which represents its estimated liability for all state regulatory
proceedings, predominantly the items discussed above. Approximately $225 of the
total estimated liability was recognized during fourth-quarter 1997. It is
possible that the ultimate liability could exceed the recorded liability by an
amount up to approximately $230. The Company will continue to monitor and
evaluate the risks associated with its local regulatory jurisdictions, and will
adjust estimates as new information becomes available.
COMPETITIVE AND REGULATORY ENVIRONMENT
For a complete discussion of the Company's competitive and regulatory
environment, see the U S WEST, Inc. Form 10-K -- Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Competitive and
Regulatory Environment.
12
MANAGEMENT'S ANALYSIS OF THE RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 COSTS
During 1997, the Company conducted a comprehensive review of its computer
systems and related software to ensure systems properly recognize the year 2000
and continue to process data. The systems evaluated include all internal systems
and those that manage the public switched network. This evaluation includes the
Company's significant vendors in determining the impact on the Company if those
third parties fail to remediate their own year 2000 issues. Based on its
internal assessment, the Company has determined that it will have to modify or
replace certain portions of its internal use software, whether developed by the
Company or provided by a third party. For public network software, there are
central office and remote switches from a variety of vendors in addition to
interoffice and loop transport equipment that also require conversion. To date,
inventory is complete for all major network elements, compliance standards have
been published and key vendors have agreed to compliance dates. Detailed plans
for the year 2000 project for all systems have been completed and conversion
activity is underway.
The estimated remaining costs of the related projects approximate $150
through 1999. Management's estimate of the costs and completion dates of the
year 2000 project are dependent on various factors including availability of
skilled resources, the ability to locate and modify all relevant software code
and vendor compliance. The Company cannot provide assurance that actual results
will not differ from management's estimates. Failure to complete the project in
a timely or complete manner, or within its estimate of project costs, could have
a material impact on future results of operations.
NEW ACCOUNTING STANDARDS
In 1998, the Company will adopt SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 130 requires that the components and total amount
of comprehensive income be displayed in the financial statements for interim and
annual periods beginning in 1998. Comprehensive income includes net income and
all changes in equity during a period that arise from nonowner sources, such as
foreign currency items and unrealized gains and losses on certain investments in
equity securities. SFAS No. 131 requires, among other things, the reporting of
detailed operating segment information of an enterprise for annual periods
beginning in 1998 and for interim periods beginning in 1999.
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," was issued in March 1998. SOP
98-1, among other things, requires that certain costs of internal use software,
whether purchased or developed internally, be capitalized and amortized over the
estimated useful life of the software. Adoption of SOP 98-1 is required as of
January 1, 1999, but earlier adoption is allowed. The Company is currently
evaluating the impacts of SOP 98-1 and believes that it could initially have a
significant impact upon results of operations.
13
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareowner and Board of Directors of U S WEST Communications, Inc.:
We have audited the accompanying consolidated balance sheets of U S WEST
Communications, Inc. (a Colorado corporation) and subsidiaries as of December
31, 1997 and 1996, and the related consolidated statements of income and cash
flows for the years then ended. These consolidated financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 U S WEST Communications,
Inc. and subsidiaries as of December 31, 1997 and 1996 and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule II on page 31 is presented for
purposes of complying with the Securities and Exchange Commission's rules and is
not a required part of the basic financial statements. This information as of
and for the years ended December 31, 1997 and 1996 has been subjected to the
auditing procedures applied in our audits of the basic financial statements and,
in our opinion, is fairly stated in all material respects in relation to the
basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Denver, Colorado,
February 6, 1998.
14
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareowner and Board of Directors of U S WEST Communications, Inc.:
We have audited the accompanying consolidated statements of income and cash
flows and the related consolidated financial statement schedule of U S WEST
Communications, Inc. for the year ended December 31, 1995. These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated results of operations of U S WEST
Communications, Inc. and its cash flows for the year ended December 31, 1995, in
conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, present fairly, in
all material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Denver, Colorado
February 12, 1996
15
U S WEST COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN MILLIONS)
Operating revenues:
Local service...................................................................... $ 5,016 $ 4,770 $ 4,344
Interstate access service.......................................................... 2,666 2,507 2,378
Intrastate access service.......................................................... 761 770 747
Long-distance network services..................................................... 885 1,100 1,189
Other services..................................................................... 755 684 626
--------- --------- ---------
Total operating revenues......................................................... 10,083 9,831 9,284
Operating expenses:
Employee-related expenses.......................................................... 3,344 3,377 3,079
Other operating expenses........................................................... 1,894 1,574 1,587
Taxes other than income taxes...................................................... 406 379 371
Depreciation and amortization...................................................... 2,103 2,101 2,022
--------- --------- ---------
Total operating expenses......................................................... 7,747 7,431 7,059
--------- --------- ---------
Operating income..................................................................... 2,336 2,400 2,225
Interest expense..................................................................... 374 414 386
Gains on sales of rural telephone exchanges.......................................... 77 59 136
Gain on sale of investment in Bellcore............................................... 53 -- --
Other expense -- net................................................................. 74 44 58
--------- --------- ---------
Income before income taxes, extraordinary item and
cumulative effect of change in accounting principle................................. 2,018 2,001 1,917
Provision for income taxes........................................................... 766 768 698
--------- --------- ---------
Income before extraordinary item and cumulative effect
of change in accounting principle................................................... 1,252 1,233 1,219
Extraordinary item -- early extinguishment of debt -- net of tax..................... -- -- (8)
--------- --------- ---------
Income before cumulative effect of change in accounting principle.................... 1,252 1,233 1,211
Cumulative effect of change in accounting principle -- net of tax.................... -- 34 --
--------- --------- ---------
NET INCOME........................................................................... $ 1,252 $ 1,267 $ 1,211
--------- --------- ---------
--------- --------- ---------
The accompanying notes are an integral part of the Consolidated Financial
Statements.
16
U S WEST COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(DOLLARS IN
MILLIONS)
ASSETS
Current assets:
Cash and cash equivalents................................................................. $ 26 $ 92
Accounts and notes receivable, less allowance
for credit losses of $50 and $37, respectively.......................................... 1,608 1,550
Inventories and supplies.................................................................. 124 109
Deferred tax asset........................................................................ 226 152
Prepaid and other......................................................................... 68 57
--------- ---------
Total current assets........................................................................ 2,052 1,960
Gross property, plant and equipment......................................................... 33,182 32,451
Less accumulated depreciation............................................................... 19,041 18,522
--------- ---------
Property, plant and equipment -- net........................................................ 14,141 13,929
Other assets................................................................................ 815 743
--------- ---------
Total assets................................................................................ $ 17,008 $ 16,632
--------- ---------
--------- ---------
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities:
Short-term debt........................................................................... $ 497 $ 834
Accounts payable.......................................................................... 1,439 998
Employee compensation..................................................................... 321 308
Dividends payable......................................................................... 192 307
Advanced billings and customer deposits................................................... 292 250
Current portion of state regulatory liability............................................. 225 --
Accrued property taxes.................................................................... 205 193
Other..................................................................................... 552 561
--------- ---------
Total current liabilities................................................................... 3,723 3,451
Long-term debt.............................................................................. 5,019 5,375
Postretirement and other postemployment benefit obligations................................. 2,365 2,347
Deferred income taxes....................................................................... 891 807
Unamortized investment tax credits.......................................................... 168 173
Deferred credits and other.................................................................. 442 419
Contingencies
Shareowner's equity
Common shares -- one share without par value, owned by parent............................. 8,017 7,677
Cumulative deficit........................................................................ (3,617) (3,617)
--------- ---------
Total shareowner's equity................................................................... 4,400 4,060
--------- ---------
Total liabilities and shareowner's equity................................................... $ 17,008 $ 16,632
--------- ---------
--------- ---------
The accompanying notes are an integral part of the Consolidated Financial
Statements.
17
U S WEST COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN MILLIONS)
OPERATING ACTIVITIES
Net income........................................................................ $ 1,252 $ 1,267 $ 1,211
Adjustments to net income:
Depreciation and amortization................................................... 2,103 2,101 2,022
Gains on sales of rural telephone exchanges..................................... (77) (59) (136)
Gain on sale of investment in Bellcore.......................................... (53) -- --
Cumulative effect of change in accounting principle............................. -- (34) --
Deferred income taxes and amortization of investment tax credits................ (23) 99 158
Changes in operating assets and liabilities:
Restructuring payments.......................................................... (67) (226) (315)
Postretirement medical and life costs, net of cash fundings..................... 77 25 (93)
Accounts receivable............................................................. (46) (12) (96)
Inventories, supplies and other current assets.................................. (53) 6 (45)
Accounts payable and accrued liabilities........................................ 574 146 24
Other -- net...................................................................... 91 25 27
--------- --------- ---------
Cash provided by operating activities............................................. 3,778 3,338 2,757
--------- --------- ---------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment.................................... (2,101) (2,392) (2,437)
Purchase of wireless PCS licenses................................................. (73) -- --
Proceeds from sales of rural telephone exchanges.................................. 67 174 214
Proceeds from sale of investment in Bellcore...................................... 65 -- --
Proceeds from (payments on) disposals of property, plant and equipment............ 22 15 (18)
--------- --------- ---------
Cash (used for) investing activities.............................................. (2,020) (2,203) (2,241)
--------- --------- ---------
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term debt................................. (639) 158 (778)
Proceeds from issuance of long-term debt.......................................... 29 23 1,647
Repayments of long-term debt...................................................... (142) (466) (327)
Dividends paid on common stock.................................................... (1,367) (1,259) (1,037)
Equity infusions from U S WEST Communications Group............................... 295 310 56
--------- --------- ---------
Cash (used for) financing activities.............................................. (1,824) (1,234) (439)
--------- --------- ---------
CASH AND CASH EQUIVALENTS
Increase (decrease)............................................................... (66) (99) 77
Beginning balance................................................................. 92 191 114
--------- --------- ---------
Ending balance.................................................................... $ 26 $ 92 $ 191
--------- --------- ---------
--------- --------- ---------
The accompanying notes are an integral part of the Consolidated Financial
Statements.
18
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(DOLLARS IN MILLIONS)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The Consolidated Financial Statements include the
accounts of U S WEST Communications, Inc., and its wholly owned subsidiaries
(the "Company"). The Company is an indirect, wholly owned subsidiary of U S
WEST. The Company was formed as a result of the January 1, 1991, merger of The
Mountain States Telephone and Telegraph Company, Northwestern Bell Telephone
Company and Pacific Northwest Bell Telephone Company. The merger was accounted
for as a transfer of assets among entities under common control similar to that
of a pooling-of-interests.
INDUSTRY SEGMENT. The Company primarily provides telecommunications
services to more than 25 million residential and business customers in the
Company's Region. The Region includes the states of Arizona, Colorado, Idaho,
Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South
Dakota, Utah, Washington and Wyoming. Primary telecommunications services
offered include local telephone exchange services, exchange access services
(which connect customers to the facilities of carriers, including long-distance
providers and wireless operators), and long-distance services within LATAs in
the Region. Other products and services include caller identification, voice
messaging, digital switched services, high-speed data network transmission
services and PCS.
Approximately 67 percent of the Company's revenues are derived from the
states of Arizona, Colorado, Minnesota, Oregon and Washington.
SIGNIFICANT CONCENTRATIONS. The largest volume of the Company's services
are provided to AT&T. During 1997, 1996 and 1995, revenues from services
provided to AT&T were $1,049, $1,046 and $1,085, respectively. Related accounts
receivable at December 31, 1997 and 1996, totaled $79 and $89, respectively. As
of December 31, 1997, the Company is not aware of any other significant
concentration of business transacted with a particular customer or supplier that
could, if suddenly eliminated, severely impact operations.
At December 31, 1997, approximately 74 percent of the Company's employees
are represented by unions. The Company's principal collective bargaining
agreements expire in August 1998. Negotiations with respect to future collective
bargaining agreements are underway.
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 reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
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.
INVENTORIES AND SUPPLIES. New and reusable materials of the Company are
carried at average cost, except for significant individual items that are valued
based on specific costs. Nonreusable material is carried at its estimated
salvage value.
PROPERTY, PLANT AND EQUIPMENT. The investment in property, plant and
equipment is carried at cost less accumulated depreciation. Additions,
replacements and substantial betterments are capitalized. Costs for normal
repair and maintenance of property, plant and equipment are expensed as
incurred.
19
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company provides for depreciation of property, plant and equipment using
various straight-line group methods and remaining useful (economic) lives based
on industry-wide studies. When the depreciable property, plant and equipment of
the Company is retired or sold, the original cost less the net salvage value is
generally charged to accumulated depreciation. The average depreciable lives
used for the major categories of property, plant, and equipment follow:
AVERAGE LIFE
CATEGORY (YEARS)
- -------------------------------------------------------------------------- -------------------
General purpose computers................................................. 6
Digital switching and circuit equipment................................... 10
Aerial and underground copper cable....................................... 15
Buried copper and fiber cable............................................. 20
Buildings................................................................. 27-49
Interest related to qualifying construction projects is capitalized and is
reflected as a reduction of interest expense. Amounts capitalized were $20, $31
and $39 in 1997, 1996 and 1995, respectively.
COMPUTER SOFTWARE. The cost of computer software, whether purchased or
developed internally, is charged to expense with two exceptions. Initial
operating systems software is capitalized and amortized over the life of the
related hardware, and initial network applications software is capitalized and
amortized over three years. Subsequent upgrades to capitalized software are
charged to expense. Capitalized computer software costs of $132 and $187 at
December 31, 1997 and 1996, respectively, are recorded in property, plant and
equipment. Amortization of capitalized computer software costs totaled $78, $81
and $69 in 1997, 1996 and 1995, respectively.
FINANCIAL INSTRUMENTS. Synthetic instrument accounting is used for interest
rate and foreign currency swaps if the index, maturity, and amount of the
instrument match the terms of the underlying debt. Net interest accrued is
recognized over the life of the instruments as an adjustment to interest expense
and is a component of cash provided by operating activities. Any gain or loss on
the termination of an instrument that qualifies for synthetic instrument
accounting would be deferred and amortized over the remaining life of the
original instrument.
Hedge accounting is used for forward contracts which qualify as hedges of
future debt issues. To qualify for hedge accounting, the contracts must have a
high inverse correlation to the exposure being hedged, and reduce the risk or
volatility associated with changes in interest rates. Qualified interest rate
contracts are associated with the related debt and amortized as yield
adjustments. Any gain or loss on the termination of a contract that qualifies
for hedge accounting would be deferred and accounted for with the underlying
transaction being hedged. The Company does not use derivative financial
instruments for trading purposes.
Gains and losses incurred on executed forward U. S. Treasury Bond contracts,
used to lock in the U. S. Treasury rate component of a future debt issue, are
deferred and recognized as an adjustment to interest expense over the life of
the underlying debt. At December 31, 1997, deferred gains of $8 and deferred
losses of $50 on the closed forward contracts are included as part of the
carrying value of the underlying debt. The deferred gains and losses are being
recognized as yield adjustments over the life of the related debt, which matures
at various dates through 2043.
Currency swaps entered into to convert foreign debt to U. S.
dollar-denominated debt are combined with the foreign currency debt and
accounted for as if fixed-rate, dollar-denominated debt were issued directly.
20
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION. Local telephone and wireless services are generally
billed monthly in advance, and revenues are recognized the following month when
services are provided. Revenues derived from exchange access, long-distance
network services, and wireless airtime usage are billed and recognized monthly
as services are provided.
ADVERTISING COSTS. Costs related to advertising are expensed as incurred.
Advertising expense was $188, $96 and $66 in 1997, 1996 and 1995, 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. For financial statement purposes, investment tax credits are being
amortized over the economic lives of the related property, plant and equipment
in accordance with the deferred method of accounting for such credits.
The Company is included in the consolidated federal income tax returns of U
S WEST. The Company recognizes federal income tax expense based upon a pro-rata
allocation agreement with U S WEST. Under the agreement, the Company is
allocated income tax consequences or benefits based upon its pro-rata
contribution to the consolidated group's taxable income, deductions and credits.
The amount of federal income tax expense recognized by the Company is not
significantly different than an amount computed on a stand-alone basis.
The Company is included in combined state tax returns filed by U S WEST. The
Company recognized state income tax expense based upon a stand-alone allocation
policy with U S WEST.
BELLCORE. Charges relating to research, development and maintenance of
existing technologies performed by Bellcore, of which the Company had a
one-seventh ownership, were $118, $97 and $95 in 1997, 1996 and 1995,
respectively.
In November 1997, the Company and the other RBOCs sold their interests in
Bellcore. As a result of the sale, the Company received cash proceeds of $65 and
recorded an after-tax gain of $32. Bellcore and other third parties will
continue to provide research and development and other services to the Company
on a contract basis.
NEW ACCOUNTING STANDARDS. In 1998, the Company will adopt SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 130 requires that the
components and total amount of comprehensive income be displayed in the
financial statements for interim and annual periods beginning in 1998.
Comprehensive income includes net income and all changes in equity during a
period that arise from nonowner sources, such as foreign currency items and
unrealized gains and losses on certain investments in equity securities. SFAS
No. 131 requires, among other things, reporting of detailed operating segment
information of an enterprise for annual periods beginning in 1998 and interim
periods beginning in 1999.
SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," was issued in March 1998. SOP 98-1, among other
things, requires that certain costs of internal use software, whether purchased
or developed internally, be capitalized and amortized over the estimated useful
life of the software. Adoption of SOP 98-1 is required as of January 1, 1999,
but earlier adoption is allowed. The Company is currently evaluating the impact
of SOP 98-1, and believes that it could initially have a significant impact upon
results of operations.
21
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2: PROPERTY, PLANT AND EQUIPMENT
The composition of property, plant and equipment follows:
DECEMBER 31,
--------------------
1997 1996
--------- ---------
Land and buildings.......................................................... $ 2,379 $ 2,372
Telecommunications network equipment........................................ 13,505 12,893
Telecommunications outside plant............................................ 13,802 13,148
General purpose computers and other......................................... 2,886 3,440
Construction in progress.................................................... 610 598
--------- ---------
33,182 32,451
--------- ---------
Less accumulated depreciation
Buildings................................................................. 664 690
Telecommunications network equipment...................................... 8,216 7,742
Telecommunications outside plant.......................................... 8,657 8,221
General purpose computers and other....................................... 1,504 1,869
--------- ---------
19,041 18,522
--------- ---------
Property, plant and equipment -- net........................................ $ 14,141 $ 13,929
--------- ---------
--------- ---------
In 1997, the Company sold certain rural telephone exchanges with a cost
basis of $160. Consideration received for the sales was $237, including $67 in
cash. In 1996 and 1995, the Company sold certain rural telephone exchanges with
a cost basis of $243 and $258, respectively, and received consideration of $306
(including $174 in cash) during 1996, and $388 (including $214 in cash) during
1995.
Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." SFAS No. 121 requires that long-lived assets and associated intangibles be
written down to fair value whenever an impairment review indicates that the
carrying value cannot be recovered on an undiscounted cash flow basis. SFAS No.
121 also requires that a company no longer record depreciation expense on assets
held for sale. Adoption of SFAS No. 121 resulted in income of $34 (net of income
tax expense of $22) in 1996 from the cumulative effect of reversing depreciation
expense recorded in prior years related to rural telephone exchanges held for
sale. Depreciation expense was reversed from the date the Company formally
committed to a plan to dispose of the rural telephone exchange assets to January
1, 1996. The income has been recorded as a cumulative effect of change in
accounting principle in accordance with SFAS No. 121. As a result of adopting
SFAS No. 121, depreciation expense for 1996 was reduced by $24.
22
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3: DEBT
SHORT-TERM DEBT
The components of short-term debt follow:
DECEMBER 31,
--------------------
1997 1996
--------- ---------
Commercial paper.............................................................. $ 62 $ 701
Current portion of long-term debt............................................. 435 133
--------- ---------
Total......................................................................... $ 497 $ 834
--------- ---------
--------- ---------
The weighted-average interest rate on commercial paper was 6.11 percent and
5.57 percent at December 31, 1997 and 1996, respectively.
The Company maintains commercial paper programs to finance short-term cash
flow requirements, as well as to maintain a presence in the short-term debt
market. In addition, the Company, which conducts its own borrowing activities,
is permitted to borrow up to $500 under short-term lines of credit, all of which
was available at December 31, 1997.
LONG-TERM DEBT
Interest rates and maturities of long-term debt at December 31 follow:
MATURITIES
------------------------------------------------------- TOTAL TOTAL
INTEREST RATES 1999 2000 2001 2002 THEREAFTER 1997 1996
- --------------------------------------------------- --------- --------- --------- --------- ----------- --------- ---------
Up to 5%........................................... $ -- $ 90 $ -- $ 100 $ 50 $ 240 $ 275
Above 5% to 6%..................................... -- -- 50 -- 211 261 561
Above 6% to 7%..................................... 71 257 133 250 1,533 2,244 2,244
Above 7% to 8%..................................... -- -- -- -- 1,646 1,646 1,646
Above 8% to 9%..................................... -- -- -- -- 250 250 250
Above 9% to 10%.................................... -- 175 -- -- -- 175 175
Variable-rate debt indexed to two- and ten-year
constant maturity U. S. Treasury rates........... 155 -- -- -- -- 155 155
--------- --------- --------- --------- ----------- --------- ---------
$ 226 $ 522 $ 183 $ 350 $ 3,690 4,971 5,306
--------- --------- --------- --------- -----------
--------- --------- --------- --------- -----------
Capital lease obligations and other................ 172 191
Unamortized discount -- net........................ (124) (122)
--------- ---------
Total.............................................. $ 5,019 $ 5,375
--------- ---------
--------- ---------
Long-term debt consists principally of debentures and medium-term notes.
During 1995, the Company refinanced $1.5 billion of commercial paper to take
advantage of favorable long-term interest rates. In addition to the commercial
paper, the Company refinanced $145 of long-term debt. Expenses associated with
the refinancing of long-term debt resulted in extraordinary charges to income of
$8, net of income tax benefits of $5.
Interest payments, net of amounts capitalized, were $374, $422 and $367 for
1997, 1996 and 1995, respectively.
23
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3: DEBT (CONTINUED)
INTEREST RATE RISK MANAGEMENT
The objective of the interest rate risk management program is to minimize
the total cost of debt over time and the interest rate variability. This is
achieved through the use of interest rate swaps, which adjust the ratio of
fixed- to variable-rate debt.
Under an interest rate swap, the Company agrees with another party to
exchange interest payments at specified intervals over a defined term. Interest
payments are calculated by reference to the notional amount based on the fixed-
and variable-rate terms of the swap agreements.
The Company entered into currency swaps to convert Swiss franc-denominated
debt to U. S. dollar-denominated debt. This allowed the Company to achieve
interest savings over issuing fixed-rate, dollar-denominated debt. The currency
swap and foreign currency debt are combined and accounted for as if fixed-rate,
dollar-denominated debt were issued directly.
The following table summarizes terms of swaps and interest rate contracts.
Variable rates are indexed to two- and ten-year constant maturity U. S. Treasury
and 30-day commercial paper rates.
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------------------------ ------------------------------------------------
WEIGHTED- WEIGHTED-
AVERAGE RATE AVERAGE RATE
NOTIONAL ---------------------- NOTIONAL ----------------------
AMOUNT MATURITIES RECEIVE PAY AMOUNT MATURITIES RECEIVE PAY
----------- ----------- ----------- --------- ----------- ----------- ----------- ---------
Variable to fixed............... $ 155 1999 5.46 6.24 $ 180 1997-1999 5.51 5.91
Currency........................ 204 1999-2001 -- 6.55 204 1999-2001 -- 6.55
The counterparties to swaps or other interest rate contracts are major
financial institutions. The Company is exposed to credit loss in the event of
nonperformance by these counterparties. The Company manages this exposure by
monitoring the credit standing of the counterparty and establishing dollar and
term limitations which correspond to the respective credit rating of each
counterparty. The Company does not have significant exposure to an individual
counterparty and does not anticipate nonperformance by any counterparty.
NOTE 4: FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of cash equivalents, other current amounts receivable and
payable, and short-term debt approximate carrying values due to their short-term
nature.
The fair values of interest rate swaps are based on estimated amounts the
Company would receive or pay to terminate such agreements taking into account
current interest rates and creditworthiness of the counterparties.
24
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4: FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
The fair values of long-term debt are based on quoted market prices where
available or, if not available, are based on discounting future cash flows using
current interest rates.
DECEMBER 31,
----------------------------------------------
1997 1996
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- --------- ----------- ---------
Debt (includes short-term portion)........................ $ 5,516 $ 5,660 $ 6,209 $ 6,160
Interest rate swap agreements -- assets................... -- -- -- (17)
Interest rate swap agreements -- liabilities.............. -- 28 -- 10
----------- --------- ----------- ---------
Debt -- net............................................... $ 5,516 $ 5,688 $ 6,209 $ 6,153
----------- --------- ----------- ---------
----------- --------- ----------- ---------
NOTE 5: LEASING ARRANGEMENTS
The Company has entered into operating leases for office facilities,
equipment and real estate. Rent expense under operating leases was $185, $161
and $179 in 1997, 1996 and 1995, respectively. Future minimum lease payments as
of December 31, 1997, under noncancelable operating leases, follow:
YEAR
- --------------------------------------------------------------------------------------
1998.................................................................................. $ 95
1999.................................................................................. 97
2000.................................................................................. 81
2001.................................................................................. 83
2002.................................................................................. 57
Thereafter............................................................................ 438
---------
Total................................................................................. $ 851
---------
---------
25
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6: SHAREOWNER'S EQUITY
Following is a reconciliation of the Company's shareowner's equity:
COMMON CUMULATIVE
SHARES DEFICIT TOTAL
----------- ----------- ---------
Balance at December 31, 1994..................................... $ 7,286 $ (3,602) $ 3,684
Net income..................................................... -- 1,211 1,211
Dividends declared............................................. -- (1,211) (1,211)
Equity infusions............................................... 62 -- 62
----------- ----------- ---------
Balance at December 31, 1995..................................... 7,348 (3,602) 3,746
----------- ----------- ---------
Net income..................................................... -- 1,267 1,267
Dividends declared............................................. -- (1,267) (1,267)
Equity infusions............................................... 329 -- 329
Other(1)....................................................... -- (15) (15)
----------- ----------- ---------
Balance at December 31, 1996..................................... 7,677 (3,617) 4,060
----------- ----------- ---------
Net income..................................................... -- 1,252 1,252
Dividends declared............................................. -- (1,252) (1,252)
Equity infusions............................................... 295 -- 295
Other(2)....................................................... 45 -- 45
----------- ----------- ---------
Balance at December 31, 1997..................................... $ 8,017 $ (3,617) $ 4,400
----------- ----------- ---------
----------- ----------- ---------
- ------------------------------
(1) During 1996, the Company absorbed an affiliated company.
(2) During 1997, the Company transferred employees and the related assets and
liabilities to an unregulated affiliated company.
NOTE 7: EMPLOYEE BENEFITS
PENSION PLAN
The Company participates in a defined benefit pension plan sponsored by U S
WEST which covers substantially all management and occupational employees.
Management benefits are based on a final pay formula while occupational benefits
are based on a flat benefit formula. The projected unit credit method is used
for the determination of pension cost for financial reporting purposes and the
aggregate cost method for funding purposes. The Company's policy is to fund
amounts required under the Employee Retirement Income Security Act of 1974 and
no funding was required in 1997, 1996 and 1995. Net pension credits for 1997,
1996 and 1995 were $(29), $(5) and $(2), respectively.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company participates in plans sponsored by U S WEST which provide
certain health care and life insurance benefits to retired employees. In
conjunction with SFAS No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions," U S WEST immediately recognized the accumulated
postretirement benefit obligation for current and future retirees. However, the
FCC and certain state jurisdictions permit amortization of the transition
obligation over the average remaining service period of active employees for
regulatory accounting purposes, with most jurisdictions requiring funding as a
stipulation for rate recovery.
26
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7: EMPLOYEE BENEFITS (CONTINUED)
The Company uses the projected unit credit method for the determination of
postretirement medical and life costs for financial reporting purposes. Net
postretirement benefit costs for 1997, 1996 and 1995 were $160, $147 and $183,
respectively. The amount funded by the Company is based on regulatory accounting
requirements.
NOTE 8: INCOME TAXES
The components of the provision for income taxes follow:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
FEDERAL:
Current........................................................................ $ 680 $ 576 $ 467
Deferred....................................................................... (16) 104 157
Investment tax credits -- net.................................................. (15) (29) (38)
--------- --------- ---------
649 651 586
--------- --------- ---------
STATE AND LOCAL:
Current........................................................................ 109 93 73
Deferred....................................................................... 8 24 39
--------- --------- ---------
117 117 112
--------- --------- ---------
Provision for income taxes....................................................... $ 766 $ 768 $ 698
--------- --------- ---------
--------- --------- ---------
The Company paid $797, $667 and $530 for income taxes in 1997, 1996 and
1995, respectively.
The effective tax rate differs from the statutory tax rate as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN PERCENT)
Federal statutory tax rate......................................................... 35.0 35.0 35.0
Investment tax credit amortization................................................. (0.5) (0.8) (1.3)
State income taxes -- net of federal effect........................................ 3.7 3.8 3.8
Other.............................................................................. (0.2) 0.4 (1.1)
--- --- ---
Effective tax rate................................................................. 38.0 38.4 36.4
--- --- ---
--- --- ---
27
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 8: INCOME TAXES (CONTINUED)
The components of the net deferred tax liability follow:
DECEMBER 31,
--------------------
1997 1996
--------- ---------
Property, plant and equipment................................................... $ 1,573 $ 1,504
State deferred taxes -- net of federal effect................................... 201 193
Other........................................................................... 46 44
--------- ---------
Deferred tax liabilities.................................................... 1,820 1,741
--------- ---------
Postemployment benefits, including pension...................................... 631 687
Restructuring and other......................................................... 20 45
Unamortized investment tax credit............................................... 59 61
State deferred taxes -- net of federal effect................................... 128 120
Other........................................................................... 317 173
--------- ---------
Deferred tax assets......................................................... 1,155 1,086
--------- ---------
Net deferred tax liability...................................................... $ 665 $ 655
--------- ---------
--------- ---------
The current portion of the deferred tax asset was $226 and $152 at December
31, 1997 and 1996, respectively. These balances resulted primarily from refunds
related to state regulatory liabilities, restructuring, interstate sharing and
compensation-related items in 1997, and restructuring charges and
compensation-related items in 1996.
At December 31, 1997 and 1996, the Company had outstanding taxes payable to
U S WEST of $27 and $35, respectively.
NOTE 9: RELATED PARTY TRANSACTIONS
The Company purchases various services, as noted below, from affiliated
companies. The amount paid by the Company for these services is determined in
accordance with FCC and state cost allocation rules, which prescribe various
cost allocation methodologies that are dependent upon the service provided.
Management believes that such cost allocation methods are reasonable. The cost
of those services is billed to the Company.
It is not practicable to provide a detailed estimate of the expenses which
would be recognized on a stand-alone basis. However, the Company believes that
corporate services, including those related to procurement, tax, legal and human
resources, are obtained more economically through affiliates than they would be
on a stand-alone basis, since the Company absorbs only a portion of the total
costs.
28
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9: RELATED PARTY TRANSACTIONS (CONTINUED)
The Company's operations include the following charges for services:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Project development and maintenance(1).................................... $ 262 $ 129 $ 178
Procurement............................................................... 79 102 120
Corporate services........................................................ 86 108 117
Marketing services........................................................ 77 74 74
Telecommunications........................................................ 43 14 10
Leased office space....................................................... 9 8 10
Other..................................................................... 10 16 18
--------- --------- ---------
Total..................................................................... $ 566 $ 451 $ 527
--------- --------- ---------
--------- --------- ---------
- ------------------------------
(1) Includes charges related to maintenance of existing technologies and
research and development performed by Bellcore.
NOTE 10: CONTINGENCIES
There are pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both.
WASHINGTON. In 1996, the WUTC acted on the Company's 1995 rate request. The
Company had sought to increase revenues by raising rates primarily for basic
residential services over a four-year period. Instead of granting the Company's
request, the WUTC ordered $91.5 in annual net revenue reductions, effective May
1, 1996.
On December 24, 1997, the Washington State Supreme Court upheld the WUTC
ruling. The Washington State Supreme Court's ruling resulted in an estimated
liability for the revenues that were collected subject to refund from May 1,
1996 through December 31, 1997, including interest, in the amount of $225. The
prospective revenue reduction as a result of this ruling approximates $115
annually, which includes the effects of business growth. In a separate action,
the WUTC authorized a rate increase of approximately $60 annually that partially
mitigates the effect of the Washington State Supreme Court's ruling. Tariffs
implementing both orders became effective February 1, 1998.
OREGON. On May 1, 1996, the OPUC approved a stipulation terminating
prematurely the Company's AFOR plan, and it then undertook a review of the
Company's earnings. In May 1997, the OPUC ordered the Company to reduce its
annual revenues by $97, effective May 1, 1997, and to issue a one-time refund,
including interest, of approximately $102 to reflect the revenue reduction for
the period May 1, 1996 through April 30, 1997. The one-time refund is for
interim rates which became subject to refund when the Company's AFOR plan was
terminated on May 1, 1996.
The Company filed an appeal of the order and asked for an immediate stay of
the refund with the Oregon Circuit Court which granted the Company's request for
a stay, pending a full review of the OPUC's order. On February 19, 1998, the
Oregon Circuit Court entered a judgment in the Company's favor on most of the
appealed issues. The OPUC has announced its intent to appeal. The potential
exposure, including interest, at December 31, 1997, is not expected to exceed
$180.
29
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10: CONTINGENCIES (CONTINUED)
UTAH. In another proceeding, the Utah Supreme Court has remanded a UPSC
order to the UPSC for hearing, thereby establishing two exceptions to the rule
against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2)
misconduct. The UPSC's initial order denied a refund request from IXCs and other
parties related to the Tax Reform Act of 1986. The potential exposure, including
interest, at December 31, 1997, is not expected to exceed $160.
STATE REGULATORY ACCRUALS. The Company has accrued $348 at December 31,
1997, which represents its estimated liability for all state regulatory
proceedings, predominantly the items discussed above. Approximately $225 of the
total estimated liability was recognized during fourth-quarter 1997. It is
possible that the ultimate liability could exceed the recorded liability by an
amount up to approximately $230. The Company will continue to monitor and
evaluate the risks associated with its local regulatory jurisdictions, and will
adjust estimates as new information becomes available.
NOTE 11: QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTERLY FINANCIAL DATA
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- -----------
1997
Operating revenues....................................................... $ 2,547 $ 2,488 $ 2,609 $ 2,439
Income before income taxes............................................... 564 571 578 305
Net income............................................................... 349 353 358 192
1996
Operating revenues....................................................... $ 2,408 $ 2,440 $ 2,456 $ 2,527
Income before income taxes and cumulative effect of change in accounting
principle.............................................................. 480 543 477 501
Income before cumulative effect of change in accounting principle........ 297 335 294 307
Net income............................................................... 331 335 294 307
1997 first-, second- and third-quarter net income includes $11, $18 and $19,
respectively, from gains on the sales of certain rural telephone exchanges. 1997
fourth-quarter net income includes a $152 regulatory charge related primarily to
the Washington Rate Order and $32 from a gain on the sale of the Company's
interest in Bellcore.
1996 first-quarter net income includes the cumulative and current effects of
$34 and $5, respectively, from adopting SFAS No. 121. 1996 second-quarter net
income includes $30 from gains on the sales of certain rural telephone exchanges
and current effects of $5 from adopting SFAS No. 121. 1996 third-quarter net
income includes $1 from a gain on the sales of certain rural telephone exchanges
and current effects of $3 from adopting SFAS No. 121. 1996 fourth-quarter net
income includes $5 from gains on the sales of certain rural telephone exchanges
and current effects of $2 from adopting SFAS No. 121.
30
U S WEST COMMUNICATIONS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN MILLIONS)
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF CHARGED TO OTHER END OF
PERIOD EXPENSE ACCOUNTS DEDUCTIONS PERIOD
------------- ------------ ----------- ------------- -----------
ALLOWANCE FOR CREDIT LOSSES
1997.................................................... $ 37 $ 101(a) -- $ 88(b) $ 50
1996.................................................... 30 89(a) -- 82(b) 37
1995.................................................... 28 66(a) -- 64(b) 30
RESERVES RELATED TO 1993 BUSINESS RESTRUCTURING, INCLUDING
WORKFORCE AND FACILITY CONSOLIDATION
1997.................................................... $ 123 -- -- $ 67 $ 56
1996.................................................... 349 -- -- 226 123
1995.................................................... 664 -- -- 315 349
- ------------------------------
(a) Does not include amounts charged directly to expense. These amounts were
$8, $7 and $6 for 1997, 1996 and 1995, respectively.
(b) Represents credit losses written off during the period, less collection of
amounts previously written off.
31
EXHIBIT INDEX
EXHIBIT
NUMBER
- ----------
(2a) Articles of Merger including the Plan of Merger between The Mountain States Telephone and
Telegraph Company (renamed U S WEST Communications, Inc.) and Northwestern Bell Telephone Company.
(Incorporated herein by this reference to Exhibit 2a to Form SE filed on January 8, 1991, File No.
1-3040).
(2b) Articles of Merger including the Plan of Merger between The Mountain States Telephone and
Telegraph Company (renamed U S WEST Communications, Inc.) and Pacific Northwest Bell Telephone
Company. (Incorporated herein by this reference to Exhibit 2b to Form SE filed on January 8, 1991,
File No. 1-3040).
3a Restated Articles of Incorporation of the Registrant.
3b Bylaws of the Registrant, as amended.
4 No instrument which defines the rights of holders of long and intermediate term debt of the
Registrant is filed herewith pursuant to Regulation S-K, Item 601(b) (4) (iii) (A). Pursuant to
this regulation, the Registrant hereby agrees to furnish a copy of any such instrument to the SEC
upon request.
(10a) Reorganization and Divestiture Agreement dated as of November 1, 1983, between American Telephone
and Telegraph Company, U S WEST Inc., and certain of their affiliated companies, including The
Mountain States Telephone and Telegraph Company, Northwestern Bell Telephone Company, Pacific
Northwest Bell Telephone Company and NewVector Communications, Inc. (Exhibit 10a to Form 10-K for
the period ended December 31, 1983, File No. 1-3040).
(10b) Shared Network Facilities Agreement dated as of January 1, 1984, between American Telephone and
Telegraph Company, AT&T Communications of the Midwest, Inc. and The Mountain States Telephone and
Telegraph Company. (Exhibit 10b to Form 10-K for the period ended December 31, 1983, File No.
1-3040).
(10c) Agreement Concerning Termination of the Standard Supply Contract effective December 31, 1983,
between American Telephone and Telegraph Company, Western Electric Company, Incorporated, The
Mountain States Telephone and Telegraph Company and Central Services Organization (Exhibit 10d to
Form 10-K for the period ended December 31, 1983, File No. 1-3040).
(10d) Agreement Concerning Certain Centrally Developed Computer Systems effective December 31, 1983,
between American Telephone and Telegraph Company, Western Electric Company, Incorporated, The
Mountain States Telephone and Telegraph Company and Central Services Organization (Exhibit 10e to
Form 10-K for the period ended December 31, 1983, File No. 1-3040).
(10e) Agreement Concerning Patents, Technical Information and Copyrights effective December 31, 1983,
between American Telephone and Telegraph Company and U S WEST, Inc. (Exhibit 10f to Form 10-K for
the period ended December 31, 1983, File No. 1-3040).
(10f) Agreement Concerning Liabilities, Tax Matters and Termination of Certain Agreements dated as of
November 1, 1983, between American Telephone and Telegraph Company, U S WEST, Inc., The Mountain
States Telephone and Telegraph Company and certain of their affiliates (Exhibit 10g to Form 10-K
for the period ended December 31, 1983, File No. 1-3040).
32
EXHIBIT
NUMBER
- ----------
(10g) Agreement Concerning Trademarks, Trade Names and Service Marks effective December 31, 1983,
between American Telephone and Telegraph Company, American Information Technologies Corporation,
Bell Atlantic Corporation, BellSouth Corporation, Cincinnati Bell, Inc., NYNEX Corporation,
Pacific Telesis Group, The Southern New England Telephone Company, Southwestern Bell Corporation
and U S WEST, Inc. (Exhibit 10i to Form 10-K for the period ended December 31, 1984, File No.
1-3040).
(10h) Shareholders' Agreement dated as of January 1, 1988, between Ameritech Services, Inc., Bell
Atlantic Management Services, Inc., BellSouth Services, Incorporated, NYNEX Service Company,
Pacific Bell, Southwestern Bell Telephone Company, The Mountain States Telephone and Telegraph
Company, Northwestern Bell Telephone Company and Pacific Northwest Bell Telephone Company (Exhibit
10h to Form SE dated March 5, 1992, File No. 1-3040).
12 Computation of Ratio of Earnings to Fixed Charges.
23 Consent of Independent Accountants.
24 Power of Attorney.
27 Financial Data Schedule.
33