SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934 (Amendment No. )
Filed by the Registrant /X/
Filed by a party other than the Registrant / /
Check the appropriate box:
/ / Preliminary Proxy Statement
/ / Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
/X/ Definitive Proxy Statement
/ / Definitive Additional Materials
/ / Soliciting material pursuant to Section 240.14a-11(c) or Section
240.14a-12
U S WEST, INC.
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) filing Proxy Statement, if other than the Registrant)
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/X/ No fee required.
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[LOGO]
1801 California Street
Denver, Colorado 80202
NOTICE OF ANNUAL MEETING
The annual meeting of shareholders of U S WEST, Inc. will be held at The
Millennium Broadway Hotel, 145 West 44th Street, New York, New York, on Tuesday,
May 11, 1999, at 10:30 a.m., eastern daylight time, for these purposes:
1. To elect three Class I Directors for three-year terms (see page 7);
2. To ratify the appointment of Arthur Andersen LLP as our independent
auditors for 1999 (see page 11); and
3. To act upon such other matters as may properly come before the annual
meeting, including shareholder proposals (see page 11).
The record date for the annual meeting is March 15, 1999. Only shareholders
of record at the close of business on that date can vote at the annual meeting.
By Order of the Board of Directors
[SIG]
MARK ROELLIG
EXECUTIVE VICE PRESIDENT -- PUBLIC
POLICY, HUMAN RESOURCES AND LAW,
GENERAL COUNSEL AND SECRETARY
MARCH 24, 1999
YOUR VOTE IS IMPORTANT.
PLEASE DATE, SIGN, AND RETURN YOUR PROXY CARD PROMPTLY.
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TABLE OF CONTENTS
Notice of Annual Meeting.................................................................................. cover
Defined Terms............................................................................................. i
Proxy Statement........................................................................................... 1
Recent Developments....................................................................................... 3
Board of Directors Meetings............................................................................... 3
Committees................................................................................................ 3
Compensation of Directors................................................................................. 4
Security Ownership of Certain Beneficial Owners and Management............................................ 5
Section 16(a) Beneficial Ownership Reporting Compliance................................................... 7
Election of Directors..................................................................................... 7
Ratification of Appointment of Independent Auditors....................................................... 11
Shareholder Proposals..................................................................................... 11
Executive Compensation.................................................................................... 17
Report of Human Resources Committee on Executive Compensation............................................. 23
Stockholder Return Performance Graphs..................................................................... 28
Other Information......................................................................................... 30
Appendix A--Selected Financial Data and Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................................... A-1
Appendix F--Report of Independent Public Accountants and Consolidated Financial Statements................ F-1
DEFINED TERMS
"U S WEST," "WE," "US," "OUR" or "COMPANY" means U S WEST, Inc.
"COMMISSION" means the Securities and Exchange Commission.
"EXECUTIVE SHORT-TERM INCENTIVE PLAN" means the U S WEST Executive
Short-Term Incentive Plan.
"LONG-TERM INCENTIVE PLAN" means the U S WEST Long-Term Incentive Plan.
"NAMED EXECUTIVE OFFICER" means collectively Solomon D. Trujillo, our Chief
Executive Officer, and the four next most highly compensated executive officers
at the end of 1998 named in "Executive Compensation--Summary Compensation
Table."
"OLD U S WEST" means the old U S WEST, Inc. that existed prior to the
Separation, which has been renamed "MediaOne Group, Inc."
"SEPARATION" means the separation by Old U S WEST of its communications
businesses and media businesses into two publicly-traded companies on June 12,
1998.
i
[LOGO]
PRINCIPAL EXECUTIVE OFFICES
1801 CALIFORNIA STREET
DENVER, COLORADO 80202
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PROXY STATEMENT
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The Board of Directors is soliciting proxies to be used at the 1999 annual
meeting to be held at The Millennium Broadway Hotel, 145 West 44th Street, New
York, New York, on Tuesday, May 11, 1999, at 10:30 a.m. eastern daylight time.
This proxy statement and the proxy card will be mailed to shareholders beginning
on or about March 24, 1999. Definitions of capitalized terms used in this proxy
statement are on the facing page.
WHO CAN VOTE
Record holders of common stock at the close of business on March 15, 1999
may vote at the annual meeting. On December 31, 1998, we had approximately
502,903,055 outstanding shares of common stock, which were held by approximately
617,300 record holders. If your shares are held in a stock brokerage account or
by a bank or other nominee, you are considered the beneficial owner of shares
held in street name and these proxy materials are being forwarded to you by your
broker or nominee who is considered, with respect to those shares, the record
holder. As the beneficial owner, you have the right to direct your broker or
nominee on how to vote and are also invited to attend the annual meeting.
However, since you are not the stockholder of record, you may not vote these
shares in person at the meeting. Your broker or nominee has enclosed a voting
instruction card for you to use. YOU ARE URGED TO VOTE BY PROXY REGARDLESS OF
WHETHER YOU ATTEND THE ANNUAL MEETING.
HOW YOU CAN VOTE
You can only vote your shares if you are either represented by proxy or
present in person at the annual meeting. You can vote your proxy by:
- mail, by completing and returning the enclosed proxy card;
- telephone, by calling 1-877-PRX-VOTE (779-8683); or
- the Internet, by accessing a special site at
http://www.eproxyvote.com/usw.
If you hold your shares through your broker in "street name," you will not be
able to vote by telephone or the Internet.
If you return a properly signed proxy card, we will vote your shares as you
direct. IF YOUR PROXY CARD DOES NOT SPECIFY HOW YOU WANT TO VOTE YOUR SHARES, WE
WILL VOTE YOUR SHARES "FOR" THE ELECTION OF ALL NOMINEES FOR DIRECTOR ACCORDING
TO COMPANY PROPOSAL A; "FOR" COMPANY PROPOSAL B ; AND "AGAINST" SHAREHOLDER
PROPOSALS 1 THROUGH 4.
VOTING BY PLAN PARTICIPANTS
If you are a participant in the U S WEST Shareowner Investment Plan, your
proxy card will cover both the number of full shares in your plan account and
shares registered in your name.
If you are a participant in the U S WEST Savings Plan/ESOP, your proxy card
will also serve as a voting instruction card for the trustees of the plans with
respect to the shares held in your accounts. The trustees will vote the shares
held in the plans for which proxies are not received (as well as shares held in
the suspense account of the plans) in the same proportion as the shares for
which proxies are received. However, the trustees will always exercise voting
obligations consistent with their fiduciary duties under the Employee Retirement
Income Security Act of 1974 or other legal requirements.
REVOCATION OF PROXIES
You can revoke your proxy at any time before it is exercised at the annual
meeting by any of these three ways:
- by voting in person at the annual meeting;
- by delivering a written notice of revocation dated after the proxy to our
Secretary; or
- by delivering another proxy dated after the previous proxy.
REQUIRED VOTES
Each share of common stock receives one vote on all matters properly brought
before the annual meeting. In order to conduct business at the annual meeting, a
quorum of a majority of the outstanding shares of common stock must be present
in person or represented by proxy. The following is an explanation of the number
of votes required for each of the matters to be voted on at the annual meeting:
- DIRECTORS. The three nominees for directors receiving the highest number
of votes will be elected.
- SHAREHOLDER PROPOSAL 2. This shareholder proposal recommends an amendment
to our Bylaws and thus will require the affirmative vote of at least 80
percent of all outstanding shares for approval.
- OTHER PROPOSALS. All other proposals at the annual meeting will require
the affirmative vote of a majority of the outstanding shares present in
person or by proxy for approval. Even if shareholder proposals are
approved by the shareholders, they still require the approval of the Board
of Directors.
The required vote for Shareholder Proposal 2 is based on the voting power of
all of the outstanding shares as of the record date. As a result, the failure by
a shareholder to vote in person or by proxy, the abstention from voting by a
shareholder and broker non-votes (as described below) will all have the same
effect as a vote "AGAINST" the proposal. The required vote of the shareholders
on all other proposals to be considered at the annual meeting is based upon the
total number of votes actually cast at the annual meeting. As a result, the
failure by a shareholder to vote in person or by proxy, the abstention from
voting by a shareholder and broker non-votes will not be included in the vote
total and will have no effect on the outcome of the vote. Shares held of record
by brokers who are prohibited from exercising discretionary authority for
beneficial owners who have not provided voting instruction are commonly
described as "broker non-votes."
EquiServe Limited Partnership, our transfer agent, will tally the votes. We
will not disclose your vote except as required by law.
ANNUAL MEETING ADMISSION TICKETS
IF YOU PLAN TO ATTEND THE ANNUAL MEETING, PLEASE MARK THE APPROPRIATE BOX ON
THE PROXY CARD AND RETURN THE PROXY CARD PROMPTLY. If you are a shareholder of
record and arrive at the annual meeting without an admission ticket, you will
only be admitted once we verify your share ownership at the shareholders'
admission counter. If you are a beneficial owner, you can obtain your ticket at
the shareholders' admission counter by presenting evidence of your beneficial
holdings, such as a bank or brokerage firm account statement.
DUPLICATE ANNUAL REPORTS
If you are receiving more than one copy of our Annual Report to
Shareholders, you can stop the mailing of the duplicate copies by marking the
designated box on the proxy card for the accounts selected. This helps reduce
the expense of printing and mailing duplicate materials but will not affect the
mailing of dividend checks, special notices, proxy materials and dividend
reinvestment statements.
2
RECENT DEVELOPMENTS
On June 12, 1998, Old U S WEST separated its communications businesses and
media businesses into two publicly-traded companies. The media businesses are
now conducted through MediaOne Group, Inc. and the communications businesses are
now conducted through our company and its subsidiaries. As part of the
Separation, the domestic directories business known as U S WEST Dex, which was
part of the media businesses of Old U S WEST, was aligned with our Company.
BOARD OF DIRECTORS MEETINGS
Regular meetings of the Board of Directors are scheduled seven times during
the year and special meetings are scheduled as needed. Since the Separation, the
Board of Directors held four meetings in 1998. Except for Mr. Colangelo and Mr.
Jacobson, attendance by incumbent Directors at meetings of the Board of
Directors and its Committees was at least 75% in the aggregate. Mr. Brown became
a member of the Board of Directors in November of 1998. In addition to attending
Board of Directors and Committee meetings, Directors carried out their
responsibilities by participating in discussions with consultants and by
communicating with members of management on matters affecting U S WEST.
COMMITTEES
The Board of Directors has established the four Committees described below
to assist it in meeting its responsibilities:
AUDIT COMMITTEE
FUNCTIONS: Oversees U S WEST's accounting and financial
reporting policies and practices. Assists the Board
of Directors in fulfilling its fiduciary and
corporate accountability responsibilities. Meets
periodically with internal auditors and independent
public accountants and provides them unrestricted
direct access to its members.
NUMBER OF MEETINGS IN 1998: 2
MEMBERS: Peter S. Hellman (Chairman effective February 1999)
Hank Brown
George J. Harad
Allen F. Jacobson (Retiring as of the annual
meeting)
Richard D. McCormick
Jerry O. Williams (Former Chairman and member--
retired January 1999)
FINANCE COMMITTEE
FUNCTIONS: Evaluates the growth strategies and financing for U
S WEST's operations. Advises U S WEST's trusts,
including the pension trust.
NUMBER OF MEETINGS IN 1998: 2
MEMBERS: George J. Harad (Chairman)
Craig R. Barrett
Peter S. Hellman
Marilyn C. Nelson
Frank Popoff
3
HUMAN RESOURCES COMMITTEE
FUNCTIONS: Assures the appropriateness of compensation and
benefits of the executive officers of U S WEST and
its subsidiaries. Administers our stock option and
long-term incentive plans and our other incentive
award plans. Provides for the orderly succession of
management and addresses other employer/employee
issues.
NUMBER OF MEETINGS IN 1998: 3
MEMBERS: Frank Popoff (Chairman)
Linda G. Alvarado
Craig R. Barrett
Jerry J. Colangelo
Marilyn C. Nelson
PUBLIC POLICY/NOMINATING COMMITTEE
FUNCTIONS: Monitors and reviews legal, regulatory, government
relations and public policy issues concerning or
involving U S WEST. Reviews management's
recommendation regarding shareholder proposals.
Nominates and evaluates the performance and
compensation of Board members. This Committee will
consider candidates for the Board recommended by
shareholders if the names and qualifications of such
candidates are submitted in writing to the Secretary
of U S WEST, 1801 California Street, Suite 5200,
Denver, Colorado 80202.
NUMBER OF MEETINGS IN 1998: 2
MEMBERS: Richard D. McCormick (Chairman)
Linda G. Alvarado
Hank Brown
Jerry J. Colangelo
Allen F. Jacobson (Retiring as of the annual
meeting)
Jerry O. Williams (Former member--retired January
1999)
COMPENSATION OF DIRECTORS
GOAL
To attract and retain highly qualified Directors, the Company offers a
competitive Director compensation package. This compensation package includes
various equity components intended to align the interests of Directors with your
long-term interests as shareholders. The Board of Directors periodically reviews
Director compensation policies, and based on the input of several nationally
recognized sources, the Board of Directors has determined that the Company's
policies are in line with suggested industry standards.
4
FEES
Directors fees, paid only to Directors who are not U S WEST employees, are
as follows:
Annual retainer......................... $35,000
Committee chairman retainer............. $ 5,000
Significant special project consultation
fee................................... $ 1,500
Attendance fee for each Board or
Committee meeting..................... $ 1,500 per day
Annual telecommunications services and
equipment allowance (net of taxes).... $ 3,000 (up to)
Any Director who is an employee of U S WEST or one of its subsidiaries
receives no compensation for serving as a Director. Directors may elect to
receive payment of all or any portion of their annual or committee chair
retainers and meeting fees in common stock.
DEFERRED FEES
Directors can choose to have the payment of all or some of their fees
deferred in the form of common stock or cash. Deferred amounts that otherwise
would be payable in common stock are credited in an account as phantom stock
units. The value of these phantom stock units rises and falls with the price of
our common stock. Also, we provide a five percent match if a Director defers
into phantom stock. Additional phantom stock units are credited to the account
when we declare a dividend on our common stock. Deferred cash payments earn
interest that is compounded quarterly at a rate equal to the average interest
rate for ten-year United States Treasury notes plus one percent.
STOCK PLAN
Under the terms of the 1998 Stock Plan, Directors also receive (i) an
up-front grant of 3,000 shares of restricted common stock, which becomes
unrestricted over four years, (ii) options to purchase 30,000 shares of common
stock that vest equally over three years, with annual grants of 10,000 options
after the initial vesting period, and (iii) shares of restricted common stock
equal to ten times the annual retainer paid to Directors which vests 50% at five
years and 10% per year thereafter for the next 5 years, and immediately upon
certain events. The options have value for Directors only if the price of our
common stock appreciates from the date of the option grant. Non-employee
Directors who were Directors of Old U S WEST are also entitled to their vested
pension on the Separation date.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth, as of December 31, 1998, information with
respect to each person who was known by U S WEST (based upon a review of
schedules and reports filed with the Commission) to be the beneficial owner of
more than 5% of U S WEST's common stock.
NUMBER OF PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES CLASS
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Capital Research and Management Company................................................. 28,571,800 5.7%
333 South Hope Street
Los Angeles, California 90071-1447
State Street Bank and Trust Company,.................................................... 26,860,681 5.3%
as trustee for the U S WEST Savings Plan/ESOP
225 Franklin Street
Boston, Massachusetts 02110
5
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth the information concerning shares of common
stock beneficially owned by each Director and Named Executive Officer of U S
WEST as of December 31, 1998 (or as of such other date as may be specified) and
by the Directors and executive officers of U S WEST as a group. These shares
represent less than one percent of the outstanding shares of U S WEST common
stock. Fractional shares have been rounded to the nearest whole share.
SHARE EQUIVALENTS
SHARES SUBJECT TO SAVINGS PLAN/ESOP HELD IN DEFERRED
TOTAL NUMBER OF OPTIONS** (INCLUDED (INCLUDED IN COMPENSATION
NAME SHARES* IN TOTAL) TOTAL) PLANS***
- ------------------------------ ------------------- ------------------- ----------------- -----------------
Linda G. Alvarado............. 10,591(1) 723
Craig R. Barrett.............. 20,558(1)
Hank Brown.................... 10,087(2) 205
Jerry J. Colangelo............ 10,891(1)
George J. Harad............... 12,643(1)(3) 2,100 2,309
Peter S. Hellman.............. 10,991(1) 645
Allen F. Jacobson............. 26,033(1)(4) 11,100 9,360
Richard D. McCormick.......... 929,891(1)(5) 722,113 722
Marilyn C. Nelson............. 24,093(1)(6) 11,100 8,122
Frank Popoff.................. 24,333(1) 9,000 732
Mark Roellig.................. 91,518 46,600 1,826 4,192
James A. Smith................ 59,100 44,326 4,895
Allan R. Spies................ 55,381 50,578 3,780 4,841
Solomon D. Trujillo........... 445,511 396,556 2,031 12,781
Jerry O. Williams............. 23,351(7) 11,100
Gregory M. Winn............... 75,493 54,508(8) 6,512(9) 1,529
All Directors and executive
officers of U S WEST (as a
group)....................... 2,030,622 1,461,797 20,725 46,561
- ------------------------------
* Includes shares subject to acquisition through exercise of stock options
within 60 days and equivalent Savings Plan/ESOP shares.
** Shares subject to acquisition through exercise of stock options within 60
days.
*** Includes units denominated as common share equivalents held in deferred
compensation accounts.
(1) Includes 9,300 unvested shares of restricted stock granted as part of
director compensation.
(2) Includes 9,087 unvested shares of restricted stock granted as part of
director compensation.
(3) Includes 40 shares subject to shared voting and investment power.
(4) Includes 1,310 shares subject to shared voting and investment power.
(5) Includes 96,603 shares subject to shared voting and investment power.
(6) Includes 28 shares subject to shared voting and investment power.
(7) Mr. Williams retired from the Board of Directors in January of 1999.
(8) Includes 900 shares subject to options held by spouse.
(9) Includes 2,979 share equivalents held by spouse.
6
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our Directors
and executive officers, and persons who own more than 10% of our common stock,
to file with the Commission, the New York Stock Exchange and the Pacific Stock
Exchange reports of ownership and changes in ownership of common stock and other
equity securities of the Company. Executive officers, Directors and greater than
10% shareholders are required by Commission regulation to furnish to us copies
of all Section 16(a) forms they file.
Based on a review of the copies of Section 16(a) forms furnished to us and
written representations that no other filings were required, U S WEST believes
that all Commission filing requirements applicable to its executive officers,
Directors and greater than 10% shareholders were complied with for 1998.
ELECTION OF DIRECTORS
(COMPANY PROPOSAL A)
(ITEM A ON THE PROXY CARD)
The Board of Directors currently consists of 11 Directors divided into three
classes (Class I, Class II and Class III) serving staggered three-year terms.
The Class I Directors are up for election at this annual meeting and the
nominees for election are all currently Class I Directors.
We will vote your shares as you specify on your proxy card. If you sign,
date and return the proxy card but do not specify how you want your shares
voted, we will vote them FOR THE ELECTION OF THE THREE NOMINEES LISTED BELOW. If
you do not wish to have your shares voted for a particular nominee, you may so
indicate in the space provided in the proxy card. If unforeseen circumstances
(such as death or disability) make it necessary for the Board of Directors to
substitute another person for any of the nominees, we will vote your shares FOR
THAT OTHER PERSON. If we do not name a substitute nominee, the size of the Board
of Directors will be reduced. The Board knows of no reason why any of the
nominees would not be available to serve at the time of the annual meeting.
Following is a brief listing of ages, terms as Director, principal
occupations, business experience and other directorships of the three nominees
for election as Directors. Similar information is also provided for the other
Directors whose terms of office do not expire at this annual meeting. Mr.
Jacobson will resign and not seek re-election at this annual meeting because he
is retiring.
NOMINEES FOR DIRECTOR IN CLASS I
(THE TERMS OF THESE NOMINEE DIRECTORS EXPIRE AT
THE ANNUAL MEETING OF SHAREHOLDERS IN 2002)
HANK BROWN
AGE: 59
DIRECTOR SINCE: 1998
PRINCIPAL OCCUPATION: President of the University of Northern Colorado since 1998.
BUSINESS EXPERIENCE: Director of the Center for Public Policy for the University of
Denver from 1997 to 1998. United States Senator for the State
of Colorado from 1991 to 1997. United States Congressman for
the State of Colorado from 1981 to 1991. Various positions with
Monfort of Colorado Incorporated from 1969 to 1981. United
States Navy from 1962 to 1966. Attorney and Certified Public
Accountant
OTHER DIRECTORSHIPS: Sealed Air Corporation
7
GEORGE J. HARAD
AGE: 54
DIRECTOR SINCE: 1998; Director of Old U S WEST from 1997 until the Separation.
PRINCIPAL OCCUPATION: Chairman of the Board of Boise Cascade Corporation since 1995.
President and Chief Executive Officer of Boise Cascade
Corporation since 1994.
BUSINESS EXPERIENCE: President and Chief Operating Officer of Boise Cascade
Corporation from 1991 to 1994. Chairman of the Board of Boise
Cascade Office Products Corporation since 1995.
OTHER DIRECTORSHIPS: Allendale Insurance Company
MARILYN CARLSON NELSON
AGE: 59
DIRECTOR SINCE: 1998; Director of Old U S WEST from 1993 until the Separation.
PRINCIPAL OCCUPATION: President, Chief Executive Officer and Vice Chair of Carlson
Companies, Inc., Co-Chair Carlson Wagonlit Travel.
BUSINESS EXPERIENCE: Since joining Carlson Companies in 1989, Ms. Nelson has held
various positions with Carlson Companies including Director,
Chief Operating Officer and Senior Vice President of Carlson
Holdings, Inc. Ms. Nelson is also President elect of Travel
Industry of America, and a member of the United States National
Tourism Organization, World Travel and Tourism Council,
International Advisory Council, Center for International
Leadership and Committee of 200.
OTHER DIRECTORSHIPS: Exxon Corporation; Carlson Companies, Inc.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" EACH OF THE NOMINEES FOR DIRECTOR.
DIRECTOR NOT SEEKING NOMINATION
ALLEN F. JACOBSON
AGE: 72
DIRECTOR SINCE: 1998; Director of Old U S WEST from 1983 until the Separation.
PRINCIPAL OCCUPATION: Retired
BUSINESS EXPERIENCE: Chairman and Chief Executive Officer of Minnesota Mining &
Manufacturing Company from 1986 to 1991.
OTHER DIRECTORSHIPS: Mobil Corporation; Valmont Industries, Inc.
8
CONTINUING DIRECTORS IN CLASS II
(THE TERMS OF THESE CONTINUING DIRECTORS EXPIRE
AT THE ANNUAL MEETING OF SHAREHOLDERS IN 2000)
PETER S. HELLMAN
AGE: 49
DIRECTOR SINCE: 1998
PRINCIPAL OCCUPATION: Former President and Chief Operating Officer of TRW Inc.
(1995-1999).
BUSINESS EXPERIENCE: Assistant President of TRW Inc. from 1994 to 1995. Chief
Financial Officer from 1992 to 1994. Vice President and Chief
Financial Officer from 1991 to 1992. Vice President and
Treasurer from 1989 to 1991. Various positions with BP America
from 1979 to 1989 and the Irving Trust Company from 1972 to
1979.
OTHER DIRECTORSHIPS: Arkwright Mutual Insurance Company
RICHARD D. MCCORMICK
AGE: 58
DIRECTOR SINCE: 1998; Chairman of Old U S WEST from 1992 until the Separation.
PRINCIPAL OCCUPATION: Chairman of the Board of U S WEST since 1998.
BUSINESS EXPERIENCE: President and Chief Executive Officer of Old U S WEST from 1991
until the Separation.
OTHER DIRECTORSHIPS: Wells Fargo and Company; UAL (United Airlines) Corporation;
United Technologies Corporation; Concept 5 Technologies, Inc.
FRANK POPOFF
AGE: 63
DIRECTOR SINCE: 1998; Director of Old U S WEST from 1993 until the Separation.
PRINCIPAL OCCUPATION: Chairman of The Dow Chemical Company since 1992.
BUSINESS EXPERIENCE: Chief Executive Officer of The Dow Chemical Company from 1987
to 1995.
OTHER DIRECTORSHIPS: American Express Company; Chemical Financial Corporation;
United Technologies Corporation
CONTINUING DIRECTORS IN CLASS III
(THE TERMS OF THESE CONTINUING DIRECTORS EXPIRE
AT THE ANNUAL MEETING OF SHAREHOLDERS IN 2001)
LINDA G. ALVARADO
AGE: 47
DIRECTOR SINCE: 1998
PRINCIPAL OCCUPATION AND President and Chief Executive Officer of Alvarado Construction,
BUSINESS EXPERIENCE: Inc. since 1978.
OTHER DIRECTORSHIPS: Cyprus Amax Minerals Company; Engelhard Corporation; Pitney
Bowes, Inc.
9
CRAIG R. BARRETT
AGE: 59
DIRECTOR SINCE: 1998
PRINCIPAL OCCUPATION: President and Chief Executive Officer of Intel Corporation
since 1998.
BUSINESS EXPERIENCE: President and Chief Operating Officer of Intel Corporation from
1997 to 1998, Executive Vice President and Chief Operating
Officer from 1993-1997 and Executive Vice-President from
1990-1993. Senior Vice-President and General Manager of the
Microcomputer Components Group of Intel Corporation from 1989
to 1990. Vice President/Senior Vice-President and General
Manager of the Components Technology and Manufacturing Group of
Intel Corporation from 1985 to 1989, and Vice President from
1984 to 1985. Various technology, engineering and manufacturing
management positions with Intel Corporation from 1974 to 1984.
Professor of Engineering at Stanford University from 1965 to
1974.
OTHER DIRECTORSHIPS: Intel Corporation; SEMATECH
JERRY J. COLANGELO
AGE: 60
DIRECTOR SINCE: 1998
PRINCIPAL OCCUPATION: Owner, Chairman and Chief Executive Officer of the Arizona
Diamondbacks since 1995. President and Chief Executive Officer
of the Phoenix Suns, NBA since 1987.
BUSINESS EXPERIENCE: General Manager of the Phoenix Suns, NBA from 1968 to 1987.
Head Scout and Director of Merchandising for the Chicago Bulls,
NBA from 1966 to 1968. Associate of D.O. Klein & Associates
from 1964 to 1965. Partner at the House of Charles, Inc. from
1962 to 1964.
OTHER DIRECTORSHIPS: Phoenix Art Museum; Phoenix Community Alliance; Arizona
Diamondbacks; Phoenix Suns Charities
SOLOMON D. TRUJILLO
AGE: 47
DIRECTOR SINCE: 1998
PRINCIPAL OCCUPATION: President and Chief Executive Officer of U S WEST since 1998.
BUSINESS EXPERIENCE: President and Chief Executive Officer of the Communications
Group of Old U S WEST from 1995 to 1998. President and Chief
Executive Officer of U S WEST Dex, Inc. from 1992 to 1995. Mr.
Trujillo joined The Mountain States Telephone and Telegraph
Company in 1974 and has been affiliated with U S WEST and its
predecessors since that time, serving in various marketing,
sales, finance and public policy positions.
OTHER DIRECTORSHIPS: BankAmerica Corporation; Dayton Hudson Corporation
10
RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS
(COMPANY PROPOSAL B)
(ITEM B ON THE PROXY CARD)
At the recommendation of the Audit Committee, the Board of Directors has
appointed the firm of Arthur Andersen LLP, Independent Public Accountants, as
independent auditors to audit the financial statements of U S WEST for calendar
year 1999.
Representatives of Arthur Andersen LLP are expected to be present at the
annual meeting, will have the opportunity to make a statement if they so desire
and will be available to respond to questions.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" COMPANY PROPOSAL B.
------------------------
SHAREHOLDER PROPOSALS
Shareholder proponents have stated that they intend to have the proposals
and supporting statements described below presented at the annual meeting. The
adoption of Shareholder Proposals 1, 3 and 4 would not legally require the
implementation of the action or policy called for by such proposal, but would
simply constitute a recommendation to the Board of Directors. The adoption of
Shareholder Proposal 2, which recommends an amendment to our Bylaws, may require
legal implementation without the benefit of review by the Board of Directors.
The Board of Directors believes that this proposed Bylaw amendment is not in the
best interests of shareholders and, based on an opinion of Delaware counsel, may
be legally invalid.
SHAREHOLDER PROPOSAL 1
DISCONTINUANCE OF THE CLASSIFIED BOARD (ITEM 1 ON THE PROXY CARD)
Mrs. Evelyn Y. Davis, Watergate Office Building, 2600 Virginia Avenue, N.W.,
Suite 215, Washington, D.C. 20037, owning of record 120 shares of U S WEST
common stock, has given notice that she intends to present at the annual meeting
the following resolution:
"RESOLVED: That the shareholders of U S WEST recommend that the Board of
Directors take the necessary steps to institute the election of directors
ANNUALLY, instead of the staggered system as is now provided."
"REASONS: The majority of New York Stock Exchange listed corporations
elect all their directors each year."
"This insures that ALL directors will be more accountable to ALL
shareholders each year and to a certain extent prevents the
self-perpetuation of the Board."
"Last year the owners of Communications Stock and Media Stock,
representing approximately 43.756% of shares VOTING, voted FOR this
proposal."
"If you AGREE, please mark your proxy FOR this resolution."
THIS PROPOSAL HAS BEEN SUBMITTED AT THE LAST TEN ANNUAL MEETINGS OF OLD U S
WEST AND WAS DEFEATED EACH TIME. THE BOARD OF DIRECTORS HAS AGAIN CONSIDERED THE
PROPOSAL AND AGAIN RECOMMENDS THAT SHAREHOLDERS VOTE "AGAINST" IT.
The Board of Directors believes that the election of Directors by classes
enhances the likelihood of continuity and stability of the Board of Directors
and its policies. When Directors are elected by classes, a change in the
composition of a majority of the Board of Directors normally requires at least
two shareholder meetings, instead of one. Board classification is also intended
to encourage any person seeking to acquire control of U S WEST to initiate that
action through arm's length negotiations with management and the Board of
Directors, who are in a position to negotiate a transaction which is fair to all
of our shareholders. With a classified Board of Directors, it is more likely
that a majority of the Directors will have prior U S WEST Board experience,
thereby facilitating the planning of our business.
11
SHAREHOLDER PROPOSAL 2
DISCONTINUANCE OF SHAREHOLDER RIGHTS PLANS (ITEM 2 ON THE PROXY CARD)
Mr. Kenneth E. Rains, 4800 Euclid Avenue, Des Moines, Iowa 50310, owning of
record 202 shares of U S WEST common stock, has given notice that he intends to
present at the annual meeting the following resolution:
"SHAREHOLDER PROPOSAL
Resolved, that the stockholders amend the bylaws of U S WEST, Inc. as
follows:
Article XI Stockholders Rights Plans
Section 1. The Corporation shall not adopt or retain any poison pill,
shareholder rights plan, rights agreement or any other form of "poison
pill," unless such a plan has been approved by a majority of stockholders.
The company shall redeem any such rights now in effect.
Section 2. This article shall be effective as of the date it is
approved.
Section 3. Notwithstanding any other provision of these bylaws, this
Article may not be amended, altered, deleted or modified by the Board of
Directors without prior approval of the stockholders.
STATEMENT OF SUPPORT
A poison pill is an anti-takeover device, which effectively prevents a
change in control of a company without the approval of the Board of
Directors. It forces potential acquirers to negotiate acquisitions with
management, instead of making an offer directly to the stockholders. In
addition, by forcing potential acquirers to negotiate with the Board, poison
pills may have a tendency to entrench management, to insulate it from
accountability, and to make management less responsive to the views of
stockholders.
The stockholders, who own U S WEST, should have the right to decide what
is a fair price for their holdings. Furthermore, they should also have the
right to decide whether the risk of such consequences may be warranted by
special circumstances that might make it appropriate to adopt a poison pill.
Since 1988, 75 stockholder proposals on poison pills have won majority
votes, including 15 in 1997 and seven so far in 1998. According to the
Investor Responsibility Research Center, 1998 proposals are winning record
average support of 56.6% of the shares voted.
The telecommunications industry is ripe with mergers. However, in my
opinion, U S WEST continues to be out of step with the industry in many
respects. At a time when scale is becoming critical to competition, U S WEST
is paring down in size instead of growing. It is the smallest Baby Bell in
terms of revenue.
I believe U S WEST is vulnerable to a takeover. However, the existence
of a poison pill may deter persons otherwise interested in making an offer,
and management may usurp stockholders right to determine if such an offer is
fair. I believe U S WEST needs to get in step with the rest of the industry
and enhance shareholder value."
THE BOARD OF DIRECTORS HAS CONSIDERED THIS PROPOSAL AND BELIEVES IT IS
OVERLY BROAD, AGAINST THE BEST INTEREST OF SHAREHOLDERS AND MAY BE LEGALLY
INVALID. ACCORDINGLY, THE BOARD OF DIRECTORS RECOMMENDS A VOTE "AGAINST" IT.
U S WEST and its management are firmly committed to maximizing shareholder
value. The U S WEST Rights Agreement was adopted to protect our shareholders
against abusive takeover tactics and to ensure that each shareholder would be
treated fairly. The U S WEST Rights Agreement is intended
12
to create an incentive for a potential acquirer to negotiate in good faith with
the Board of Directors, not to preclude unsolicited, non-abusive offers to
acquire your shares of common stock at a fair price. The U S WEST Rights
Agreement strengthens the ability of our Board to fulfill its fiduciary
responsibilities to our shareholders because it provides the Board of Directors
with time to evaluate the fairness of any unsolicited offer and the credibility
of a bidder, thereby enhancing the Board of Directors' ability to obtain the
best results for our shareholders. In fact, premiums paid to acquire target
companies with poison pills were on average eight percentage points higher than
premiums paid for target companies that did not have poison pills according to a
1997 study by Georgeson & Company, Inc.
The Board of Directors also believes that the proposed Bylaw amendment may
be legally invalid. The Company has received an opinion of special Delaware
counsel to the effect that although the issue has not been decided by a Delaware
court, the proposed Bylaw amendment would not be valid under the Delaware
General Corporation Law if it were adopted by the shareholders. As indicated
above, the opinion states that there is no Delaware case which specifically
addresses the validity or invalidity of the proposed Bylaw amendment or of any
similar bylaw.
The Board of Directors believes that the continued existence of the U S WEST
Rights Agreement is in the best interest of the Company and its shareholders.
The U S WEST Rights Agreement is an important tool that the Board of Directors
should have in the event of an unfair or coercive takeover attempt. Any action
to redeem the rights issued pursuant to the U S WEST Rights Agreement should
only be made in the context of a specific acquisition proposal.
------------------------
SHAREHOLDER PROPOSAL 3
LIMITATION ON FUTURE CHANGE OF CONTROL COMPENSATION (ITEM 3 ON THE PROXY CARD)
Mr. Glen McBarron, 4451 146th Avenue, South East, Bellevue, Washington
98006, beneficial owner of the equivalent of approximately 82 shares of U S WEST
common stock, has given notice that he intends to present at the annual meeting
the following resolution:
"SHAREHOLDER PROPOSAL
RESOLVED, that the U S WEST Board of Directors should adopt a policy
against making any future compensation awards to the officers and directors
of this corporation, which are contingent on a change of control of the
corporation, unless such compensation awards are submitted to a vote of the
shareholders and approved by a majority of the votes cast; provided,
however, that such policy would not apply to existing agreements, plans or
other obligations.
STATEMENT OF SUPPORT
Golden parachutes are lucrative compensation awards, which are provided
to senior executives. U S WEST has golden parachutes that are contingent
upon termination following a change of control which by definition occurs if
someone acquires 20% or more of the outstanding voting stock, or if there is
a change of majority of the directors within a two-year period.
Golden parachutes have been provided for Messrs. Trujillo, Winn, Roellig
and Spies, but none of these golden parachutes have the approval of the
shareholders. The amounts to be paid would be calculated by computing an
amount equal to THREE times the sum of the annual salary and short-term
incentive compensation (i.e. bonus). In the case of Mr. Trujillo, the golden
parachute also includes a sum of three times the value of stock option and
dividend equivalent unit (DEU) awards. If change of control payments were
made to Mr. Trujillo, he would be restricted from competing with U S WEST
for a period of three years.
13
I believe that the golden parachute awarded to Mr. Trujillo is
particularly excessive in view of the fact that it includes a multiplier for
stock option awards. When the multiplier for stock options is included,
there is the potential for truly astronomical payouts.
For example, U S WEST's 1998 proxy statement reflects that Mr. Trujillo
received approximately $2.48 million which includes salary, bonus, and
present value of stock awards in 1997, but not DEU awards. This roughly
implies a golden parachute payment of $7.4 million for Mr. Trujillo, if the
payment were made in 1998, and the potential for larger amounts in later
years.
Total payments to the top four executive officers (including Mr.
Trujillo) that have golden parachutes could amount to roughly $11.7 million
if paid in 1998. The actual payments could be more depending on the value of
future bonuses, stock option and DEU awards.
In my view, a conflict of interest is created when executives are
awarded special compensation that is to be paid only in the event of a
future merger or acquisition. Such awards provide management with a personal
financial incentive to perform their duties in a way that might be
detrimental to shareholder interests.
Management's first priority should be to maximize shareholder value.
However, actions that might temporarily restrain the growth of shareholder
value may make the company look more attractive as the potential target of a
merger or acquisition. Management may also be tempted to support a merger or
acquisition proposal without seeking a better deal for shareholders. In the
alternative, excessive golden parachutes may also discourage an attempt to
acquire control of U S WEST by increasing its cost.
Please vote FOR this proposal."
THE BOARD OF DIRECTORS HAS CONSIDERED THIS PROPOSAL AND RECOMMENDS THAT
SHAREHOLDERS VOTE "AGAINST" IT.
The Board of Directors believes that it would not be in your best interests
as shareholders or that of U S WEST to arbitrarily restrict compensation awards
as the proponent recommends. Executive compensation is carefully reviewed by the
Human Resources Committee, a committee composed of independent, non-employee
directors. The Human Resources Committee attempts to compensate executives in a
manner that will attract and retain the quality of leadership that will give U S
WEST a competitive advantage and promote its continued success. Companies that
are perceived as potential targets may have difficulty in attracting and
retaining talented executives absent the ability to provide compensation in the
event of a change of control. Often, top-level executives lose their positions
following an acquisition; however, change of control agreements encourage both
continuity and cooperation of management during periods of uncertainty.
It should be noted that if change of control payments were made to Mr.
Trujillo, he would be restricted from competing with U S WEST for a period of
three years. By providing a minimal level of financial security in the event of
potential job loss, change of control awards encourage management to objectively
assess takeover bids and tender offers with less concern about the possible loss
of personal income. The Board of Directors believes that the continued ability
to offer change of control awards to attract and retain effective management is
in the best interests of U S WEST and its shareholders.
14
SHAREHOLDER PROPOSAL 4
TWO NOMINEES FOR EACH DIRECTORSHIP (ITEM 4 ON THE PROXY CARD)
Richard A. Dee, 115 East 89th Street, New York, New York 10128, beneficial
owner of the equivalent of approximately 28 shares of U S WEST common stock, and
John J. Gilbert, 29 East 64th Street, New York, New York 10021, beneficial owner
of 94 shares of U S WEST common stock, have given notice that they intend to
present at the annual meeting the following resolution:
"SHAREHOLDER PROPOSAL
"STOCKHOLDERS OF PUBLICLY-OWNED CORPORATIONS DO NOT 'ELECT' DIRECTORS.
Directors are 'selected' by incumbent directors and management--stockholders
merely 'RATIFY' or approve those selections much as they ratify selections
of auditors.
"The term 'Election of Directors' has been misused in corporate proxy
materials for many years to refer to the process by which directors are
empowered. The term is not only inappropriate--it is misleading. WITH NO
CHOICE OF CANDIDATES, THERE IS NO ELECTION.
"Understandably, incumbent directors are anxious to protect their
absolute power over corporate activities. The root of that absolute power is
control of Corporate Governance--which is assured by control of board
composition. Unfortunately, the 'ELECTIVE PROCESS RIGHTS' of stockholders
are being ignored.
"Approval of this Corporate Governance proposal will provide U S WEST
stockholders with a choice of director candidates each year--and an
opportunity to vote for those whose qualifications and stated intentions
they favor. Approval will provide stockholders with 'duly' elected
representatives.
"Public officials who govern are duly elected--and held accountable.
Continuing in office depends upon satisfying constituents, not just
nominators. Corporate directors take office unopposed and answer only to
fellow directors.
"In our opinion, far too many directors divide their time between too
many masters. The 'pool' from which directors are selected must be expanded
from the current preponderance of chairmen and CEO's to include younger
executives, including many more women, whose backgrounds qualify them well
to represent the stockholders of particular companies.
"As long as incumbents select and propose only the number of so-called
"candidates" as directorships to be filled, and as long as it is impossible,
realistically, for stockholders to utilize successfully what is supposed to
be their right to nominate and elect directors, no practical means will
exist for stockholders to bring about director turnover--until this or a
similar proposal is adopted. Turnover reduces the possibility of inbreeding
and provides sources for new viewpoints, approaches, and ideas.
"IT IS HEREBY REQUESTED THAT THE BOARD OF DIRECTORS PROMPTLY ADOPT A
RESOLUTION REQUIRING THE PUBLIC POLICY/NOMINATING COMMITTEE TO NOMINATE TWO
CANDIDATES FOR EACH DIRECTORSHIP TO BE FILLED BY THE VOTING OF STOCKHOLDERS
AT ANNUAL MEETINGS. IN ADDITION TO CUSTOMARY PERSONAL BACKGROUND
INFORMATION, PROXY STATEMENTS SHALL INCLUDE A STATEMENT BY EACH CANDIDATE AS
TO WHY HE OR SHE BELIEVES THEY SHOULD BE ELECTED.
"Even though all nominees will continue to be selected by incumbents,
approval of this proposal will enable stockholders to replace any or all
directors if they become dissatisfied with them or with the results of
corporate policies and/or performance. Not a happy prospect even for those
able to nominate their possible successors.
15
"Any burden that the company may claim will be imposed upon it by having
to provide a choice of able director candidates is far outweighed by the
benefits that will accrue to U S WEST stockholders from a
democratically-elected board--a board composed of representatives willing to
have their respective qualifications reviewed and weighed carefully by the
stockholders whose interests they are to serve.
"PLEASE VOTE FOR THIS PROPOSAL."
THE BOARD OF DIRECTORS HAS CONSIDERED THIS PROPOSAL AND RECOMMENDS THAT
SHAREHOLDERS VOTE "AGAINST" IT.
U S WEST believes that the appropriate role of the Board of Directors is to
provide the U S WEST shareholders with a slate of director candidates whom the
Board of Directors believe, in their best judgment, to be the most qualified and
who are ready, willing and able to manage the affairs of U S WEST. It is not the
role of the Board of Directors to create a political environment, such as this
proposal would foster, in which nominees compete with each other for the
available directorships.
The Board of Directors views the current nominating process to be the most
practical means of ensuring that individuals with appropriate qualifications
continue to serve on the U S WEST Board of Directors. The Public
Policy/Nominating Committee serves a critical function for U S WEST and its
shareholders by reviewing numerous candidates and selecting only those nominees
possessing the highest quality and skills necessary and appropriate for service
on the U S WEST Board of Directors. In this manner, the composition of the Board
of Directors will remain diverse and balanced in its experience, expertise, and
other respects.
U S WEST's Board currently consists of a diverse group of extremely
qualified individuals ranging from a former Senator to CEOs, business leaders,
entrepreneurs and leaders in various fields. U S WEST believes that the election
contests suggested in this proposal would deter many talented candidates from
seeking nomination. In addition, the current process allows for alternative
candidates to be proposed by shareholders on a timely basis and the appropriate
information about such candidates to be included in the Company's proxy
material.
The present system of nominating a slate of directors is in keeping with the
Board of Directors' fiduciary responsibility of advising shareholders on matters
upon which they are asked to vote. The Board of Directors believes that the
present nominating process has provided U S WEST with extremely qualified
leadership and shareholder value over the years and should be preserved in the
best interest of U S WEST.
16
EXECUTIVE COMPENSATION
The table below shows the compensation for the last two years for Solomon D.
Trujillo, who served as Chief Executive Officer in 1998, and the four next most
highly compensated executive officers at the end of 1998. Compensation for 1997
and from January 1, 1998 until the Separation date relates to services rendered
to Old U S WEST.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
--------------------------------------
OTHER ANNUAL
SALARY BONUS COMPENSATION RESTRICTED STOCK
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) AWARD(S) ($)(1)
- ---------------------------------------- ---- -------- -------- ------------ -----------------
SOLOMON D. TRUJILLO..................... 1998 $716,041 $650,000 $42,432
President and Chief Executive Officer 1997 $525,220 $645,000 $11,821
GREGORY M. WINN......................... 1998 $338,099 $217,000 $11,475 (2)
Executive Vice President-Operations & 1997 $264,127 $225,000 $ 9,033 $67,987(3)
Technology
ALLAN R. SPIES.......................... 1998 $309,621 $181,600 $ 8,086 $11,985(5)
Executive Vice President and Chief 1997 $230,317 $160,000 $ 330
Financial Officer
MARK ROELLIG............................ 1998 $315,027 $164,700 $ 9,050
Executive Vice President-Public Policy, 1997 $273,519 $185,000 $ 317
Human Resources and Law, General
Counsel and Secretary
JAMES A. SMITH.......................... 1998 $290,000 $197,925 $ 2,067
Executive Vice President and President 1997 $269,165 $152,552 $ 4,281
of U S WEST Dex, Inc.
LONG-TERM COMPENSATION
-----------------------------------------------
SECURITIES
UNDERLYING
OPTIONS/SARS ALL OTHER
------------ LTIP PAYOUTS COMPENSATION(4)
NAME AND PRINCIPAL POSITION (#) ($) ($)
- ---------------------------------------- ------------ ------------ -----------------
SOLOMON D. TRUJILLO..................... 1,063,000 $414,090 $ 62,948
President and Chief Executive Officer 113,836 $267,319 $ 51,129
GREGORY M. WINN......................... 364,071 $ 50,397 $111,376
Executive Vice President-Operations & 25,933 $ 32,956 $301,296
Technology
ALLAN R. SPIES.......................... 156,931 $ 35,952 $ 35,568
Executive Vice President and Chief 33,100 $ 23,431 $ 28,489
Financial Officer
MARK ROELLIG............................ 162,500 $ 28,890 $ 95,952
Executive Vice President-Public Policy, 7,500 $ 19,002 $ 70,643
Human Resources and Law, General
Counsel and Secretary
JAMES A. SMITH.......................... 149,406 $ 54,570 $ 28,692
Executive Vice President and President 17,161 $ 35,814 $ 22,468
of U S WEST Dex, Inc.
- ------------------------------
NOTE: On June 5, 1998, the shareholders of Old U S WEST approved of the
Separation. As part of the Separation: (i) restricted Old U S WEST Media Group
targeted stock ("Media Stock"), held by individuals who became employees of U S
WEST, was replaced immediately prior to the Separation with substitute
restricted Old U S WEST Communications Group targeted stock ("Communications
Stock"), each share of which, along with existing restricted Communications
Stock, was then replaced with a share of restricted U S WEST common stock in the
Separation; (ii) phantom stock units for Media Stock, held by individuals who
became employees of U S WEST, were replaced immediately prior to the Separation
with substitute phantom stock units of Communications Stock, each unit of which,
along with each existing unit of Communications Stock, was then replaced with a
phantom unit for U S WEST common stock in the Separation; (iii) option holders
who continued employment with U S WEST did not forfeit their stock options for
Media Stock as a result of their termination of employment with Old U S WEST;
and (iv) stock options for Communications Stock were replaced with substitute
options for U S WEST common stock. On October 31, 1995, the shareholders of Old
U S WEST approved the creation of two classes of common stock, Communications
Stock and Media Stock, intended to reflect separately the communications
businesses and the multimedia businesses of Old U S WEST (the "1995
Recapitalization"). Options granted between November 1, 1995 and June 12, 1998
were options in either Communications Stock or Media Stock.
(1) At December 31, 1998, Messrs. Trujillo, Winn, Spies, Roellig and Smith,
respectively, held 0, 9,600, 204, 35,912 and 0 shares of restricted U S WEST
stock with an aggregate value, respectively, of $-0-, $620,400, $13,184,
$2,320,813 and $-0-.
(2) Mr. Winn was granted 30,000 shares of restricted U S WEST common stock in
tandem with a grant of 300,000 options on August 6, 1998. This tandem grant
cliff vests in four years. Upon vesting, Mr. Winn shall only be entitled to
receive one of the tandem grants with the other grant being forfeited.
(3) Mr. Winn received 1,550 shares of Communications Stock in February of 1997,
subject to a six-month restriction as to sale or transferability. Mr. Winn
received an additional 2,100 shares of Communications Stock in February of
1997, subject to a four-year restriction as to sale or transferability. At
December 31, 1997, Mr. Winn held 10,600 shares of restricted Communications
Stock and 1,000 shares of restricted Media Stock, all of which were entitled
to dividends, if any, paid during the restriction period, and which had an
aggregate value of $478,325 and $28,875, respectively.
(4) The amounts in this column are attributed to (i) the U S WEST matching
contribution under the Deferred Compensation Plan, (ii) the U S WEST
matching contribution under the Savings Plan/ESOP, (iii) the current dollar
value of the remainder of the premium paid under a split-dollar insurance
arrangement and (iv) the amount paid for the term insurance portion of the
foregoing split-dollar arrangement. The separate components of these amounts
are set forth below. In 1998, U S WEST and Old U S WEST also paid Mr. Winn
$68,450 for certain additional
17
relocation expenses including spousal travel. In 1997, Old U S WEST also
paid Mr. Winn $274,977 to cover certain housing expenses he incurred in
connection with a relocation. In 1998 and 1997, Mr. Roellig was paid $60,000
and $40,000 respectively in accordance with his 1996 retention agreement.
DEFERRED COMPENSATION SAVINGS PLAN COMPANY SPLIT-DOLLAR PREMIUM TERM PORTION
COMPANY MATCH MATCH VALUE PREMIUM
--------------------- -------------------- -------------------- ------------
YEAR ENDED DECEMBER 31, 1998
----------------------------------------------------------------------------------
Solomon D. Trujillo........... $29,576 $8,000 $24,770 $602
Gregory M. Winn............... $22,768 $7,480 $12,468 $210
Allan R. Spies................ $16,312 $8,000 $11,024 $232
Mark Roellig.................. $17,325 $7,142 $11,295 $190
James A. Smith................ -- $7,999 $20,453 $240
YEAR ENDED DECEMBER 31, 1997
----------------------------------------------------------------------------------
Solomon D. Trujillo........... $19,250 $8,000 $23,441 $438
Gregory M. Winn............... $ 6,666 $7,157 $12,319 $177
Allan R. Spies................ $10,388 $7,269 $10,674 $158
Mark Roellig.................. $ 7,676 $7,471 $15,352 $144
James A. Smith................ -- $8,000 $14,269 $199
(5) Mr. Spies received 204 shares of restricted U S WEST common stock in
December of 1998.
OPTION/SAR GRANTS IN LAST FISCAL YEAR AND YEAR END OPTION/SAR VALUES
The table below shows the stock options granted to the Named Executive
Officers during 1998 by U S WEST and Old U S WEST. We employed the Black-Scholes
option pricing model to develop the theoretical values set forth under the
"Grant Date Present Value" column. These stock options comprise a portion of the
Named Executive Officers' total long-term compensation potential.
INDIVIDUAL GRANTS
--------------------------------------------------------------------------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS/SARS EXERCISE OR
UNDERLYING GRANTED TO BASE GRANT DATE
OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION PRESENT VALUE
NAME GRANTED(#)(1) FISCAL YEAR ($/SH) DATE ($)
- ----------------------------- ------------------- -------------- --------------- ----------- -------------
Solomon D. Trujillo.......... 313,000 3.5385% $ 49.625 2/19/08 $ 2,540,965(5)
750,000(2) 8.4788% $ 51.625 8/06/08 $ 7,090,500(6)
Gregory M. Winn.............. 63,000 0.7122% $ 49.625 2/19/08 $ 511,440(5)
322 0.0036% $ 50.312 1/04/02 $ 2,740(7)
749 0.0085% $ 50.312 12/2/04 $ 6,612(7)
300,000(3) 3.3915% $ 51.625 8/06/08 $ 2,599,320(6)
Allan R. Spies............... 56,300 0.6365% $ 49.625 2/19/08 $ 457,049(5)
100,000(4) 1.1305% $ 51.625 8/06/08 $ 866,440(6)
631 0.0071% $ 58.750 6/19/05 $ 6,171(8)
Mark Roellig................. 62,500 0.7066% $ 49.625 2/19/08 $ 507,381(5)
100,000(4) 1.1305% $ 51.625 8/06/08 $ 866,440(6)
James A. Smith............... 44,000 0.4974% $ 49.625 2/19/08 $ 357,196(5)
5,406 0.0611% $ 53.687 12/02/04 $ 50,927(7)
100,000(4) 1.1305% $ 51.625 8/06/08 $ 866,440(6)
- ------------------------------
(1) Except as otherwise noted, these stock options become exercisable in
one-third increments on the first, second and third anniversaries of the
date of grant, and include a reload feature. The reload feature gives the
optionee the right to receive a further option, at the then current market
price, for a number of shares equal to the number of shares of stock
surrendered by the optionee in payment of the exercise price of the original
option.
(2) All of these stock options cliff vest five years from the date of grant.
18
(3) Mr. Winn was granted 30,000 shares of restricted U S WEST common stock in
tandem with a grant of 300,000 options on August 6, 1998. This tandem grant
cliff vests in four years. Upon vesting, Mr. Winn shall only be entitled to
receive one of the tandem grants with the other grant being forfeited.
(4) All of these stock options cliff vest three years from the date of grant.
(5) This value reflects the standard application of the Black-Scholes option
pricing model to options issued on U S WEST common stock, using the
following assumptions: volatility of 22.87%, dividend yield of 4.49% and a
risk-free rate of return of 5.40% to 5.49% based on the options being
outstanding for an average term of 4.0 years.
(6) This value reflects the standard application of the Black-Scholes option
pricing model to options issued on U S WEST common stock, using the
following assumptions: volatility of 22.87%, dividend yield of 4.20% and a
risk-free rate of return of 5.36% to 5.49% based on the options being
outstanding for a term ranging from 36 months to 60 months.
(7) This value reflects the standard application of the Black-Scholes option
pricing model to options issued on U S WEST common stock, using the
following assumptions: volatility of 22.87%, dividend yield of 4.03% and a
risk-free rate of return of 5.59% to 5.68% based on the options being
outstanding for an average term of 4.0 years.
(8) This value reflects the standard application of the Black-Scholes option
pricing model to options issued on U S WEST common stock, using the
following assumptions: volatility of 22.87%, dividend yield of 3.83% and a
risk-free rate of return of 4.61% to 4.7% based on the options being
outstanding for an average term of 4.0 years.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES
NUMBER OF SECURITIES
VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE- MONEY OPTIONS/SARS
VALUE OPTIONS/SARS AT FY-END (#) AT FY- END ($)
SHARES ACQUIRED ON REALIZED -------------------------- ---------------------------
NAME EXERCISE (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -------------------------- ------------------- ----------- ----------- ------------- ------------ -------------
Solomon D. Trujillo....... 5,558 $ 171,269 267,556 1,145,668 $ 9,192,901 $ 17,157,044
Gregory M. Winn........... 1,700 $ 48,381 23,907 410,357 $ 753,709 $ 6,353,342
Allan R. Spies............ 1,019 $ 34,776 28,179 181,833 $ 981,175 $ 2,929,561
Mark Roellig.............. -- -- 23,267 169,800 $ 878,961 $ 2,475,700
James A. Smith............ 8,000 $ 258,190 26,160 163,740 $ 886,833 $ 2,466,609
LONG-TERM INCENTIVE PLANS--AWARDS IN LAST FISCAL YEAR
The table below shows dividend equivalent units granted to the Named
Executive Officers during 1998 under the Long-Term Incentive Plan for U S WEST
and Old U S WEST. Each dividend equivalent unit represents the right to receive
an amount equal to the cumulative dividends paid on our common stock during a
performance period, multiplied by a percentage representing the extent to which
our Company achieves certain performance goals based on financial results,
revenue, productivity and efficiency, service and customer care, employee
satisfaction, and stock performance.
ESTIMATED FUTURE PAYOUTS UNDER NON- STOCK
PERFORMANCE PERIOD PRICED-BASED PLAN(1)
UNTIL MATURATION ----------------------------------------
NAME NUMBER OF UNITS OR PAYOUT THRESHOLD TARGET($) MAXIMUM($)
- ----------------------------------- --------------- ------------------ ----------- ------------ -------------
Solomon D. Trujillo................ 231,000 1998-2000 0 $ 1,483,020 $ 2,224,530
Gregory M. Winn.................... 47,000 1998-2000 0 $ 301,740 $ 452,610
Allan R. Spies..................... 41,500 1998-2000 0 $ 266,430 $ 399,645
Mark Roellig....................... 46,100 1998-2000 0 $ 295,962 $ 443,943
James A. Smith..................... 33,000 1998-2000 0 $ 211,860 $ 317,790
- ------------------------------
(1) Estimated future payouts assume a quarterly dividend rate of $0.535 per
share over the performance period. Any changes to the quarterly dividend
rate would vary the payouts.
19
U S WEST PENSION PLANS
The tables below show the maximum estimated annual benefits payable to the
Named Executive Officers when they retire under the U S WEST Pension Plans.
These estimates are based on applicable pension plan formulas for specified
final average annual compensation and specified years of service. The second
table is based on the "defined lump sum" pension plan formula. Messrs. Trujillo,
Winn, Spies, Roellig, and Smith are eligible to receive the greater of any
pension amount that is calculated under either table.
PENSION PLAN TABLE
FIRST TABLE
YEARS OF SERVICE
FINAL AVERAGE ANNUAL ------------------------------------------------------------------------------------
COMPENSATION 15 20 25 30 35 40 45
- -------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ------------
$ 500,000................ $ 112,500 $ 160,000 $ 187,500 $ 225,000 $ 262,500 $ 293,750 $ 325,000
600,000................. 135,000 180,000 225,000 270,000 315,000 352,500 390,000
700,000................. 157,500 210,000 262,500 315,000 367,500 411,250 455,000
800,000................. 180,000 240,000 300,000 360,000 420,000 470,000 520,000
900,000................. 202,500 270,000 337,500 405,000 472,500 528,750 585,000
1,000,000................ 225,000 300,000 375,000 450,000 525,000 587,500 650,000
1,100,000................ 247,500 330,000 412,500 495,000 577,500 646,250 715,000
1,200,000................ 270,000 360,000 450,000 540,000 630,000 705,000 780,000
1,300,000................ 292,500 390,000 487,500 585,000 682,500 763,750 845,000
1,400,000................ 315,000 420,000 525,000 630,000 735,000 822,500 910,000
1,500,000................ 337,500 450,000 562,500 675,000 787,500 881,250 975,000
1,600,000................ 360,000 480,000 600,000 720,000 840,000 940,000 1,040,000
1,700,000................ 382,500 510,000 637,500 765,000 892,500 998,750 1,105,000
SECOND TABLE
YEARS OF SERVICE
FINAL AVERAGE ANNUAL ------------------------------------------------------------------------------------
COMPENSATION 15 20 25 30 35 40 45
- -------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ------------
$ 500,000................ $ 141,100 $ 173,700 $ 195,400 $ 211,700 $ 222,600 $ 228,000 $ 233,400
600,000................. 169,800 209,000 235,100 254,700 267,700 274,300 280,800
700,000................. 198,400 244,200 274,700 297,600 312,900 320,500 328,200
800,000................. 227,100 279,500 314,400 340,600 358,100 366,800 375,500
900,000................. 255,700 314,700 354,100 383,600 403,200 413,100 422,900
1,000,000................ 284,400 350,000 393,700 426,500 448,400 459,400 470,300
1,100,000................ 313,000 385,200 433,400 469,500 493,600 505,600 517,700
1,200,000................ 341,700 420,500 473,100 512,500 538,800 551,900 565,000
1,300,000................ 370,300 455,700 512,700 555,400 583,900 598,200 612,400
1,400,000................ 398,900 491,000 552,400 598,400 629,100 644,400 659,800
1,500,000................ 427,600 526,300 592,000 641,400 674,300 690,700 707,200
1,600,000................ 456,200 561,500 631,700 684,300 719,400 737,000 754,500
1,700,000................ 484,900 596,800 671,400 727,300 764,600 783,300 801,900
The pension benefits, listed in the above tables, set forth the projected
benefit assuming the executive retires at age 65. The calculation of "final
average annual compensation" is the highest average compensation for 60
consecutive months of the 120 consecutive-month period preceding retirement and
includes
20
compensation that would appear under the "Salary" and "Bonus" columns of the
Summary Compensation Table. At December 31, 1998, Messrs. Trujillo, Winn, Spies,
Roellig, and Smith had 24, 28, 28, 15, and 20 years of service, respectively.
Benefits set forth in the preceding tables are computed as a straight-life
annuity and are subject to deduction for Social Security. For information
relating to a recent increase in Mr. Trujillo's base salary, please refer to the
section entitled "Report of Human Resources Committee on Executive
Compensation--Base Salary."
EXECUTIVE CHANGE OF CONTROL AND TERMINATION ARRANGEMENTS
We have entered into change of control agreements with certain of our
executive officers, including each of our Named Executive Officers. By providing
these executive officers with either compensation or termination benefits or
both, if a change of control of the Company occurs, these agreements encourage
these executive officers to continue to perform their duties after the
announcement of a change of control. The following discussion is a summary of
such agreements. The actual forms of the agreements have been filed as exhibits
to our filings with the Commission.
In certain circumstances, the officers are entitled to receive specified
benefits upon termination of their employment or if their duties or compensation
and benefits are reduced or substantially changed in another manner after a
change of control. Since the Chief Executive Officer's duties necessarily are
significantly impacted as a result of a change of control, he may voluntarily
resign within 90 days after a change of control and receive his benefits.
WHAT IS A CHANGE OF CONTROL?
Any of the following events is a change of control:
(i) a change of control that would have to be reported under Item 6(e)
of Schedule 14A of the Securities Exchange Act of 1934, even if the Company
is not subject to that reporting requirement;
(ii) a party or certain related parties directly or indirectly acquiring
securities representing twenty percent or more of the total voting power of
the Company's outstanding voting securities at that time;
(iii) any period of two consecutive calendar years during which a
majority of the Board of Directors ceases to be composed of individuals who
either (a) were a Director at the beginning of the two-year period or (b)
are a new Director whose election by the Board or nomination for election by
the Company's shareholders was approved by at least two-thirds of the
Directors who either were Directors at the beginning of the two-year period
or whose election or nomination for election was previously so approved (and
excluding for this purpose any individual whose initial assumption of office
resulted from an actual or threatened proxy contest);
(iv) shareholders of the Company approve a merger, consolidation, sale
or other disposition of all or substantially all of the assets of the
Company, unless immediately afterwards the holders of the Company's voting
securities prior to this change of control hold securities representing more
than seventy percent of the voting power of the outstanding voting
securities of the Company or other surviving entity at that time and, also
immediately afterwards, no party or certain related parties (other than
trustees of employee benefit plans) hold twenty percent or more of the total
voting power of the Company's outstanding voting securities at that time and
members of the Board of Directors prior to such transaction constitute more
than half of the Company's or other surviving entity's Board of Directors;
(v) the shareholders of the Company approve a plan of complete
liquidation or dissolution; or
(vi) any other event that a majority of the Board of Directors deems to
be a change of control.
21
Under the change of control agreements, termination benefits are to be paid
immediately following the officer's termination, under certain circumstances,
after a change of control. These benefits include salary and payments under both
short and long-term incentive plans in which the officers participate. These
benefit payments will be calculated as if a change of control had also occurred
under these plans.
Termination benefits also consist of three times an amount equal to the sum
of:
- the officer's annual base salary before termination, plus
- the officer's annual bonus amount under any short-term incentive program
in which the officer participates (which will be calculated as if 100% of
the target was achieved, unless the percentage actually achieved is
greater than 100%, in which case the higher percentage shall apply), plus
- for the Chief Executive Officer, the annual long-term incentive grant
value under any long-term incentive program in which he participates (also
calculated as if 100% of the target was achieved, unless the percentage
actually achieved is greater than 100%, in which case the higher
percentage shall apply).
In addition, all unvested stock options held by the officer on the termination
date will vest immediately and be fully exercisable, and any restrictions on
restricted stock will immediately lapse. The Company will adjust income in order
to cover any excise taxes incurred in connection with the benefits paid upon
termination. The change of control agreements also provide for continued health
care benefits on terms substantially similar to those that would have been
provided if the officer were eligible for retiree health care benefits
immediately before the change of control. If pension benefits are not already
vested, they will vest immediately before the change of control and an
additional three years will be added to both the officer's age and years of
service for the purpose of calculating the officer's benefits.
AUTOMATIC RENEWAL; CANCELLATION
The change of control agreements automatically renew every three years.
However, the Board of Directors may cancel them before renewal by giving the
officers notice at least 90 days before the approaching three-year renewal date.
CHIEF EXECUTIVE OFFICER'S COVENANT NOT TO COMPETE
In exchange for receiving these benefits on a change of control, the Chief
Executive Officer has agreed he will not, for a three-year period after his
termination:
(i) directly or indirectly engage in the United States, in any business
that competes with the Company's business as of his termination date or at
any time during such three-year period (certain investments of not more than
two percent are nonetheless permissible);
(ii) solicit, entice or endeavor to solicit or entice away from the
Company or its subsidiaries any person who was an officer, employee or sales
representative either for his own account or for another individual, firm or
corporation, even if as a result of leaving the Company or its subsidiaries,
such officer, employee or sales representative would not breach his or her
employment contract with the Company;
(iii) directly or indirectly employ any person who was an officer,
employee or sales representative of the Company or its subsidiaries or who,
by reason of such position at any time, possesses or may likely possess any
confidential information or trade secrets relating to the Company's or its
subsidiaries' businesses or products; and
(iv) solicit, entice or endeavor to solicit or entice away from the
Company or its subsidiaries any of the Company's customers or prospective
customers, either for his own account or for another individual, firm or
corporation.
22
Many of these restrictions also apply to other officers of U S WEST.
EXECUTIVE SEVERANCE AGREEMENTS
We have also entered into executive severance agreements with certain of our
officers, including the Named Executive Officers with the exception of the Chief
Executive Officer. These agreements set forth benefits that are payable in
certain circumstances, including a change of control of the Company, an
officer's termination that is not for cause, an officer's termination in
connection with a downsizing, or an officer's resignation after electing not to
accept a reassignment to a non-comparable position.
In general, if an officer's employment is terminated as a result of certain
circumstances set forth in the agreements, he or she will be entitled to the
following severance benefits:
(i) a sum equal to between 1.5 and 2 times, depending upon the officer,
of his or her base salary;
(ii) amounts due under the Executive Short-Term Incentive Plan and any
long-term incentive plan, based on the officer's date of termination and
calculated as if each plan's applicable targeted performance levels had been
fully achieved; and
(iii) financial counseling services through the year after the year in
which the officer was terminated, or the cash value of such financial
counseling services.
Restrictions placed on certain grants of common stock issued to the officer
would be terminated and the vesting of a proportionate amount of the officer's
stock options would be accelerated. In addition, terminated officers are
entitled to certain medical, dental and vision benefits. The agreements also
contain certain confidentiality and arbitration provisions. Before receiving
severance benefits, an executive officer must deliver to the Company a waiver
and a release of claims. If a change of control occurs, the executive severance
agreements will be superseded by any applicable change of control agreement.
In order to encourage Mr. Roellig's continued employment, he received prior
to the Separation 15,800 shares of restricted Communications Stock and 25,400
shares of restricted Media Stock, all pursuant to a 1996 retention agreement
which was assumed by U S WEST. As described earlier, these shares were replaced
by restricted U S WEST common stock. Subject to his continuous employment, these
shares will vest on March 15, 2001. This agreement also entitles Mr. Roellig to
annual cash payments, which are conditioned on his continuous employment until
such payments are due. There are two remaining annual cash payments due under
the agreement payable at the end of 1999 and 2000 totaling $180,000.
In order to encourage Mr. Winn's continued employment, he received 30,000
shares of restricted U S WEST common stock in tandem with a grant of 300,000
options in August of 1998 which cliff vest in four years, all pursuant to a 1998
retention agreement. Upon vesting, Mr. Winn will only be entitled to receive one
of the tandem grants with the other grant being forfeited. This agreement also
entitles Mr. Winn to annual cash payments, which are conditioned on his
continuous employment until such payments are due. There are three annual cash
payments due under the agreement payable in 1999, 2000 and 2001 totaling
$200,000.
REPORT OF HUMAN RESOURCES COMMITTEE ON EXECUTIVE COMPENSATION
HUMAN RESOURCES COMMITTEE
The Human Resources Committee of the Board of Directors is made up of
independent outside Directors who meet regularly to oversee executive
compensation and benefits plans. The Human Resources Committee makes every
effort to ensure that executive compensation and benefit plans are both
appropriately competitive with the marketplace and aligned with your interests
as a shareholder. The Human Resources Committee submits reports to the full
Board of Directors concerning its activities and decisions. None of the Human
Resources Committee's Directors has interlocking or other relationships
23
with other boards or the Company that would call into question his or her
independence as a Human Resources Committee member.
COMPENSATION PHILOSOPHY; OVERALL PRINCIPLES
The Company takes an integrated and managed approach to developing its
executive compensation strategy and programs. This approach balances the overall
needs of the Company, including its unique business strategies and human
resources initiatives. The Human Resources Committee has approved a compensation
plan designed to attract, motivate and retain the high-caliber executives needed
to achieve the Company's business strategies. The plan rewards those executives
for building and enhancing long-term value for Company shareholders.
Each element of the compensation plan supports the Company's mission, values
and culture. The following compensation principles link the individual elements
into an integrated compensation strategy:
(i) creating and maintaining a compensation structure that aligns the
interests and concerns of executives with those of shareholders;
(ii) providing competitive compensation that is comparable to
compensation provided by the industry and our peer companies;
(iii) developing and maintaining customized business unit plans that
reflect the unique characteristics of the Company's diversified operations;
(iv) providing individual compensation that is highly correlated with
personal performance and the creation of shareholder value; and
(v) implementing executive development and succession planning programs
to provide for long-term organizational strength and flexibility.
Overall, the Human Resources Committee believes that the Company's
competitive market for executive talent is more comprehensive than those
established by industry peer groups to compare shareholder returns, as are set
forth on the accompanying Performance Graphs. Accordingly, the population of
companies surveyed for compensation data extends beyond the companies included
in peer group indices set forth in the Performance Graphs.
For each component of compensation, the Human Resources Committee targets
total compensation to industry median benchmarks of surveyed companies. As a
result, superior performance will lead to above-market total compensation
delivered through variable-pay components, and less-than-satisfactory
performance will result in below-market total compensation.
KEY ELEMENTS
The key elements of the Company's executive compensation program are base
salary, annual incentives, and long-term incentive compensation. In developing
an executive's total compensation package, the Human Resources Committee
considers each of these key elements, as well as retirement benefits, insurance,
and limited perquisites.
BASE SALARY
The Company has implemented a combined market and performance-based salary
structure for its executive employees. Determination of appropriate compensation
is based on the following factors:
- the executive's level of responsibility,
- the scope and impact of decision-making, and
- internal and external comparability.
24
For purposes of comparability and competitive market pricing, the Company
uses annual executive compensation salary surveys that are prepared by
nationally recognized independent compensation consulting firms. These surveys
encompass the telecommunications industry as well as companies of similar size
in other industries. On average, the Company seeks to target executive base
salary levels at the median range of the surveyed companies.
Executive salary reviews generally are conducted on a 12-month cycle. Base
salary adjustments may occur at the time of these reviews and depend upon
individual performance results, changes in job responsibilities, competitive
forces, and/or the overall financial condition of the Company.
Mr. Trujillo's salary was adjusted in August 1998. At that time, his base
salary was increased to $900,000, an increase of approximately 29%, which
reflects Mr. Trujillo's new position as Chief Executive Officer of the Company.
Mr. Trujillo's current base salary places him within the median range of
surveyed companies.
SHORT-TERM INCENTIVE COMPENSATION
The Executive Short-Term Incentive Plan, which was approved by shareholders
in May 1994 and ratified as part of the Separation by the Company, provides each
Named Executive Officer with the potential to earn annual cash awards based on
the achievement of pre-established performance goals. Participants include the
Chief Executive Officer and any individual employed by the Company at the end of
any calendar year who appears in the Summary Compensation Table of this proxy
statement to shareholders. The cash bonus pool from which the Company pays the
bonuses for the Chief Executive Officer and the other Named Executive Officers
is limited to 0.25% of "Cash Provided by Operating Activities" for the annual
performance period. The Human Resources Committee may pay any portion of this
pool based on various factors, including the Company's performance relative to
pre-set financial, strategic and customer goals, as well as individual
performance goals. Any amount of the cash bonus pool not paid in this manner may
be added, at the Human Resources Committee's sole discretion, to the cash bonus
pool that is available for any subsequent year or combination of years. The
Human Resources Committee has elected not to add unpaid portions of the 1998
cash bonus pool to the bonus pool for 1999 and subsequent years.
The pre-set performance goals for 1998 were based on various factors
including the Company's net cash flow, operating income, revenue, service and
independent customers' analysis of the reputation of the Company (CVA or
Customer Value Analysis).
In determining the amount to be paid to Mr. Trujillo in connection with 1998
performance goals, the Human Resources Committee considered the above-mentioned
pre-set performance goals for the Company and his individual performance. Mr.
Trujillo received Executive Short-Term Incentive Plan compensation of $650,000,
or approximately 91% of his 1998 base salary.
LONG-TERM INCENTIVE COMPENSATION
For 1998, the Company's long-term incentive compensation included
performance-based dividend equivalent units issued under the Long-Term Incentive
Plan and stock options issued under either the U S WEST 1994 Stock Plan or the U
S WEST 1998 Stock Plan. Shareholders have previously approved all three plans.
During the past year, the combination of stock options and performance-based
long-term incentive opportunities provided a strategic mix of equity-based
incentives that:
- continues to focus performance on the attainment of long-term strategic
objectives;
- provides an incentive to the executives to increase total shareholder
return; and
25
- provides continuity throughout the officer team by rewarding long-term
commitment to the Company.
THE LONG-TERM INCENTIVE PLAN
In general, the Human Resources Committee has assigned dividend equivalent
units to participants in the Long-Term Incentive Plan at the beginning of each
performance period. A "dividend equivalent unit" equals the regular cash
dividends, if any, that are paid on our common stock that is paid during a
performance period under the Long-Term Incentive Plan. The Long-Term Incentive
Plan includes a three-year performance period that ended on December 31, 1998.
At the conclusion of each performance period, participants may receive a
percentage of the product of their respective dividend equivalent units times
the total value of dividends paid during the performance period on one share of
our common stock. The percentage, which for the 1996-1998 performance period
could not exceed 100%, is determined pursuant to a performance formula
established by the Human Resources Committee. This formula is based on one or
more of the Company's financial results, productivity and efficiency measures,
customer service, stock performance and employee and management satisfaction
measures. Under this formula, Mr. Trujillo received 6,508 shares of our common
stock worth $414,090.
STOCK OPTIONS
In general, the Human Resources Committee has elected to grant stock options
annually. The Company's stock option grants are designed to deliver, together
with other long-term incentives, the opportunity for the executive to earn a
market-based percentage of salary dependent on future stock performance. In
determining the current year's stock option grants, the Human Resources
Committee may take into consideration prior years' grants and circumstances.
Stock options granted during 1998 have an exercise price equal to the market
price of our common stock on the date of grant, vest in one-third increments
beginning one year from the grant date and carry a ten-year term.
Mr. Trujillo received a stock option grant of 313,000 shares of common stock
in February of 1998. The Human Resources Committee believes that the grant to
Mr. Trujillo in 1998 is consistent with its total compensation philosophy to
link a substantial portion of the Chief Executive Officer's compensation
directly with the long-term value created for shareholders. In addition, Mr.
Trujillo's option grant is consistent with the average grants made to peer
company chief executive officers as determined by market survey data. In
connection with the Separation, Mr. Trujillo also received a grant of 750,000
stock options in August of 1998 as a special long-term performance grant that
will vest in 5 years.
DEDUCTIBILITY OF COMPENSATION; TAX CODE CONCERNS
The Human Resources Committee has carefully considered Section 162 (m) of
the Internal Revenue Code of 1986 and believes the Company's pay-for-performance
practices ensure that executive compensation is strongly tied to performance.
The Human Resources Committee believes it is in the best interests of the
Company and its shareholders to comply with the tax law while still preserving
the flexibility to reward executives consistent with the Company's pay
philosophy for each compensation element. The Human Resources Committee is
obligated to the Board of Directors and shareholders to recognize and reward
performance that increases the value of the Company. Accordingly, the Human
Resources Committee will exercise its discretion in those instances where tax
law considerations would compromise the interests of the shareholders.
STOCK OWNERSHIP GUIDELINES
To encourage further growth in shareholder value, the Board of Directors has
approved stock ownership targets for the Company's executive officers. The Board
of Directors established these targets
26
because it believes that a significant level of stock ownership provides a
powerful incentive to executive officers to manage the Company as owners. On an
annual basis, the Human Resources Committee reviews executive officers' stock
ownership and, at its discretion, may consider such ownership in the granting of
restricted shares and stock options.
The target ownership level for the Chief Executive Officer equals 5 times
his base salary. At the end of 1998, Mr. Trujillo held common stock valued at
approximately 32 times his 1998 salary.
CONCLUSION
It is the Human Resources Committee's opinion that the Company's integrated
executive compensation strategy aligns the Company's executive compensation
practices with corporate performance and your best interests as a shareholder.
The strategy does so by ensuring both the continuity and ongoing development of
a strong leadership team that is fully in line with our shareholders. We trust
this letter and the accompanying tables and graphs will help you understand
further the Company's compensation philosophy, programs and actions.
U S WEST, Inc. Human Resources Committee of the Board of Directors:
Frank Popoff (Chairman)
Linda G. Alvarado
Craig R. Barrett
Jerry J. Colangelo
Marilyn C. Nelson
27
STOCKHOLDER RETURN PERFORMANCE GRAPHS
The graph and chart below compares the yearly change in cumulative total
stockholder return on our common stock since the Separation and Old U S WEST
Communications Group ("Communications Group") targeted stock from October 31,
1995 to the Separation, including the reinvestment of dividends, with the return
on the Standard & Poor's 500 Stock Index, the S&P Telecommunications Index, and
a customized peer group (the "Communications Peer Group") that includes
companies that offer communications services, including local telephone
services, to business and residential customers in domestic geographic markets.
The performance graph shows the return of $100 invested in Communications Group
targeted stock on October 31, 1995, and reflects a return for (i) Communications
Group targeted stock from October 31, 1995 to the Separation, which occurred on
June 12, 1998, and (ii) U S WEST common stock for periods after the Separation
to December 31, 1998. In accordance with the Separation, holders of
Communications Group targeted stock received one share of U S WEST common stock
for each share of Communications Group targeted stock.
COMPARISON OF 38-MONTH CUMULATIVE TOTAL RETURN(A)
AMONG U S WEST/COMMUNICATIONS GROUP,
S&P 500 STOCK INDEX, S&P TELECOMMUNICATIONS INDEX(B),
AND COMMUNICATIONS PEER GROUP(C)
[LOGO]
OCT-1995 DEC-1995 DEC-1996 DEC-1997 DEC-1998
----------- ----------- ----------- ----------- -----------
U S WEST/Communications Group............................... $ 100 $ 124 $ 120 $ 177 $ 265
S&P 500..................................................... $ 100 $ 107 $ 131 $ 174 $ 224
S&P Telecommunications Index--Weighted...................... $ 100 $ 110 $ 111 $ 155 $ 227
Communications Peer Group--Weighted......................... $ 100 $ 109 $ 111 $ 154 $ 224
- ------------------------------
Notes.
(a) Total return assumes the reinvestment of dividends. As of the Separation,
our common stock also reflects the addition of U S WEST Dex.
28
(b) Consists of returns weighted by market capitalization of Alltel, Ameritech,
Bell Atlantic, Bell South, Frontier, GTE and SBC.
(c) Consists of returns weighted by market capitalization of Alltel, Ameritech,
Bell Atlantic, Bell South, Cincinnati Bell, Frontier, GTE, Nynex, Pacific
Telesis, SBC and Southern New England Telecommunications. Pacific Telesis
was acquired by SBC Communications on April 1, 1997 and NYNEX was acquired
by Bell Atlantic on August 14, 1997. The total shareholder returns of
Pacific Telesis Group and NYNEX parallel those of SBC Communications and
Bell Atlantic respectively, after such dates.
Assumes $100 invested on October 31, 1995 in Communications Group targeted
stock, the Standard & Poor's 500 Stock Index, the S&P Telecommunications Index,
and the Communications Peer Group.
The graph and chart below compares the monthly change in cumulative total
stockholder return on our common stock since the Separation, including the
reinvestment of dividends, with the return on the Standard & Poor's 500 Stock
Index, the S&P Telecommunications Index, and the Communications Peer Group. The
performance graph shows the return of $100 invested in our common stock for
monthly periods after the Separation to December 31, 1998.
COMPARISON OF 6-MONTH CUMULATIVE TOTAL RETURN(A)
AMONG U S WEST, S&P 500 STOCK INDEX, S&P TELECOMMUNICATIONS INDEX(B),
AND COMMUNICATIONS PEER GROUP(C)
[LOGO]
JUN-98 JUL-98 AUG-98 SEP-98 OCT-98 NOV-98 DEC-98
------ ------ ------ ------ ------ ------ ------
U S WEST..................................... $100 $115 $112 $113 $125 $136 $141
S&P 500...................................... $100 $ 99 $ 85 $ 90 $ 97 $103 $109
S&P Telecommunications Index--Weighted....... $100 $103 $ 99 $108 $116 $123 $133
Communications Peer Group--Weighted.......... $100 $102 $ 98 $107 $116 $122 $133
- ------------------------------
Notes.
(a) Total return assumes the reinvestment of dividends.
29
(b) Consists of returns weighted by market capitalization of Alltel, Ameritech,
Bell Atlantic, Bell South, Frontier, GTE and SBC.
(c) Consists of returns weighted by market capitalization of Alltel, Ameritech,
Bell Atlantic, Bell South, Cincinnati Bell, Frontier, GTE, Nynex, Pacific
Telesis, SBC and Southern New England Telecommunications. Pacific Telesis
was acquired by SBC Communications on April 1, 1997 and NYNEX was acquired
by Bell Atlantic on August 14, 1997. The total shareholder returns of
Pacific Telesis Group and NYNEX parallel those of SBC Communications and
Bell Atlantic respectively, after such dates.
Assumes $100 invested on June 30, 1998 in our common stock, the Standard &
Poor's 500 Stock Index, the S&P Telecommunications Index, and the Communications
Peer Group.
OTHER INFORMATION
EXPENSES OF SOLICITATION
We will bear the costs of soliciting proxies from our shareholders. We have
retained Beacon Hill Partners, Inc., at an estimated fee of $17,500 plus
associated costs and expenses, to assist us in the solicitation of proxies from
brokerage firms and other custodians, nominees and fiduciaries. In addition to
soliciting proxies by mail, our directors, officers and employees, may solicit
proxies by telephone, by telegram or in person. Arrangements also will be made
with brokerage firms and other custodians, nominees and fiduciaries to forward
solicitation materials to the beneficial owners of shares of common stock held
of record by such persons. The Company will reimburse such brokerage firms,
custodians, nominees and fiduciaries for reasonable out-of-pocket expenses that
are incurred by them.
A complete list of the stockholders entitled to vote at the annual meeting
will be available for examination by any stockholder for any purpose germane to
the meeting, during ordinary business hours for a period of at least 10 days
prior to the annual meeting, at the offices of Beacon Hill Partners, Inc., 90
Broad Street, 20th Floor, New York, New York 10004. Such list will also be
available for examination at the annual meeting.
SHAREHOLDER PROPOSALS
Proposals intended for inclusion in next year's Proxy Statement should be
sent to our Secretary at 1801 California Street, Suite 5100, Denver Colorado,
80202 and must be received by November 25, 1999.
Our Bylaws have an advance notice procedure for shareholders to bring
business before an annual meeting of shareholders. The advance notice procedure
requires that a shareholder interested in presenting a proposal for action at an
annual meeting of shareholders must deliver a written notice of the proposal,
together with certain specified information relating to such shareholder's stock
ownership and identity, to our Secretary at least 90 days before the date of the
annual meeting. We preliminarily plan to hold our annual meeting for 2000 on or
about April 20, 2000. A copy of our Bylaws was filed as an exhibit to our Form
8-K/A dated June 26, 1998 and is available on the Commission's web site at
http:// www.sec.gov. The persons designated as proxies by the Company in
connection with the 2000 annual meeting will have discretionary voting authority
with respect to any shareholder proposal of which the Company did not receive
timely notice.
FINANCIAL STATEMENTS AVAILABLE
CONSOLIDATED FINANCIAL STATEMENTS FOR U S WEST AND ITS SUBSIDIARIES ARE
INCLUDED IN THE APPENDICES TO THIS PROXY STATEMENT FOR 1998. ADDITIONAL COPIES
OF THESE STATEMENTS AND THE ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDED
DECEMBER 31, 1998 (EXCLUDING EXHIBITS, UNLESS SUCH EXHIBITS HAVE BEEN
SPECIFICALLY INCORPORATED BY REFERENCE THEREIN), MAY BE OBTAINED WITHOUT CHARGE
FROM OUR SECRETARY, 1801 CALIFORNIA STREET SUITE 5100, DENVER COLORADO, 80202.
THE ANNUAL REPORT ON FORM 10-K/A IS ALSO ON FILE WITH THE COMMISSION,
WASHINGTON, D.C. 20549 AND WITH THE NEW YORK STOCK EXCHANGE.
Dated: March 24, 1999
30
U S WEST, INC.
SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
DOLLARS IN MILLIONS (EXCEPT PER SHARE AMOUNTS)
Operating revenues................................... $ 12,378 $ 11,479 $ 11,168 $ 10,508 $ 10,132
Operating expenses................................... 9,329 8,703 8,356 7,931 7,616
Operating income..................................... 3,049 2,776 2,812 2,577 2,516
Income before extraordinary item and cumulative
effect of change in accounting principle(1)........ 1,508 1,527 1,501 1,431 1,403
Net income(2)........................................ 1,508 1,524 1,535 1,423 1,403
Pro forma income(3).................................. 1,436 1,365 1,339 * *
Historical earnings per share:(1,2,4)
Basic............................................ 3.05 3.16 3.21 3.02 3.09
Diluted.......................................... 3.02 3.12 3.17 2.98 3.03
Average common shares outstanding (thousands):
Basic............................................ 494,395 482,751 477,549 470,716 453,316
Diluted.......................................... 498,798 491,232 488,591 481,933 463,801
Pro forma earnings per share:(3)
Basic............................................ $ 2.86 * * * *
Diluted.......................................... 2.84 * * * *
Pro forma average common shares outstanding
(thousands):
Basic............................................ 501,827 * * * *
Diluted.......................................... 506,230 * * * *
Dividends per common share........................... $ 2.14 $ 2.14 $ 2.14 $ 2.14 $ 2.14
Total assets......................................... 18,407 17,667 17,279 16,960 16,317
Total debt(5)........................................ 9,919 5,715 6,545 6,782 6,147
Debt to total capital ratio.......................... 92.9% 56.7% 61.6% 65.0% 64.7%
Capital expenditures................................. $ 2,905 $ 2,672 $ 2,831 $ 2,770 $ 2,513
Telephone network access lines in service
(thousands)........................................ 16,601 16,033 15,424 14,795 14,299
Billed access minutes of use (millions):
Interstate......................................... 58,927 55,362 52,039 47,801 43,768
Intrastate......................................... 12,366 11,729 10,451 9,504 8,507
Total employees...................................... 54,483 51,110 51,477 54,552 55,246
Telephone company employees.......................... 46,310 43,749 45,427 47,934 47,493
Telephone company employees per 10,000 access
lines.............................................. 27.9 27.3 29.5 32.4 33.2
- ------------------------------
(1) 1998 income includes separation expenses of $68 ($0.13 per diluted share)
associated with the separation of Old U S WEST into two independent
companies and an asset impairment charge of $21 ($0.04 per diluted share).
1997 income includes a $152 regulatory charge ($0.31 per diluted share)
related primarily to the 1997 Washington State Supreme Court ruling that
upheld a Washington rate order, a gain of $32 ($0.07 per diluted share) on
the sale of an interest in Bell Communications Research, Inc. and a gain of
$48 ($0.10 per diluted share) on the sales of local telephone exchanges.
1996 income includes a gain of $36 ($0.07 per diluted share) on the sales of
local telephone exchanges and the current effect of $15 ($0.03 per diluted
share) from adopting Statement of Financial Accounting Standards ("FAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." 1995 income includes a gain of $85 ($0.18 per
diluted share) on the sales of local
A-1
U S WEST, INC.
SELECTED FINANCIAL DATA (CONTINUED)
telephone exchanges and costs of $8 ($0.02 per diluted share) associated
with the 1995 Recapitalization discussed in footnote 4 below. 1994 income
includes a gain of $51 ($0.11 per diluted share) on the sales of local
telephone exchanges.
(2) 1997 net income was reduced by an extraordinary charge of $3 ($0.01 per
diluted share) for the early extinguishment of debt. 1996 net income
includes a gain of $34 ($0.07 per diluted share) for the cumulative effect
of the adoption of FAS No. 121. 1995 net income was reduced by an
extraordinary item of $8 ($0.02 per diluted share) for the early
extinguishment of debt.
(3) Pro forma income reflects the incremental interest expense associated with
the refinancing of $3,900 of Old U S WEST debt (the "Dex Indebtedness"),
formerly allocated to the U S WEST Media Group (the "Media Group"), from the
beginning of the period presented up to June 12, 1998 (the "Separation
Date"). The pro forma earnings per diluted share amount also reflect the
issuance of approximately 16,341,000 shares of common stock (net of the
redemption of approximately 305,000 fractional shares) issued in connection
with the contribution of the domestic directory businesses of Media Group,
known as U S WEST Dex, Inc. (the "Dex Alignment"), as if the shares had been
issued at the beginning of the period indicated.
(4) The historical average shares outstanding assume a one-for-one conversion of
historical U S WEST Communications Group common shares outstanding into
shares of U S WEST as of the Separation Date. The 1998 historical average
common shares outstanding include the issuance of approximately 16,341,000
shares of common stock (net of redemption of approximately 305,000
fractional shares) issued in connection with the Dex Alignment. Effective
November 1, 1995, each share of common stock of Old U S WEST was converted
into one share each of U S WEST Communications Group Common Stock and U S
WEST Media Group Common Stock (the "1995 Recapitalization"). Earnings per
common share and dividends per common share for 1995 and 1994 have been
presented on a pro forma basis to reflect the two classes of stock as if
they had been outstanding since January 1, 1994.
(5) 1998 debt includes $3,900 of Dex Indebtedness.
* Information has not been presented.
A-2
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the information presented constitutes "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Although U S WEST, Inc. believes that its expectations are based
on reasonable assumptions within the bounds of its knowledge of its businesses
and operations, there can be no assurance that actual results will not differ
materially from our expectations. Factors that could cause actual results to
differ from expectations include:
- greater than anticipated competition from new entrants into the local
exchange, intraLATA (local access transport area) toll, wireless, data and
directories markets, causing loss of customers and increased price
competition;
- changes in demand for our products and services, including optional custom
calling features;
- higher than anticipated employee levels, capital expenditures and
operating expenses (such as costs associated with interconnection and Year
2000 remediation);
- the loss of significant customers;
- pending and future state and federal regulatory changes affecting the
telecommunications industry, including changes that could have an impact
on the competitive environment in the local exchange market;
- a change in economic conditions in the various markets served by our
operations;
- higher than anticipated start-up costs associated with new business
opportunities;
- delays in our ability to begin offering interLATA long-distance services;
- consumer acceptance of broadband services, including telephony, data,
video and wireless services; and
- delays in the development of anticipated technologies, or the failure of
such technologies to perform according to expectations.
These cautionary statements should not be construed by you as an exhaustive
list or as any admission by us regarding the adequacy of disclosures made by us.
We cannot always predict or determine after the fact what factors would cause
actual results to differ materially from those indicated by our forward-looking
statements or other statements. In addition, you are urged to consider
statements that include the terms "believes," "belief," "expects," "plans,"
"objectives," "anticipates," "intends," or the like to be uncertain and
forward-looking. All cautionary statements should be read as being applicable to
all forward-looking statements wherever they appear.
We do not undertake any obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed herein might not occur.
GENERAL
On October 25, 1997, the Board of Directors of our former parent company,
herein referred to as "Old U S WEST," adopted a proposal to separate Old U S
WEST into two independent companies (the "Separation"). Old U S WEST had
conducted its businesses through two groups: (i) the U S WEST
A-3
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Communications Group (the "Communications Group"), which included the
communications businesses of Old U S WEST, and (ii) the Media Group, which
included the multimedia and directories businesses of Old U S WEST. On June 4,
1998, stockholders of Old U S WEST voted in favor of the Separation, which
became effective June 12, 1998. As part of the Separation, Old U S WEST
contributed to us the businesses of the Communications Group and the domestic
directories business of the Media Group known as U S WEST Dex, Inc. ("Dex"). Old
U S WEST has continued as an independent public company comprised of the
businesses of Media Group other than Dex and has been renamed MediaOne Group,
Inc. ("MediaOne").
The Separation was implemented according to the terms of a separation
agreement between U S WEST and MediaOne. In connection with the Dex Alignment,
(i) Old U S WEST distributed, as the Dex dividend to holders of Media Group
common stock, approximately 16,341,000 shares of our common stock (net of the
redemption of approximately 305,000 fractional shares) with an aggregate value
of $850 (the "Dex Dividend") and (ii) we refinanced $3,900 of Old U S WEST debt,
formerly allocated to Media Group.
The consolidated financial statements include the consolidated historical
results of operations, financial position and cash flows of the businesses that
comprise the Communications Group and Dex, as if such businesses operated as a
separate entity for all periods and as of all dates presented. However, certain
financial effects of the Separation and the Dex Alignment, including interest
expense associated with the refinancing of the Dex Indebtedness and the dilutive
effect of the Dex Dividend, are not reflected in the historical consolidated
statements of income prior to the Separation Date.
RESULTS OF OPERATIONS
1998 COMPARED WITH 1997
Several non-recurring and non-operating items impacted net income in 1998
and 1997. Results of operations for the two years, normalized to exclude the
effects of such items, are as follows:
INCREASE
1998 1997 (DECREASE)
--------- --------- --------------------
Net income.................................................................. $ 1,508 $ 1,524 $ (16) (1.0)%
Pro forma adjustment(1)..................................................... (72) (162) 90 55.6
--------- --------- --------- ---------
Pro forma net income........................................................ 1,436 1,362 74 5.4
Non-recurring and non-operating items....................................... 89 (77) 166 215.6
--------- --------- --------- ---------
Normalized pro forma income................................................. $ 1,525 $ 1,285 $ 240 18.7%
--------- --------- --------- ---------
--------- --------- --------- ---------
Pro forma diluted earnings per share(2)..................................... $ 2.84 $ 2.70 $ 0.14 5.2%
Non-recurring and non-operating items....................................... 0.17 (0.16) 0.33 206.3
--------- --------- --------- ---------
Normalized pro forma diluted earnings per share............................. $ 3.01 $ 2.55* $ 0.46* 18.0%
--------- --------- --------- ---------
--------- --------- --------- ---------
- ------------------------------
* Amount does not foot due to the rounding of individual components.
A-4
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
(1) Reflects incremental (after-tax) interest expense associated with the Dex
Indebtedness from the beginning through the end of each period presented up
to the Separation Date.
(2) Reflects the issuance of approximately 16,341,000 shares of common stock
(net of the redemption of approximately 305,000 fractional shares) issued in
connection with the Dex Alignment as if the shares had been issued as of the
beginning of each period indicated.
Non-recurring and non-operating items in 1998 include:
- an after-tax charge of $68 or $0.13 per diluted share for Separation costs
and
- an after-tax charge of $21 or $0.04 per diluted share related to the
impairment of certain long-lived assets associated with our video
operations.
Non-recurring and non-operating items in 1997 include:
- an after-tax charge of $3 or $0.01 per diluted share relating to the early
extinguishment of debt and
- an after-tax gain of $80 or $0.17 per diluted share relating to the sales
of local telephone exchanges and our investment in Bell Communications
Research, Inc. ("Bellcore").
Normalized pro forma income increased $240 or 18.7% in 1998 and normalized
pro forma diluted earnings per share increased $0.46 or 18.0%. The increases
were primarily due to revenue growth associated with increased demand for
services and lower regulatory rate adjustments which unfavorably impacted
revenue. The 1997 regulatory rate adjustments include a $152 ($250 pretax)
charge primarily attributable to a state of Washington adjustment (the
"Washington Rate Order"). Partially offsetting the revenue increases were higher
operating costs driven by growth initiatives and interconnection activities.
The following sections provide a more detailed discussion of the changes in
revenues and expenses.
OPERATING REVENUES
1998 1997 INCREASE
--------- --------- ----------------------
Local service revenues......................................... $ 5,525 $ 5,016 $ 509 10.1%
--------- --------- --------- ---
--------- --------- --------- ---
LOCAL SERVICE REVENUES. Local service revenues include basic monthly
service fees, fees for calling services, such as call waiting and caller
identification, public phone revenues and installation and connection charges.
Most local service rates are regulated by state public service commissions.
Local service revenues increased in 1998 due largely to access line growth
and increased sales of calling services. Second line additions by residential
and small business customers contributed to access line growth due to continuing
demand for Internet access and data transport capabilities. In 1998, we provided
a total of 568,000 additional access lines, an increase of 3.5% over 1997. Of
this increase, second line installations accounted for 241,000 lines, an
increase of 18.0% compared with 1997. In addition, regulatory rate increases in
various jurisdictions accounted for $53 or 10.4% of the increase in local
service revenues in 1998. Unfavorable regulatory rate adjustments and other
provisions for estimated state regulatory liabilities decreased $122 in 1998
compared to 1997, due in part, to the Washington Rate Order.
While the number of access lines, calling services and associated revenue
increased in 1998, the growth rate has declined from 1997. The decline in the
growth rate was partially attributable to our customer retention strategy of
offering customers bundles of services at lower prices in return for entering
into longer-term contracts. Some business customers have also opted to migrate
from multiple single lines
A-5
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
to high capacity lines, which decreases local service revenues but increases
access service revenues. Lastly, the work stoppage in the third quarter of 1998
negatively impacted revenue growth. We believe we will continue to experience
declining growth rates as the level of customer demand slows and competition
increases. Additionally, we are planning the sale of approximately 500,000
access lines that accounted for approximately $270 of 1998 revenues. While the
sale is expected to provide us with a one-time gain in 1999 or 2000, the loss of
the lines will negatively impact future revenue growth.
1998 1997 INCREASE
------ ------ -------------
Interstate access service revenues...... $2,816 $2,666 $ 150 5.6%
Intrastate access service revenues...... 822 761 61 8.0
------ ------ ----- -----
------ ------ ----- -----
INTERSTATE AND INTRASTATE ACCESS SERVICE REVENUES. Interstate and
intrastate access service revenues are derived primarily from charging
interexchange carriers, such as AT&T and MCI WorldCom, for use of our local
network to connect customers to their long-distance networks. We also collect
fees from telephone customers to connect to their long-distance carriers.
In 1998, interstate access service revenues were affected by a change in the
classification of fees paid into the universal service funds. In 1997 and prior
years, fees paid into the universal service funds were netted against interstate
access service revenues. In 1998, with the advent of the Federal Communications
Commission's ("FCC's") new universal service fund structure and funding
mechanism, these fees were recorded as access expense within other operating
expenses. Excluding the effects of the reclassification, interstate access
service revenues increased $65 or 2.4% in 1998 due to greater demand for
interstate access services. The volume of access minutes billed increased 6.4%
in 1998. The increase in demand was substantially offset by price reductions as
mandated by the FCC. Commencing in 1999, the FCC will allow us to recover
non-recurring costs incurred in connection with establishing local number
portability.
The increase in intrastate access service revenues was primarily
attributable to a $68 charge recognized in 1997 resulting from the Washington
Rate Order. Greater demand also contributed to the increase. The volume of
access minutes of use increased 5.4% in 1998.
1998 1997 DECREASE
------ ------ -------------
Long-distance network services
revenues.............................. $ 779 $ 885 $ 106 12.0%
------ ------ ----- -----
------ ------ ----- -----
LONG-DISTANCE NETWORK SERVICES REVENUES. Long-distance network services
revenues are derived from customer calls to locations outside of their local
calling area but within the same local access and transport area ("LATA"). The
decrease in long-distance network services revenues was attributable to greater
competition and regulatory rate reductions in 1998, offset by a $51 charge
recognized in 1997 resulting from the Washington Rate Order. As of December 31,
1998, in five of the 14 states in which we operate, customers are able to choose
an alternative provider for intraLATA calls without dialing a special access
code when placing the call. Additionally, contributing to the revenue decline
was the expansion of multiple toll carrier plans ("MTCPs") in 1997, whereby
other telephone companies provide toll services previously provided by us.
Although we no longer receive these revenues, the revenue loss has been offset
with increased intrastate access service revenues and lower access expenses.
We believe we will continue to experience further declines in long-distance
network services revenues as regulatory actions provide for increased levels of
competition. We are responding to competition
A-6
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
through competitive pricing of intraLATA long-distance services and increased
promotional efforts to retain customers. See "Special Note Regarding
Forward-Looking Statements" on page A-3.
1998 1997 INCREASE
------ ------ -------------
Directory services...................... $1,277 $1,197 $ 80 6.7%
------ ------ ----- -----
------ ------ ----- -----
DIRECTORY SERVICES. Directory services revenues are primarily derived from
selling advertising in our published directories. The increase in directory
services revenues was primarily attributable to a 7.5% increase in revenue per
local advertiser, resulting from price increases of 4.7% and an increase in
volume and additional features of advertisements sold.
1998 1997 INCREASE
------ ------ --------------
Other services revenues................. $1,159 $ 954 $ 205 21.5%
------ ------ ----- ------
------ ------ ----- ------
OTHER SERVICES REVENUES. Other services revenues include voice messaging,
inside wire installation and maintenance, wireless communications, billings and
collections for interexchange carriers, interconnection rent and customer
equipment sales. Other services revenues increased primarily as a result of
greater sales of wireless communications services, which commenced in 1997, and
inside wire installation and maintenance. Interconnection rent revenues,
continued market penetration in voice messaging services and increased sales of
other unregulated products and services also contributed to the increase.
EXPENSES
1998 1997 INCREASE
------ ------ -------------
Employee-related expenses............... $4,312 $3,953 $ 359 9.1%
------ ------ ----- -----
------ ------ ----- -----
EMPLOYEE-RELATED EXPENSES. Employee-related expenses include salaries and
wages, benefits, payroll taxes and contract labor. Employee-related expenses in
1998 include $21 of net costs incurred in connection with the third-quarter work
stoppage, including incremental travel costs, contract labor costs and bonuses
paid to management for work performed during the strike. Partially offsetting
these additional costs were lower salaries and wages for occupational employees
not working during the strike. Excluding these costs, employee-related expenses
increased $338 or 8.6%.
Employee-related expenses increased because of growth in several sectors of
the business, primarily wireless and data communications, resulting in increased
employee levels. Across-the-board wage increases also contributed to the
increase in employee-related expenses. We also incurred higher contract labor
costs for systems development, including interconnection and year 2000 costs and
marketing and sales efforts. Additionally, approximately 530 employees were
transferred from Old U S WEST as part of the Separation. Prior to the
Separation, these costs were allocated to us and included in other operating
expenses. Partially offsetting these increases was a $101 pension credit in 1998
compared to a $33 pension credit in 1997.
A-7
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Approximately 33,000 of our telephone company employees are represented by
the Communications Workers of America. In October 1998, members of the union
ratified a three-year contract providing for salary increases of 10.9% over
three years, effective in August of each year, and a cumulative pension increase
of 21% over three years.
1998 1997 INCREASE
------ ------ -------------
Other operating expenses................ $2,818 $2,587 $ 231 8.9%
------ ------ ----- -----
------ ------ ----- -----
OTHER OPERATING EXPENSES. Other operating expenses include access charges
paid to independent local exchange carriers for the routing of long-distance
traffic through their facilities, network software expenses, paper, printing,
delivery and distribution costs associated with publishing activities and other
selling, general and administrative costs. As discussed in "interstate and
intrastate access service revenues," universal service funding expenses were
netted against revenues in 1997 and prior years and have been classified to
other operating expenses in 1998. Excluding the effects of the reclassification,
other operating expenses increased $146 or 5.6% in 1998. The increase was
primarily attributable to the following:
- increased costs associated with growth initiatives, including wireless
handset costs and related marketing and advertising,
- higher interconnection and local number portability costs,
- costs of $94 that were directly attributable to the Separation, including
executive severance, legal and financial advisory fees, securities
registration fees, printing and mailing costs and internal systems and
rearrangement costs, and
- an asset impairment charge of $35 related to certain long-lived assets
used in our video operations in Omaha, Nebraska. Recent technological
advances have permitted us to pursue and use more economical DSL
technology in cable overbuild situations. Because the projected future
cash flows were less than the assets' carrying value, an impairment loss
was recognized. See Note 3 to the consolidated financial statements.
Partially offsetting the increase in other operating expenses was the effect
of transferring approximately 530 employees from Old U S WEST. Costs related to
these employees are now included in employee-related expenses. Previously, these
costs were allocated from Old U S WEST and included in other operating expenses.
1998 1997 INCREASE
------ ------ --------
Depreciation and amortization expense........ $2,199 $2,163 $36 1.7%
------ ------ --- ---
------ ------ --- ---
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense increased primarily due to higher overall property, plant and equipment
balances resulting from continued investment in our network.
1998 1997 INCREASE
------ ------ -------------
Other expense--net...................... $ 630 $ 347 $ 283 81.6%
------ ------ ----- -----
------ ------ ----- -----
A-8
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OTHER EXPENSE--NET. Interest expense was $543 in 1998 compared to $405 in
1997. The increase was primarily attributable to the Dex Indebtedness. On a pro
forma basis, assuming the Dex Indebtedness had occurred at the beginning of each
year presented, interest expense would have been $660 in 1998 compared to $667
in 1997. The decline in pro forma interest expense is attributable to overall
lower average pro forma debt balances in 1998 compared to 1997.
Also included in other expense--net, were other expenses of $87 in 1998
compared to other income of $58 in 1997. The 1998 other expenses resulted
primarily from interest expense on state regulatory liabilities whereas 1997
other income was derived primarily from sales of local telephone exchanges and
our investment in Bellcore, offset by interest expense on state regulatory
liabilities.
INCREASE (DECREASE)
1998 1997
--------- --------- --------------------
Segment results:
Retail segment.............................................. $ 6,194 $ 5,940 $ 254 4.3%
Wholesale segment........................................... 1,908 2,176 (268) (12.3)%
Network segment............................................. (2,776) (2,738) (38) (1.4)%
Directory segment........................................... 657 615 42 6.8%
--------- --------- --------- ---------
--------- --------- --------- ---------
SEGMENT RESULTS. For segment reporting purposes, segment margins exclude
certain costs and expenses, including depreciation and amortization, corporate
expenses, taxes other than income and other non-recurring charges. See Note 12
to the consolidated financial statements.
Margin from the retail services segment increased due to revenue growth,
primarily from local service revenues. The revenue increase was partially offset
by the higher operating expenses driven by growth initiatives. Margin from the
wholesale services segment decreased as a result of price reductions as mandated
by the FCC and higher operating costs, primarily interconnection costs,
partially offset by greater demand for interstate access services. Margin from
the network services segment decreased as a result of additional expenditures to
support growth in the retail services segment. Margin from the directory segment
increased due to growth in directory services revenue partially offset by
increased printing, paper and sales support costs.
1998 1997 INCREASE
--------- --------- ----------
Provision for income taxes............................................. $ 911 $ 902 $ 9 1.0%
-- --
-- --
--------- ---------
--------- ---------
PROVISION FOR INCOME TAXES. On a pro forma basis assuming the Dex
Indebtedness had occurred at the beginning of each year presented, the effective
tax rate was 37.6% for 1998 compared to 37.0% for 1997. The increase in the
effective tax rate was primarily attributable to the non-deductibility of
certain Separation costs and lower amortization of investment tax credits.
A-9
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
1997 COMPARED TO 1996
Several non-recurring and non-operating items impacted reported net income
in 1997 compared to 1996. Results of operations for the two years, normalized to
exclude the effects of such items, are as follows:
INCREASE
1997 1996 (DECREASE)
------ ------ ---------------
Net income.............................. $1,524 $1,535 $ (11) (0.7)%
Non-recurring and non-operating items... (77) (85) 8 9.4
------ ------ ------ -------
Normalized income....................... $1,447 $1,450 $ (3) (0.2)%
------ ------ ------ -------
------ ------ ------ -------
Diluted earnings per share.............. $ 3.12 $ 3.17 $(0.05) (1.6)
Non-recurring and non-operating items... (0.16) (0.17) 0.01 5.9
------ ------ ------ -------
Normalized diluted earnings per share... $ 2.96 $ 2.99* $(0.03)* (1.0)%
------ ------ ------ -------
------ ------ ------ -------
- ------------------------------
* Normalized diluted earnings per share does not foot due to rounding.
Non-recurring and non-operating items in 1997 include:
- an after-tax charge of $3 or $0.01 per diluted share relating to the early
extinguishment of debt and
- an after-tax gain of $80 or $0.17 per diluted share relating to the sale
of local telephone exchanges and our investment in Bellcore.
Non-recurring and non-operating items in 1996 include:
- an after-tax gain of $36 or $0.07 per diluted share relating to the sale
of local telephone exchanges and
- an after-tax gain of $49 or $0.10 per diluted share relating to the
cumulative and current year effect of a change in accounting principle.
See Note 3 to the consolidated financial statements.
Normalized income decreased $3 or 0.2% in 1997 and normalized diluted
earnings per share decreased $0.03 or 1.0%. The decreases were primarily due to
the $152 after-tax regulatory charge ($250 pretax) relating primarily to the
Washington Rate Order. Absent the effects of this charge, normalized income
increased $149 or 10.3%. The increase was primarily due to strong demand for our
telecommunications business and directory services and a 1996 after-tax charge
of $15 to reorganize and reduce headcount in the directory services segment.
Partially offsetting the effects of increased demand were higher expenses for
interconnection, provisions for estimated regulatory liabilities other than in
Washington and start-up costs associated with growth initiatives.
The following section provides a more detailed discussion of the changes in
revenues and expenses.
OPERATING REVENUES
1997 1996 INCREASE
------ ------ -------------
Local service revenues.................. $5,016 $4,770 $ 246 5.2%
------ ------ ----- -----
------ ------ ----- -----
A-10
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LOCAL SERVICE REVENUES. Local service revenues increased in 1997 due
largely to access line growth and increased demand for calling services. In
1997, we provided a total of 609,000 additional access lines, an increase of
3.9% over 1996. Of this increase, second line installations accounted for
294,000 lines, an increase of 28.2% compared with 1996. Additionally, regulatory
rate increases of $37 and interim per call compensation revenues from
interexchange carriers as a result of FCC payphone orders favorably impacted
revenue. While local service revenues increased in 1997, the rate of growth of
5.2% declined from a 9.8% growth rate in 1996. The decline in growth was
attributable to $181 in state regulatory charges, primarily related to the
Washington Rate Order and provisions for other state regulatory liabilities.
Lower wireless interconnection access prices caused by regulatory mandate and
the effects of local exchange sales also negatively impacted local service
revenue growth in 1997.
INCREASE
1997 1996 (DECREASE)
------ ------ -------------
Interstate access service revenues...... $2,666 $2,507 $ 159 6.3%
Intrastate access service revenues...... 761 770 (9) (1.2)
------ ------ ----- -----
------ ------ ----- -----
INTERSTATE AND INTRASTATE ACCESS SERVICE REVENUES. The increase in
interstate access service revenues resulted from greater demand for private line
services, access line growth and an increase of 6.4% in billed interstate access
minutes of use. Additionally, 1997 was favorably impacted by lower accruals for
refunds to interexchange carriers in 1997 compared to 1996. Lower prices under
the FCC's price cap plan and a $25 charge for an FCC-ordered refund to
interexchange carriers partially offset the effects of greater demand.
The decrease in intrastate access service revenues was primarily due to a
$68 charge recognized as part of the Washington Rate Order. A 12.2% increase in
billed access minutes of use, higher demand for private line services and $7 of
regulatory rate increases largely offset the effects of the Washington Rate
Order.
1997 1996 DECREASE
------ ------ -------------
Long-distance network services
revenues.............................. $ 885 $1,100 $(215) (19.5)%
------ ------ ----- -----
------ ------ ----- -----
LONG-DISTANCE NETWORK SERVICES REVENUES. The decrease in long-distance
network services revenues was partially attributable to a $51 charge resulting
from the Washington Rate Order. The effects of competition, the introduction of
MTCPs in various jurisdictions in 1997 and 1996 and $20 of regulatory rate
reductions also contributed to the revenue decrease.
1997 1996 INCREASE
------ ------ -------------
Directory services...................... $1,197 $1,120 $ 77 6.9%
------ ------ ----- -----
------ ------ ----- -----
DIRECTORY SERVICES. The increase in directory services revenues was largely
a result of an average 7.3% increase in revenue per local advertiser, primarily
resulting from price increases of 4.6% and an increase in volume and additional
features of advertisements sold. These increases were offset slightly by
decreased revenue associated with exited product lines that were non-strategic
to the directories business.
A-11
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
1997 1996 INCREASE
------ ------ -------------
Other services revenues................. $ 954 $ 901 $ 53 5.9%
------ ------ ----- -----
------ ------ ----- -----
OTHER SERVICES REVENUES. Other services revenues increased primarily as a
result of continued market penetration of voice messaging services, greater
sales of inside wire installation and maintenance and other unregulated products
and services and the launch of wireless communications services. Partially
offsetting these increases was a reduction in contract revenues due to the
completion of a large federal government telephony project in 1996.
EXPENSES
1997 1996 INCREASE
------ ------ -------------
Employee-related expenses............... $3,953 $3,893 $ 60 1.5%
------ ------ ----- -----
------ ------ ----- -----
EMPLOYEE-RELATED EXPENSES. Employee-related expenses increased largely as a
result of growth in interconnection costs. Higher contract labor costs,
predominantly 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 employee benefit costs also contributed to the total
growth in employee-related expenses. Partially offsetting these increases were
lower salaries and wages related to headcount reductions, lower conference and
travel expenses and decreases in overtime costs. A charge of $25 in 1996 to
reorganize and reduce headcount in the directories business also partially
offset the increase.
1997 1996 INCREASE
------ ------ -------------
Other operating expenses................ $2,587 $2,305 $ 282 12.2%
------ ------ ----- -----
------ ------ ----- -----
OTHER OPERATING EXPENSES. The increase in other operating expenses was
attributable to the following:
- higher advertising expenses,
- increased interconnection expenses,
- increased costs associated with strategic and growth initiatives,
primarily wireless communications services,
- increased equipment rentals, and
- increased printing, paper and sales support costs in the directories
business which were associated with an increase in the volume and
complexity of advertisements sold.
Partially offsetting these increases were the effects of reduced access
expense, primarily related to the introduction of the MTCPs, the completion of a
large federal government telephony project in 1996 and lower material and
supplies expense. Additionally, the directory services segment's discontinuance
of various product development activities in 1996 and an $11 charge in 1996 to
discontinue the Omaha broadband video service trial partially offset the
increases.
1997 1996 DECREASE
------ ------ -------------
Other expense--net...................... $ 347 $ 435 $ (88) (20.2)%
------ ------ ----- -----
------ ------ ----- -----
A-12
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OTHER EXPENSE--NET. Interest expense was $405 in 1997 compared to $448 in
1996. The decrease was primarily attributable to a lower average debt level,
partially offset by a reduction in the amount of interest capitalized on assets
under construction.
Also included in other expense--net was other income of $58 in 1997 compared
to other income of $13 in 1996. Other income in 1997 was derived from sales of
local telephone exchanges and our investment in Bellcore, partially offset by
interest expense on state regulatory liabilities. The other income in 1996 was
also from the sale of selected local telephone exchanges offset by an adjustment
related to our equity investment in Bellcore.
INCREASE (DECREASE)
1997 1996
--------- --------- --------------------
Segment results:
Retail segment............................................... $ 5,940 $ 5,605 $ 335 6.0%
Wholesale segment............................................ 2,176 2,183 (7) (0.3)%
Network segment.............................................. (2,738) (2,553) (185) (7.2)%
Directory segment............................................ 615 524 91 17.4%
--------- --------- --------- ---
--------- --------- --------- ---
SEGMENT RESULTS. For segment reporting purposes, segment margins exclude
certain costs and expenses, including depreciation and amortization, corporate
expenses, taxes other than income and other non-recurring charges. See Note 12
to the consolidated financial statements.
Margin from the retail services segment increased due to revenue growth,
primarily from local service revenues. The revenue increase was partially offset
by higher operating expenses driven by start-up costs associated with growth
initiatives. Margin from the wholesale services segment remained relatively
consistent in 1997 compared to 1996. Margin from the network services segment
decreased as a result of additional expenditures to support growth in the retail
services segment. Margin from the directory segment increased due to growth in
directory services revenue from both volume and price increases. Partially
offsetting this income growth were revenue declines associated with exited
product lines that were non-strategic to the directories business and increased
printing, paper and sales support costs.
1997 1996 INCREASE
--------- --------- -----------
Provision for income taxes............................................ $ 902 $ 876 $ 26 3.0%
--
--
--------- --------- ---
--------- --------- ---
PROVISION FOR INCOME TAXES. The effective tax rate was 37.1% for 1997
compared to 36.9% for 1996. The increase in the effective tax rate was primarily
attributable to lower amortization of investment tax credits.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. Cash provided by operations was $3,927, $4,191 and
$3,614 in 1998, 1997 and 1996, respectively. The decrease in operating cash flow
in 1998 resulted from a reduction in payables, the effects of refunds paid
relating to regulatory rulings and an increase in accounts receivable. Partially
offsetting these items were the effects of business growth in both the
communications and directories businesses and lower income tax payments.
A-13
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Cash from operations increased $577 during 1997 primarily due to business
growth and efforts to manage working capital in the communications business.
Lower restructuring expenditures, a decrease in funding postretirement benefits
and growth in the directories business also contributed to the increase.
Future cash needs could increase with the pursuit of new business
opportunities, and be impacted by continued implementation of the requirements
of the Telecommunications Act of 1996 (the "Telecommunications Act" or "Act").
Interconnection, local number portability, universal service and access charge
reform will negatively impact cash flows to the extent recovery mechanisms
provided for by the FCC and state commissions are inadequate. We expect that
such cash needs will be funded through operations and, when necessary, the
issuance of debt securities.
INVESTING ACTIVITIES. Total capital expenditures, on a cash basis, were
$2,672, $2,168 and $2,444 in 1998, 1997 and 1996, respectively. Capital
expenditures have primarily been, and continue to be, focused on expanding
access line growth, modernization of the telecommunications network and meeting
the requirements of the Act, including interconnection and local number
portability. We are also continuing to expand our investment to compete in the
wireless, data communications and video markets. In addition to investments in
property, plant and equipment, we paid $18 in 1998 and $73 in 1997 to purchase
wireless personal communications services ("PCS") licenses in connection with
our launch of PCS in various markets.
In 1999, we anticipate capital expenditures will approximate $3,300 to
$3,600, (including the impact of capitalizing software costs that were
previously expensed; see "New Accounting Standards") which include the launch of
PCS in additional markets, expansion of the Internet data business and
additional interconnection costs. See "Special Note Regarding Forward-Looking
Statements" on page A-3.
We received cash proceeds of $67 in 1997 and $174 in 1996 from the sale of
local telephone exchanges. Also during 1997, we sold our equity interest in
Bellcore for proceeds of $65.
FINANCING ACTIVITIES. Cash used for financing activities was $1,136, $2,157
and $1,451 in 1998, 1997 and 1996, respectively. In 1998, total debt increased
by $4,204 to $9,919 at December 31, 1998, of which approximately $3,900 was
attributable to the Dex Indebtedness. The Dex Indebtedness was incurred at the
Separation Date to repay Old U S WEST debt.
During 1997, total debt decreased $830, partially driven by increased
operating cash flows and lower capital expenditures. During 1997, Old U S WEST
redeemed its zero coupon subordinated notes with a recorded value of $303
attributed to us. Floating-rate Old U S WEST debt, due on demand, financed the
redemption.
During 1996, total debt decreased $237 primarily due to growth in operating
cash flow.
Historically, prior to the Separation Date, Old U S WEST funded our
nonregulated activities, including Dex, with short-term advances. The net
(repayments of) proceeds from such Old U S WEST short-term advances were $(198),
$153 and $(42) during 1998, 1997 and 1996, respectively.
We paid dividends on our common shares totaling $1,056, $992 and $939 in
1998, 1997 and 1996, respectively. Prior to the Separation, Dex paid dividends
to Old U S WEST equal to its net income, adjusted for the amortization of
intangibles, totaling $194, $336 and $303 in 1998, 1997 and 1996, respectively.
A-14
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
We maintain commercial paper programs to finance short-term cash flow
requirements, as well as to maintain a presence in the short-term debt market.
As of December 31, 1998, we had lines of credit with a total borrowing capacity
of $2,360.
RISK MANAGEMENT
Over time, we are exposed to market risks arising from changes in interest
rates. The objective of our interest rate risk management program is to manage
the level and volatility of our interest expense. We may employ derivative
financial instruments to manage our interest rate risk exposure. We have also
employed derivative instruments to hedge interest rate and foreign currency
exposures associated with particular debt issues in order to synthetically
obtain below-market interest rates. We do not use derivative financial
instruments for trading purposes.
As of December 31, 1998 and 1997, $951 and $62, respectively, of
floating-rate debt was exposed to changes in interest rates. This exposure was
primarily linked to the 30-day commercial paper rate. A hypothetical 10% change
in the 30-day commercial paper rate would not have had a material effect on our
annual earnings. As of December 31, 1998 and 1997, we also had $228 and $340,
respectively, of fixed-rate debt obligations maturing in the following fiscal
year. Any new debt obtained to refinance this debt would be exposed to changes
in interest rates. A hypothetical 10% change in the interest rates on this debt
would not have had a material effect on our earnings.
As of December 31, 1998 and 1997, we had entered into interest rate swaps
with a notional amount of $155. These swaps synthetically transform certain
floating rate issues into fixed-rate obligations. The swaps and associated debt
issues are indexed to two- and 10-year constant maturity U.S. Treasury rates.
Any gains (losses) on the swaps would be offset by losses (gains) on the
associated debt instruments.
As of December 31, 1998 and 1997, we had also entered into cross-currency
swaps with a notional amount of $204. The cross-currency swaps synthetically
transformed $182 and $171 of Swiss Franc borrowings at December 31, 1998 and
1997, respectively, into U.S. dollar obligations. Any gains (losses) on the
cross-currency swaps would be offset by losses (gains) on the Swiss Franc debt
obligations.
CONTINGENCIES
We have pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both. See Note 14 to the consolidated
financial statements.
OTHER ITEMS
From time to time, we engage in discussions regarding restructurings,
dispositions, acquisitions and other similar transactions. Any such transaction
could include, among other things, the transfer, sale or acquisition of
significant assets, businesses or interests, including joint ventures, or the
incurrence, assumption or refinancing of indebtedness, and could be material to
our financial condition and results of operations. There is no assurance that
any such discussions will result in the consummation of any such transaction.
COMPETITION
When Congress passed the Telecommunications Act, its primary purpose was to
open the local markets of the telecommunications industry to competition. Now,
three years later, the Act's impact on the industry and on us can be seen. We
face increasing competition from a variety of sources, including other
A-15
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
local service providers, long-distance service providers, cable TV companies,
wireless service providers, Internet service providers and other entrants from
closely related industries. As a result of these competitors' efforts, we are
experiencing an erosion of our market share as well as pressure on our profit
margins which could have a material adverse effect on our operations going
forward.
To date, the most significant competition has developed in the business
market where competitors have targeted high-volume business customers in densely
populated urban centers and selected businesses in smaller communities. In the
residential market, competitors are focusing on areas of highly concentrated
customers, such as multiple dwelling units. We are facing competition in
virtually all areas of our business: local calling, intraLATA long-distance,
wireless, Internet and data services. Our directory business is facing
competition from services provided by web-based electronic providers and
traditional directory publishers. We are also encountering competition from at
least two cellular providers as well as other PCS companies in each market where
we offer wireless service.
As part of the Act, we must provide interconnection to our network for
competitors and furnish number portability to our customers. Both of these areas
have, and will continue to increase our cost structure while providing others
with the means to effectively compete with us. We must meet all parts of a
14-point checklist and then receive FCC approval before we are allowed to enter
the interLATA long-distance market. The Act, as well as other state regulatory
proceedings, have also significantly impacted pricing and the speed with which
we may bring new products and services to market. For a further discussion of
regulatory matters, you should read the section entitled "Regulation" below.
Technological advancements will help to shape the competitive landscape of
the future. Examples include the wireless replacement of wireline capabilities,
migration from circuit-switched to packet-switched technology such as IP
telephony, the capabilities associated with xDSL (Digital Subscriber Line)
services versus hybrid fiber/coax abilities and the analog conversions to
digital. Also, the mega-mergers announced in recent years (SBC-Ameritech,
AT&T-TCI, GTE-Bell Atlantic and WorldCom-MCI) will give competitors greater
access to our markets and provide increased financial resources that can be used
to fund projects that will compete directly with us.
We are countering the competition by expanding and improving our product and
service offerings. In addition to enhancing current service offerings, including
PCS, high-speed data, Internet access, interconnection services and video
transmission, we will be investigating other services. We are also working to
ease the regulatory barriers we face for entry into the interLATA long-distance
market as well as addressing our needs to have increased pricing flexibility for
our products and services. We will also evaluate and form strategic alliances
that we believe will be beneficial as the competitive environment intensifies.
Finally, we believe that our ability to bundle and integrate a comprehensive
telecommunications package that can be made available through one-stop shopping
will provide a significant competitive advantage. For factors which could cause
actual results to differ from expectations, you should read "Special Note
Regarding Forward-Looking Statements" on page A-3.
REGULATION
THE TELECOMMUNICATIONS ACT OF 1996. The Telecommunications Act
fundamentally changed the competitive landscape by permitting local telephone
companies, long-distance carriers and cable television companies to enter each
other's lines of business. Under the Telecommunications Act, the regional Bell
operating companies ("RBOCs") are permitted to provide interLATA long-distance
services by opening their local networks to competitors and satisfying a
detailed list of requirements, including providing interconnection and number
portability ("LNP"). The Telecommunications Act also lifts the ban on cross-
A-16
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
ownership between cable television and telephone companies. The
Telecommunications Act also reaffirmed the concept of universal service and
directed the FCC and state regulators to determine universal service funding
policies. The FCC and state regulators have been given the responsibility to
interpret and oversee implementation of the Telecommunications Act.
The FCC issued an order (the "FCC Order") in August of 1996, establishing a
framework of rules that enable the states and the FCC to implement the local
competition provisions of the Telecommunications Act. Key provisions that relate
to us and other incumbent local exchange companies ("ILECs") include the
requirements that we:
- provide interconnection to any requesting telecommunications carrier under
certain terms and conditions;
- provide unrestricted access to network services on an unbundled basis;
- offer for resale at a discount any telecommunications services that the
ILECs provide at retail to subscribers;
- provide reciprocal compensation arrangements for wireline and wireless
local service providers;
- provide physical collocation of equipment necessary for interconnection at
ILECs' facilities, unless physical collocation is not practical for
technical reasons or because of space limitations; and
- meet a strict list of requirements, applicable only to RBOCs, to open
their networks prior to being allowed entry into the interLATA
long-distance business.
INTERCONNECTION. The FCC Order established interconnection costing and
pricing rules which, from our perspective, significantly impeded negotiations
with new entrants to the local exchange market, state public utility commission
interconnection rulemakings and interconnection arbitration proceedings.
We appealed the FCC Order and sought a stay of certain of its provisions,
including certain pricing provisions, pending appellate review. Litigation of
the FCC Order centered on the FCC's authority over pricing rules, unbundled
element requirements and pick and choose provisions. On January 25, 1999, the
U.S. Supreme Court ("Supreme Court") issued a ruling in this proceeding.
Although the decision stated that the 1996 Telecommunications Act was ambiguous
and self-contradictory, the Court ruled that:
- the FCC has authority to set pricing methodology;
- unbundled network elements must be provided in cases where necessary or
the lack of availability would impair competition;
- ILECs must sell on a bundled basis, at the Competitive Local Exchange
Carriers' ("CLECs") request, network elements the ILEC uses itself on a
bundled basis; and
- CLECs may pick and choose pricing or other terms and conditions from
multiple contracts within certain bounds.
The impact the Supreme Court order will have is unclear since state
regulatory commissions have generally followed the FCC's pricing and unbundling
requirements in setting unbundled network element prices. It is anticipated that
a new FCC rulemaking will be required to define the "necessary and impair"
standard in light of the Supreme Court decision and further review of the
legality of the FCC's pricing rules will occur at the Eighth Circuit Court of
Appeals. Additionally, we have established interconnection agreements with the
majority of carriers seeking interconnection. We have secured approximately 500
A-17
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
interconnection agreements with approximately 100 carriers as of December 31,
1998. In light of the Supreme Court decision and the need for further regulatory
and judicial proceedings, we cannot provide assurance that we will be able to
fully recover our costs related to providing interconnection services.
INTERLATA LONG-DISTANCE ENTRY. Several RBOCs have filed for entry into the
interLATA long-distance business. Although many of these applications have been
approved by state regulatory commissions, the FCC has rejected all applications
to date. These rejections and the FCC's interpretation of the checklist
provisions in the Telecommunications Act are driving up our costs and delaying
our entry into the interLATA long-distance business.
We view entry into this segment as important to our strategy of providing an
integrated bundle of services to our customers. In 1998, we filed applications
to enter the interLATA long-distance business in Nebraska, Montana and Wyoming.
We expect to continue filing applications in other states during 1999. We cannot
predict when our applications to enter the interLATA long-distance markets will
be approved due to the extreme opposition of the incumbent long-distance
companies and the remaining uncertainty of how the FCC will interpret the
long-distance entry checklist requirements.
NUMBER PORTABILITY. In 1998, we deployed LNP capability, which allows
customers to change service providers while maintaining their existing telephone
number, in our top 10 markets. On December 14, 1998, the FCC issued its final
cost recovery rules for LNP. On January 25, 1999, we filed a tariff with the FCC
for a monthly surcharge on all LNP capable lines to be in place for 5 years. We
expect the FCC to issue a ruling on our LNP tariff in the first half of 1999.
Ultimately, the FCC will decide which LNP costs are allowable and a final
surcharge rate will be established. We also filed an Application for Review on
January 13, 1999, asking that several provisions of the FCC's LNP order be
changed to allow us to recover a larger portion of our LNP costs.
UNIVERSAL SERVICE. Under the FCC's 1997 Universal Service Order, all
providers of interstate telecommunications services will contribute to universal
service funding, which will be based on retail telecommunications revenues. The
FCC and the federal/state joint board have issued orders and recommendations
concerning this new explicit mechanism to support high-cost service in rural
areas, such as ours. An important aspect of these deliberations is the
recognition that certain states do not have the capability to fund high costs
areas solely at the state level and will need additional funding from a
nationwide fund. Important decisions still need to be issued by the FCC
concerning the ultimate size of any national fund and the criteria to determine
who may draw from the fund and the level of the draw. The FCC has stated its
intention to issue its final rules in time for a new high-cost fund to be
implemented on July 1, 1999. Given the substantial work that remains to be done
for implementation, the July 1, 1999 date appears at significant risk.
The FCC's Universal Service Order also established two separate funds to
help connect 1) eligible schools and libraries and 2) rural health care
providers to the global telecommunications network. These funds were initially
capped at $2,250 and $400, respectively. These funds were phased in during 1998
and will be funded at their maximum levels beginning July 1, 1999. These funds
are used to reimburse telecommunications service providers for discounts on
eligible services given to schools, libraries and rural health care providers.
On July 17, 1997, we filed a petition with the FCC for reconsideration and
clarification of certain issues in the Universal Service Order. Among other
things, we requested the FCC to reconsider: (i) establishing a national fund to
ensure high-cost support is sufficient and (ii) assessing contributions as
explicit end-user surcharges. Appeals of other issues addressed by the Universal
Service Order have been filed by various other companies. The petition for
reconsideration is still pending.
A-18
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The FCC's Universal Service Order has also been appealed to the U.S. Court
of Appeals for the Fifth Circuit. We and other parties are claiming that the
FCC's order does not ensure all subsidies are explicit and competitively
neutral. Oral argument was heard on December 1, 1998 and a decision is expected
in 1999.
ACCESS REFORM. In its Access Reform Order, the FCC mandated a substantial
restructuring of interstate access pricing. A significant portion of the
services that were charged using minutes-of-use pricing are now being charged
using a combination of minutes-of-use rates, flat-rate pre-subscribed
interexchange carrier charges ("PICCs") and subscriber line charges ("SLCs").
Although an increase in the SLC to multi-line business users occurred on July 1,
1997, the bulk of the mandated pricing changes occurred on January 1, 1998.
Additional mandated pricing changes occurred on January 1, 1999 and more will be
implemented on January 1 of 2000 and 2001. The net effect of these changes will
be to decrease minutes-of-use charges and increase flat-rate charges (i.e.,
PICCs and SLCs).
The Access Reform Order also continued in place the current rules by which
ILECs may not assess interstate access charges on information service providers
and purchasers of unbundled network elements.
Along with other ILECs, we appealed the Access Reform Order stating that the
FCC acted unlawfully by exempting purchasers of enhanced services from payment
of interstate access charges. In addition, interexchange carriers appealed the
FCC order contending the access charges had to be immediately set at cost. The
Eighth Circuit Court affirmed the Access Reform Order in July 1998.
PRICE CAP ORDER. Our interstate services have been subject to price cap
regulation since January 1991.
The FCC's May 1997 Price Cap Order required ILECs that were subject to price
cap regulation to increase their price cap index productivity factor. The order
eliminated the lower productivity factor options that required sharing of
earnings above a specified level.
On June 23, 1997, we petitioned the Tenth Circuit Court of Appeals (the
"Tenth Circuit") for a review of the Price Cap Order. The Tenth Circuit has
transferred review of the Price Cap Order to the District of Columbia Court of
Appeals. Among other things we, and other appellants, are requesting the
District of Columbia Court of Appeals to review the propriety of increasing the
productivity factor and its retroactive application. This case was heard on
January 20, 1999 and a decision is expected in 1999.
Our 1998 price cap filing resulted in rates designed to collect
approximately the same level of revenue as the previous year. This was primarily
caused by one-time adjustments to the price cap formulas that offset mandated
reductions due to the increased productivity factor. In our 1999 price cap
filing, which will go into effect July 1, 1999, we expect a reduction in
revenues. The Price Cap Order will, over time, significantly reduce the prices
we charge for interstate access.
ADVANCED TELECOMMUNICATIONS SERVICES. In August 1998, the FCC issued an
order and Notice of Proposed Rulemaking addressing the deployment of Advanced
Telecommunications Services ("ATS") by ILECs. In this order, the FCC proposed
strict separate subsidiary requirements for the provision of ATS, such as
high-speed data services, if an ILEC wishes to be treated as a CLEC in the
provision of these services. We oppose these requirements and believe they would
significantly increase cost and will impede the broad deployment of these
services. The FCC is expected to issue a further order in early 1999 that will
clarify its rules.
A-19
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
YEAR 2000 COSTS
BACKGROUND. During 1997 and 1998, we conducted a comprehensive review of
our computer-based systems and related software and began to take measures to
ensure that such systems will properly recognize the year 2000 and continue to
process beyond December 31, 1999. The systems we evaluated include (i) Public
Switched Telephone Network (the "Network"), (ii) Information Technologies ("IT")
and (iii) individual Business Units (the "Business Units").
The Network, which processes voice and data information relating to our core
communications business, relies on remote switches, central office equipment,
interoffice equipment, and loop transport equipment that is predominantly
provided to us by telecommunications network vendors. IT is comprised of our
internal business systems that employ hardware and software on an
enterprise-wide basis, including operational, financial and administrative
functions. The Business Units, which include internal organizations such as
finance, procurement, directory services, operator services, wireless, data
networks, real estate, etc., employ systems that support desktop and
departmental applications, as well as embedded computer chip technologies, which
relate specifically to each of our Business Unit's functions and generally are
not part of the Network or IT.
We have approached year 2000 remediation activities through five general
phases: (i) inventory/ assessment, (ii) planning, (iii) conversion, (iv)
testing/certification and (v) implementation. Additionally, we have monitored
and improved our year 2000 related activities and progress, communicated with
our customers and vendors, participated in cooperative testing with others and
taken steps to assure that we have contingency plans in place prior to the end
of 1999. We plan to continue these activities during 1999.
NETWORK UPDATE. With regard to the Network, we are working with our
telecommunications network vendors to obtain and convert to compliant releases
of hardware and software. We also are testing, at our own initiative, in
cooperation with certain of our customers and vendors, and in cooperation with
other major wireline telecommunications companies, network equipment over
multiple configurations involving a broad spectrum of services. Toward this end,
we participate in the Telco Year 2000 Forum (the "Forum"), an organization that
addresses the year 2000 readiness of network elements and network
interoperability. The Forum has contracted with Bellcore, a former affiliate
engaged in telecommunications industry research, development and maintenance
activities, to engage in inter-region interoperability testing. We also
participate in the FCC's Network Reliability and Interoperability Council IV
working group, which is tasked to evaluate the year 2000 readiness of the public
telecommunications network, and in the Alliance for Telecommunications Industry
Solutions ("ATIS"), which is testing inter-network interoperability, and which,
in conjunction with the Cellular Telecommunications Industry Association
("CTIA"), is testing network interoperability with wireless networks. Our
inventory/assessment, planning and conversion phases for the Network are
complete. The network testing/certification phase was approximately 99% complete
as of December 31, 1998 and we anticipate that this phase will be complete
during the first quarter of 1999. Cooperative testing with certain customers,
vendors and other telecommunications companies is expected to continue during
1999. As of December 31, 1998 approximately 79% of our Network remediation
implementation was complete, with completion of the remainder anticipated by
July 1999. We have initiated Network contingency planning activities and
approximately 10% of the anticipated Network contingency planning activity was
complete as of December 31, 1998. We anticipate that the remainder of our
Network contingency planning activity will be complete by mid-1999.
IT UPDATE. Within IT, we have identified approximately 570 applications
that support our critical business processes, such as billing and collections,
network monitoring, repair and ordering. The inventory/ assessment and planning
phases for such IT applications are complete. As of December 31, 1998,
A-20
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
approximately 96% of IT conversion activities, 84% of IT testing activities and
81% of IT implementation had been completed. We anticipate that each of these
phases for IT will be complete by July 1999. IT contingency planning activity is
approximately 40% complete and we anticipate that the remainder will be complete
by mid-1999.
BUSINESS UNITS UPDATE. Within our Business Units, it is estimated that as
of December 31, 1998, approximately 95% of the inventory/assessment activity,
70% of the planning activity, 20% of the conversion activity and 5% of the
testing and remediation implementation activity were complete. We anticipate
that each of these phases will be complete in the Business Units for major
conversions and upgrades by the end of the third quarter of 1999. Some of our
Business Units, such as the retail markets organization, are at the beginning of
the conversion, testing and implementation phases, while other Business Units,
such as our finance organization, have substantially completed all of the
phases. We have recently initiated Business Unit contingency planning activities
and we anticipate those will be complete by mid-1999.
COSTS RELATING TO YEAR 2000. We have spent approximately $115 from the
beginning of 1997 through the end of 1998 on year 2000 projects and activities.
We estimate that additional costs for year 2000 related projects and activities
will be approximately $60 through the end of 1999. We estimate total spending on
year 2000 projects and activities from the beginning of 1997 through the end of
1999 will be approximately $175. Virtually all year 2000 related expenditures
are being funded through operations. Though year 2000 costs will directly impact
the reported level of future net income, we intend to control our total cost
structure, including deferral of non-critical projects to future years, in an
effort to mitigate the impact of year 2000 costs on our historical rate of
earnings growth. The estimates stated above are subject to change. The timing of
our expenses may vary and is not necessarily indicative of readiness efforts or
progress to date.
CONTINGENCY PLAN. We cannot provide assurance that the results of our year
2000 compliance efforts or the costs of such efforts will not differ materially
from estimates. Accordingly, we are developing year 2000 specific business
continuity and contingency plans to address high risk areas as they are
identified. Our year 2000 contingency planning activities will include training
of crisis managers on year 2000 issues and potential business impacts to their
particular process areas, reviewing and modifying existing business continuity
plans to address year 2000 issues and establishing rapid response teams and
communications procedures for each of the major critical operations and
facilities to handle potential post-implementation year 2000 failures. These
year 2000 specific contingency planning activities are to be in place by the
third quarter of 1999. In addition, we have in place our standard overall
business continuity, contingency and disaster recovery plans (such as diesel
generator back-up power supply sources for our Network, Network rerouting
capabilities, computer data and records safe-keeping and back-up and recovery
procedures) which will be verified, and as appropriate, augmented for specific
year 2000 contingencies.
DEPENDENCIES. Within Network, we are highly dependent upon our
telecommunications network vendors to provide year 2000 compliant hardware and
software in a timely manner, and on third parties that are assisting us in the
focused testing and implementation phases regarding the Network. Because of
these dependencies, we have developed and implemented a vendor compliance
process whereby we have obtained written assurances of timely year 2000
compliance from most of our critical vendors (not only for Network, but also for
IT and the Business Units). In addition, we monitor and actively participate in
coordinated Network testing activities, as discussed above, with respect to the
Forum, ATIS and Bellcore. Within IT, we depend on the development of software by
experts, both internal and external, and the availability of critical resources
with the requisite skill sets. Because of this dependency, we have developed
A-21
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
detailed timetables, resource plans and standardized year 2000 testing
requirements for identified critical applications (irrespective of whether these
applications are used primarily by IT, the Network or the Business Units).
Within the Business Units, we are dependent on vendor supplied goods and
services and operability of the Network and critical IT and Business Unit
specific applications. Because of these dependencies, we are implementing the
same type of vendor compliance processes and application planning and testing
processes at the Business Units, as discussed above with respect to the Network
and IT. Overall, we have sought compliance assurances from approximately 6,750
vendors concerning approximately 28,900 products and have received assurances
for approximately 77% of those products as of December 31, 1998. During 1999, we
will continue to pursue assurances of timely year 2000 compliance for the
remaining critical vendors.
As with any large-scale computer-related project such as year 2000
remediation, the testing phase may require resources in excess of other project
phases and the other project phases may be affected by and dependent upon the
results of the testing phase.
SUMMARY. In management's view, the most reasonably likely worse case
scenario for year 2000 failure prospects we face is that a limited number of
important IT and/or Business Unit specific applications may unexpectedly fail.
In addition, there may be problems with the Network relating to the year 2000.
Our failure or the failure by certain of our vendors to remediate year 2000
compliance issues in advance of the year 2000 and to execute appropriate
contingency plans in the event that a critical failure is experienced, could
result in disruption of our operations, possibly impacting the Network and
impairing our ability to bill or collect revenues. However, while no assurance
can be given, management believes that our efforts at remediation and testing,
year 2000 specific contingency planning, and overall business continuity,
contingency and disaster recovery planning will likely be successful, and that
the aforementioned "worse case scenario" is unlikely to develop or significantly
disrupt our financial operations.
The above discussion regarding year 2000 contains many statements that are
"forward-looking" within the meaning of the Reform Act. Although we believe that
our estimates are based on reasonable assumptions, we cannot assure that actual
results will not differ materially from these expectations or estimates. See
"Special Note Regarding Forward-Looking Statements" on page A-3.
NEW ACCOUNTING STANDARDS
On January 1, 1999, we adopted the accounting provisions required by the
American Institute of Certified Public Accountants' Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," 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.
Based on information currently available, adoption of the SOP may result in
an initial increase in net income in 1999 of approximately $100-$150 or
$0.20-$0.29 per diluted share. Thereafter, in periods after adoption, if
software expenditures remain level, the impact on earnings will decline until
the amortization expense related to the capitalized software equals the software
costs expensed prior to the accounting change. The estimated net income impact
for 1999 and thereafter will be subject to change as further information becomes
available. See "Special Note Regarding Forward-Looking Statements" on page A-3.
On June 15, 1998, the Financial Accounting Standards Board issued FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. FAS No. 133 requires, among other
things,
A-22
U S WEST, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
that all derivative instruments be recognized at fair value as assets or
liabilities on the balance sheet and that changes in fair value generally be
recognized currently in earnings unless specific criteria are met. The standard
is effective for fiscal years beginning after June 15, 1999, though earlier
adoption is permitted. Financial statement impacts of adopting the new standard
depend upon the amount and nature of the future use of derivative instruments
and their relative changes in valuation over time. Had we adopted FAS No. 133 in
1998, its impact on the financial statements would not have been material.
A-23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of U S WEST, Inc.:
We have audited the accompanying consolidated balance sheets of U S WEST,
Inc., formerly USW-C, Inc., (a Delaware corporation) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of income
and cash flows for each of the three years in the period ended December 31,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with 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, Inc. and
subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado
January 22, 1999 (except with respect to
Note 12 and Note 14, as to which the
date is March 22, 1999)
F-1
U S WEST, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Operating revenues:
Local service.................................................................. $ 5,525 $ 5,016 $ 4,770
Interstate access service...................................................... 2,816 2,666 2,507
Intrastate access service...................................................... 822 761 770
Long-distance network services................................................. 779 885 1,100
Directory services............................................................. 1,277 1,197 1,120
Other services................................................................. 1,159 954 901
--------- --------- ---------
Total operating revenues..................................................... 12,378 11,479 11,168
Operating expenses:
Employee-related expenses...................................................... 4,312 3,953 3,893
Other operating expenses....................................................... 2,818 2,587 2,305
Depreciation and amortization.................................................. 2,199 2,163 2,158
--------- --------- ---------
Total operating expenses..................................................... 9,329 8,703 8,356
--------- --------- ---------
Operating income................................................................. 3,049 2,776 2,812
Other income (expense):
Interest expense................................................................. (543) (405) (448)
Gains on sales of local telephone exchanges...................................... -- 77 59
Gain on sale of investment in Bellcore........................................... -- 53 --
Other expense--net............................................................... (87) (72) (46)
--------- --------- ---------
Total other expense--net....................................................... (630) (347) (435)
--------- --------- ---------
Income before income taxes, extraordinary item and cumulative effect of change in
accounting principle........................................................... 2,419 2,429 2,377
Provision for income taxes....................................................... 911 902 876
--------- --------- ---------
Income before extraordinary item and cumulative effect of change in accounting
principle...................................................................... 1,508 1,527 1,501
Extraordinary item--early extinguishment of debt--net of tax..................... -- (3) --
--------- --------- ---------
Income before cumulative effect of change in accounting principle................ 1,508 1,524 1,501
Cumulative effect of change in accounting principle--net of tax.................. -- -- 34
--------- --------- ---------
Net income....................................................................... $ 1,508 $ 1,524 $ 1,535
--------- --------- ---------
--------- --------- ---------
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
U S WEST, INC.
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Basic earnings per share:
Income before extraordinary item and cumulative effect of change in
accounting principle..................................................... $ 3.05 $ 3.16 $ 3.14
Extraordinary item--early extinguishment of debt........................... -- (0.01) --
Cumulative effect of change in accounting principle........................ -- -- 0.07
---------- ---------- ----------
Basic earnings per share..................................................... $ 3.05 $ 3.16 $ 3.21
---------- ---------- ----------
---------- ---------- ----------
Basic average shares outstanding (in 000's).................................. 494,395 482,751 477,549
---------- ---------- ----------
---------- ---------- ----------
Diluted earnings per share:
Income before extraordinary item and cumulative effect of change in
accounting principle..................................................... $ 3.02 $ 3.13 $ 3.10
Extraordinary item--early extinguishment of debt........................... -- (0.01) --
Cumulative effect of change in accounting principle........................ -- -- 0.07
---------- ---------- ----------
Diluted earnings per share................................................... $ 3.02 $ 3.12 $ 3.17
---------- ---------- ----------
---------- ---------- ----------
Diluted average shares outstanding (in 000's)................................ 498,798 491,232 488,591
---------- ---------- ----------
---------- ---------- ----------
Dividends per share.......................................................... $ 2.14 $ 2.14 $ 2.14
---------- ---------- ----------
---------- ---------- ----------
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
U S WEST, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(DOLLARS IN
MILLIONS,
EXCEPT SHARE
AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents................................................................. $ 49 $ 27
Accounts receivable less allowance for uncollectibles of
$69 and $72, respectively............................................................... 1,743 1,717
Inventories and supplies.................................................................. 197 150
Deferred directory costs.................................................................. 274 257
Deferred tax assets....................................................................... 151 271
Prepaid and other......................................................................... 78 82
--------- ---------
Total current assets........................................................................ 2,492 2,504
Property, plant and equipment--net.......................................................... 14,908 14,308
Other assets--net........................................................................... 1,007 855
--------- ---------
Total assets................................................................................ $ 18,407 $ 17,667
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........................................................................... $ 1,277 $ 695
Accounts payable.......................................................................... 1,347 1,377
Accrued expenses.......................................................................... 1,702 1,791
Advance billings and customer deposits.................................................... 370 336
--------- ---------
Total current liabilities................................................................... 4,696 4,199
Long-term debt.............................................................................. 8,642 5,020
Postretirement and other postemployment benefit obligations................................. 2,643 2,534
Deferred income taxes....................................................................... 786 791
Unamortized investment tax credits.......................................................... 159 168
Deferred credits and other.................................................................. 726 588
Commitments and Contingencies
Stockholders' equity:
Preferred stock--$1.00 par value, 190,000,000 shares authorized, none issued and
outstanding............................................................................. -- --
Series A junior preferred stock--$1.00 par value 10,000,000 shares authorized, none issued
and outstanding......................................................................... -- --
Common stock--$0.01 par value, 2,000,000,000 shares authorized, 503,207,058 and
484,522,015 issued, 502,903,055 and 484,515,415 outstanding............................. 532 --
Retained earnings......................................................................... 223 --
Pre-separation equity..................................................................... -- 4,367
--------- ---------
Total stockholders' equity.................................................................. 755 4,367
--------- ---------
Total liabilities and stockholders' equity.................................................. $ 18,407 $ 17,667
--------- ---------
--------- ---------
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
U S WEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN MILLIONS)
OPERATING ACTIVITIES
Net income......................................................................... $ 1,508 $ 1,524 $ 1,535
Adjustments to net income:
Depreciation and amortization.................................................. 2,199 2,163 2,158
Gains on sales of local telephone exchanges.................................... -- (77) (59)
Gain on sale of investment in Bellcore......................................... -- (53) --
Asset impairment............................................................... 35 -- --
Cumulative effect of change in accounting principle............................ -- -- (34)
Deferred income taxes and amortization of investment tax credits............... 106 (15) 87
Changes in operating assets and liabilities:
Accounts receivable............................................................ (26) (60) 1
Inventories, supplies and other current assets................................. (12) (63) 18
Accounts payable, accrued expenses and advance billings........................ (13) 487 (70)
Other.......................................................................... 130 285 (22)
--------- --------- ---------
Cash provided by operating activities............................................ 3,927 4,191 3,614
--------- --------- ---------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment................................... (2,672) (2,168) (2,444)
Proceeds from (payments on) disposals of property, plant and equipment........... (30) 22 15
Proceeds from sales of local telephone exchanges................................. -- 67 174
Proceeds from sale of investment in Bellcore..................................... -- 65 --
Other............................................................................ (67) (73) --
--------- --------- ---------
Cash used for investing activities............................................... (2,769) (2,087) (2,255)
--------- --------- ---------
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term debt................................ 887 (640) 159
Net (repayments of) proceeds from issuance of Old U S WEST short-term debt....... (198) 153 (42)
Proceeds from issuance of long-term debt......................................... 3,781 29 23
Repayment of Old U S WEST debt in connection with the Dex Alignment.............. (3,829) -- --
Repayments of long-term debt..................................................... (442) (446) (483)
Proceeds from issuance of common stock........................................... 88 75 134
Dividends paid on common stock................................................... (1,056) (992) (939)
Dividends paid to Old U S WEST................................................... (194) (336) (303)
Payment to Old U S WEST for debt refinancing costs............................... (140) -- --
Return of capital from Old U S WEST.............................................. 13 -- --
Purchases of treasury stock...................................................... (46) -- --
--------- --------- ---------
Cash used for financing activities............................................... (1,136) (2,157) (1,451)
--------- --------- ---------
CASH AND CASH EQUIVALENTS
Increase (decrease).............................................................. 22 (53) (92)
Beginning balance................................................................ 27 80 172
--------- --------- ---------
Ending balance................................................................... $ 49 $ 27 $ 80
--------- --------- ---------
--------- --------- ---------
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 1: U S WEST SEPARATION
On October 25, 1997, the board of directors of our former parent company
(herein referred to as "Old U S WEST") adopted a proposal to separate Old U S
WEST into two independent companies (the "Separation"). Old U S WEST conducted
its businesses through two groups: (i) the U S WEST Communications Group (the
"Communications Group"), which included the communications businesses of Old U S
WEST, and (ii) the U S WEST Media Group (the "Media Group"), which included the
multimedia and directory businesses of Old U S WEST. Old U S WEST had
outstanding two separate classes of common stock. One class of stock, U S WEST
Communications Group Common Stock (the "Communications Stock"), reflected the
performance of the Communications Group and the other class of stock, U S WEST
Media Group Common Stock (the "Media Stock"), reflected the performance of the
Media Group.
On June 4, 1998, stockholders of Old U S WEST voted in favor of the
Separation, which became effective June 12, 1998 (the "Separation Date"). As
part of the Separation, Old U S WEST contributed the Communications Group
businesses and the domestic directories business of Media Group (known as U S
WEST Dex, Inc. ("Dex")) to us. We renamed the new entity U S WEST, Inc. ("U S
WEST"). The alignment of Dex with U S WEST is referred to herein as the "Dex
Alignment". Old U S WEST has continued as an independent public company
comprised of the businesses of Media Group other than Dex and has been renamed
MediaOne Group, Inc. ("MediaOne").
Under the terms of a separation agreement (the "Separation Agreement")
between U S WEST and MediaOne, Old U S WEST redeemed each issued and outstanding
share of Communications Stock (other than shares of Communications Stock held as
treasury stock) for one share of U S WEST common stock. Each outstanding share
of Media Stock remained outstanding and thereafter represented one share of
MediaOne common stock. Each share of Communications Stock held as treasury stock
by Old U S WEST was cancelled.
In connection with the Dex Alignment, under the Separation Agreement, (i)
Old U S WEST distributed, as a dividend to holders of MediaOne common stock,
approximately 16,341,000 shares of our common stock (net of the redemption of
approximately 305,000 fractional shares) with an aggregate of $850 in value (the
"Dex Dividend") and (ii) U S WEST refinanced $3,900 of Old U S WEST debt,
formerly allocated to Media Group (the "Dex Indebtedness").
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements include the
consolidated historical results of operations, financial position and cash flows
of the businesses that comprise the Communications Group and Dex, as if such
businesses operated as a separate entity for all periods and as of all dates
presented. However, certain financial effects of the Separation and the Dex
Alignment, including interest expense associated with refinancing the Dex
Indebtedness and the dilutive effect of the Dex Dividend, are not reflected in
the accompanying historical consolidated statements of income prior to the
Separation Date.
For periods prior to the Separation Date, the consolidated financial
statements include an allocation of certain costs, expenses, assets and
liabilities from Old U S WEST to us. We believe the allocations were reasonable;
however the amount of costs allocated to us were not necessarily indicative of
the costs that
F-6
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
would have been incurred if we had operated as a stand-alone company. The
consolidated financial statements may not necessarily reflect the financial
position, results of operations or cash flows in the future or what they would
have been had we been a separate, stand-alone company during such periods.
We are incorporated under the laws of the State of Delaware. The
consolidated financial statements include the accounts of U S WEST and its
majority-owned subsidiaries. All significant intercompany amounts and
transactions have been eliminated.
Certain reclassifications within the consolidated financial statements have
been made to conform to the current year presentation.
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 our regulated
business 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. Inventories of our nonregulated businesses are carried
at the lower of cost or market on a first-in, first-out basis.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is carried at
cost. Property, plant and equipment of our regulated business is depreciated
using straight-line group methods. When the depreciable property, plant and
equipment is retired or sold, gross book cost less salvage value is generally
charged to accumulated depreciation; no gain or loss is recognized. The
nonregulated businesses provide for depreciation using the straight-line method
over the assets' estimated useful lives. When such depreciable property, plant
and equipment is retired or sold, the resulting gain or loss is included in
income. The average depreciable lives used for the major categories of property,
plant and equipment follow:
CATEGORY LIFE (YEARS)
- ------------------------------------------------------------------------------------- -------------
Buildings............................................................................ 19-40
Telecommunications network equipment................................................. 8-14
Telecommunications outside plant..................................................... 8-57
General purpose computers and other.................................................. 3-17
Interest related to qualifying construction projects is capitalized and
reflected as a reduction of interest expense. Amounts capitalized were $25, $20
and $31 in 1998, 1997 and 1996, respectively.
COMPUTER SOFTWARE. The cost of computer software, whether purchased or
developed internally, is generally expensed as incurred; however, initial
operating systems software is capitalized and amortized
F-7
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 $196 and $133 at December 31, 1998
and 1997, respectively, are recorded in property, plant and equipment.
Amortization of capitalized computer software costs totaled $84, $78 and $82 in
1998, 1997 and 1996, respectively.
FINANCIAL INSTRUMENTS. The objective of our interest rate risk management
program is to obtain the minimum total cost of debt over time consistent with an
acceptable level of interest rate volatility. This objective is achieved through
the type of debt issued, interest rate swaps that adjust the ratio of fixed- to
variable-rate debt, cross-currency swaps that convert foreign-denominated debt
to dollar-denominated debt and forward contracts to hedge future debt issues.
Under an interest rate swap, we agree with another party to exchange
interest payments, based on a notional amount, at specified intervals over a
defined term. Interest rate swaps are accounted for under the synthetic
instruments accounting model 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.
Under a cross-currency swap, we agree with another party to exchange U. S.
dollars for foreign currency based on a notional amount, at specified intervals
over a defined term. Cross-currency swaps are accounted for under the synthetic
instruments accounting model if the index, maturity and amount of the
instruments match the terms of the underlying debt. The cross-currency swaps and
the foreign currency debt are combined and accounted for as if
dollar-denominated debt was issued directly.
Under a forward contract, we agree with another party to sell a specified
amount of U. S. Treasuries to hedge the treasury-rate component of future debt
issues. The gain or loss on the forward contract is recorded as part of the
carrying value of the related debt and is amortized as a yield adjustment.
REVENUE RECOGNITION AND DEFERRED DIRECTORY COSTS. Local telephone, wireless
and Internet services are generally billed in advance with revenues recognized
when services are provided. Revenues derived from exchange access, long-distance
network services and wireless airtime usage are recognized as services are
provided.
Directory advertising revenues and related directory costs are generally
deferred and recognized over the period directories are used, normally 12
months.
ADVERTISING COSTS. Costs related to advertising are expensed as incurred.
Advertising expense was $263, $214 and $117 in 1998, 1997 and 1996,
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.
F-8
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS. Stock incentive plans are accounted for in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," under which no compensation expense is recognized for options
granted to employees at fair market value, except when the plan is determined to
be variable in nature.
NEW ACCOUNTING STANDARDS. On January 1, 1999, we adopted the accounting
provisions required by the American Institute of Certified Public Accountants'
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," 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.
Based on information currently available, adoption of the SOP may result in
an initial increase in net income in 1999 of approximately $100-$150 or
$0.20-$0.29 per diluted share. In periods after adoption, if software
expenditures remain level, the impact on earnings will decline until the
amortization expense related to the capitalized software equals the software
costs expensed prior to the accounting change. The estimated net income impact
for 1999 and thereafter may be subject to change as further information becomes
available.
In 1998, we adopted Statement of Financial Accounting Standards ("FAS") No.
130, "Reporting Comprehensive Income." FAS No. 130 requires that the components
and total amount of comprehensive income be displayed in the financial
statements 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. We do not have any components of comprehensive income other
than net income.
On June 15, 1998, the Financial Accounting Standards Board issued FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. FAS No. 133 requires, among other
things, that all derivative instruments be recognized at fair value as assets or
liabilities on the balance sheet and changes in fair value are generally
recognized currently in earnings unless specific criteria are met. This standard
is effective for fiscal years beginning after June 15, 1999, although earlier
adoption is permitted. Financial statement impacts of adopting the new standard
depend upon the amount and nature of the future use of derivative instruments
and their relative changes in valuation over time. Had we adopted FAS No. 133 in
1998, its impact on the financial statements would not have been material.
F-9
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 3: PROPERTY, PLANT AND EQUIPMENT
The components of property, plant and equipment are as follows:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Land and buildings.......................................................... $ 2,491 $ 2,443
Telecommunications network equipment........................................ 14,750 13,513
Telecommunications outside plant............................................ 14,342 13,802
General purpose computers and other......................................... 3,374 3,280
Construction in progress.................................................... 681 613
--------- ---------
35,638 33,651
--------- ---------
Less accumulated depreciation:
Buildings................................................................. 748 690
Telecommunications network equipment...................................... 8,950 8,223
Telecommunications outside plant.......................................... 9,151 8,657
General purpose computers and other....................................... 1,881 1,773
--------- ---------
20,730 19,343
--------- ---------
Property, plant and equipment--net.......................................... $ 14,908 $ 14,308
--------- ---------
--------- ---------
Effective January 1, 1996, we adopted FAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of,"
that requires 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. Adoption of FAS No. 121
resulted in income of $34 (net of income tax expense of $22) in 1996 from the
cumulative effect of reversing depreciation expense related to local telephone
exchanges held for sale as recorded in prior years. Depreciation expense was
reversed from the date we formally committed to a plan to dispose of local
telephone exchange assets to January 1, 1996. The income was recorded as a
cumulative effect of change in accounting principle in accordance with FAS No.
121. As a result of adopting FAS No. 121, depreciation expense for 1996 was
reduced by $24.
ASSET IMPAIRMENT. During 1998, we recorded a non-cash charge of $21 (net of
a $14 income tax benefit) related to the impairment of certain long-lived assets
associated with our video operations in Omaha, Nebraska. The impaired assets
primarily consist of underground cable and hardware. Recent technological
advances have permitted us to pursue and use more economical DSL technology in
cable overbuild situations. Because the projected future cash flows were less
than the assets' carrying value, an impairment loss was recognized in accordance
with FAS No. 121. The amount of impairment was determined based on the net
present value of the expected future cash flows of the video operations,
discounted at our cost of capital. The pretax charge is recorded in "other
operating expenses" within the consolidated statements of income.
LEASING ARRANGEMENTS. Certain office facilities, real estate and equipment
used in operations are under operating leases. Rent expense under operating
leases for 1998, 1997 and 1996 was $210, $235 and
F-10
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 3: PROPERTY, PLANT AND EQUIPMENT (CONTINUED)
$208, respectively. At December 31, 1998, the future minimum rental payments
under noncancelable operating leases for the years 1999 through 2003 and
thereafter are $157, $148, $136, $102, $102 and $653, respectively.
NOTE 4: ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Employee compensation.......................................................... $ 434 $ 412
Dividends payable.............................................................. 269 259
Current portion of state regulatory liability.................................. 42 225
Accrued property taxes......................................................... 190 207
Other.......................................................................... 767 688
--------- ---------
Total accrued expenses......................................................... $ 1,702 $ 1,791
--------- ---------
--------- ---------
NOTE 5: DEBT
SHORT-TERM DEBT
The components of short-term debt are as follows:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Commercial paper................................................................. $ 951 $ 62
Current portion of long-term debt................................................ 326 435
Allocated from Old U S WEST...................................................... -- 198
--------- ---------
Total............................................................................ $ 1,277 $ 695
--------- ---------
--------- ---------
The weighted-average interest rate on commercial paper was 5.70% and 6.11%
at December 31, 1998 and 1997, respectively. The weighted-average interest rate
on the allocated Old U S WEST debt was 7.45% at December 31, 1997.
At U S WEST, we maintain commercial paper programs to finance short-term
cash flow requirements, as well as to maintain a presence in the short-term debt
market. We enter into lines of credit as backup facilities in issuing commercial
paper. We have lines of credit totaling $1,360, which expire in 1999. Commitment
fees on the unused portion of the lines range from .04% to .064%. As of December
31, 1998, there was no outstanding balance. To the extent we continue our
commercial paper programs, we plan to renew our lines of credit.
F-11
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 5: DEBT (CONTINUED)
LONG-TERM DEBT
Interest rates and maturities of long-term debt at December 31 are as
follows:
MATURITIES
---------------------------------- TOTAL TOTAL
INTEREST RATES 2000 2001 2002 2003 THEREAFTER 1998 1997
- ----------------------------------- ---- ---- ---- ---- ---------- ------ ------
Up to 5%........................... $ 90 $-- $100 $ 50 $-- $ 240 $ 240
Above 5% to 6%..................... -- 50 -- -- 531 581 261
Above 6% to 7%..................... 257 133 750 43 4,490 5,673 2,244
Above 7% to 8%..................... -- -- -- 62 1,584 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
---- ---- ---- ---- ---------- ------ ------
$522 $183 $850 $155 $6,855 8,565 4,971
---- ---- ---- ---- ----------
---- ---- ---- ---- ----------
Capital lease obligations and
other............................ 213 173
Unamortized discount--net.......... (136) (124)
------ ------
Total.............................. $8,642 $5,020
------ ------
------ ------
Long-term debt consists principally of debentures and medium-term notes.
During 1997, Old U S WEST redeemed its zero coupon subordinated notes, $303 of
which was attributed to us. The debt extinguishment resulted in an extraordinary
charge to income of $3, net of income tax benefits of $2, primarily related to
the write-off of deferred debt issuance costs.
In June 1998, U S WEST Capital Funding, Inc., a wholly owned financing
subsidiary, issued approximately $4,100 in new debt securities, of which
approximately $1,000 was short-term commercial paper. Approximately $3,830 in
proceeds from the issuance of these securities were used to repay Old U S WEST
debt in connection with the Dex Alignment. The remaining proceeds were primarily
used to fund our share of operating expenses and debt refinancing costs incurred
by Old U S WEST that were directly attributable to the Separation. In addition,
we refinanced approximately $200, including $70 of Dex debt, assumed in the Dex
Alignment.
Interest paid by us, net of amounts capitalized, was $640, $394 and $430 in
1998, 1997 and 1996, respectively.
We have a $1,000 line of credit which expires in 2003. The line has a
commitment fee on the unused portion of the line of .08%. As of December 31,
1998, there was no outstanding balance.
F-12
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 5: DEBT (CONTINUED)
FINANCIAL CONTRACTS
The following table summarizes the terms of outstanding interest rate and
cross-currency swaps at December 31, 1998 and 1997. Variable rates are indexed
to two- and ten-year constant maturity U. S. Treasuries. Cross-currency swaps
are tied to the Swiss franc.
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------------------- --------------------------------------
WEIGHTED- WEIGHTED-
AVERAGE RATE AVERAGE RATE
NOTIONAL -------------- NOTIONAL --------------
AMOUNT MATURITIES RECEIVE PAY AMOUNT MATURITIES RECEIVE PAY
-------- ---------- ------- ---- -------- ---------- ------- ----
Variable to fixed............. $155 1999 5.16 6.24 $155 1999 5.46 6.24
Cross-currency................ 204 1999-2001 -- 6.55 204 1999-2001 -- 6.55
At December 31, 1998, deferred credits of $8 and deferred charges of $49 on
closed forward contracts are included as part of the carrying value of the
underlying debt. The deferred credits and charges are recognized as yield
adjustments over the life of the debt that matures at various dates through
2043.
In the event we are owed money under the swap agreements, we could be
exposed to risk in the event of nonperformance by counterparties. We manage this
exposure by monitoring the credit standing of the counterparties and
establishing dollar and term limitations that correspond to the respective
credit rating of each counterparty. As of December 31, 1998, we do not believe
that we have any exposure to any individual counterparty and do not anticipate
nonperformance by any counterparty.
NOTE 6: FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of cash equivalents and current amounts receivable and payable
approximate carrying values due to their short-term nature.
The fair values of interest rate and cross-currency swaps are based on
estimated amounts we would receive or pay to terminate such agreements allowing
for current interest/foreign exchange rates and creditworthiness of the
counterparties.
The fair values of long-term debt are based on quoted market prices where
available or, if not available, based on discounting future cash flows using
current interest rates.
DECEMBER 31,
----------------------------------------------
1998 1997
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- --------- ----------- ---------
Debt (includes short-term portion)...................................... $ 9,919 $ 10,342 $ 5,715 $ 5,860
Swap agreements--liabilities............................................ -- 24 -- 28
----------- --------- ----------- ---------
Total Debt.............................................................. $ 9,919 $ 10,366 $ 5,715 $ 5,888
----------- --------- ----------- ---------
----------- --------- ----------- ---------
F-13
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 7: STOCKHOLDERS' EQUITY
Activity in stockholders' equity is as follows:
U S WEST PRE-
COMMON SEPARATION COMMON RETAINED
STOCK EQUITY STOCK EARNINGS TOTAL
----------- ----------- --------- ----------- ---------
(SHARES IN
THOUSANDS)
BALANCE, JANUARY 1, 1996................................. 473,635 $ 3,657 $ -- $ -- $ 3,657
Net income............................................. -- 1,535 -- -- 1,535
Dividends declared on common stock..................... -- (1,024) -- -- (1,024)
Dividends declared to Old U S WEST..................... -- (286) -- -- (286)
Common stock issuances................................. 6,822 216 -- -- 216
Equity returned to Old U S WEST........................ -- (21) -- -- (21)
Other.................................................. -- 8 -- -- 8
----------- ----------- --------- ----- ---------
BALANCE, DECEMBER 31, 1996............................... 480,457 4,085 -- -- 4,085
Net income............................................. -- 1,524 -- -- 1,524
Dividends declared on common stock..................... -- (1,034) -- -- (1,034)
Dividends declared to Old U S WEST..................... -- (347) -- -- (347)
Common stock issuances................................. 4,058 138 -- -- 138
Other.................................................. -- 1 -- -- 1
----------- ----------- --------- ----- ---------
BALANCE, DECEMBER 31, 1997............................... 484,515 4,367 -- -- 4,367
Net income from January 1 to June 12, 1998............. -- 747 -- -- 747
Dividends declared on common stock..................... -- (528) -- -- (528)
Dividends declared to Old U S WEST..................... -- (159) -- -- (159)
Common stock issuances................................. 1,100 55 -- -- 55
Return of capital from Old U S WEST.................... -- 13 -- -- 13
Treasury stock purchases............................... (574) (32) -- -- (32)
Other.................................................. -- 2 -- -- 2
JUNE 12, 1998 SEPARATION:
Contributed capital from Old U S WEST upon Separation,
excluding assumption of debt......................... -- (4,465) 4,465 -- --
Repayment of Dex Indebtedness to MediaOne.............. -- -- (3,829) -- (3,829)
Issuance of common stock to MediaOne stockholders net
of repurchases....................................... 16,646 -- 850 -- 850
Distribution to MediaOne stockholders for Dex
Dividend............................................. -- -- (850) -- (850)
Dividend to MediaOne for share of Old U S WEST's debt
refinancing costs.................................... -- -- (140) -- (140)
Common stock issuances................................. 1,521 -- 58 -- 58
Treasury stock purchases............................... (305) -- (15) -- (15)
Net income from June 13 to December 31, 1998........... -- -- -- 761 761
Dividends declared on common stock..................... -- -- -- (538) (538)
Other.................................................. -- -- (7) -- (7)
----------- ----------- --------- ----- ---------
BALANCE, DECEMBER 31, 1998............................... 502,903 $ -- $ 532 $ 223 $ 755
----------- ----------- --------- ----- ---------
----------- ----------- --------- ----- ---------
F-14
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 7: STOCKHOLDERS' EQUITY (CONTINUED)
COMMON STOCK. Prior to the Separation, Old U S WEST had two separate
classes of outstanding common stock; Communications Stock and Media Stock. In
conjunction with the Separation, on June 12, 1998, Old U S WEST redeemed each
issued and outstanding share of Communications Stock (other than shares of
Communications Stock held as treasury stock) for one share of U S WEST common
stock. Each share of Communications Stock held as treasury stock by Old U S WEST
was cancelled. For presentation purposes, Communications Stock shares
outstanding prior to June 12, 1998 are shown as U S WEST shares.
DIVIDENDS. We declared dividends of $2.14 per share of common stock during
1998, 1997 and 1996. Prior to the Separation Date, we paid dividends monthly to
Old U S WEST based on Dex's net income adjusted for the amortization of
intangibles.
LEVERAGED EMPLOYEE STOCK OWNERSHIP PLAN ("LESOP"). Prior to the Separation,
we participated in the defined contribution savings plan sponsored by Old U S
WEST (the "Old U S WEST Savings Plan") which covered substantially all
employees. Old U S WEST matched a percentage of the eligible employee
contributions with shares of Communications Stock and/or Media Stock in
accordance with participant elections. Old U S WEST maintained a LESOP to
provide shares of common stock for matching contributions. During 1998, prior to
the Separation, the outstanding debt of the LESOP which was used to acquire
common stock, was fully paid down. Contributions to the LESOP as well as
dividends on unallocated shares of common stock held by the LESOP were used for
debt service.
In connection with the Separation, the unallocated shares in the LESOP as of
June 12, 1998, were split between us and MediaOne. We received 342,814 and
196,014 shares of U S WEST and MediaOne common stock, respectively. We sold the
MediaOne common stock in the open market, the proceeds of which were used to
acquire shares of our common stock for matching contributions. As of December
31, 1998, all of such unallocated shares received by us from the LESOP had been
allocated to participant accounts.
As a result of the Separation, we assumed sponsorship of the Old U S WEST
Savings Plan which covers substantially all our employees (the "U S WEST Savings
Plan"), and MediaOne adopted a new plan ("MediaOne Savings Plan"), covering
eligible employees of MediaOne. Existing account balances of such MediaOne
employees were transferred from the Old U S WEST Savings Plan to the MediaOne
Savings Plan.
As of October 1998, we had utilized all the unallocated shares of the LESOP
for purposes of making matching contributions. Through this time period, we
recognized contribution expense based upon the cash payments method as specified
in SOP 76-3, "Accounting Practices for Certain Employee Stock Ownership Plans."
Subsequent to October 1998, we made $14 of cash contributions to the U S
WEST Savings Plan, which utilized the cash to purchase shares of common stock in
the open market. Compensation expense for
F-15
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 7: STOCKHOLDERS' EQUITY (CONTINUED)
this period was equal to our cash contributions. The following LESOP information
applies to the time period contributions were accounted for under SOP 76-3.
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----- ----- -----
Benefit expense.............................................................. $ 84 $ 74 $ 59
Interest expense............................................................. 3 6 8
--- --- ---
Total expense................................................................ $ 87 $ 80 $ 67
--- --- ---
--- --- ---
Dividends for debt service................................................... $ 1 $ 3 $ 5
--- --- ---
--- --- ---
STOCKHOLDERS RIGHTS PLAN. Our board of directors has adopted a stockholders
rights plan which, in the event of a takeover attempt, would entitle existing
stockholders to certain preferential rights. These rights expire on June 1, 2008
and are redeemable by us at any time prior to the date they become effective.
NOTE 8: EARNINGS PER SHARE
Certain of the financial effects of the Separation and the Dex Alignment,
including interest expense associated with the refinancing of the Dex
Indebtedness and the dilutive effects of the Dex Dividend, are not reflected in
the historical consolidated statements of income prior to the Separation Date.
As a result, earnings per share for 1998 are presented on both a pro forma and
historical basis. The pro forma earnings per share amounts give effect to the
Dex Indebtedness and the issuance of approximately 16,341,000 shares (net of the
redemption of 305,000 fractional shares) of common stock in connection with the
Dex Alignment as if such transactions had been consummated as of January 1,
1998.
The following reflects the computation of basic and diluted earnings per
share on a historical and pro forma basis. Income and earnings per share are
before an extraordinary item and the cumulative effect of change in accounting
principle. The earnings per share amounts presented on the consolidated
statements of income may not foot due to rounding of individual components.
YEAR ENDED DECEMBER 31,
-------------------------------
BASIC EARNINGS PER SHARE 1998 1997 1996
- ----------------------------------------------------------------- --------- --------- ---------
(SHARES IN THOUSANDS)
Income........................................................... $1,508 $1,527 $1,501
--------- ---------
--------- ---------
Pro forma adjustment(1).......................................... (72)
---------
Pro forma income................................................. $1,436
---------
---------
Basic weighted average shares(2)................................. 494,395 482,751 477,549
--------- ---------
--------- ---------
Pro forma adjustment(3).......................................... 7,432
---------
Pro forma basic weighted average shares.......................... 501,827
---------
---------
Basic earnings per share......................................... $3.05 $3.16 $3.14
Pro forma basic earnings per share............................... $2.86
F-16
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 8: EARNINGS PER SHARE (CONTINUED)
YEAR ENDED DECEMBER 31,
-------------------------------
DILUTED EARNINGS PER SHARE 1998 1997 1996
- ----------------------------------------------------------------- --------- --------- ---------
(SHARES IN THOUSANDS)
Income........................................................... $1,508 $1,527 $1,501
Interest on convertible zero coupon subordinated notes, net of
tax............................................................ -- 9 13
--------- --------- ---------
Income used for diluted earnings per share....................... 1,508 $1,536 $1,514
--------- ---------
--------- ---------
Pro forma adjustment(1).......................................... (72)
---------
Pro forma income................................................. $1,436
---------
---------
Basic weighted average shares(2)................................. 494,395 482,751 477,549
Effect of dilutive securities:
Stock options.................................................. 4,403 2,386 1,536
Convertible zero coupon subordinated notes..................... -- 6,095 9,506
--------- --------- ---------
Diluted weighted average shares.................................. 498,798 491,232 488,591
--------- ---------
--------- ---------
Pro forma adjustment(3).......................................... 7,432
---------
Pro forma diluted weighted average shares........................ 506,230
---------
---------
Diluted earnings per share....................................... $3.02 $3.13 $3.10
Pro forma diluted earnings per share............................. $2.84
- ------------------------------
(1) Reflects incremental (after-tax) interest expense associated with the Dex
Indebtedness from the beginning through the end of the period presented up
to the Separation Date.
(2) Historical average shares assume a one-for-one conversion of historical
Communications Stock outstanding into shares of U S WEST as of the
Separation Date.
(3) Reflects the issuance of approximately 16,341,000 shares of common stock
(net of the redemption of approximately 305,000 fractional shares) issued in
connection with the Dex Alignment as if the shares had been issued at the
beginning of the period indicated.
The dilutive securities represent the incremental weighted-average shares
from the assumed exercise of stock options and the assumed conversion of the
zero coupon subordinated notes redeemed in August 1997.
NOTE 9: STOCK INCENTIVE PLANS
We maintain stock incentive plans for employees and nonemployees, primarily
members of the board of directors. The 1998 U S WEST stock plan (the "Plan"),
under which we may grant awards in the form of stock options, stock appreciation
rights and restricted stock, as well as substitute stock options and restricted
stock awards, was approved by stockholders on June 12, 1998, in connection with
the Separation. The Plan is a successor plan to the Amended 1994 Stock Plan (the
"Predecessor Plan"), under which shares of Communications Stock were previously
issued. No further grants may be made under the Predecessor Plan.
F-17
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 9: STOCK INCENTIVE PLANS (CONTINUED)
Effective June 12, 1998, each outstanding Communications Group stock option
was converted into one U S WEST stock option, whether held by U S WEST or
MediaOne employees. Each option granted under the Plan has the same terms,
conditions, exercise price, vesting and restrictions as the Communications Group
stock awards it replaced.
Under the Plan, a maximum of 4.8 million shares could be granted in 1998.
Thereafter, the maximum aggregate number of shares of stock granted in any
calendar year for all purposes under the Plan is one percent (1.00%) of the
shares outstanding (excluding shares held in our treasury) on the first day of
such year. In the event that fewer than the full aggregate number of shares
available for issuance in any year are issued in any calendar year, the shares
not issued shall be added to the shares available for issuance in any subsequent
year or years. The options' exercise price is equal to the fair market value of
the common stock on the date of the grant. Options granted vest over periods up
to five years and may be exercised no later than 10 years after the grant date.
FAS No. 123, "Accounting for Stock-Based Compensation," requires the fair
value of stock options to be calculated using an option pricing model. We have
elected the "pro forma, disclosure only" option permitted under FAS No. 123,
instead of recording a charge to operations, as shown below:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Net income:
As reported........................................................ $ 1,508 $ 1,524 $ 1,535
Adjusted for FAS No. 123........................................... 1,479 1,511 1,533
Earnings per share:
As reported--basic................................................. $ 3.05 $ 3.16 $ 3.21
As reported--diluted............................................... 3.02 3.12 3.17
Adjusted for FAS No. 123--basic.................................... 2.99 3.13 3.21
Adjusted for FAS No. 123--diluted.................................. 2.97 3.10 3.14
Because the FAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the pro forma compensation cost may not
represent that expected in future years.
Following are the weighted-average assumptions used with the Black-Scholes
option-pricing model to estimate the fair value of options granted during 1998,
1997 and 1996:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Risk-free interest rate.............................................. 5.5% 6.4% 6.5%
Expected dividend yield.............................................. 4.2% 5.8% 6.7%
Expected option life (years)......................................... 4.0 4.0 4.5
Expected stock price volatility...................................... 22.9% 25.0% 19.6%
Weighted average grant date fair value............................... $ 8.75 $ 5.70 $ 3.67
F-18
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 9: STOCK INCENTIVE PLANS (CONTINUED)
Information on outstanding options is summarized as follows (shares in
thousands):
WEIGHTED
NUMBER OF AVG. EXERCISE
SHARES PRICE
----------- -------------
Outstanding January 1, 1996............................................. 9,423 $ 24.39
Granted............................................................... 3,625 30.97
Exercised............................................................. (1,206) 22.37
Canceled or expired................................................... (429) 25.01
-----------
Outstanding December 31, 1996........................................... 11,413 26.67
Granted............................................................... 9,492 34.87
Exercised............................................................. (2,649) 25.41
Canceled or expired................................................... (637) 27.54
-----------
Outstanding December 31, 1997........................................... 17,619 31.23
Granted............................................................... 9,589 50.81
Exercised............................................................. (2,480) 23.03
Canceled or expired................................................... (700) 36.99
-----------
Outstanding December 31, 1998........................................... 24,028 38.45
-----------
-----------
The outstanding options at December 31, 1998, have the following
characteristics (shares in thousands):
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
--------------------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER REMAINING EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ----------------------------------- ----------- ------------- ----------- ------------- -----------
$16.08 - $26.11.................... 3,297 5.84 $ 22.21 3,057 $ 23.95
26.34 - 32.63...................... 3,395 7.01 31.05 2,197 30.84
32.75 - 36.13...................... 7,585 8.23 34.28 1,158 35.54
36.25 - 49.63...................... 2,795 8.79 46.12 699 46.14
49.75 - 63.94...................... 6,956 9.46 51.22 -- 50.31
----------- --- ----------- ----- -----------
Total............................ 24,028 8.15 $ 38.45 7,111 $ 30.15
----------- --- ----------- ----- -----------
----------- --- ----------- ----- -----------
Options to purchase 5,299,955 and 3,881,100 shares of common stock at
weighted-average exercise prices of $25.72 and $25.71 were exercisable at
December 31, 1997 and 1996, respectively.
Approximately 2 million shares of common stock were available for grant at
December 31, 1998. Approximately 26 million shares of common stock were reserved
for issuance at December 31, 1998.
F-19
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS
PENSION, POSTRETIREMENT AND OTHER POST EMPLOYMENT BENEFITS
We have a noncontributory defined benefit pension plan (the "Pension Plan")
for substantially all management and occupational employees and postretirement
healthcare and life insurance plans for retirees. We also provide post
employment benefits for certain former employees.
Prior to the Separation, we participated in the defined benefit pension plan
and postretirement healthcare and life insurance plans sponsored by Old U S
WEST. Accordingly, our financial statements for periods prior to the Separation
Date reflect an allocation of costs from Old U S WEST for its employees and
retirees while they were included in Old U S WEST's plans.
On June 12, 1998, we assumed sponsorship of the Old U S WEST pension plan
and MediaOne established a new defined benefit pension plan for eligible
MediaOne employees (the "MediaOne Pension Plan"). In connection with the
Separation, a portion of the existing assets of the Old U S WEST pension plan
were transferred at fair value to the MediaOne Pension Plan such that the ratio
of plan assets to plan liabilities, calculated on a projected benefit obligation
basis as determined by independent actuaries, was the same for the Pension Plan
and the MediaOne Pension Plan. The pension benefit obligation and plan assets
transferred to the MediaOne Pension Plan at June 12, 1998 were approximately
$150 and $200, respectively.
In addition, on June 12, 1998, the three funded retiree medical and life
insurance benefits trusts, maintained by Old U S WEST under an employee welfare
benefit program for its employees, were split between us and MediaOne. One of
the trusts covered hourly employees only and was transferred in its entirety to
us. The remaining two trusts were transferred to us, and MediaOne established
new trusts. A portion of the assets of the latter two trusts was transferred to
MediaOne's trusts based upon the same methodology used to transfer assets of the
Pension Plan to the MediaOne Pension Plan, except that the liabilities were
calculated by independent actuaries using the accumulated postretirement benefit
obligation method. The accumulated postretirement benefit obligation and plan
assets transferred to MediaOne's trusts at June 12, 1998 were approximately $20
and $5, respectively.
Pension benefits for management employees are based upon their salary while
occupational employee benefits are based upon years of service and job
classification. Pension and postretirement costs are recognized over the period
in which the employee renders services and becomes eligible to receive benefits
as determined by using the projected unit credit method. Our funding policy is
to make contributions with the objective of accumulating sufficient assets to
pay all benefits when due. No pension funding was required in 1998, 1997 or
1996.
Since plan assets for pension and postretirement benefits were not
historically segregated into separate accounts or restricted to providing
benefits to employees of U S WEST, assets of the plan were used to provide
benefits to employees of both U S WEST and MediaOne. Therefore, the following
pension and postretirement benefits plan information for periods prior to June
12, 1998, reflects the pension cost (credit), postretirement benefit cost,
benefit obligation, assets and funded status of the Old U S WEST plans.
F-20
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS (CONTINUED)
The portion of the pension credit applicable to U S WEST was $33 in 1997 and
$5 in 1996. The components of the pension credit are as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Details of pension cost (credit):
Service cost.......................................................... $ 189 $ 176 $ 192
Interest cost......................................................... 639 625 586
Expected return on plan assets........................................ (852) (759) (714)
Amortization of transition asset...................................... (79) (80) (80)
Amortization of prior service cost.................................... 2 2 (5)
Recognized actuarial loss............................................. -- -- 16
--------- --------- ---------
Net pension credit...................................................... $ (101) $ (36) $ (5)
--------- --------- ---------
--------- --------- ---------
The portion of the postretirement benefit cost applicable to U S WEST was
$179 in 1997 and $166 in 1996. The components of the postretirement benefit cost
are as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Details of postretirement benefit cost:
Service cost.......................................................... $ 72 $ 66 $ 70
Interest cost......................................................... 319 296 259
Expected return on plan assets........................................ (213) (174) (157)
Amortization of prior service cost.................................... 19 19 3
Recognized actuarial gain............................................. (30) (28) (9)
--------- --------- ---------
Total postretirement benefit cost....................................... $ 167 $ 179 $ 166
--------- --------- ---------
--------- --------- ---------
Since plan assets for pension and postretirement benefits were not
historically segregated into separate accounts or restricted to providing
benefits to employees of U S WEST, assets of the plan were used to provide
benefits to employees of both U S WEST and MediaOne. Therefore, the following
pension and postretirement benefit plan information for periods prior to June
12, 1998, reflects the benefit obligation, assets and funded status of the Old U
S WEST plans.
F-21
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS (CONTINUED)
Following is a reconciliation of the benefit obligation for the pension and
postretirement plans:
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
YEAR ENDED DECEMBER YEAR ENDED DECEMBER
31, 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Benefit obligation at beginning of year.................... $ 9,167 $ 8,310 $ 4,406 $ 3,891
Service cost............................................... 189 176 72 66
Interest cost.............................................. 639 625 319 296
Actuarial gain............................................. 499 750 297 307
Plan amendments............................................ -- -- (105) --
Divestitures............................................... (224) -- (23) --
Benefits paid.............................................. (648) (694) (141) (154)
--------- --------- --------- ---------
Benefit obligation at end of year.......................... $ 9,622 $ 9,167 $ 4,825 $ 4,406
--------- --------- --------- ---------
--------- --------- --------- ---------
Following is a reconciliation of the change in the fair value of plan assets
for the pension and postretirement plans.
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
YEAR ENDED DECEMBER YEAR ENDED DECEMBER
31, 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Fair value of plan assets at beginning of year.......... $ 12,260 $ 10,958 $ 2,413 $ 2,063
Actual return on plan assets............................ 1,579 1,996 264 394
Employer contributions.................................. -- -- 18 33
Divestitures............................................ (212) -- (4) --
Section 420 transfer.................................... (54) -- 54 --
Benefits paid........................................... (648) (694) (141) (77)
--------- --------- --------- ---------
Fair value of plan assets at end of year................ $ 12,925 $ 12,260 $ 2,604 $ 2,413
--------- --------- --------- ---------
--------- --------- --------- ---------
In December 1998, under provisions of section 420 of the Internal Revenue
Code, $54 of pension assets were transferred to the postretirement benefit plan
to pay for current year retiree health care benefits.
F-22
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS (CONTINUED)
The following table represents the funded status of the pension and
postretirement plans:
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Funded (unfunded) status............................... $ 3,303 $ 3,093 $ (2,221) $ (1,993)
Unrecognized net actuarial gain........................ (2,195) (1,966) (482) (631)
Unamortized prior service cost......................... 4 6 140 160
Balance of unrecognized transition asset............... (466) (546) -- --
--------- --------- --------- ---------
Prepaid (accrued) benefit cost......................... $ 646 $ 587 $ (2,563) $ (2,464)
--------- --------- --------- ---------
--------- --------- --------- ---------
The actuarial assumptions used to account for the plans are as follows:
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Weighted-average discount rate.............................. 6.75% 7.00% 6.75% 7.00%
Expected long-term rate of return on plan assets*........... 8.80% 8.50% 8.80% 8.50%
Weighted-average rate of compensation increase.............. 4.65% 5.50% N/A N/A
- ------------------------------
* The expected long-term rate of return on plan assets for the pension and
postretirement plans was 8.5% for 1996.
For measurement purposes, an 8.0% annual rate of increase in the healthcare
cost trend rate for 1998 is assumed. The healthcare cost trend rate is assumed
to gradually decline to an ultimate rate of 5.0% in 2011.
A 1.0% change in the assumed healthcare cost trend rate would have had the
following effects in 1998:
ONE-PERCENT CHANGE
------------------------
INCREASE DECREASE
----------- -----------
Effect on the aggregate of the service and interest cost components of net
periodic postretirement benefit cost....................................... $ 53 $ (43)
Effect on accumulated postretirement benefit obligation...................... 541 (451)
In October 1998, the Communications Workers of America voting members (who
are our employees), ratified new three-year contracts. These contracts provide
for both salary increases of 10.9% and pension increases totaling 21% over three
years. These benefit changes are reflected in the above calculations.
We provide other post employment benefits, such as worker's compensation and
disability to former or inactive employees who are not eligible for retirement.
F-23
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 11: INCOME TAXES
The components of the provision for income taxes are as follows:
YEAR ENDED
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
FEDERAL:
Current............................................................. $ 685 $ 798 $ 697
Deferred............................................................ 103 (10) 93
Investment tax credits--net......................................... (13) (16) (28)
--------- --------- ---------
775 772 762
--------- --------- ---------
STATE AND LOCAL:
Current............................................................. 108 119 92
Deferred............................................................ 28 11 22
--------- --------- ---------
136 130 114
--------- --------- ---------
Provision for income taxes............................................ $ 911 $ 902 $ 876
--------- --------- ---------
--------- --------- ---------
We paid $678, $906 and $814 for income taxes in 1998, 1997 and 1996,
respectively.
The effective tax rate differs from the statutory tax rate as follows:
YEAR ENDED
DECEMBER 31,
----------------
1998 1997 1996
---- ---- ----
(IN PERCENT)
Federal statutory tax rate........................ 35.0 35.0 35.0
Investment tax credit amortization................ (0.4) (0.4) (0.7)
State income taxes--net of federal effect......... 3.7 3.5 3.1
Other............................................. (0.6) (1.0) (0.5)
---- ---- ----
Effective tax rate................................ 37.7 37.1 36.9
---- ---- ----
---- ---- ----
F-24
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 11: INCOME TAXES (CONTINUED)
The components of the net deferred tax liability are as follows:
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Property, plant and equipment.................................................. $ 1,633 $ 1,574
State deferred taxes--net of federal effect.................................... 205 198
Other.......................................................................... 40 40
--------- ---------
Deferred tax liabilities..................................................... 1,878 1,812
--------- ---------
Postretirement benefits, net of pension........................................ 701 672
Restructuring and other........................................................ -- 21
Unamortized investment tax credit.............................................. 56 59
State deferred taxes--net of federal effect.................................... 135 141
Other.......................................................................... 351 399
--------- ---------
Deferred tax assets.......................................................... 1,243 1,292
--------- ---------
Net deferred tax liability..................................................... $ 635 $ 520
--------- ---------
--------- ---------
TAX SHARING AGREEMENT. We entered into a tax sharing agreement with
MediaOne that governs the allocation of federal, state, local and foreign tax
liabilities and related tax matters such as the preparation and filing of tax
returns and the conduct of audits and other tax proceedings for taxable periods
up to the Separation. In general, the tax sharing agreement provides that (i) we
will be responsible for, and will indemnify MediaOne against, tax liabilities
relating to the Communications Group, for taxable periods ending on or prior to
the Separation and (ii) MediaOne will be responsible for, and will indemnify us
against, tax liabilities relating to the Media Group, for taxable periods ending
on or prior to the Separation.
NOTE 12: SEGMENT INFORMATION
We operate in four segments: retail services, wholesale services, network
services and directory services. The retail services segment provides local
telephone services, long-distance services, wireless services and data services.
The wholesale services segment provides exchange access services that connect
customers to the facilities of interexchange carriers and interconnection to our
telecommunications network to competitive local exchange carriers. Our network
services segment provides access to our telecommunications network, including
our information technologies, primarily to our retail services and wholesale
services segments. The directory services segment publishes approximately 270
White and Yellow Pages telephone directories and provides electronic directory
and other information services. We provide our services to more than 25 million
residential customers and business customers in Arizona, Colorado, Idaho, Iowa,
Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota,
Utah, Washington and Wyoming.
Following is a breakout of our segments. Because significant expenses of
operating the retail services and wholesale services segments are not allocated
to the segments for decision making purposes, management does not believe the
segment margins are representative of the actual operating results of the
F-25
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 12: SEGMENT INFORMATION (CONTINUED)
segments. The margin for the retail services and wholesale services segments
excludes network and corporate expenses. The margin for the network services
segment and the directory services segment excludes corporate expenses. The
"other" category includes our corporate expenses. The communications and related
services column represents a total of the retail services, wholesale services
and network services segments. As a result of regulatory actions and changes in
internal reporting, the classification of certain operating revenues and
expenses has changed during 1998, 1997 and 1996. It has not been practicable to
restate 1997 and 1996 results to conform to the current year's presentation.
Accordingly, the operating revenues and margins may not be comparable for each
year.
TOTAL
COMMUNICATIONS
AND
RETAIL WHOLESALE NETWORK RELATED DIRECTORY RECONCILING
SERVICES SERVICES SERVICES SERVICES SERVICES OTHER ITEMS
-------------- --------- --------- --------- -------------- --------- --------------
1998
Operating revenues............ $ 8,556 $2,590 $ 214 $11,360 $ 1,277 $ -- $ (259)(1)
Margin........................ 6,194 1,908 (2,776) 5,326 657 (234) (3,330)
Assets........................ (3) (3) (3) (3) 524 (3) 17,883(3)
Capital expenditures.......... 362(4) -- 2,376 2,738 42 125 --
1997
Operating revenues............ 7,893 2,609 163 10,665 1,190 -- (376)(1)
Margin........................ 5,940 2,176 (2,738) 5,378 615 (396) (3,168)
Assets........................ (3) (3) (3) (3) 516 (3) 17,151(3)
Capital expenditures.......... 340(4) -- 2,214 2,554 29 89 --
1996
Operating revenues............ 7,401 2,648 176 10,225 1,115 -- (172)(1)
Margin........................ 5,605 2,183 (2,553) 5,235 524 (385) (2,997)
Assets........................ (3) (3) (3) (3) 493 (3) 16,786(3)
Capital expenditures.......... 105(4) -- 2,546 2,651 25 155 --
CONSOLIDATED
TOTAL
-------------
1998
Operating revenues............ $12,378
Margin........................ 2,419(2)
Assets........................ 18,407
Capital expenditures.......... 2,905
1997
Operating revenues............ 11,479
Margin........................ 2,429(2)
Assets........................ 17,667
Capital expenditures.......... 2,672
1996
Operating revenues............ 11,168
Margin........................ 2,377(2)
Assets........................ 17,279
Capital expenditures.......... 2,831
- ------------------------------
(1) Represents primarily intersegment charges. The 1997 amount also includes
$230 of regulatory charges, primarily attributable to the state of
Washington.
(2) Represents income before income taxes, extraordinary item and cumulative
effect of change in accounting principle. Adjustments that are made to the
total of the segments' income in order to arrive at income before income
taxes, extraordinary item and cumulative effect of change in accounting
principle include the following:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Costs and adjustments to reconcile segment data to the consolidated
total:
Separation costs..................................................... $ 94 $ -- $ --
Asset impairment charge.............................................. 35 -- --
Regulatory charges................................................... -- 230 --
Other expense--net................................................... 630 347 435
Taxes other than income taxes........................................ 372 428 404
Depreciation and amortization........................................ 2,199 2,163 2,158
--------- --------- ---------
$ 3,330 $ 3,168 $ 2,997
--------- --------- ---------
--------- --------- ---------
(3) A breakout of assets for all segments is not provided to our chief operating
decision maker. The reconciling items column represents the amount to
reconcile to the consolidated total.
F-26
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 12: SEGMENT INFORMATION (CONTINUED)
(4) Capital expenditures reported for the retail services segment include only
expenditures for wireless services and certain data services. Additional
capital expenditures relating to these services are included in network
services capital expenditures.
In addition to the operating revenues disclosed above, intersegment
operating revenues of the retail services segment were $28, $30 and $26 for
1998, 1997 and 1996, respectively. Intersegment operating revenues of the
network services segment were $70, $64 and $63 for 1998, 1997 and 1996,
respectively. Intersegment operating revenues of the directory services segment
were $10, $6 and $5 for 1998, 1997 and 1996, respectively.
SIGNIFICANT CONCENTRATIONS. The wholesale services segment derives
significant revenues from AT&T Corp. ("AT&T"). During 1998, 1997 and 1996
revenues from services provided to AT&T were $900, $1,049 and $1,046,
respectively. As of December 31, 1998, we are not aware of any other significant
concentration of business transacted with a particular customer that could, if
suddenly eliminated, severely impact operations.
At December 31, 1998, we had 54,483 employees, of which 46,310 are employees
of U S WEST Communications, Inc., a wholly owned subsidiary ("USWC") and 3,580
are employees of Dex. Approximately 72% of USWC employees and 63% of Dex
employees are represented by unions.
NOTE 13: RELATED PARTY TRANSACTIONS
BELL COMMUNICATIONS RESEARCH, INC. ("BELLCORE"). Charges relating to
research, development and maintenance of existing technologies performed by
Bellcore, in which we had a one-seventh ownership interest, were $118 and $97 in
1997 and 1996, respectively.
In 1997, we sold our interest in Bellcore. We received cash proceeds of $65
and recorded an after-tax gain of $32. Bellcore continues to provide research
and development and other services to us on a contract basis.
NOTE 14: COMMITMENTS AND CONTINGENCIES
COMMITMENTS
We have entered into an agreement with Olympic Properties of the United
States to sponsor the 2002 Salt Lake City Winter Olympics and the U.S. Olympic
Teams through 2004. As of December 31, 1998, we have a remaining commitment of
$55 to be paid in a combination of cash and services through 2004.
CONTINGENCIES
USWC has pending regulatory actions in local regulatory jurisdictions which
call for price decreases, refunds or both.
OREGON. On May 1, 1996, the Oregon Public Utilities Commission ("OPUC")
approved a stipulation terminating prematurely USWC's alternative form of
regulation ("AFOR") plan and it then undertook a review of USWC's earnings. In
May 1997, the OPUC ordered USWC 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
F-27
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 14: COMMITMENTS AND CONTINGENCIES (CONTINUED)
the revenue reduction for the period May 1, 1996 through April 30, 1997. This
one-time refund for interim rates became subject to refund when USWC's AFOR plan
was terminated on May 1, 1996.
USWC filed an appeal of the order and asked for an immediate stay of the
refund with the Oregon Circuit Court which granted USWC'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 USWC's favor on most of the appealed issues.
The OPUC appealed to the Oregon Court of Appeals on March 19, 1998, and the
appeal remains pending. USWC continues to charge interim rates, subject to
refund, during the pendency of that appeal. The potential exposure, including
interest, at December 31, 1998, is not expected to exceed $315.
UTAH. 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: i) unforeseen and extraordinary events
and ii) misconduct. The UPSC's initial order denied a refund request from
interexchange carriers and other parties related to the Tax Reform Act of 1986.
The potential exposure, including interest at December 31, 1998, is not expected
to exceed $175.
NEW MEXICO. The New Mexico State Corporation Commission ("NMSCC") issued an
order on May 29, 1998, requiring USWC to reduce its annual revenues by
approximately $22. A rehearing before the NMSCC was denied. The NMSCC's order
was then removed to the New Mexico Supreme Court for review that effectively
stays the order. In March 1999, the New Mexico Supreme Court ruled that USWC
must reduce rates prospectively and refund approximately $18.
STATE REGULATORY ACCRUALS. USWC has accrued $203 at December 31, 1998,
which represents its estimated liabilities for all state regulatory proceedings,
predominately the items discussed above. It is possible that the ultimate
liabilities could exceed the amounts accrued by up to approximately $300. USWC
will continue to monitor and evaluate the risks associated with its local
regulatory jurisdictions and will adjust estimates as new information becomes
available.
In addition to its estimated liabilities for state regulatory proceedings,
USWC has an accrued liability of approximately $38 at December 31, 1998 related
to refunds in the state of Washington.
OTHER CONTINGENCIES. In December 1998, we were informed of the possibility
of a claim by a purported class challenging the transfer of approximately $54
from the U S WEST pension trust to the U S WEST health care trust to pay retiree
medical expenses pursuant to Section 420 of the Internal Revenue Code of 1986,
as amended. We believe that this transfer complied with the applicable law and
the associated plan documents. We plan to vigorously defend any such claim if
and when it is asserted.
F-28
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 15: QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTERLY FINANCIAL DATA
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- -----------
1998
Operating revenues......................................................... $ 3,009 $ 3,053 $ 3,112 $ 3,204
Net income................................................................. 434 327 379 368
Pro forma net income....................................................... 393 296 379 368
Earnings per share:
Basic.................................................................... 0.89 0.67 0.76 0.73
Diluted.................................................................. 0.89 0.67 0.75 0.73
Pro forma basic.......................................................... 0.78 0.59 0.76 0.73
Pro forma diluted........................................................ 0.78 0.59 0.75 0.73
1997
Operating revenues......................................................... $ 2,867 $ 2,830 $ 2,960 $ 2,822
Income before extraordinary item........................................... 420 416 423 268
Earnings per share before extraordinary item:
Basic.................................................................... 0.87 0.86 0.88 0.55
Diluted.................................................................. 0.86 0.85 0.87 0.55
Net income................................................................. 420 416 420 268
Earnings per share:
Basic.................................................................... 0.87 0.86 0.87 0.55
Diluted.................................................................. 0.86 0.85 0.86 0.55
Pro forma income before extraordinary item................................. 380 375 383 227
Pro forma earnings per share before extraordinary item:
Basic.................................................................... 0.76 0.75 0.77 0.45
Diluted.................................................................. 0.75 0.74 0.76 0.45
1998 second-quarter net income includes Separation expenses of $68 ($0.13
per diluted share) and a $21 ($0.04 per diluted share) charge related to the
impairment of certain long-lived assets associated with our video operations.
1997 first-quarter net income includes $11 ($0.02 per diluted share) from
gains on the sales of local telephone exchanges. 1997 second-quarter net income
includes $18 ($0.04 per diluted share) from gains on the sales of local
telephone exchanges. 1997 third-quarter net income includes $19 ($0.04 per
diluted share) from gains on the sales of local telephone exchanges and an
extraordinary charge of $3 ($0.01 per diluted share) for the early
extinguishment of debt. 1997 fourth-quarter net income includes a $152 ($0.31
per diluted share) regulatory charge related primarily to the 1997 Washington
State Supreme Court ruling
F-29
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 15: QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
that upheld a 1996 rate order and a $32 ($0.07 per diluted share) gain on the
sale of our investment in Bellcore.
MARKET PRICE
----------------------------------
PER SHARE MARKET AND DIVIDEND DATA HIGH LOW CLOSE DIVIDENDS
- ------------------------------------------------------------------ ---------- ---------- ---------- -----------
1998
First quarter................................................... $ 56.3125 $ 45.3750 $ 54.6250 $ 0.5350
Second quarter.................................................. 57.4375 46.8125 46.8125 0.5350
Third quarter................................................... 54.9375 48.4375 52.5000 0.5350
Fourth quarter.................................................. 65.0000 51.8750 64.6250 0.5350
1997
First quarter................................................... $ 37.2500 $ 31.7500 $ 33.8750 $ 0.5350
Second quarter.................................................. 38.5000 31.1250 37.6875 0.5350
Third quarter................................................... 39.4375 35.6250 38.5000 0.5350
Fourth quarter.................................................. 46.9375 36.8750 45.1250 0.5350
Per share market and dividend data prior to June 12, 1998 represents data of
Communications Stock. Per share market and dividend data as of and subsequent to
June 12, 1998 represents data of U S WEST.
F-30
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PRINTED ON RECYCLED PAPER WSTNC-PS-99
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PROXY CARD
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THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS FOR THE ANNUAL
MEETING OF STOCKHOLDERS ON MAY 11, 1999.
The undersigned hereby appoints Richard D. McCormick, Linda G. Alvarado and
Frank P. Popoff, and each of them, proxies with the powers the undersigned would
possess if personally present, and with full power of substitution, to vote all
common shares of U S WEST of the undersigned on the reverse side of this proxy
at the Annual Meeting to be held at The Millennium Broadway Hotel, 145 W. 44th
Street, New York, New York, beginning at 10:30 a.m., on May 11, 1999, and at any
adjournments or postponements thereof, upon all subjects that may properly come
before the Annual Meeting including the matters described in the Proxy Statement
furnished herewith, subject to any directions indicated on the reverse side of
this card. IF NO DIRECTIONS ARE GIVEN, THE PROXIES WILL VOTE FOR THE ELECTION OF
ALL LISTED NOMINEES, IN ACCORDANCE WITH THE DIRECTORS' RECOMMENDATIONS ON THE
OTHER SUBJECTS LISTED ON THE REVERSE SIDE OF THIS CARD AND AT THEIR DISCRETION
ON ANY OTHER MATTER THAT MAY PROPERLY COME BEFORE THE ANNUAL MEETING.
Your vote for the election of Directors may be indicated on the reverse. The
nominees for Class I are Hank Brown, George J. Harad and Marilyn Carlson Nelson.
If you are a participant in the U S WEST Shareowner Investment Plan, your proxy
card will cover both the number of full shares in your plan account and shares
registered in your name.
If you are a participant in the U S WEST Savings Plan/ESOP, your proxy card will
also serve as a voting instruction card for the trustees of the plans with
respect to the shares held in your accounts. The trustees will vote the shares
held in the plans for which proxies are not received (as well as shares held in
the suspense account of the plans) in the same proportion as the shares for
which proxies are received.
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To vote your shares for all Director nominees, mark the "For" box on item "A."
To withhold voting for all nominees, mark the "Withhold" box. If you do not wish
your shares voted "For" a particular nominee, mark the "For All Except" box and
enter the name(s) of the exception(s) in the space provided, and your shares
will be voted for the remaining nominees.
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DIRECTORS RECOMMEND A VOTE "FOR"
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A. Election of Directors in Class I Exceptions For / /
B. Ratification of Appointment of Independent Auditors For / /
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DIRECTORS RECOMMEND A VOTE "AGAINST" THE SHAREHOLDER PROPOSALS REGARDING
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1. Discontinuance of Classified Board For / /
2. Discontinuance of Shareholder Rights Plans For / /
3. Limitation on Future Change of Control Compensation For / /
4. Two Nominees for Each Directorship For / /
A. Withhold / / For All Except / /
B. Against / / Abstain / /
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1. Against / / Abstain / /
2. Against / / Abstain / /
3. Against / / Abstain / /
4. Against / / Abstain / /
Date ________________________, 1999
Sign here as name appears
x _________________________________
x _________________________________
Please sign this proxy and return
promptly whether or not you plan to
attend the Annual Meeting.
1. Mark here if you plan to attend the Annual Meeting / /
2. Mark here to discontinue duplicate annual reports / /