================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 1-14087
U S WEST, Inc.
A Delaware Corporation IRS Employer No. 84-0953188
1801 California Street, Denver, Colorado 80202
Telephone Number 303-672-2700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X_ No __
At October 31, 1998, 502,510,651 shares of common stock were outstanding.
================================================================================
U S WEST, INC.
FORM 10-Q
TABLE OF CONTENTS
Item Page
PART I - FINANCIAL INFORMATION
1. Financial Statements
Consolidated Statements of Income -
Three and Nine Months Ended September 30, 1998 and 1997 3
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
PART II - OTHER INFORMATION
1. Legal Proceedings 27
2. Changes in Securities and Use of Proceeds 27
5. Other Information 28
6. Exhibits and Reports on Form 8-K 33
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) U S WEST, Inc.
- ------------------------------------------------------- ---------------------------- ----------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
Dollars in millions (except per share 1998 1997 1998 1997
amounts)
- ------------------------------------------------------- -------------- ------------- ------------- --------------
Operating revenues:
Local service $1,398 $1,314 $4,117 $3,739
Interstate access service 693 663 2,102 2,028
Intrastate access service 208 208 616 608
Long-distance network services 199 231 595 721
Directory services 315 296 935 879
Other services 299 248 809 682
-------------- ------------- ------------- --------------
Total operating revenues 3,112 2,960 9,174 8,657
Operating expenses:
Employee-related expenses 1,104 1,018 3,179 2,915
Other operating expenses 567 539 1,798 1,517
Taxes other than income taxes 84 106 274 320
Depreciation and amortization 558 541 1,625 1,616
-------------- ------------- ------------- --------------
Total operating expenses 2,313 2,204 6,876 6,368
-------------- ------------- ------------- --------------
Operating income 799 756 2,298 2,289
Interest expense 172 100 378 304
Gains on sales of rural telephone exchanges - 30 - 77
Other expense - net 19 12 77 51
-------------- ------------- ------------- --------------
Income before income taxes and extraordinary
item 608 674 1,843 2,011
Provision for income taxes 229 251 703 752
-------------- ------------- ------------- --------------
Income before extraordinary item 379 423 1,140 1,259
Extraordinary item - early extinguishment
of debt - net of tax - (3) - (3)
============== ============= ============= ==============
NET INCOME $379 $420 $1,140 $1,256
============== ============= ============= ==============
EARNINGS PER SHARE:
Basic - before extraordinary item $0.76 $0.88 $2.32 $2.61
Extraordinary item - (0.01) - (0.01)
============== ============= ============= ==============
Basic earnings per share $0.76 $0.87 $2.32 $2.60
============== ============= ============= ==============
Diluted - before extraordinary item $0.75 $0.87 $2.30 $2.58
Extraordinary item - (0.01) - (0.01)
============== ============= ============= ==============
Diluted earnings per share $0.75 $0.86 $2.30 $2.57
============== ============= ============= ==============
Average shares outstanding (000s):
Basic 501,807 483,218 491,608 482,374
Diluted 505,949 491,407 495,718 492,528
PRO FORMA EARNINGS PER SHARE BEFORE
EXTRAORDINARY ITEM:
Basic $0.76 $0.77 $2.13 $2.28
Diluted 0.75 0.76 2.11 2.25
Pro forma average shares outstanding (000s):
Basic 501,807 499,559 501,545 498,715
Diluted 505,949 507,748 505,655 508,869
DIVIDENDS PER SHARE $0.535 $0.535 $1.605 $1.605
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS (Unaudited) U S WEST, Inc.
- --------------------------------------------------------------------- --------------------- -------------------
September 30, December 31,
Dollars in millions 1998 1997
- --------------------------------------------------------------------- --------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents $22 $ 27
Accounts and notes receivable - net 1,735 1,717
Inventories and supplies 248 150
Deferred directory costs 261 257
Deferred tax asset 205 271
Prepaid and other 82 82
--------------------- -------------------
Total current assets 2,553 2,504
Gross property, plant and equipment 34,840 33,651
Accumulated depreciation 20,342 19,343
--------------------- -------------------
Property, plant and equipment - net 14,498 14,308
Other assets 1,010 855
--------------------- -------------------
Total assets $18,061 $ 17,667
===================== ===================
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS U S WEST, Inc.
(Unaudited), continued
- ---------------------------------------------------------------------- ------------------- ---------------------
September 30, December 31,
Dollars in millions, except per share amounts 1998 1997
- ---------------------------------------------------------------------- ------------------- ---------------------
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities:
Short-term debt $1,913 $497
Old U S WEST debt - 198
Accounts payable 1,121 1,377
Employee compensation 414 412
Dividends payable 269 259
Advanced billings and customer deposits 362 336
Other 1,179 1,120
------------------- ---------------------
Total current liabilities 5,258 4,199
Long-term debt 7,920 5,020
Postretirement and other postemployment
benefit obligations 2,556 2,534
Deferred income taxes 822 791
Deferred credits and other 880 756
Contingencies
Shareowners' equity
Preferred shares -$1.00 per share par value,
200,000,000 shares authorized, none issued
and outstanding
Common shares - $0.01 per share par value, 2,000,000,000 shares authorized,
502,082,955 and 484,515,415 issued and outstanding at September 30,
1998, and December 31, 1997, respectively 625 -
Pre-recapitalization equity - 4,367
------------------- ---------------------
Total shareowners' equity 625 4,367
------------------- ---------------------
Total liabilities and shareowners' equity $18,061 $ 17,667
=================== =====================
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) U S WEST, Inc.
- --------------------------------------------------------------------------------------- ------------ ------------
Nine Months Ended September 30, 1998 1997
- --------------------------------------------------------------------------------------- ------------ ------------
(Dollars in millions)
OPERATING ACTIVITIES
Net income $1,140 $1,256
Adjustments to net income:
Depreciation and amortization 1,625 1,616
Gains on sales of rural telephone exchanges - (77)
Deferred income taxes and amortization of investment tax credits 102 7
Changes in operating assets and liabilities:
Accounts receivable (18) 40
Inventories, supplies and other current assets (49) (75)
Accounts payable and accrued liabilities 116 245
Other - net 34 141
----------- ------------
Cash provided by operating activities 2,950 3,153
----------- ------------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (1,937) (1,322)
Proceeds from (payments on) disposals of property, plant
and equipment (14) 27
Purchase of PCS licenses (18) (57)
Proceeds from sales of rural telephone exchanges - 51
Other (39) -
----------- ------------
Cash used for investing activities (2,008) (1,301)
----------- ------------
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term debt 1,519 (701)
Net (repayments of) proceeds from issuance of Old U S WEST debt (198) 303
Proceeds from issuance of long-term debt 3,066 -
Repayment of Old U S WEST debt in connection with the
Dex Alignment (3,829) -
Repayments of long-term debt (411) (412)
Dividends paid on common stock (787) (733)
Dividends paid to Old U S WEST (194) (243)
Payment to Old U S WEST for debt refinancing costs (140) -
Return of capital from Old U S WEST 13 -
Proceeds from issuance of common stock 60 50
Purchases of treasury stock (46) -
----------- ------------
Cash used for financing activities (947) (1,736)
----------- ------------
CASH AND CASH EQUIVALENTS
Increase (decrease) (5) 116
Beginning balance 27 80
----------- ------------
Ending balance $22 $196
=========== ============
See Notes to Consolidated Financial Statements.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Nine Months Ended September 30, 1998
(Dollars in millions, except per share amounts)
(Unaudited)
A. U S WEST Separation
On October 25, 1997, the Board of Directors of the former parent of U S WEST,
Inc., 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: the U S WEST Communications Group (the
"Communications Group"), which included the communications businesses of Old U S
WEST, and the U S WEST Media Group (the "Media Group"), which included the
multimedia businesses of Old U S WEST. On June 4, 1998, shareholders of Old U S
WEST voted in favor of the Separation, which became effective June 12, 1998 (the
"Separation Date"). At that time, the Communications Group became an independent
public company renamed "U S WEST, Inc." ("U S WEST" or the "Company") and Media
Group's directory business known as U S WEST Dex, Inc. ("Dex") was aligned with
U S WEST (the "Dex Alignment"). Old U S WEST has continued as an independent
public company comprised of the current businesses of Media Group other than Dex
and has been renamed "MediaOne Group, Inc." ("MediaOne Group").
The Separation was implemented pursuant to the terms of a separation agreement
(the "Separation Agreement") between U S WEST and MediaOne Group. In connection
with the Dex Alignment, (i) U S WEST distributed, as a dividend to holders of
MediaOne Group common stock, an aggregate of $850 in value of U S WEST common
stock and (ii) $3.9 billion of Old U S WEST debt, formerly allocated to Media
Group, was refinanced by U S WEST (the "Dex Indebtedness").
The Consolidated Financial Statements include the consolidated historical
results of operations, balance sheets 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
of the financial effects of the Separation and the Dex Alignment, including
interest expense associated with the refinancing of $3.9 billion of Dex
Indebtedness and the dilutive effects of the issuance of $850 of U S WEST common
stock, are not reflected in the accompanying Consolidated Statements of Income
prior to the Separation Date. These Consolidated Financial Statements should be
read in conjunction with the U S WEST, Inc. Unaudited Pro Forma Condensed
Combined Statements of Income which have been separately presented under Part II
- - Item 5(C) - "Other Information - Pro Forma Financial Information."
Further information about the Separation is contained in Old U S WEST's proxy
statement mailed to all Old U S WEST shareowners on April 20, 1998.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
B. Summary of Significant Accounting Policies
Basis of Presentation. U S WEST is 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. Investments in less than majority-owned
ventures are generally accounted for using the equity method.
Certain reclassifications within the Consolidated Financial Statements have been
made to conform to the current year presentation.
The Consolidated Financial Statements have been prepared pursuant to the interim
reporting rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally accompanying
financial statements prepared in accordance with generally accepted accounting
principles ("GAAP") have been condensed or omitted pursuant to such SEC rules
and regulations. In the opinion of management, the Consolidated Financial
Statements include all adjustments, consisting of only normal recurring
adjustments, necessary to present fairly the financial information set forth
therein. It is suggested that these Consolidated Financial Statements be read in
conjunction with the 1997 U S WEST Combined Financial Statements and notes
thereto included in Annex G of Old U S WEST's proxy statement mailed to all Old
U S WEST shareowners on April 20, 1998.
C. Debt Refinancing
In connection with the Separation, U S WEST and MediaOne Group refinanced
substantially all of the indebtedness issued or guaranteed by Old U S WEST
through a combination of tender offers, prepayments, consent solicitations and
exchange offers (the "Refinancing").
In connection with the Refinancing and the Dex Alignment, in June 1998 U S WEST
Capital Funding, Inc. ("Capital Funding"), a wholly-owned financing subsidiary
of U S WEST, issued approximately $4.1 billion in new debt securities, of which
approximately $1.0 billion is commercial paper with an average rate of 5.82% and
$3.1 billion is long-term debt having the following rates and maturities:
---------------------- ------------------------ ------------------------
Effective Interest
Term Amount Rate (%)
---------------------- ------------------------ ------------------------
4 year $ 500 6.31 %
7 year 500 6.41 %
10 year 600 6.55 %
30 year 1,500 6.98 %
---------------------- ------------------------ ------------------------
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
Approximately $3.83 billion in proceeds from the issuance of these securities
were used to repay Old U S WEST debt in connection with Dex Alignment. The
remaining proceeds were primarily used to fund U S WEST's share of operating
expenses and debt refinancing costs incurred by Old U S WEST that were directly
attributable to the Separation. The Company additionally refinanced
approximately $200, including $70 of Dex debt assumed in connection with the Dex
Alignment.
The Company and U S WEST Communications, Inc. ("U S WEST Communications"), a
wholly-owned subsidiary of the Company that provides telecommunications
services, maintain commercial paper programs to finance short-term cash flow
requirements as well as to maintain a presence in the short-term debt market. In
addition, U S WEST Communications, which conducts its own borrowing activities,
is permitted to borrow up to $700 under short-term lines of credit, all of which
was available at September 30, 1998. U S WEST is permitted to borrow and has
available up to approximately $2.4 billion under lines of credit to meet the
combined business needs of its nonregulated subsidiaries at September 30, 1998.
D. Asset Impairment
During second-quarter 1998, the Company recorded a non-cash charge of $21 (net
of a $14 tax benefit) related to the impairment of certain long-lived assets
associated with the Company's video operations in Omaha, Nebraska, which are
included in the communications and related services segment. The impaired assets
primarily consist of underground cable and hardware. Recent technological
advances have permitted the Company to pursue and use more economical Video
Digital Subscriber Line ("VDSL") technology in cable overbuild situations.
Because the projected future cash flows were less than the carrying values an
impairment loss was recognized in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The amount of
impairment was determined based on the net present value of the future cash
flows of the business, discounted at the Company's cost of capital. The pretax
charge is recorded in "other operating expenses" within the Consolidated
Statements of Income.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
E. Earnings Per Share
Certain of the financial effects of the Separation and the Dex Alignment,
including interest expense associated with the refinancing of $3.9 billion of
Dex Indebtedness by U S WEST and the dilutive effects of the issuance of $850 of
U S WEST common stock, are not reflected in the historical Consolidated
Statements of Income prior to the Separation Date. As a result, earnings per
share for the nine months ended September 30, 1998, and for the three and nine
months ended September 30, 1997, are presented on both a pro forma and
historical basis.
The following reflects the computation of basic and diluted earnings per share
on a historical and pro forma basis. The unaudited pro forma earnings per share
amounts for the nine months ended September 30, 1998 and the three and nine
months ended September 30, 1997, give effect to the Dex Indebtedness and the
issuance of shares in connection with the Dex Alignment as if such transactions
had been consummated as of January 1, 1998 and 1997, respectively. For a full
presentation of these pro forma adjustments please see Part II Item 5(C) -
"Other Information - Pro Forma Financial Information."
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
- --------------------------------------------------- ------------------------------ ----------------------------
Three Months Ended Nine Months Ended
September 30, September
30,
Basic Earnings Per Share (1) 1998 1997 1998 1997
- --------------------------------------------------- --------------- -------------- -------------- -------------
Reported net income $379 $423 $1,140 $1,259
Pro forma adjustment (2) - (40) (72) (121)
=============== =============== ============== =============
Pro forma income $379 $383 $1,068 $1,138
=============== =============== ============== =============
Basic average shares (thousands) (3) 501,807 483,218 491,608 482,374
Pro forma adjustment (4) - 16,341 9,937 16,341
=============== ============== ============== =============
Pro forma basic average shares 501,807 499,559 501,545 498,715
=============== ============== ============== =============
Basic earnings per share (1) $0.76 $0.88 $2.32 $2.61
Pro forma basic earnings per share (1) 0.76 0.77 2.13 2.28
=================================================== =============== ============== ============== =============
- -------------------------------------------------- ------------------------------- ----- ----------------------------
Three Months Ended Nine Months Ended
September 30, September
30,
Diluted Earnings Per Share (1) 1998 1997 1998 1997
- -------------------------------------------------- ---------------- --------------- ---- -------------- --------------
Reported net income $379 $423 $1,140 $1,259
Interest on convertible zero coupon
subordinated notes, net of tax - 2 - 9
---------------- --------------- -------------- --------------
Income used for diluted earnings per share 379 425 1,140 1,268
Pro forma adjustment (2) - (40) (72) (121)
---------------- --------------- -------------- --------------
Pro forma income used for diluted earnings
per share $379 $385 $1,068 $1,147
================ =============== ============== ==============
Basic average shares (thousands) (3) 501,807 483,218 491,608 482,374
Effect of dilutive securities:
Stock options 4,142 2,474 4,110 2,005
Convertible zero coupon notes 5,715 - 8,149
--------------- --------------- -------------- --------------
Diluted average shares 505,949 491,407 495,718 492,528
Pro forma adjustment (4) - 16,341 9,937 16,341
=============== =============== ============== ==============
Pro forma diluted average shares 505,949 507,748 505,655 508,869
=============== =============== ============== ==============
Diluted earnings per share (1) $0.75 $0.87 $2.30 $2.58
Pro forma diluted earnings per share (1) 0.75 0.76 2.11 2.25
=================================================== =============== =============== ============== ==============
<FN>
<F1>
(1) Before extraordinary item of $3, or $0.01 per share, related to a 1997 early extinguishment of debt.
<F2>
(2) 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.
<F3>
(3) Historical average shares assume a one-for-one conversion of historical
Communications Group common stock outstanding into shares of U S WEST as of
the Separation Date.
<F4>
(4) Reflects the issuance of approximately 16,341,000 shares (net of the
redemption of approximately 305,000 fractional shares) issued on June 15,
1998 in connection with the Dex Alignment as if the shares had been issued
at the beginning of each period indicated.
</FN>
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
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, which were redeemed in August 1997.
F. Contingencies
U S WEST Communications has pending regulatory actions in local regulatory
jurisdictions that call for price decreases, refunds or both.
Oregon. On May 1, 1996, the Oregon Public Utilities Commission ("OPUC") approved
a stipulation terminating prematurely U S WEST Communications' alternative form
of regulation ("AFOR") plan, and it then undertook a review of U S WEST
Communications' earnings. In May 1997, the OPUC ordered U S WEST Communications
to reduce its annual revenues by $97, effective May 1, 1997, and to issue a
one-time refund, including interest, of approximately $102 to reflect the
revenue reduction for the period May 1, 1996 through April 30, 1997. The
one-time refund is for interim rates which became subject to refund when U S
WEST Communications' AFOR plan was terminated on May 1, 1996.
U S WEST Communications filed an appeal of the order and asked for an immediate
stay of the refund with the Oregon Circuit Court which granted U S WEST
Communications' 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 U S WEST
Communications' favor on most of the appealed issues. The OPUC appealed to the
Oregon Court of Appeals on March 19, 1998, and the appeal is pending. U S WEST
Communications continues to charge interim rates, subject to refund, during the
pendency of that appeal. The potential refund exposure, including interest, at
September 30, 1998, is not expected to exceed $280.
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: 1) unforeseen and extraordinary events,
and 2) misconduct. The UPSC's initial order denied a refund request from
interexchange carriers ("IXCs") and other parties related to the Tax Reform Act
of 1986. The potential exposure, including interest, at September 30, 1998, is
not expected to exceed $170.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
New Mexico. The New Mexico State Corporation Commission ("NMSCC") issued an
order on May 29, 1998, requiring U S WEST Communications to reduce its annual
revenues by approximately $22. U S WEST Communications sought a rehearing before
the NMSCC which was denied. The NMSCC's order was then removed to the New Mexico
Supreme Court for review which effectively stays the order. The potential for
retroactive exposure, at September 30, 1998, is remote.
State Regulatory Accruals. U S WEST Communications has accrued $200 at September
30, 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
$265. U S WEST Communications 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, U S
WEST Communications has an accrued liability of approximately $160 at September
30, 1998 related to refunds in the state of Washington. Approximately $80 was
refunded to IXCs and independent local exchange carriers during the nine-month
period ended September 30, 1998. The remaining liability is expected to be
refunded to ratepayers by the first half of 1999, with the majority of the
refunds occurring in fourth-quarter 1998.
G. Shareholder Rights Plan
The U S WEST Board of Directors has adopted a shareholder rights plan which, in
the event of a takeover attempt, would entitle existing shareowners to certain
preferential rights. The rights expire on June 1, 2008 and are redeemable by the
Company at any time prior to the date they would become effective.
H. New Accounting Standards
On January 1, 1999, the Company will adopt the accounting provisions required by
the AICPA 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.
Form 10-Q - Part I
U S WEST, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
(Unaudited)
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 -
$0.30 per share. Thereafter, in periods after adoption, if software expenditures
remain level, 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. Please see Part I
- - Item II- "Forward-Looking Information."
On June 15, 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and for Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. SFAS No. 133 requires, among other
things, that all derivative instruments be recognized at fair value as either
assets or liabilities on the balance sheet and that changes in fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. The Standard is effective for fiscal years beginning after June 15, 1999,
though earlier adoption is permitted. The financial statement impacts of the
Company's adoption of the new standard are dependent upon the amount and nature
of future use of derivative instruments, and their relative changes in valuation
over time.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts)
Forward-Looking Information
Some of the information presented in or in connection with this report
constitutes "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Although the Company believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. Factors that could
cause actual results to differ from expectations include: (i) greater than
anticipated competition from new entrants into the local exchange, intraLATA
toll, wireless, data and directories markets, (ii) changes in demand for the
Company's products and services, including optional custom calling features,
(iii) higher than anticipated employee levels, capital expenditures, and
operating expenses (such as costs associated with year 2000 remediation), (iv)
the loss of significant customers, (v) pending regulatory actions in state
jurisdictions, (vi) regulatory changes affecting the telecommunications
industries, including changes that could have an impact on the competitive
environment in the local exchange market, (vii) a change in economic conditions
in the various markets served by the Company's operations that could adversely
affect the level of demand for telephone, wireless, directories or other
services offered by the Company, (viii) greater than anticipated competitive
activity requiring new pricing for services, (ix) higher than anticipated
start-up costs associated with new business opportunities, (x) increases in
fraudulent activity with respect to wireless services, (xi) delays in the
Company's ability to begin offering interLATA long-distance services, (xii)
consumer acceptance of broadband services, including telephony, data, and
wireless services, or (xiii) delays in the development of anticipated
technologies, or the failure of such technologies to perform according to
expectations.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Results of Operations - Three and Nine Months Ended September 30, 1998 Compared
with 1997
Net Income
Following are details of the Company's reported and pro forma net income, and
pro forma diluted earnings per share, normalized to exclude the effects of
certain nonrecurring and nonoperating items.
- ---------------------------------- ------------------------- ---------------- - ----------------------- --------------
Three Months Increase Nine Months Ended Increase
Ended (Decrease) September (Decrease)
September 30, 30,
1998 1997 $ % 1998(1) 1997(1) $ %
- ----------------------------------- ---------- ----------- ------- --------- ---------- --------- -------- --------
Reported net income (2) $379 $423 $(44) (10.4) $1,140 $1,259 $(119) (9.5)
Pro forma adjustment (3) - (40) 40 - (72) (121) 49 40.5
---------- ----------- ------- -------- ---------- --------- --------- -------
Pro forma income 379 383 (4) (1.0) 1,068 1,138 (70) (6.2)
Adjustments:
Separation costs - - - - 68 - 68 -
Asset impairment - - - - 21 - 21 -
Gains on sales of rural
telephone exchanges - (19) 19 - - (48) 48 -
========== ========== ======== ======== ========== ========= ========= =======
Normalized pro forma income $379 $364 $15 4.1 $1,157 $1,090 $67 6.1
========== ========== ======== ======== ========== ========= ========= =======
Pro forma diluted average
shares outstanding (4) 505.9 507.7 (1.8) (0.4) 505.7 508.9 (3.2) (0.6)
========== ========== ======== ======== ========== ========= ========= =======
Pro forma diluted earnings
Per share (2) $0.75 $0.76 $(0.01) (1.3) $2.11 $2.25 $(0.14) (6.2)
Adjustments:
Separation costs - - - - 0.13 - 0.13 -
Asset impairment - - - - 0.04 - 0.04 -
Gains on sales of rural
Telephone exchanges - (0.04) 0.04 - - (0.10) 0.10 -
========== ========== ======== ======== ========== ========= ========= =======
Normalized pro forma diluted
earnings per share $0.75 $0.72 $0.03 4.2 $2.29 $2.16 $0.13 6.0
=================================== ========== ========== ======== ======== ========== ========= ========= =======
(See "Note E - Earnings Per Share" - to the Consolidated Financial Statements.)
<FN>
<F1>
(1) Diluted pro forma earnings per share does not foot due to rounding.
<F2>
(2) Before extraordinary item of $3, or $0.01 per share, related to a 1997 early extinguishment of debt.
<F3>
(3) 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.
<F4>
(4) Average shares assume a one-for-one conversion of historical Communications
Group common shares outstanding into shares of U S WEST as of the
Separation Date, adjusted to reflect the issuance of approximately
16,341,000 shares (net of the redemption of approximately 305,000
fractional shares) issued on June 15, 1998, in connection with the Dex
Alignment as if the shares had been issued at the beginning of each period
indicated.
</FN>
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
U S WEST normalized pro forma income increased by $15, or 4.1 percent, to $379,
and by $67, or 6.1 percent, to $1,157, during the three- and nine-month periods
ended September 30, 1998, respectively. Normalized pro forma diluted earnings
per share increased by $0.03, or 4.2 percent, to $0.75, and by $0.13, or 6.0
percent, to $2.29, during the same periods, respectively. A pension credit
adjustment relating to the first half of 1998 contributed $12, or $0.02 per
share, to third quarter earnings. The remaining increase in third quarter net
income is primarily due to higher demand for services partially offset by
interstate access rate reductions and higher operating costs, including
increased start-up costs associated with growth initiatives and higher expenses
related to interconnection.
Operating Revenues
- --------------------------------- ----------------------- ---------------- -- ----------------------- --------------
Three Months Ended Increase Nine Months Ended Increase
September (Decrease) September (Decrease)
30, 30,
1998 1997 $ % 1998 1997 $ %
- ------------------------------------ --------- --------- -------- -------- --------- ---------- -------- --------
Local service $1,398 $1,314 $84 6.4 $4,117 $3,739 $378 10.1
Interstate access service 693 663 30 4.5 2,102 2,028 74 3.6
Intrastate access service 208 208 - - 616 608 8 1.3
Long-distance network services 199 231 (32) (13.9) 595 721 (126) (17.5)
Other services 309 257 52 20.2 837 707 130 18.4
--------- --------- -------- -------- --------- ---------- -------- --------
Communications and related
services 2,807 2,673 134 5.0 8,267 7,803 464 5.9
Directory services 315 296 19 6.4 935 879 56 6.4
Intersegment eliminations (10) (9) (1) 11.1 (28) (25) (3) 12.0
--------- --------- -------- -------- --------- ---------- -------- --------
Total $3,112 $2,960 $152 5.1 $9,174 $8,657 $517 6.0
==================================== ========= ========= ======== ======== == ========= ========== ======== ========
Communications and Related Services
Local Service Revenues. Local service revenues increased $84, or 6.4 percent, to
$1,398, and $378, or 10.1 percent, to $4,117, during the three- and nine-month
periods, respectively. Excluding the non-recurring impact of a regulatory charge
in last year's second quarter, local services revenues increased by 8.2 percent
for the nine-month period. Local service revenues increased primarily as a
result of access line growth and increased demand for new products and services,
and existing central office features. Total reported access lines increased
579,000, or 3.7 percent, during the past 12 months, of which 243,000 was
attributable to second lines. Second line installations increased 19.4 percent.
Also contributing to the increase in revenues were the effects of rate increases
in various jurisdictions aggregating $14 in the third quarter and $45 for the
nine months. Interim compensation revenues from IXCs as a result of Federal
Communications Commission ("FCC") payphone orders, which took effect in April
1997, also contributed to revenue growth in the first nine months of the year.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Interstate Access Service Revenues. Interstate access service revenues increased
$30, or 4.5 percent, to $693, and $74, or 3.6 percent, to $2,102, during the
three- and nine-month periods, respectively. The increases are primarily due to
the effects of a change in the classification of universal service fundings,
which increased revenues by $23 in the third quarter and $61 in the nine-month
period. In 1997 these fundings were offset against interstate access service
revenues. Beginning in 1998 these fundings are recorded as access expense within
other operating expenses. Excluding the effects of the reclassification,
interstate access revenues during third quarter increased $7, or 1.1 percent,
and nine-month revenues increased $13, or 0.6 percent. Increased demand for
interstate access services, as evidenced by increases of 6.9 percent and 6.8
percent in billed interstate access minutes of use during the three- and
nine-month periods, respectively, was largely offset by price reductions.
Intrastate Access Service Revenues. Intrastate access service revenues were
unchanged from last year's third quarter and increased by $8, or 1.3 percent,
during the nine-months ended September 30. During third quarter, the effects of
rate decreases offset increased demand. The increase for the nine months was
primarily due to higher demand, including increased demand for private line
services, partially offset by net rate reductions. Net rate reductions
aggregated $9 and $23 in the three- and nine-month periods, respectively, the
majority of which were in the state of Washington. Competitive effects have also
adversely impacted intrastate access revenue growth. Intrastate billed access
minutes of use increased by 5.0 and 5.8 percent during each respective period.
Long Distance Network Services Revenues. Long-distance network services revenues
decreased by $32, or 13.9 percent, in the third quarter and by $126, or 17.5
percent, in the first nine months of 1998. The decreases were primarily due to
the effects of competition and rate reductions of $10 in the third quarter and
$37 in the first nine months of 1998 in several jurisdictions, most
significantly in the state of Washington. Also contributing to the decline in
the nine-month period were the implementation of multiple toll carrier plans
("MTCPs") in various jurisdictions in 1997. The MTCPs essentially allow
independent telephone companies to act as toll carriers and are net income
neutral to the Company, with the reduction in toll revenues largely offset by
increased intrastate access service revenues and lower access expense.
Other Services Revenues. Revenues from other services increased by $52, or 20.2
percent, in the third quarter and by $130, or 18.4 percent, in the first nine
months of 1998, as a result of greater sales of wireless communications services
and inside wire 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.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Directory Services
Revenues related to directory services increased by $19, or 6.4 percent, and
$56, or 6.4 percent in the three- and nine-month periods, respectively. The
increases are driven by an average 8.7 percent increase in revenue per local
advertiser primarily resulting from price increases of 4.7 percent and an
increase in volume and complexity of advertisements sold.
Intersegment Eliminations
Intersegment eliminations consist primarily of sales of customer lists, billing
and collection services and other services by U S WEST Communications to Dex at
market price. Also included are commercial property management services provided
by U S WEST Business Resources, Inc. to Dex.
Costs and Expenses
- ----------------------------------- ----------------------- --------------- --- ---------------------- ------------
Three Months Ended Increase Nine Months Ended Increase
September 30, (Decrease) September (Decrease)
30,
1998 1997 $ % 1998 1997 $ %
- ------------------------------------- --------- --------- -------- -------- --------- -------- -------- --------
Employee-related expenses $1,104 $1,018 $86 8.4 $3,179 $2,915 $264 9.1
Other operating expenses (1) 567 539 28 5.2 1,798 1,517 281 18.5
Taxes other than income taxes 84 106 (22) (20.8) 274 320 (46) (14.4)
Depreciation and amortization 558 541 17 3.1 1,625 1,616 9 0.6
Interest expense (as reported) 172 100 72 72.0 378 304 74 24.3
Pro forma adjustment - 65 (65) - 117 196 (79) (40.3)
--------- --------- -------- -------- -------- --------- -------- --------
Interest expense (pro forma) 172 165 7 4.2 495 500 (5) 1.0
Gains on sales of rural telephone
Exchanges - 30 (30) - - 77 (77) -
Other expense - net 19 12 7 58.3 77 51 26 51.0
- ------------------------------------- --------- --------- -------- -------- --- -------- --------- -------- --------
<FN>
(1) Includes separation expenses of $94 and an asset impairment charge of $35
during second-quarter 1998.
</FN>
Employee-Related Expenses. Total employee-related expenses increased $86, or 8.4
percent, and $264, or 9.1 percent, during the three-and nine-month periods,
respectively. Employee-related expenses include $21 of net costs incurred in
conjunction with the 1998 third-quarter work stoppage. These work stoppage costs
include incremental travel costs, contract labor costs and employee bonus costs
paid to management employees for work performed during the strike. Partially
offsetting these additional costs were lower salaries and wages and overtime
savings associated with occupational employees not working during the work
stoppage.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Excluding these costs, employee-related expenses increased $65, or 6.4 percent,
and $243, or 8.3 percent, during the three- and nine-month periods,
respectively. The increases were primarily due to higher contract labor costs
and increased salaries and wages. The higher contract labor costs were largely a
result of systems development work (which includes expenses related to
interconnection and year 2000 costs) and marketing and sales efforts. Higher
salaries and wages were a result of increases in wages and the number of
employees, including the effects of transferring approximately 530 employees
from Old U S WEST in connection with the Separation. Prior to the third quarter,
costs related to these employee transfers were allocated to the Company by Old U
S WEST and included in other operating expenses. Partially offsetting these
increases during the three- and nine-month periods were pension credits, which
include a third-quarter $20 pension credit adjustment relating to the first half
of 1998.
Other Operating Expenses. Excluding nonrecurring charges as described in Note 1
to the above table, other operating expenses increased by $28, or 5.2 percent,
and by $152, or 10.0 percent, during the three- and nine-month periods,
respectively. The increases are primarily due to increased costs associated with
growth initiatives including, wireless handset costs, marketing and advertising
costs, and higher interconnection costs. The aforementioned change in
classification of universal service funding expenses increased other operating
expenses by $23 in the third quarter and $61 in the first half of 1998 as
compared to the same periods in 1997. The effects of the transfer of
approximately 530 employees from Old U S WEST resulted in a reduction of costs
formerly allocated to the Company by Old U S WEST which partially offset the
increase in other operating expenses. A 1997 reserve adjustment associated with
billing and collection activities performed for IXCs also partially offset the
nine-month period increase.
Other operating expenses for the nine-month period include $94 in costs incurred
during second quarter that are directly attributable to the Separation. These
Separation costs include executive severance, legal and financial advisory fees,
securities registration fees, printing and mailing costs, and internal systems
and rearrangement costs.
During second quarter of 1998, U S WEST also recorded in other operating
expenses a pretax charge of $35 related to the impairment of certain long-lived
assets associated with the Company's video operations in Omaha, Nebraska. Recent
technological advances have permitted the Company to pursue and use more
economical VDSL technology in cable overbuild situations. Because the projected
future cash flows were less than the carrying values, an impairment loss was
recognized in accordance with SFAS No. 121. (See "Note D Asset Impairment" - to
the Consolidated Financial Statements.)
Taxes Other Than Income Taxes. Taxes other than income taxes decreased primarily
because of a third quarter property tax settlement in addition to adjustments
related to the 1997 property tax accrual.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Interest Expense. The increase in interest expense as reported reflects the
impact of the Dex Indebtedness incurred since the Separation Date, partially
offset by the effects of lower average debt levels.
Pro forma interest expense reflects the full effects of the Dex Indebtedness as
if such indebtedness had occurred at the beginning of each period indicated. On
a pro forma basis, the increase in interest expense for the three-month period
was primarily a result of higher quarterly average debt levels. The decline in
interest expense for the nine-month period was primarily a result of lower
average debt levels.
Gains On Sale of Rural Telephone Exchanges. During the nine-month period ended
September 30, 1997, the Company sold selected rural telephone exchanges in
Minnesota, Iowa, Nebraska, and South Dakota for pretax gains of $77.
Other Expense - Net. Other expense increased primarily due to additional
interest expense associated with the Company's state regulatory liabilities.
Provision for Income Taxes
The effective tax rate for the first nine months of 1998 is 38.1 percent as
compared to 37.3 percent on a pro forma basis during the first nine months of
1997. The increase in the effective tax rate is primarily due to the impact of
certain expenses related to the Separation, which are not deductible for tax
purposes, and the effects of lower amortization of investment tax credits. The
effective tax rate is expected to approximate 38 percent for the twelve months
ended December 31, 1998.
Liquidity and Capital Resources
Operating Activities
Cash provided by operating activities was $2,950 and $3,153 during the first
nine months of 1998 and 1997, respectively. The decrease in operating cash flow
primarily reflects a reduction in accounts payable financing, the effect of
refunds in regulatory jurisdictions and lower accounts receivable collections.
Partially offsetting the decreases were the effects of business growth in both
the core communications and directory businesses.
The Company's operating cash flow during fourth-quarter 1998 and the first half
of 1999 will be affected by the payment of approximately $160 of rate refunds in
the state of Washington. The rate refunds are for revenues that were collected
subject to refund (with interest) from May 1, 1996 through January 31, 1998.
(See "Note F - Contingencies" - to the Consolidated Financial Statements.)
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Investing Activities
Total capital expenditures, on a cash basis, were $1,937 during the first nine
months of 1998, of which the majority related to access line growth and
continued improvement of the telecommunications network. Expenditures associated
with entering wireless communications markets and meeting the requirements of
the Telecommunications Act of 1996, including interconnection and local number
portability, also impacted capital expenditures. In 1998, capital expenditures
are expected to approximate $2.9 billion.
During the first nine months of 1998, the Company paid $18 to purchase PCS
licenses in connection with its launch of PCS service in various markets.
Financing Activities
Debt Activity
Total debt increased by $4,118 as compared to December 31, 1997, of which
approximately $3.9 billion is attributable to the Dex Indebtedness. The Dex
Indebtedness was incurred at the Separation Date, with proceeds used to repay
Old U S WEST debt, offset by a reduction of shareowners' equity. Debt financing
was also the source of funds used for approximately $140 in debt refinancing
costs paid to Old U S WEST in addition to certain operating costs related to the
Separation. Higher capital expenditures also contributed to the increase in
debt.
The nonregulated activities of U S WEST, including Dex, are funded with
short-term advances. The net repayments on and proceeds from such short-term
advances were $(198) and $303 during the first nine months of 1998 and 1997,
respectively. Prior to the Separation Date, these short-term advances were
provided by Old U S WEST.
Prior to the Separation, Dex paid dividends to Old U S WEST equal to its net
income adjusted for the amortization of intangibles. These dividends totaled
$194 and $243 during the first nine months of 1998 and 1997, respectively.
Year 2000 Costs
During 1997 U S WEST conducted a comprehensive high level review of its computer
systems and related software to ensure that systems properly recognize the year
2000 and continue to process data. The systems evaluated include (i) the 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 the core communications
business, relies on remote switches, central office and interoffice equipment,
and loop transport equipment that is predominately provided by
telecommunications network vendors.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
IT is comprised of the Company's internal business systems that employ hardware
and software with an enterprise-wide scope, including operational, financial and
administrative functions. The Business Units, which include internal
organizations such as finance, procurement, Yellow Pages, operator services,
wireless, data networks, real estate, etc., employ systems that support desktop
and departmental applications that relate specifically to their business and are
not generally part of the Network or IT.
The Company's approach to year 2000 remediation activities is broken down into
five general phases: (i) inventory/assessment, (ii) planning, (iii) conversion,
(iv) testing/certification and (v) implementation.
With regard to the Network, the Company is working with telecommunications
network vendors to obtain compliant releases of hardware and software. The
Company is also working on a focused testing approach given the requirement that
Network testing must be done over multiple equipment configurations involving a
broad spectrum of services. The inventory/assessment and planning phases for the
Network are complete and management expects that the testing/certification
phases will be completed by December 1998, with implementation completed by July
1999. To facilitate Network testing, the Company participates, along with other
major wireline providers of telecommunications services, as a member of 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. The Company is also participating 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.
Within IT, the Company has identified the applications that support its critical
business processes such as billing and collections, network monitoring, repair
and ordering. The inventory/assessment and planning phases for IT are complete
and management expects that conversion will be completed by the end of 1998 or
shortly thereafter, with testing and implementation continuing through 1999.
Within the Business Units, the Company is generally in the inventory/assessment
phase, though some Business Units have completed this phase and are into the
planning, conversion and testing/certification phases. Accordingly, a majority
of the Business Units have established project plans and associated schedules to
accomplish the remaining phases. The objective is to complete any major
conversions or upgrades by third-quarter 1999.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
The Company has spent approximately $90 through the third quarter of 1998 on
year 2000 projects and activities. The estimated total incremental costs for
year 2000 related projects and activities are approximately $200 through 1999,
excluding capital expenditures. Additional incremental capital expenditures over
the same period will approximate $50-$80. Virtually all expenditures relate to U
S WEST Communications and are being funded through operations. Though year 2000
costs will directly impact the reported level of future net income, the Company
intends to manage its total cost structure, including deferral of non-critical
projects, in an effort to mitigate the impact of year 2000 costs on its
historical rate of earnings growth. The estimate stated above may be subject to
change.
Management cannot provide assurance that the result of its year 2000 compliance
efforts or the cost of such efforts will not differ materially from estimates.
Accordingly, year 2000 specific business continuity and contingency plans are
being developed to address high risk areas as they are identified. These year
2000 specific contingency plans will conform to detailed Company-wide
requirements now being established by the Company's Year 2000 Program Office.
These plans will be in place no later than third-quarter 1999. In addition, the
Company has in place its standard overall business continuity, contingency and
disaster recovery plans (such as diesel generator back-up power supply sources
for its Network, Network rerouting capabilities, and computer back-up and
recovery procedures) which will be verified, and if required, augmented for
specific year 2000 scenarios.
Within Network, the Company is highly dependent on the telecommunications
network vendors to provide compliant hardware and software in a timely manner,
and on third parties that are assisting the Company in the focused testing of
the Network. Because of these dependencies, the Company has developed and
implemented a vendor compliance process whereby the Company has obtained written
assurances of timely year 2000 compliance from most of its critical vendors (not
only for Network, but also for IT and the Business Units). The Company continues
to pursue such assurances from the remaining critical vendors. In addition, the
Company monitors and actively participates in coordinated Network testing
activities, as discussed above, with respect to the Forum and Bellcore. Within
IT, the Company is dependent 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, the Company has developed
detailed timetables, resource plans and standardized year 2000 testing
requirements for all identified critical applications (irrespective of whether
these applications are used primarily by IT, the Network or the Business Units).
Within the Business Units, the Company is dependent on vendor supplied goods and
services, and operability of the Network, critical IT and business unit specific
applications. Because of these dependencies, the Company is implementing the
same type of vendor compliance process and application planning and testing
process at the Business Units, as discussed above with respect to the Network
and IT.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
In management's view, the most reasonable worst case scenario for year 2000
failure prospects faced by the Company is that a limited number of important IT
and/or Business Unit specific applications may unexpectedly fail. In addition,
no assurance can be given that there may not be problems with the Network
relating to year 2000. Failure by the Company or by certain of its 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 the Company's operations, possibly
impacting the Network and impairing the Company's ability to bill or collect
revenues. However, management believes that its efforts at advance remediation
and testing, obtaining written vendor assurances and advance vendor remediation,
year 2000 specific contingency planning, and overall business continuity,
contingency and disaster recovery planning will be successful, and that the
aforementioned "worst case scenario" is unlikely to develop or significantly
disrupt the Company's financial operations.
The above discussion regarding year 2000 contains statements that are
"forward-looking" within the meaning of the Private Securities Litigation Reform
Act of 1995. Although the Company believes that its estimates are based on
reasonable assumptions, there can be no assurance that actual results will not
differ materially from these estimates.
Union Contracts
On October 9, 1998, the Communications Workers of America ("CWA") informed the
Company that a majority of its voting members ratified new three-year contracts
for U S WEST Communications and U S WEST Business Resources, Inc. employees. The
contracts provide for salary increases of 10.9 percent over three years,
effective in August of each year, and pension increases totaling 21 percent over
three years. The contract also provides employees with a $500 ratification bonus
in lieu of additional future wage increases. The agreement covers approximately
33,000 CWA members.
On October 15, 1998, Dex and CWA union members tentatively agreed upon a new
three-year contract. The agreement covers approximately 1,900 sales, operations
and customers service employees.
Other Items
U S WEST from time to time engages in discussions regarding restructurings,
dispositions, acquisitions and other similar transactions. Any such transaction
may 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
the financial condition and results of operations of U S WEST. There is no
assurance that any such discussions will result in the consummation of any such
transaction.
Form 10-Q - Part I
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Dollars in millions, except per share amounts), continued
Contingencies
U S WEST Communications has pending regulatory actions in local regulatory
jurisdictions that call for price decreases, refunds or both. (See "Note F -
Contingencies" - to the Consolidated Financial Statements.)
Form 10-Q - Part II
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
U S WEST and its subsidiaries are subject to claims and proceedings arising in
the ordinary course of business. At U S WEST Communications, there are pending
certain regulatory actions in local regulatory jurisdictions that call for price
decreases, refunds or both. For a discussion of these actions, see "Note F -
Contingencies" - to the Consolidated Financial Statements.
Item 2. Changes in Securities and Use of Proceeds
(a) On June 12, 1998, the Company was separated from Old U S WEST in accordance
with the terms of the Separation Agreement dated as of June 5, 1998, by and
between the Company and Old U S WEST. Pursuant to the Separation Agreement,
Old U S WEST redeemed each outstanding share of U S WEST Communications
Group Common Stock for one share of Common Stock of the Company. The Common
Stock of the Company was registered with the SEC on Form S-4 filed on
February 6, 1998, as amended, and declared effective on April 10, 1998
(File No. 333-45765). The Separation was approved by shareholders of Old U
S WEST on June 4, 1998. For a further discussion of the Separation, please
refer to the Company's Form 8-K/A filed with the SEC on June 26, 1998.
(b) On June 29, 1998, Capital Funding issued $3.1 billion of Notes and
Debentures which were guaranteed as to principal and interest by U S WEST.
The Notes and Debentures were registered with the SEC on Form S-3 on May 6,
1998, as amended, and declared effective on May 22, 1998 (File Nos.
333-51907 and 333-51907-01) (the "Capital Funding Form S-3"). The Notes and
Debentures were issued on June 29, 1998 with net proceeds of
$3,065,632,000. The underwriting discount was $22,900,000. The remaining
difference represents the discounted price to the public. The Company
estimates its expenses at $1,270,000 ($1,032,500 of which relates to the
SEC filing fee). The net proceeds from the issuance of the Notes and
Debentures were used to repay existing commercial paper indebtedness (which
was issued in accordance with Section 4(2) of the Securities Act of 1933,
as amended). For a listing of the managing underwriters, please refer to
the Company's Form 424(b)(2) filed with the SEC on June 26, 1998. Some of
those underwriters acted as dealers in the issuance of the commercial paper
indebtedness. The Capital Funding Form S-3 has approximately $400 million
in remaining debt capacity, all or a portion of which may be issued from
time to time for the purposes described therein. U S WEST Communications
has approximately $320 million of remaining debt capacity on its Form S-3
registration statement, all or a portion of which may be issued from time
to time for the purposes described therein.
Form 10-Q - Part II
Item 5. Other Information
A. Advance Notice Bylaw Procedure
The Company's Bylaws have an advance notice procedure for stockholders to bring
business before an annual meeting of stockholders. The advance notice procedure
requires that a stockholder interested in presenting a proposal for action at an
annual meeting of stockholders must deliver a written notice of the proposal,
together with certain specified information relating to such stockholder's stock
ownership and identity, to the Secretary of the Company at least 90 days before
the annual meeting. A copy of the Company's Bylaws was filed as an exhibit to
its Form 8-K/A dated June 26, 1998 and is available on the Securities and
Exchange Commission's web site at http://www.sec.gov.
Stockholder proposals intended for inclusion in the Company's 1999 Proxy
Statement should be sent to the Secretary of the Company at 1801 California
Street, Suite 5100, Denver, Colorado 80202, and must be received by December 21,
1998.
B. Union Contract
On October 9, 1998 the Communications Workers of America informed the Company
that a majority of its voting members ratified both of the contracts for U S
WEST Communications and U S WEST Business Resources, Inc. employees. Both
contracts are effective August 16, 1998 and will continue in effect until August
18, 2001.
C. Pro Forma Financial Information
The consolidated historical financial statements of U S WEST included herein
reflect the historical results of operations, balance sheets and cash flows of
the businesses that comprise Communications Group and Dex as if such businesses
operated as a separate entity for all periods presented. The financial effects
of the Dex Alignment, including the refinancing of the Dex Indebtedness and the
issuance of approximately 16,341,000 shares (net of the redemption of
approximately 305,000 fractional shares) of U S WEST common stock in connection
with the Dex Alignment, are reflected in the consolidated financial statements
since the Separation Date.
Form 10-Q - Part II
Item 5. Other Information (continued)
The following unaudited pro forma condensed combined statements of income of U S
WEST for the nine months ended September 30, 1998 and 1997, and years ended
December 31, 1997 and 1996, give effect to the refinancing by U S WEST of the
Dex Indebtedness and the issuance of shares in connection with the Dex Alignment
(the "Separation Adjustments") as if such transactions had been consummated as
of the beginning of each period indicated.
The pro forma adjustments included herein are based on available information and
certain assumptions as of the Separation Date that management believes are
reasonable and are described in the accompanying notes. The unaudited pro forma
financial statements do not necessarily represent what U S WEST's financial
position or results of operations would have been had the transactions occurred
at such dates or to project U S WEST's results of operations at or for any
future date or period. In the opinion of management, all adjustments necessary
to present fairly the unaudited pro forma financial information have been made.
The unaudited pro forma financial statements should be read in conjunction with
the historical financial statements of U S WEST.
Form 10-Q - Part II
Item 5. Other Information (continued)
U S WEST, Inc.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
Dollars in millions (except per share amounts)
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
U S WEST Separation U S WEST U S WEST Separation U S WEST
Historical Adjustments Pro forma Historical Adjustments Pro forma
Operating revenues $9,174 - $9,174 $8,657 - $8,657
Operating expenses 6,876 - 6,876 6,368 - 6,368
--------------- ------------ ------------ ------------- ----------- ------------
Operating income 2,298 2,298 2,289 2,289
Interest expense 378 $117(A) 495 304 $196(A) 500
Gains on sales of rural
telephone exchanges - - - 77 - 77
Other expense - net 77 - 77 51 - 51
-
--------------- ------------ ------------ ------------- ----------- ------------
Income (loss) before
income taxes(E) 1,843 (117) 1,726 2,011 (196) 1,815
Provision (benefit) for
income taxes 703 (45)(B) 658 752 (75)(B) 677
--------------- ------------ ------------ ------------- ----------- ------------
Income (loss) (E) $1,140 $(72) $1,068 $1,259 $(121) $1,138
=============== ============ ============ ============= =========== ============
Basic earnings per
share(C, E) $2.32 - $2.13 $2.61 - $2.28
Average basic shares
outstanding (millions)(D)
491.6 9.9 501.5 482.4 16.3 498.7
Diluted earnings per
share(C, E) $2.30 - $2.11 $2.58 - $2.25
Average diluted shares
outstanding (millions)(D)
495.7 9.9 505.7 492.5 16.3 508.9
Shares may not foot due to rounding
See Notes to Unaudited Pro Forma Condensed Combined Statements of Income.
Form 10-Q - Part II
Item 5. Other Information (continued)
U S WEST, Inc.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
Dollars in millions (except per share amounts)
Year Ended Year Ended
December 31, 1997 December 31, 1996
U S WEST Separation U S WEST U S WEST Separation U S WEST
Historical Adjustments Pro forma Historical Adjustments Pro forma
Operating revenues $11,479 - $11,479 $11,168 - $11,168
Operating expenses 8,703 - 8,703 8,356 - 8,356
--------------- ------------- --------------- ----------- -------------- -----------
Operating income 2,776 2,776 2,812 - 2,812
Interest expense 405 $262(A) 667 448 $262(A) 710
Gains on sales of rural
telephone exchanges 77 - 77 59 - 59
Gain on sale of investment
in Bellcore 53 - 53 - - -
Other expense - net 72 - 72 46 - 46
--------------- ------------- --------------- ----------- -------------- -----------
Income (loss) before
income taxes(E) 2,429 (262) 2,167 2,377 (262) 2,115
Provision (benefit) for
income taxes 902 (100)(B) 802 876 (100)(B) 776
--------------- ------------- --------------- ----------- -------------- -----------
Income (loss)(E) $1,527 $(162) $1,365 $1,501 $(162) $1,339
=============== ============= =============== =========== ============== ===========
Basic earnings per
share(C, E) $3.16 - $2.73 $3.14 - $2.71
Average basic shares
outstanding (millions)(D)
482.8 16.3 499.1 477.6 16.3 493.9
Diluted earnings per
share(C, E) $3.13 - $2.71 $3.10 - $2.68
Average diluted shares
outstanding (millions)(D)
491.3 16.3 507.6 488.6 16.3 504.9
See Notes to Unaudited Pro Forma Condensed Combined Statements of Income.
Form 10-Q - Part II
Item 5. Other Information (continued)
U S WEST, Inc.
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED
STATEMENTS OF INCOME
Dollars in millions
A. Reflects incremental interest expense associated with the Dex Indebtedness
from the beginning through the end of each period presented up to the
Separation Date.
B. Reflects the estimated income tax effects of the pro forma adjustments.
C. The financial effects of the Dex Alignment, including interest expense
associated with the refinancing of $3.9 billion of Dex Indebtedness by U S
WEST and the dilutive effects of the issuance of $850 of U S WEST common
stock, are reflected in the U S WEST historical Consolidated Statements of
Income since the Separation Date June 12, 1998.
D. Represents historical Communications Group average common shares
outstanding, adjusted to reflect the incremental impact of the issuance of
approximately 16,341,000 shares (net of the redemption of approximately
305,000 fractional shares) issued on June 15, 1998, in connection with the
Dex Alignment.
E. Amounts are before an extraordinary item in 1997 and the cumulative effect
of a change in accounting principle in 1996.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3(i) Restated Certificate of Incorporation of U S WEST, Inc.
*3(ii) Bylaws of U S WEST, Inc. (formerly "USW-C, Inc."), effective as of
June 12, 1998 (Exhibit 3(ii) to Form 8-K/A dated June 26, 1998,
File No. 1-14087).
*4(a) Form of Rights Agreement between U S WEST, Inc. (formerly "USW-C,
Inc.") and State Street Bank and Trust Company, as Rights Agent
(Exhibit 4-A to the Form S-4 Registration Statement No. 333-45765,
filed February 6, 1998, as amended).
*4(b) Form of Indenture among U S WEST Capital Funding, Inc., USW-C
(renamed "U S WEST, Inc.") and First National Bank of Chicago,
as Trustee, (Exhibit 4-A to Form S-3 Registration Statement
No. 333-51907, filed May 6, 1998, as amended).
*10(a) Separation Agreement between U S WEST, Inc. (renamed "MediaOne
Group, Inc.") and USW-C, Inc. (renamed "U S WEST, Inc."), dated
June 5, 1998 (Exhibit 99.1 to Form 8-K/A dated June 26, 1998, File
No. 1-14087).
*10(b) Employee Matters Agreement between U S WEST, Inc. (renamed
"MediaOne Group, Inc.") and USW-C, Inc. (renamed "U S WEST, Inc."),
dated June 5, 1998 (Exhibit 99.2 to Form 8-K/A dated June 26, 1998,
File No. 1-14087).
*10(c) Tax Sharing Agreement between U S WEST, Inc. (renamed "MediaOne
Group, Inc.") and USW-C, Inc. (renamed "U S WEST, Inc."), dated
June 5, 1998 (Exhibit 99.3 to Form 8-K/A dated June 26, 1998, File
No. 1-14087).
*10(d) 364-Day $3.5 Billion Credit Agreement, dated May 8, 1998, with
Morgan Guaranty Trust Company of New York as Administrative
Agent (Exhibit 10A to Form 10-Q for the quarter ended March
31, 1998, File No. 1-14087).
*10(e) Five-Year $1.0 Billion Credit Agreement, dated May 8, 1998,
with Morgan Guaranty Trust Company of New York as
Administrative Agent (Exhibit 10B to Form 10-Q for the quarter
ended March 31, 1998, File No. 1-14087).
10(e)(1) Amendment No. 1 to Credit Agreements dated as of June 30, 1998 to
the 364-Day $3.5 Billion Credit Agreement and the Five-Year $1.0
Billion Credit Agreement, each dated as of May 8, 1998, among
U S WEST Capital Funding, Inc.; U S WEST, Inc.; the Banks listed
on the signature pages thereto and Morgan Guaranty Trust Company of
New York.
Form 10-Q - Part II
Item 6. Exhibits and Reports on Form 8-K (continued)
*10(f) Change of Control Agreement for the President and Chief Executive
Officer (Exhibit 10(f) to Form 10-Q for the quarter ended June 30,
1998, File No. 1-14087).
*10(g) Form of Change of Control Agreement for Tier II Executives (Exhibit
10(g) to Form 10-Q for the quarter ended June 30, 1998, File No.
1-14087).
*10(h) Form of Executive Severance Agreement (Exhibit 10(g) to Form 10-Q
for the quarter ended June 30, 1998, File No. 1-14087).
*10(i) 1998 U S WEST Stock Plan (Exhibit 10-A to the Form S-4 Registration
Statement No. 333-45765, filed February 6, 1998, as amended).
*10(j) U S WEST Long-Term Incentive Plan (Exhibit 10-D to the Form S-4
Registration Statement No. 333-45765, filed February 6, 1998, as
amended).
*10(k) U S WEST Executive Short-Term Incentive Plan (Exhibit 10-E to the
Form S-4 Registration Statement No. 333-45765, filed February 6,
1998, as amended).
10(l) U S WEST 1998 Broad Based Stock Option Plan dated June 12, 1998.
10(m) U S WEST Deferred Compensation Plan, amended and restated effective
as of June 12, 1998.
10(n) U S WEST 1998 Stock Plan, as amended June 22, 1998.
12 Statement regarding computation of earnings to fixed charges ratio
of U S WEST, Inc.
27 Financial Data Schedule
- -------------------
* Previously filed.
(b) Reports on Form 8-K filed during the Third Quarter of 1998
(i) Form 8-K dated July 15, 1998 concerning a press released reporting
certain one-time charges for the second quarter of 1998.
(ii) Form 8-K dated July 28, 1998 concerning the Company's second quarter
results of operations.
Form 10-Q - Part II
Item 6. Exhibits and Reports on Form 8-K (continued)
(iii Form 8-K/A dated July 29, 1998, amending Form 8-K dated July 28,
1998, concerning the Company's second quarter earnings results.
(iv) Form 8-K dated August 16, 1998 concerning a press release announcing
the work stoppage commenced by clerical and technical employees
represented by the Communications Workers of America.
(v) Form 8-K dated August 31, 1998 concerning a press release announcing
a tentative agreement reached on the Labor Contract between the
Company and the Communications Workers of America.
(vi) Form 8-K dated October 21, 1998 concerning the Company's third
quarter results of operations.
(vii) Form 8-K dated October 27, 1998 reiterating the Company's earnings
projections.
(viii) Form 8-K dated November 2, 1998 concerning a press release
announcing the naming of a new member to the Company's board of
directors.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
U S WEST, Inc.
/s/ ALLAN R. SPIES
By:___________________________________
Allan R. Spies
Executive Vice President and Chief Financial Officer
November 6, 1998