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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2000
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 000-22609
Qwest Communications International Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
Delaware 84-1339282
-------- ----------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation of organization)
</TABLE>
1801 California Street, Denver, Colorado 80202
(Address of principal executive offices and zip code)
Telephone Number (303) 992-1400
(Registrant's telephone number, including area code)
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 July 31, 2000, 1,660,818,053 shares of common stock were outstanding.
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<PAGE>
Qwest Communications International Inc.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C>
Item Page
PART I - FINANCIAL INFORMATION
1. Financial Statements
Condensed Consolidated Statements of Operations -
Three and six months ended June 30, 2000 and 1999.............................. 3
Condensed Consolidated Balance Sheets -
June 30, 2000 and December 31, 1999............................................ 4
Condensed Consolidated Statements of Cash Flows -
Six months ended June 30, 2000 and 1999........................................ 5
Notes to Condensed Consolidated Financial Statements........................... 6
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................ 15
3. Quantitative and Qualitative Disclosures
About Market Risk.............................................................. 23
PART II - OTHER INFORMATION
1. Legal Proceedings....................................................................... 27
6. Exhibits and Reports on Form 8-K........................................................ 27
Signature page.......................................................................... 33
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Qwest Communications International Inc.
Condensed Consolidated Statements of Operations
(in millions, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2000 1999 2000 1999
---- ---- ---- ----
Revenues:
<S> <C> <C> <C> <C>
Local services..................................... $2,071 $1,920 $4,111 $3,783
Access services.................................... 733 684 1,442 1,355
Directory services................................. 331 319 678 645
Long-distance services............................. 99 156 206 330
Other services..................................... 216 148 390 282
------------- -------------- ------------- -------------
Total revenues.................................. 3,450 3,227 6,827 6,395
------------- -------------- ------------- -------------
Operating expenses:
Employee-related expenses.......................... 1,217 1,153 2,373 2,275
Other operating expenses........................... 674 671 1,388 1,327
Depreciation and amortization...................... 600 573 1,186 1,175
Merger-related expenses............................ 291 - 306 -
------------- -------------- ------------- -------------
Total operating expenses........................ 2,782 2,397 5,253 4,777
------------- -------------- ------------- -------------
Operating income......................................... 668 830 1,574 1,618
Other expense (income):
Interest expense................................... 207 163 418 316
Decline in market value of Global Crossing
Ltd. financial instruments........................ 639 - 768 -
Gain on sales of investments....................... - - (79) -
Other expense-net.................................. 15 13 14 14
------------- -------------- ------------- -------------
Total other expense-net......................... 861 176 1,121 330
------------- -------------- ------------- -------------
Earnings (loss) before income taxes and cumulative effect
of change in accounting principle.....................
(193) 654 453 1,288
Provision (benefit) for income taxes..................... (72) 248 170 488
------------- -------------- ------------- -------------
Earnings (loss) before cumulative effect of change in
accounting principle.................................. (121) 406 283 800
Cumulative effect of change in accounting principle...... - - - 240
------------- -------------- ------------- -------------
Net earnings (loss)...................................... $(121) $406 $283 $1,040
============= ============== ============= =============
Basic earnings (loss) per share.......................... $(0.14) $0.47 $0.32 $1.19
============= ============= ============== ==============
Basic average shares outstanding......................... 887 871 882 871
============= ============= ============== ==============
Diluted earnings (loss) per share........................ $(0.14) $0.46 $0.32 $1.18
============= ============= ============== ==============
Diluted average shares outstanding....................... 887 879 895 879
============= ============= ============== ==============
Dividends per share...................................... $0.31 $0.43 $0.31 $0.74
============= ============= ============== ==============
<FN>
<F1>
The accompanying notes are an integral part of the condensed consolidated financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Qwest Communications International Inc.
Condensed Consolidated Balance Sheets
(in millions, except per share amounts)
(unaudited)
June 30, December 31,
2000 1999
----------------- -----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents....................................................... $900 $78
Accounts receivable-net......................................................... 3,832 2,455
Receivable from sale of Global Crossing Ltd. common stock....................... - 1,140
Inventories and supplies........................................................ 322 272
Prepaid and other............................................................... 750 247
----------------- -----------------
Total current assets............................................................... 5,804 4,192
Property, plant and equipment(-)net ............................................... 23,627 16,404
Goodwill-net....................................................................... 29,016 -
Investment in KPNQwest N.V......................................................... 7,925 -
Other assets(-)net................................................................. 3,476 2,676
----------------- -----------------
Total assets....................................................................... $69,848 $23,272
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt................................................................. $4,736 $2,882
Accounts payable................................................................ 1,820 1,700
Accrued expenses and other current liabilities.................................. 2,741 1,840
Advance billings and deposits................................................... 414 344
----------------- -----------------
Total current liabilities.......................................................... 9,711 6,766
Long-term debt..................................................................... 13,429 10,189
Postretirement and other postemployment benefit obligations........................ 2,823 2,890
Deferred income taxes.............................................................. 1,124 1,191
Deferred credits and other......................................................... 1,371 981
Commitments and contingencies
Stockholders' equity:
Preferred stock-$0.01 par value, 200 million shares authorized, none issued and
outstanding.................................................................. - -
Common stock-$0.01 par value, 5 billion shares authorized, 1,655 million and
876 million issued, 1,655 million and 875 million outstanding................ 40,839 656
Retained earnings............................................................... 389 377
Accumulated other comprehensive income.......................................... 162 222
----------------- -----------------
Total stockholders' equity......................................................... 41,390 1,255
----------------- -----------------
Total liabilities and stockholders' equity......................................... $69,848 $23,272
================= =================
<FN>
<F1>
The accompanying notes are an integral part of the condensed consolidated financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Qwest Communications International Inc.
Condensed Consolidated Statements of Cash Flows
(in millions)
(unaudited)
Six Months Ended
June 30,
------------------------------
2000 1999
---- ----
<S> <C> <C>
Cash provided by operating activities................................................. $1,799 $2,069
-------------- --------------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment........................................ (2,702) (1,681)
Proceeds from sale of Global Crossing Ltd. common stock............................... 1,140 -
Cash from acquisition................................................................. 407 -
Investment in Global Crossing Ltd. common stock....................................... - (2,464)
Other................................................................................. (206) (32)
-------------- --------------
Cash used for investing activities.................................................... (1,361) (4,177)
-------------- --------------
FINANCING ACTIVITIES
Net proceeds from short-term debt..................................................... 89 2,940
Proceeds from issuance of long-term debt.............................................. 992 17
Repayments of long-term debt.......................................................... (270) (280)
Proceeds from issuance of common stock................................................ 115 42
Dividends paid on common stock........................................................ (542) (538)
-------------- --------------
Cash provided by financing activities................................................. 384 2,181
-------------- --------------
CASH AND CASH EQUIVALENTS
Increase.............................................................................. 822 73
Beginning balance..................................................................... 78 49
-------------- --------------
Ending balance........................................................................ $900 $122
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Non-cash investing activities:
Acquisitions, net of cash acquired.................................................... $39,700 $-
============== ==============
<FN>
<F1>
The accompanying notes are an integral part of the condensed consolidated financial statements.
</FN>
</TABLE>
<PAGE>
Qwest Communications International Inc.
Notes to Condensed Consolidated Financial Statements
Three and six months ended June 30, 2000
(unaudited)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The condensed consolidated interim financial
statements are unaudited. We prepared these financial statements in accordance
with the instructions for Form 10-Q and therefore, did not include all
information and footnotes required by generally accepted accounting principles.
In our opinion, we made all the adjustments (consisting only of normal recurring
adjustments) necessary to fairly present our consolidated results of operations,
financial position and cash flows as of June 30, 2000 and for all periods
presented. A description of our accounting policies and other financial
information is included in the audited consolidated financial statements filed
with the Securities and Exchange Commission in U S WEST, Inc.'s ("U S WEST")
Annual Report on Form 10-K for the year ended December 31, 1999 (see Note 2).
The consolidated results of operations for the six months ended June 30, 2000
are not necessarily indicative of the results expected for the full year. We
made certain reclassifications to prior year balances to conform with the
current year presentation.
NOTE 2: MERGER WITH U S WEST
On June 30, 2000, Qwest Communications International Inc. ("Qwest")
completed its acquisition of U S WEST (the "Merger"). Each outstanding share of
U S WEST common stock was converted into the right to receive 1.72932 shares of
Qwest common stock (and cash in lieu of fractional shares), resulting in the
issuance of approximately 882 million Qwest shares. In addition, all outstanding
U S WEST stock options were converted into options to acquire Qwest common
stock. Shares outstanding, average shares and earnings (loss) per share have
been restated to give retroactive effect to the exchange ratio. The total value
of the consideration was approximately $40 billion. The Merger has been
accounted for as a reverse acquisition under the purchase method of accounting
with U S WEST being deemed the accounting acquirer.
A preliminary allocation of the purchase price has been made to certain
identified tangible and intangible assets and liabilities of Qwest, based upon
information available to management at the date of the preparation of the
accompanying financial statements. Upon completion of an appraisal and further
analysis, a final allocation will be made that may include certain in-process
research and development projects, other intangible assets, such as customer
relationships and other tangible assets and liabilities. The preliminary
purchase price allocation is as follows: (i) $3.7 billion to tangible assets and
liabilities, net; (ii) $7.4 billion to Qwest's investment in KPNQwest N.V.
("KPNQwest"); and (iii) $29.0 billion to goodwill, which will be amortized over
40 years. We will complete the final purchase price allocation within one year
from the acquisition date. The actual results of operations will differ, perhaps
significantly, from the pro forma unaudited results of operations presented
below because of a variety of factors, including access to additional
information, changes in value not currently identified and changes in operating
results between the date of the pro forma financial information and the date the
Merger was completed.
The pro forma unaudited results of operations as though the Merger had been
completed as of the beginning of 1999 and 2000 are as follows (in millions
except for per share amounts):
<TABLE>
<CAPTION>
Six Months
Ended June 30,
-------------------------------------------
2000 1999
---- ----
<S> <C> <C>
Revenues.......................................................... $9,326 $8,147
Net earnings...................................................... 195 445
Diluted earnings per share........................................ $0.12 $0.27
</TABLE>
NOTE 3: WEIGHTED AVERAGE SHARES
The following table is a reconciliation of basic weighted average
shares to diluted weighted average shares (in millions):
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- ----------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic weighted average shares outstanding................ 887 871 882 871
Dilutive effect of stock options......................... - 8 13 8
------------- ------------- ------------- -------------
Diluted weighted average shares outstanding.............. 887 879 895 879
============= ============= ============= =============
</TABLE>
Diluted weighted average shares outstanding for the three months ended June
30, 2000 excludes 13 million incremental shares related to stock options. These
shares are excluded due to their anti-dilutive effect as a result of our net
loss for the three months ended June 30, 2000.
NOTE 4: SEGMENT INFORMATION
We operate in four segments: retail, wholesale, network and directory
services. The retail services segment provides communications services,
including Internet, wireless, data and long-distance 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 and wholesale services
segments. The directory services segment publishes White and Yellow Pages
telephone directories and provides electronic directory and other information
services.
Following is a breakout of our segments. Because significant operating
expenses of 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 segments. The margins for the retail and wholesale services segments
exclude network and corporate expenses. The margins for the network and
directory services segments exclude corporate expenses. The "other" category
includes our corporate expenses and intersegment eliminations.
<TABLE>
<CAPTION>
Total
Communications
and
Retail Wholesale Network Related Directory Reconciling Consolidated
Services Services Services Services Services Other Items Total
-------- -------- -------- -------- -------- ----- ----- -----
Three Months Ended June 30, (in millions)
2000
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues........ $2,410 $818 $68 $3,296 $336 $- $(182)(1) $3,450
Margin.......... 1,510 578 (672) 1,416 166 (213) (1,562)(2) (193)
Assets.......... -(3) -(3) -(3) -(3) 741 -(3) 69,107 (3) 69,848
Capital
expenditures. 175(4) 58(4) 1,164 1,397 12 - 16 1,425
1999
----
Revenues........ $2,222 $719 $65 $3,006 $322 $- $(101)(1) $3,227
Margin.......... 1,543 526 (699) 1,370 145 (3) (858)(2) 654
Assets.......... -(3) -(3) -(3) -(3) 834 -(3) 21,156 (3) 21,990
Capital
expenditures. 93(4) 9(4) 831 933 10 38 (53) 928
-----------------------
<FN>
<F1>
(1) Represents primarily intersegment charges.
<F2>
(2) Adjustments made to arrive at consolidated earnings (loss) before
income taxes and cumulative effect of change in accounting principle
include the following (in millions):
</FN>
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended June 30,
------------------------------------------
2000 1999
------------------- -------------------
Costs excluded from segment data but included in the consolidated total:
<S> <C> <C>
Taxes other than income taxes................................... $101 $109
Depreciation and amortization................................... 600 573
Decline in market value of Global Crossing Ltd. financial
instruments................................................ 639 -
Interest expense................................................ 207 163
Other expense-net............................................... 15 13
------------------- -------------------
$1,562 $858
=================== ===================
<FN>
<F1>
(3) We do not provide a breakout of assets for all segments to our chief
operating decision-maker. The reconciling items column represents the
amount to reconcile to the consolidated total.
<F2>
(4) Additional capital expenditures relating to those services are included
in network services capital expenditures.
</FN>
</TABLE>
<TABLE>
<CAPTION>
Total
Communications
and
Retail Wholesale Network Related Directory Reconciling Consolidated
Services Services Services Services Services Other Items Total
-------- -------- -------- -------- -------- ----- ----- -----
Six Months Ended June 30, (in millions)
2000
----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues......... $4,734 $1,565 $142 $6,441 $685 $- $(299)(1) $6,827
Margin........... 2,978 1,160 (1,333) 2,805 356 (188) (2,520)(2) 453
Assets........... -(3) -(3) -(3) -(3) 741 -(3) 69,107 (3) 69,848
Capital
expenditures..... 329(4) 82(4) 2,214 2,625 23 - 54 2,702
1999
----
Revenues......... $4,390 $1,409 $115 $5,914 $650 $- $(169)(1) $6,395
Margin........... 3,047 1,055 (1,384) 2,718 310 (36) (1,704)(2) 1,288
Assets........... -(3) -(3) -(3) -(3) 834 -(3) 21,156 (3) 21,990
Capital
expenditures..... 204(4) 40(4) 1,469 1,713 17 38 (87) 1,681
-----------------------
<FN>
<F1>
(1) Represents primarily intersegment charges.
<F2>
(2) Adjustments made to arrive at consolidated earnings before income taxes
and cumulative effect of change in accounting principle include the
following (in millions):
</FN>
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30,
------------------------------------------
2000 1999
------------------- -------------------
Costs excluded from segment data but included in the consolidated total:
<S> <C> <C>
Taxes other than income taxes................................... $213 $199
Depreciation and amortization................................... 1,186 1,175
Decline in market value of Global Crossing Ltd. financial
instruments................................................ 768 -
Gain on sale of investments..................................... (79) -
Interest expense................................................ 418 316
Other expense-net............................................... 14 14
------------------- -------------------
$2,520 $1,704
=================== ===================
<FN>
<F1>
(3) We do not provide a breakout of assets for all segments to our chief operating decision-maker. The reconciling items
column represents the amount to reconcile to the consolidated total.
<F2>
(4) Additional capital expenditures relating to those services are included in network services capital expenditures.
</FN>
</TABLE>
In addition to the operating revenues disclosed above, intersegment
operating revenues were (in millions):
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Retail services............................... $30 $8 $54 $14
Network services.............................. 11 17 27 31
Wholesale services............................ 28 12 47 19
Directory services............................ 4 3 7 5
</TABLE>
NOTE 5: OTHER COMPREHENSIVE EARNINGS (LOSS)
Total comprehensive earnings (loss) for the three and six months ended
June 30, 2000 and 1999 is as follows (in millions):
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- ----------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net earnings (loss)...................................... $(121) $406 $283 $1,040
Other comprehensive earnings (loss):
Net unrealized gains (losses) on available for
sale marketable securities......................... 62 68 (60) 83
------------- ------------- ------------- -------------
Comprehensive earnings (loss)............................ $(59) $474 $223 $1,123
============= ============= ============= =============
</TABLE>
Net unrealized gains for the quarters ended June 30, 2000 and 1999 were net
of deferred taxes of $39 million and $38 million, respectively. Net unrealized
gains (losses) for the six months ended June 30, 2000 and 1999 were net of
deferred taxes (benefit) of $(40) million and $49 million, respectively.
For the quarter ended June 30, 2000, we determined the decline in the
market value of our investment in Global Crossing Ltd. ("Global Crossing")
common stock was other than temporary. We reduced the cost basis of our
investment to reflect the decline in its market value and recognized a pre-tax
loss of $447 million.
For the six months ended June 30, 2000, unrealized losses on marketable
securities include reclassification adjustments of $319 million, net of deferred
taxes of $128 million, pertaining to an other than temporary impairment of our
investment in Global Crossing common stock offset by realized gains from the
sale of securities. These reclassification adjustments have now been realized
through the Statement of Operations.
<PAGE>
NOTE 6: COMMITMENTS AND CONTINGENCIES
Commitments
In March 2000, Qwest and IBM Global Services ("IBM") formed a strategic
business alliance to deliver next-generation e-business services and
applications through the construction and activation of new Qwest CyberCentersSM
throughout North America. IBM, as contractor, will build and provide operational
support for 28 CyberCenters for Qwest. IBM will lease hosting space in these
CyberCenters and will purchase telecommunications services from Qwest, with the
total revenue expected to be approximately $2.5 billion over the seven-year term
of the agreement. Under this alliance, Qwest agreed to purchase equipment and
services from IBM, as contractor, over a seven-year period, which combined with
the construction services, is expected to be approximately $2.5 billion. We have
not purchased any of these services as of June 30, 2000.
Contingencies
Regulatory Contingencies. In May 1996, the Oregon Public Utilities
Commission ("OPUC") approved a stipulation terminating prematurely the
alternative form of regulation ("AFOR") plan of U S WEST Communications, Inc.
("USWC"), U S WEST's wholly owned subsidiary, and it then undertook a review of
USWC's earnings. In May 1997, the OPUC ordered USWC to reduce its annual
revenues by $97 million, effective May 1997, and to issue a one-time refund,
including interest, of approximately $102 million to reflect the revenue
reduction for the period May 1996 through April 1997.
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, pending a
full review of the OPUC's order. In February 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 in March 1998, and the appeal remains
pending. USWC continues to charge interim rates, subject to refund, during the
pendency of that appeal.
In September 1999, USWC and the OPUC staff entered into a tentative
settlement agreement whereby USWC would refund approximately $270 million to
current and former Oregon customers of USWC and issue temporary bill credits of
$63 million annually until the OPUC sets final rates. In April 2000, the OPUC
announced its acceptance of the settlement agreement. We have reserved for the
proposed refunds.
USWC has pending regulatory actions in local regulatory jurisdictions which
call for price decreases, refunds or both. These actions are generally routine
and incidental to USWC's business. USWC will continue to monitor and evaluate
risks associated with its local regulatory jurisdictions.
Other Contingencies. In 1999, twelve complaints were filed against us and
the former U S WEST directors in the following jurisdictions: California
Superior Court, Los Angeles County (1); New York Supreme Court, New York County
(1); Colorado District Court, City and County of Denver (2); Delaware Court of
Chancery (8). These actions are purported class actions brought on behalf of all
persons, other than the defendants, who own our common stock, against us and the
directors. Each of the complaints makes substantially similar allegations that
the defendants breached their fiduciary duties to the class members by refusing
to seek all bona fide offers for U S WEST and refusing to consider the Qwest
proposal, resulting in the stockholders being prevented from maximizing the
value of their common stock. The complaints seek various injunctive and monetary
relief, including orders: (a) requiring defendants to act in accordance with
their fiduciary duties by considering any bona fide proposal which would
maximize stockholder value; (b) requiring the directors to undertake an
evaluation of U S WEST as a merger acquisition candidate and take steps to
enhance that value and create an active auction for U S WEST; (c) preventing
defendants from using a stockholder rights plan to impede any bona fide offer
for U S WEST; (d) enjoining the consummation of the proposed Global Crossing-U S
WEST merger until all alternatives are explored; (e) requiring defendants to
account for all damages suffered by plaintiffs as a result of defendants'
actions with respect to the tender offer for the shares of Global Crossing
common stock and the proposed Global Crossing-U S WEST merger; and (f) requiring
defendants to pay damages to plaintiffs.
In April 1999, CSX Transportation, Inc. filed a complaint in federal
district court in Jacksonville, Florida against us claiming breach of a 1995
contact. Qwest believes it is in full compliance with all terms and conditions
of the contract. Management believes that we have substantial defenses to the
claims asserted and intends to vigorously defend against these actions. We have
also filed a motion to dismiss the case, which is pending. Trial is scheduled to
commence in June 2001.
Through July 2000, U S WEST and USWC has been served with four class action
complaints purportedly on behalf of over 300,000 customers in the states of
Colorado, Arizona, Oregon and New Mexico. The complaints allege, inter alia,
that from 1993 to the present, U S WEST, in violation of alleged statutory and
common law obligations, willfully delayed the provision of local telephone
service to the purported class members. In addition, the complaints allege that
U S WEST misrepresented the date on which such local telephone service was to be
provided to the purported class members. The complaints seek compensatory
damages for purported class members, disgorgement of profits and punitive
damages.
Through July 2000, Qwest has been named as a defendant in several purported
class actions, filed in Texas, Indiana, Tennessee, Missouri, Georgia, Louisiana
and Oregon which involve our right to install our fiber optic cable network in
easements and right-of-ways crossing the plaintiffs' land. In general, we
obtained the rights to construct our network from railroads, utilities, and
others, and installed our network along the rights of way so granted. Plaintiffs
in the purported class actions assert that they are the owners of lands over
which our fiber optic cable network passes, and that the railroads, utilities,
and others who granted to us the right to construct and maintain our network did
not have the legal ability to do so. The Indiana and Texas actions purport to be
on behalf of a national class of owners of land over which our network passes;
the Georgia, Louisiana, Oregon, Tennessee and Missouri actions purport to be on
behalf of a class of such owners in Georgia, Louisiana, Oregon, Tennessee and
Missouri. The complaints seek damages on theories of trespass and unjust
enrichment, and punitive damages as well. We have received, and may in the
future receive, claims and demands related to rights of way issues similar to
the issues in these cases that may be based on similar or different legal
theories.
From March 2, 2000 to March 6, 2000, five class action complaints were
filed in the Delaware Court of Chancery against Qwest and its directors. A sixth
class action complaint was brought against the same defendants in state court in
New York on March 9, 2000. The actions have been brought on behalf of a
purported class of Qwest stockholders claiming that Qwest and its directors
breached their fiduciary duty by entering into the U S WEST merger and by
agreeing not to solicit alternative transactions without fully informing
themselves about the availability of alternative transactions and without fully
informing themselves as to Qwest's value. Plaintiffs seek, among other things,
injunctive relief against the consummation of the U S WEST merger and ordering
Qwest to explore alternative transactions, including alternative transactions
involving Deutsche Telekom AG. On March 21, 2000, the Delaware actions were
consolidated into one action and the plaintiffs were ordered to file a
consolidated amended complaint as soon as practicable. On May 16, 2000, the
defendants moved to dismiss, or in the alternative stay, the New York action. By
order of the Court, the return date of that motion has been extended to October
16, 2000.
On March 17, 2000, and March 20, 2000, two class action complaints were
filed in federal district court in Delaware against Qwest and Joseph P. Nacchio,
our Chairman and Chief Executive Officer. The actions have been brought on
behalf of two purported classes of U S WEST stockholders and allege, among other
things, that Qwest and Mr. Nacchio made material false statements in violation
of Section 14(a) of the Securities Exchange Act of 1934. Plaintiffs claim we
represented in the U S WEST merger agreement and in the joint proxy statement
that Qwest would not take action to solicit or encourage an alternative
acquisition transaction, when Qwest and Mr. Nacchio always intended to entertain
third party bids for Qwest, even after stockholder approval for the U S WEST
merger had been obtained. Plaintiffs seek, among other things, damages sustained
by U S WEST stockholders, and particularly arbitrageurs who held long positions
in U S WEST, when U S WEST's stock price declined on March 1 in response to
reports that Qwest and Mr. Nacchio were negotiating with Deutsche Telekom AG.
In June 2000, a proposed class action complaint was filed against U S WEST
claiming breach of fiduciary duty of loyalty and breach of contract. The
plaintiff claims that the defendants were under a duty to assure that Qwest pays
the dividend declared for shareholders of record as of June 30, 2000 if the
merger closed between July 1 and July 20, 2000. Plaintiffs demand that the
change of the record date for payment of the declared dividend from June 30,
2000 to July 10, 2000 was made in breach of the fiduciary duties and contractual
obligations of the defendants and is therefore unlawful and unenforceable.
Management believes that we have substantial defenses to the claims asserted and
intends to vigorously defend against these actions.
Management believes that we have substantial defenses to each of the claims
asserted and intends to virorously defend against these actions.
We have been named as a defendant in various other litigation matters.
Management intends to vigorously defend these outstanding claims. Management
believes it has adequate accrued loss contingencies and that, although the
ultimate outcome of these claims cannot be ascertained at this time, current
pending or threatened litigation matters are not expected to have a material
adverse impact on our consolidated results of operations or financial position.
We frequently receive offers to take licenses for patent and other
intellectual rights, including rights held by competitors in the
telecommunications industry, in exchange for royalties or other substantial
consideration. We also regularly receive allegations that our products or
services infringe upon various intellectual property rights, together with
demands that we discontinue the alleged infringement. We normally investigate
such offers and allegations and respond appropriately including defending
ourselves vigorously when appropriate. There can be no assurance that, if one or
more of these allegations proved to have merit and involved significant rights
or royalties, it would not have a material adverse effect on Qwest.
In connection with the Merger, Qwest was required to divest transport
services between local access and transport areas ("LATAs") within U S WEST's
14-state region. In June 2000, Qwest sold its interLATA customer base, along
with other assets. Under the terms of the agreement, the purchase price paid is
subject to adjustment for revenue fluctuations during the 90 days subsequent to
the agreement date. We do not expect the adjustment, if any, to have a material
adverse impact on our consolidated results of operations or financial position.
NOTE 7: CHANGE IN ACCOUNTING METHOD
Prior to 1999, our directory business ("Dex") recognized revenues and
expenses related to publishing directories using the "deferral method," under
which revenues and expenses were recognized over the lives of the directories,
generally one year. Effective the fourth quarter of 1999, Dex changed to the
"point of publication" method of accounting, which recognizes revenues and
expenses at the time the related directory is published. The change in
methodology was made to align our revenue and expense policy with the earnings
process and to better reflect the operating activity of the business. The
accounting change resulted in a one-time increase in 1999 in net income of $240
million (net of income tax of $153 million), or $0.27 per diluted share, which
was reported as a cumulative effect (as of January 1, 1999) of a change in
accounting principle. We restated our quarter and six months ended June 30, 1999
results of operations to give effect to the point of publication method which
decreased net income by $15 million and $18 million (each $0.02 per diluted
share), respectively, as compared to results that would have been reported under
the deferral method.
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward-Looking Statements
This Form 10-Q contains financial projections, synergy estimates and other
"forward-looking statements" as that term is used in federal securities laws
about Qwest Communications International Inc.'s ("Qwest" or the "Company")
financial condition, results of operations and business. These statements
include, among others:
- statements concerning the benefits that Qwest expects will result
from its business activities and certain transactions Qwest has
completed, such as increased revenues, decreased expenses and avoided
expenses and expenditures; and
- statements of Qwest's expectations, beliefs, future plans and
strategies, anticipated developments and other matters that are not
historical facts.
These statements may be made expressly in this Form 10-Q. You can find many
of these statements by looking for words such as "believes," "expects,"
"anticipates," "estimates," or similar expressions used in this Form 10-Q.
These forward-looking statements are subject to numerous assumptions, risks
and uncertainties that may cause Qwest's actual results to be materially
different from any future results expressed or implied by Qwest in those
statements.
The most important facts that could prevent Qwest from achieving its stated
goals include, but are not limited to, the following:
- potential fluctuation in quarterly results;
- volatility of Qwest's stock price;
- intense competition in the communications services market;
- changes in demand for Qwest's products and services;
- dependence on new product development and acceleration of the
deployment of advanced new services, such as broadband data, wireless
and video services, which could require substantial expenditure of
financial and other resources in excess of contemplated levels;
- rapid and significant changes in technology and markets;
- adverse changes in the regulatory or legislative environment
affecting Qwest's business and delays in Qwest's ability to begin
long-distance services between local access and transport areas
("LATAs") in the 14 state U S WEST Inc. ("U S WEST") region;
- failure to maintain necessary rights of way; and
- failure to achieve the projected synergies and financial results
expected to result from the acquisition of U S WEST timely or at all
and difficulties in combining the operations of Qwest and U S WEST.
Because the statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by the
forward-looking statements. Qwest cautions you not to place undue reliance on
the statements, which speak only as of the date of this Form 10-Q.
The cautionary statements contained or referred to in this section should
be considered in connection with any subsequent written or oral forward-looking
statements that Qwest or persons acting on its behalf may issue. Qwest does not
undertake any obligation to review or confirm analysts' expectations or
estimates or to release publicly any revisions to any forward-looking statements
to reflect events or circumstances after the date of this Form 10-Q or to
reflect the occurrence of unanticipated events.
Merger with U S WEST
On June 30, 2000, Qwest completed its acquisition of U S WEST (the
"Merger"). Each outstanding share of U S WEST common stock was converted into
the right to receive 1.72932 shares of Qwest common stock receive (and cash in
lieu of fractional shares), resulting in the issuance of approximately 882
million Qwest shares. In addition, all outstanding U S WEST stock options were
converted into options to acquire Qwest common stock. Shares outstanding,
average shares and earnings (loss) per share have been restated to give
retroactive effect to the exchange ratio. The total value of the consideration
was approximately $40 billion. The Merger has been accounted for as a reverse
acquisition under the purchase method of accounting with U S WEST being deemed
the accounting acquirer.
A preliminary allocation of the purchase price has been made to certain
identified tangible and intangible assets and liabilities of Qwest, based upon
information available to management at the date of the preparation of the
accompanying condensed consolidated financial statements. Upon completion of an
appraisal and further analysis, a final allocation will be made that may include
certain in-process research and development projects, other intangible assets,
such as customer relationships and other tangible assets and liabilities. The
preliminary purchase price allocation is as follows: (i) $3.7 billion to
tangible assets and liabilities, net; (ii) $7.4 billion to Qwest's investment in
KPNQwest N.V. ("KPNQwest"); and (iii) $29.0 billion to goodwill, which will be
amortized over 40 years. We will complete the final purchase price allocation
within one year from the acquisition date. The actual results of operations will
differ, perhaps significantly, from the pro forma unaudited results of
operations reflected herein because of a variety of factors, including access to
additional information, changes in value not currently identified and changes in
operating results between the date of the pro forma financial information and
the date the Merger was completed.
Results of Operations
Three and Six Months Ended June 30, 2000 Compared with 1999
Several non-recurring items impacted net earnings (loss) for the three and
six months ended June 30, 2000 and 1999. Results of operations, normalized to
exclude the effects of such items, are as follows (in millions):
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------ --------------------
Increase Increase
2000 1999 (Decrease) 2000 1999 (Decrease)
--------- ------- -------------------- --------- --------- -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net earnings (loss)............. $(121) $406 $(527) (130.0)% $283 $1,040 $(757) (72.8)%
Non-recurring items............. 568(1) - 568 100.0 609(2) (240)(3) 849 353.8
--------- ------- -------- ------- -------- ---------- -------- ---------
Normalized net earnings......... $447 $406 $41 10.1% $892 $800 $92 11.5%
========= ======= ======== ======= ======== ========== ======== =========
Diluted earnings (loss) per share $(0.14) $0.46 $(0.60) (130.4)% $0.32 $1.18 $(0.86) (72.9)%
Non-recurring items............. 0.64(1) - 0.64 100.0 0.68(2) (0.27)(3) 0.95 351.9
--------- ------- -------- -------- -------- ---------- -------- ---------
Normalized diluted earnings
per share.................. $0.50 $0.46 $0.04 8.7% $1.00 $0.91 $0.09 9.9%
========= ======= ======== ========== ========= ========= ======== =========
<FN>
<F1>
(1) Reflects an after-tax charge of $390 million or $0.44 per diluted share
for the decline in the market value of Global Crossing Ltd. financial
instruments and an after-tax charge of $178 million or $0.20 per
diluted share for merger-related costs.
<F2>
(2) Reflects an after-tax charge of $471 million or $0.53 per diluted share
for the decline in the market value of Global Crossing Ltd. financial
instruments, an after-tax charge of $187 million or $0.21 per diluted
share for merger-related costs and an after-tax benefit of $49 million
or $0.06 per diluted share for the gain on sales of investments.
<F3>
(3) Reflects an after-tax benefit of $240 million or $0.27 per diluted
share representing the cumulative effect of a change in accounting
principle applicable to the change in accounting method for directory
publishing revenues and expenses.
</FN>
</TABLE>
The following sections provide a more detailed discussion of the
changes in revenues and expenses.
<PAGE>
<TABLE>
<CAPTION>
Revenues (in millions)
Three Months Ended Six Months
June 30, Ended June 30,
-------- Increase -------------- Increase
2000 1999 (Decrease) 2000 1999 (Decrease)
---- ---- ---------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Local services ....... $2,071 $1,920 $151 7.9% $4,111 $3,783 $328 8.7%
Access services ...... 733 684 49 7.2 1,442 1,355 87 6.4
Directory services ... 331 319 12 3.8 678 645 33 5.1
Long-distance
services .......... 99 156 (57) (36.5) 206 330 (124) (37.6)
Other services ....... 216 148 68 45.9 390 282 108 38.3
</TABLE>
Local services. Local services revenues include retail and wholesale basic
monthly service fees, fees for calling services such as voice messaging and
caller identification, wireless revenues, subscriber line charges ("SLCs"),
MegaBit(TM) data services, local number portability ("LNP") charges, public
phone revenues, interconnection, paging and installation and connection charges.
State public utility commissions ("PUCs") regulate most local service rates.
Revenue growth for the quarter ended June 30, 2000 was primarily
attributable to greater wireless sales ($63 million), increased demand for basic
telephone services ($49 million) and increased sales of calling services ($16
million). Revenue growth for the six months ended June 30, 2000 was primarily
attributable to greater wireless sales ($129 million), increased demand for
basic telephone services ($74 million) and increased sales of calling services
($39 million). Also contributing to revenue growth were greater revenues from
interconnection, increases in the subscriber base of our MegaBit(TM) data
services, paging services and LNP charges. Offsetting these increases in revenue
were regulatory rate changes and accruals for regulatory proceedings of $36
million and $17 million for the three and six months ended June 30, 2000,
respectively.
Access services. Access services revenues are derived primarily from
charging interexchange carriers ("IXCs"), such as AT&T and MCI WorldCom, for use
of our local network to connect customers to their long-distance networks. Also
included in access services revenues are special access and private line
revenues from end-users buying dedicated local exchange capacity to support
their private networks.
Increased demand for private line and special access services, as well as
demand from IXCs resulted in increases of $78 million and $153 million for the
quarter and six months ended June 30, 2000, respectively. Access minutes of use
increased 2.7% and 3.7% for the three and six months ended June 30, 2000.
Offsetting demand increases were FCC and state mandated rate reductions
aggregating $29 million and $64 million for the quarter and six months ended
June 30, 2000, respectively.
Directory services. Directory services revenues are derived primarily from
selling advertising in our published directories. The increases in directory
services revenues for the three and six months ended June 30, 2000 were
primarily attributable to price increases and increased revenues from our
directory-related Internet products.
Long-distance services. Long-distance services revenues are derived from
customer calls to locations outside of their local calling area but within the
same LATA. The decreases in long-distance services revenues for the three and
six months ended June 30, 2000 were primarily attributable to greater
competition and strategic price reductions resulting in revenue declines of $48
million and $105 million, respectively. Mandated rate reductions of $9 million
and $19 million for the three and six months ended June 30, 2000, also
contributed to the revenue declines.
We believe we will continue to experience further declines in long-distance
services revenues as regulatory actions provide for increased levels of
competition. We are responding to competition through competitive pricing of
intraLATA long-distance services and increased promotional efforts to retain
customers. See "Special Note Regarding Forward-Looking Statements" on Page 15.
Other services. Other services revenues include billing and collection
services for IXCs, collocation services for other competitive local exchange
carriers ("CLECs"), customer equipment sales and sales of other unregulated
products, such as U S WEST.net(R), our Internet service. Other services revenues
increased primarily as a result of increased customer equipment sales, the
national expansion of our data business, increased subscribers for U S
WEST.net(R) and increased revenues from billing and collection services.
<TABLE>
<CAPTION>
Operating Expenses (in millions)
Three Months Ended Six Months
June 30, Ended June 30,
2000 1999 Increase 2000 1999 Increase
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Employee-related expenses.. $1,217 $1,153 $64 5.6% $2,373 $2,275 $98 4.3%
Other operating expenses... 674 671 3 0.4 1,388 1,327 61 4.6
Depreciation and
amortization............ 600 573 27 4.7 1,186 1,175 11 0.9
Merger-related expenses.... 291 - 291 100.0 306 - 306 100.0
Other expense-net.......... 861 176 685 389.2 1,121 330 791 239.7
</TABLE>
Employee-related expenses. Employee-related expenses include salaries and
wages, benefits, payroll taxes and contract labor.
Employee-related expenses increased due to growth in several sectors of the
business, primarily wireless and data communications, resulting in increased
employee levels. Additionally, increased commitments towards improving customer
service, including responding to requests for installation and repair services,
resulted in higher labor costs. Across-the-board wage increases also contributed
to the increase in employee-related expenses. Partially offsetting these
increases were improvements in benefit-related costs, primarily in our pension
plan, mainly attributable to favorable returns on pension plan assets. Pension
credits were $83 million in the second quarter of 2000 compared to $50 million
in the second quarter of 1999. Pension credits were $157 million for the six
months ended June 30, 2000 compared to $75 million for the comparable 1999
period.
Other operating expenses. Other operating expenses include access charges
paid to carriers for the routing of local and long-distance traffic through
their facilities, taxes other than income taxes, paper, printing, delivery and
distribution costs associated with publishing activities and other operating
costs. The increases in other operating expenses for the three and six months
ended June 30, 2000 were primarily attributable to the following:
o increased costs of product sales associated with our growth initiatives,
including wireless handset costs and costs applicable to our data
communications services and other communication services;
o increased provision for uncollectibles, primarily attributable to increased
wireless revenues; and
o increased rent expense.
Offsetting the increases in other operating expense for the three and six
months ended June 30, 2000 was the reduction in access expense related to
end-users dialing toll calls using IXCs. A decrease in property taxes due to
adjustments related to 1999 property taxes also partially offset the increase in
other operating expenses for the three months ended June 30, 2000.
Depreciation and amortization. The increases in depreciation and
amortization expense were primarily attributable to higher overall property,
plant and equipment balances resulting from our continued investment in our
network. Offsetting the increase to depreciation and amortization expense for
the six months ended June 30, 2000 was the cessation of depreciation, beginning
in April 1999, associated with access lines that were approved to be sold in
1999.
Merger-related expenses. In connection with the Merger, we incurred several
one-time charges that were primarily employee-related. Included in the charge
were severance and benefit payments to employees who left the Company upon
consummation of the Merger. Additionally, retention bonus payments were made
that were subject to consummation of the Merger. We anticipate additional
merger-related expenses, including additional severance and retention bonuses,
contract terminations and asset impairment charges will be recognized in future
quarters. See "Special Note Regarding Forward-Looking Statements" on Page 15.
Other expense-net. Interest expense was $207 million for the second quarter
of 2000 compared to $163 million for the second quarter of 1999 and $418 million
for the six months ended June 30, 2000, compared to $316 million for the six
months ended June 30, 1999. The increases in interest expense were primarily
attributable to debt U S WEST incurred to acquire 39 million shares of Global
Crossing Ltd. ("Global Crossing") common stock in connection with U S WEST's
proposed merger with Global Crossing and general corporate borrowings.
In December 1999, we entered into equity swaps on 24 million shares of
Global Crossing common stock. The market value of the swaps declined by $192
million and $321 million for the quarter and six months ended June 30, 2000,
respectively. Additionally, in the second quarter of 2000, we determined the
decline in the market value of our remaining investment in Global Crossing stock
was other than temporary. We reduced the cost basis of our investment to reflect
the decline in its market value and recognized a loss of $447 million.
For the six months ended June 30, 2000, we sold other marketable securities
resulting in gains of $79 million.
Segment results. Segment results represent margins which, for segment
reporting purposes, exclude certain costs and expenses, including depreciation
and amortization. See Note 4 to the condensed consolidated financial statements.
<TABLE>
<CAPTION>
Three Months Ended Six Months
June 30, Ended June 30,
-------------------- ---------------------
Increase Increase
(in millions) 2000 1999 (Decrease) 2000 1999 (Decrease)
--------- --------- ------------------- ---------- --------- -------------------
Segment results:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Retail services....... $1,510 $1,543 $(33) (2.1)% $2,978 $3,047 $(69) (2.3)%
Wholesale services.... 578 526 52 9.9 1,160 1,055 105 10.0
Network services...... (672) (699) 27 3.9 (1,333) (1,384) 51 3.7
Directory services.... 166 145 21 14.5 356 310 46 14.8
</TABLE>
Margins from the retail services segment decreased due to increased
operating expenses. Revenue from the retail services segment increased 8.4% and
7.8% for the three and six months ended June 30, 2000, respectively over the
comparable 1999 periods, primarily due to growth in local services revenues. The
revenue increases were offset by higher operating expenses driven by growth
initiatives and costs associated with enhancing customer service. Margins from
the wholesale services segment increased as a result of greater demand for
access and interconnection services, partially offset by price reductions as
mandated by both federal and state regulatory authorities and higher operating
costs associated with access charge expenses. Margins from the network services
segment increased due to reduced operating expenses. Margins from the directory
services segment increased due to price increases, increased sales of
directory-related Internet products and increased efforts to control costs.
<TABLE>
<CAPTION>
Three Months Ended Six Months
June 30, Ended June 30,
(in millions) 2000 1999 Decrease 2000 1999 Decrease
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Provision (benefit)
for income taxes... $(72) $248 $(320) (129.0)% $170 $488 $(318) (65.2)%
</TABLE>
Provision (benefit) for income taxes. The effective tax rate for the three
months ended June 30, 2000 of 37.3% decreased from the comparable 1999 rate of
37.9%. The effective tax rate of 37.5% for the six months ended June 30, 2000
decreased from the comparable 1999 rate of 37.9%. The decreases in the effective
tax rate were primarily attributable to a lower composite state tax rate for
2000.
Liquidity and Capital Resources
Operating Activities. Cash provided by operations declined to $1.8 billion
for the six months ended June 30, 2000 from $2.1 billion for the prior
comparable period. The decrease was primarily related to a decline in net income
caused by merger-related payments in the second quarter of 2000.
Investing Activities. Total capital expenditures were $2.7 billion for the
six months ended June 30, 2000 and $1.7 billion for the six months ended June
30, 1999. On a pro forma basis, assuming the Merger had been consummated at the
beginning of the year, total capital expenditures are anticipated to be between
$8.0 billion and $8.5 billion for 2000. Capital expenditures have primarily been
and continue to be focused on the modernization and expansion of our network and
meeting the requirements of the Telecommunications Act of 1996 (the "Act"),
including interconnection services such as LNP, operational support systems,
collocation and trunking. We continue to expand our investment to compete in the
wireless, data and video markets. See "Special Note Regarding Forward-Looking
Statements" on page 15.
Future cash needs could increase with the pursuit of new business
opportunities, including the acceleration of the deployment of additional and/or
advanced new services to customers, such as broadband data, wireless and video
services, and may additionally be impacted by continued implementation of the
requirements of the Act. The acceleration of such additional and/or advanced new
services are not expected to have a material adverse impact on our financial
condition or results of operations. Interconnection, LNP, universal service and
access charge reform will negatively impact cash flows to the extent recovery
mechanisms provided by the Federal Communications Commission ("FCC") and PUCs
are inadequate. We would expect that such cash needs will be funded through
operations and, when necessary, the issuance of securities.
Partially offsetting these capital expenditures was the receipt of $1.1
billion on the sale of 24 million shares of Global Crossing common stock in the
first quarter of 2000. In the second quarter of 1999, we invested $2.5 billion
to purchase approximately 39 million shares of Global Crossing common stock in a
tender offer.
Financing Activities. Cash provided by financing activities was $384
million and $2.2 billion for the six months ended June 30, 2000 and 1999,
respectively. In 1999, we increased borrowings to finance the Global Crossing
tender offer.
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 June 30, 2000, we had lines of credit with a total unused borrowing
capacity of approximately $4 billion.
Quantitative and Qualitative Disclosures About Market Risk
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 financial derivatives to hedge interest rate and foreign currency
exposures associated with particular debt issues to synthetically obtain below
market interest rates and have employed derivatives to hedge our risk associated
with equity instruments.
As of June 30, 2000 and December 31, 1999, approximately $4.3 billion and
$2.3 billion, respectively, of floating-rate debt was exposed to changes in
interest rates. This exposure is linked to commercial paper and LIBOR rates. A
hypothetical increase of one-percentage point in commercial paper rates would
increase annual pre-tax interest expense by $43 million. As of June 30, 2000 and
December 31, 1999, we also had $300 million and $522 million, respectively, of
long-term fixed rate debt obligations maturing in the following 12 months. Any
new debt obtained to refinance this debt would be exposed to changes in interest
rates. A hypothetical 10% change in the interest rates on this debt would not
have had a material effect on our earnings.
As of June 30, 2000 and December 31, 1999, we had entered into
cross-currency swaps with notional amounts of $133 million. The cross-currency
swaps synthetically transform $92 million and $94 million of Swiss Franc
borrowings at June 30, 2000 and December 31, 1999, respectively, into U.S.
dollar obligations. Any gains (losses) on the cross-currency swaps would be
offset by losses (gains) on the Swiss Franc debt obligations.
As of June 30, 2000 and December 31, 1999, we had entered into equity swaps
with notional amounts of $932 million and $1.1 billion relating to the sale of
24 million shares of Global Crossing common stock. In connection with the equity
swaps, we entered into several equity collars on certain shares. The equity
collars restrict the magnitude of any gains or losses generated by the equity
swaps. A hypothetical 10% reduction in the market price of Global Crossing
common shares, based upon a market price of $26.31 at June 30, 2000, would
decrease the market value of our net position by $33 million. A hypothetical
increase of one-percentage point in interest rates would decrease the market
value of our net position by $8 million.
At June 30, 2000 and December 31, 1999, we held marketable equity
investments recorded at fair values of $674 million and $1.2 billion,
respectively, which included net unrealized gains of $160 million and $222
million, respectively. The investments have exposure to price risk. The
estimated potential loss in fair value resulting from a hypothetical 10%
decrease in prices quoted by stock exchanges would decrease the fair value of
our equity investments by $67 million.
Recent Regulatory Developments
Access Reform. In May 2000, the FCC adopted the access reform and universal
service proposal developed by the Coalition for Affordable Local and Long
Distance Service ("CALLS plan"). The five year plan significantly reduces
switched access rates, eliminates the Presubscribed Interexchange Carrier Charge
("PICC") while raising current SLC caps, and establishes a new $650 million
universal fund to replace implicit subsidies in interstate access charges. The
CALLS plan is mandatory for the 2000-01 annual price cap tariff filing and
carriers that opt out of the voluntary provisions of the CALLS plan will be
required to conduct a forward-looking cost study to set their rates. We have
appealed the order and asked for a stay of certain provisions. The FCC denied
the request for stay.
The access reform order also continued to allow information service
providers to avoid access charges. This will continue to negatively impact
results of in-region local exchange operations as the volume of information
service-related usage continues to increase without an associated increase in
revenues.
In 2000, the incumbent local exchange carriers ("ILECs") and WorldCom
appealed the February 1999 FCC order declaring Internet traffic to be
interstate. The FCC order required current agreements to remain intact for
reciprocal compensation with CLECs until it rules on this matter. In March 2000,
the U.S. Court of Appeals partially vacated and remanded the order back to the
FCC. Until this is resolved, there will remain uncertainty regarding our local
exchange business' payment obligation for Internet traffic.
Court Remand of 6.5% Productivity Factor. In 1999, the District of Columbia
U.S. Court of Appeals issued a ruling reversing and remanding back to the FCC
its order requiring ILECs to retroactively increase the productivity offset to
price caps to 6.5% in their annual price cap filings. The Court found that the
FCC's order did not justify the increase. In December 1999, the FCC issued a
notice of proposed rulemaking responding to the issues raised in the Court's
remand. As part of adopting CALLS, the FCC noted that the CALLS participants
have agreed to waive any right to recoupment they might be entitled to seek if
the FCC could not justify 6.5% productivity factor on remand. We are reviewing
this issue and considering our options.
Advanced Telecommunications Services. In March 2000, the District of
Columbia U.S. Court of Appeals partially vacated and remanded back to the FCC
its order establishing expanded collocation requirements for both conventional
voice and advanced services. We also appealed the December 1999 FCC order
requiring that line sharing be provided as an unbundled network element ("UNE").
Line sharing allows a CLEC to provide advanced services over the same loop that
the ILEC uses to provide analog voice service. Previously, CLECs purchased a
separate loop to provision advanced services. In March 2000, we and GTE appealed
the FCC's December 1999 order on remand concerning the application of the
unbundling requirement to the provision of advanced services.
Implementation of the 1996 Telecommunications Act. In July 2000, the Eighth
Circuit Court of Appeals affirmed in part and reversed in part the FCC's UNE and
resale pricing rules, vacating and remanding the rules to the FCC. The Court
also affirmed several of its previous rulings regarding other aspects of the
FCC's UNE rules. In June 2000, the FCC affirmed and extended its November 1999
interim constraint on conversion of special access services to unbundled network
element combination pricing and clarified what constitutes a "significant amount
of local exchange service" for determining when loop-transport UNE combination
are available.
InterLATA Long-Distance Entry. We filed applications to enter the interLATA
long-distance business in ten of the states in the U S WEST region and continue
to work with the state PUCs in those states to gain approval. We are addressing
operational support system issues and have agreed to participate in multistate
testing where the states are agreeable. We intend to file entry applications
with our remaining state PUCs by the end of the first quarter of 2001, with FCC
filings following favorable state action. See "Special Note Regarding
Forward-Looking Statements " on page 15.
In June 2000, the FCC approved SBC Communications, Inc.'s application to
provide long distance service in Texas. On August 1, 2000, the US Court of
Appeals for the DC Circuit upheld the FCC's December 1999 approval of Bell
Atlantic-New York's (now Verizon Communications) application to provide
interLATA service in New York. Bell Atlantic has already gained some long
distance market share in New York and SBC is expected to do the same in Texas
now that approval has been granted. This could negatively affect Qwest's long
distance business in those states.
Number Pooling. In March 2000, the FCC issued an order substantially
changing the way telephone numbers are allocated among carriers in order to
avoid the premature exhaustion of telephone numbers in North America. This new
approach must be in place by mid-2001 in our region and will require significant
modifications to operational support systems and switch software with costs
exceeding $345 million. The FCC has issued a further notice of proposed
rulemaking to determine how ILECs may recover these costs in a competitively
neutral way.
Contingencies
We have certain pending regulatory actions. See Note 6 to the condensed
consolidated financial statements.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("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 in the consolidated balance
sheets and changes in fair value generally be recognized currently in earnings
unless specific hedge accounting criteria are met. This standard is effective
for our 2001 fiscal year, 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 2000, its impact on the
consolidated financial statements would not have been material.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (the "Bulletin"), "Revenue Recognition in Financial
Statements," which addresses revenue recognition issues. The Bulletin requires,
in certain cases, nonrefundable up-front fees for services to be deferred and
recognized over the expected period of performance. The Bulletin also requires
that incremental direct costs incurred in obtaining the up-front fees be
deferred and recognized over the same period as the up-front fees. The
implementation of the Bulletin has been delayed until the fourth quarter of 2000
for fiscal years beginning after December 15, 1999. The application of the
Bulletin will be retroactive to January 1, 2000. We are assessing the types of
transactions that may be impacted by this pronouncement. The impact of the
Bulletin on the consolidated financial statements is not yet known.
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Our Company and its subsidiaries are subject to claims and proceedings
arising in the ordinary course of business. For a discussion of these actions,
see Note 6: "Commitments and Contingencies" - to the consolidated financial
statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed for the Company through the filing of this Form 10-Q.
<TABLE>
<CAPTION>
<S> <C>
(2.1) Separation Agreement, dated June 5, 1998, between U S WEST,
Inc. (renamed MediaOne Group, Inc.) ("MediaOne Group") and
USW-C, Inc (renamed U S WEST, Inc.) ("U S WEST"),
(incorporated by reference to U S WEST's Current Report on
Form 8-K/A dated June 26, 1998, File No. 1-14087).
(2.2) Amendment to the Separation Agreement between MediaOne Group
and U S WEST, dated June 12, 1998 (incorporate by reference
to U S WEST's Annual Report on Form 10-K/A for the year
ended December 31, 1998, File No. 1-14087).
(3.1) Amended and Restated Certificate of Incorporation of Qwest,
(incorporated herein by reference to Qwest's Registration
Statement on Form S-4/A, File No. 333-81149, filed September
17, 1999).
(3.2) Amended and Restated Bylaws of Qwest (incorporated herein by
reference to Qwest's Registration Statement on Form S-4/A,
File No. 333-81149, filed September 17, 1999).
(4.1)*** Indenture dated as of October 15, 1997 with Bankers Trust
Company (including form of Qwest's 9.47% Senior Discount
Notes due 2007 and 9.47% Series B Senior Discount Notes due
2007 as an exhibit thereto).
(4.2)**** Indenture dated as of August 28, 1997 with Bankers Trust
Company (including form of Qwest's 10-7/8% Series B Senior
Notes due 2007 as an exhibit thereto).
(4.3)**** Indenture dated as of January 29, 1998 with Bankers Trust
Company (including form of Qwest's 8.29% Senior Discount
Notes due 2008 and 8.29% Series B Senior Discount Notes due
2008 as an exhibit thereto).
(4.4) Indenture dated as of November 4, 1998 with Bankers Trust
Company (including form of Qwest's 7.50% Senior Discount
Notes due 2008 and 7.50% Series B Senior Discount Notes due
2008 as an exhibit thereto) (incorporated by reference to
Qwest's Registration Statement on Form S-4, File No.
333-71603, filed February 2, 1999).
(4.5) Indenture dated as of November 27, 1998 with Bankers Trust
Company (including form of Qwest's 7.25% Senior Discount
Notes due 2008 and 7.25% Series B Senior Discount Notes due
2008 as exhibit thereto) (incorporated by reference to
Qwest's Registration Statement on Form S-4, File No.
333-71603, filed February 2, 1999).
(4.6) Registration Agreement dated November 27, 1998 with Salomon
Brothers Inc. relating to Qwest's 7.25% Senior Discount
Notes due 2008 (incorporated by reference to Qwest's
Registration Statement on Form S-4, File No. 333-71603,
filed February 2, 1999).
(4.7) Indenture dated as of June 23, 1997 between LCI
International, Inc., and First Trust National Association,
as trustee, providing for the issuance of Senior Debt
Securities, including Resolutions of the Pricing Committee
of the Board of Directors establishing the terms of the
7.25% Senior Notes due June 15, 2007 (incorporated by
reference to Exhibit 4(c) in LCI's Current Report on Form
8-K dated June 23, 1997).
(4.8) Registration Rights Agreement, dated August 20, 1999,
between U S WEST Capital Funding Inc., U S WEST, Inc., J.P.
Morgan Securities, Inc. and Merrill Lynch, Pierce, Fenner &
Smith Incorporated (incorporated herein by reference to U S
WEST's Form S-4 Registration Statement, File No. 333-92523,
filed December 10, 1999).
(4.9) Indenture, dated as of June 29, 1998, by and among U S WEST
Capital Funding, Inc., U S WEST, Inc., and The First
National Bank of Chicago (now known as Bank One Trust
Company, National Association), as Trustee (incorporated
herein by reference to U S WEST's Current Report on Form
8-K, dated November 18, 1998, File No. 1-14087).
4.10 First Supplemental Indenture, dated as of June 30, 2000, by
and among U S WEST Capital Funding, Inc., U S WEST, Inc.,
Qwest Communications International Inc., and Bank One Trust
Company, as Trustee.
(10.1)** Growth Share Plan, as amended, effective October 1, 1996.*
(10.2) Equity Incentive Plan, as amended* (incorporated herein by
reference from Exhibit A to Qwest's definitive proxy
statement on Schedule 14A, filed March 17, 2000.
(10.3) Qwest Communications International Inc. Employee Stock
Purchase Plan (incorporated herein by reference to Qwest's
Preliminary Proxy Statement for the Annual Meeting of
Stockholders, filed February 26, 1999).*
(10.4) Qwest Communications International Inc. Deferred
Compensation Plan (incorporated herein by reference to
Qwest's Annual Report on Form 10-K for the year ended
December 31, 1998).*
(10.5)**** Equity Compensation Plan for Non-Employee Directors.
(10.6) Qwest Communications International Inc. 401-K Plan
(incorporated herein by reference to Qwest's Annual Report
on Form 10-K for the year ended December 31, 1998).*
(10.7)** Employment Agreement dated December 21, 1996 with Joseph P.
Nacchio.*
(10.8)**** Growth Share Plan Agreement with Joseph P. Nacchio,
effective January 1, 1997, and Amendment thereto.*
(10.9)**** Non-Qualified Stock Option Agreement with Joseph P. Nacchio,
effective June 23, 1997.*
(10.11)** Promissory Note dated November 20, 1996 and Severance
Agreement dated December 1, 1996 with Robert S. Woodruff.*
(10.12)**** Employment Agreement dated March 7, 1997 with Stephen M.
Jacobsen.*
(10.15)**** Employment Agreement dated October 8, 1997 with Lewis O.
Wilks.*
(10.16)**+ IRU Agreement dated as of October 18, 1996 with Frontier
Communications International Inc.
(10.17)**+ IRU Agreement dated as of February 26, 1996 with WorldCom
Network Services, Inc.
(10.18)**+ IRU Agreement dated as of May 2, 1997 with GTE.
(10.19) LCI International, Inc. 1992 Stock Option Plan (incorporated
herein by reference to LCI's Registration Statement No.
33-60558).*
(10.20) LiTel Communications, Inc. 1993 Stock Option Plan
(incorporated herein by reference to LCI's Registration
Statement No. 33-60558).*
(10.21) LCI International, Inc. 1994/1995 Stock Option Plan
(incorporated herein by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1993).*
(10.22) LCI International, Inc. 1995/1996 Stock Option Plan
(incorporated herein by reference to LCI's Proxy Statement
for the 1995 Annual Meeting of Shareowners.)*
(10.23) LCI International Management Services, Inc. Supplemental
Executive Retirement Plan (incorporated herein by reference
to LCI's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1995).*
(10.24) 1997/1998 LCI International, Inc. Stock Option Plan
(incorporated herein by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1996).*
(10.25) 1995 Stock Option Plan of Icon CMT Corp. (incorporated
herein by reference to Icon CMT Corp.'s Registration
Statement on Form S-1/A, No. 333-38339).*
(10.26) Amendment to Amended and Restated 1995 Stock Option Plan of
Icon CMT Corp. (incorporated herein by reference to Qwest's
Annual Report on Form 10-K for the year ended December 31,
1998).*
(10.27) U.S. Long Distance Corp. 1990 Employee Stock Option Plan
(incorporated herein by reference to Qwest's Annual Report
on Form 10-K for the year ended December 31, 1998).*
(10.28) Participation Agreement dated as of November 1996 among LCI
International, Inc., as the Construction Agent and as the
Lessee, First Security Bank, National Association, as the
Owner Trustee under the Stuart Park Trust, the various banks
and lending institutions which are parties thereto from time
to time as the Holders, the various banks and lending
institutions which are parties thereto from time to time as
the Lenders and NationsBank of Texas, N.A., as the Agent for
the Lenders (incorporated herein by reference to LCI's
Annual Report on Form 10-K for the year ended December 31,
1996).
(10.29) Agency Agreement between LCI International, Inc., as the
Construction Agent and First Security Bank, National
Association, as the Owner Trustee under the Stuart Park
Trust as the Lessor dated as of November 15, 1996
(incorporated herein by reference to LCI's Annual Report on
Form 10-K for the year ended December 31, 1996).
(10.30) Deed of Lease Agreement dated as of November 15, 1996
between First Security Bank, National Association as the
Owner Trustee under the Stuart Park Trust, as Lessor and LCI
International, Inc. as Lessee (incorporated herein by
reference to LCI's Annual Report on Form 10-K for the year
ended December 31, 1996).
(10.31) Common Stock Purchase Agreement dated as of December 14,
1998 with Microsoft Corporation (incorporated herein by
reference to Qwest's Current Report on Form 8-K filed
December 16, 1998).
(10.32) Registration Rights Agreement dated December 14, 1998 with
Microsoft Corporation (incorporated herein by reference to
Qwest's Current Report on Form 8-K filed December 16, 1998).
(10.33) Registration Rights Agreement dated as of April 18, 1999
with Anschutz Company and Anschutz Family Investment Company
LLC (incorporated herein by reference to Qwest's Current
Report on Form 8-K/A filed April 28, 1999).
(10.34) Common Stock Purchase Agreement dated as of April 19, 1999
with BellSouth Enterprises, Inc. (incorporated herein by
reference to Qwest's Current Report on Form 8-K/A filed
April 28, 1999).
(10.35) Registration Rights Agreement dated as of April 19, 1999
with BellSouth Enterprises, Inc. (incorporated herein by
reference to Qwest's Current Report on Form 8-K/A filed
April 28, 1999).
(10.36) Voting Agreement dated as of July 18, 1999 among each of the
shareholders listed on the signature page thereto and U S
WEST, Inc. (incorporated herein by reference to Qwest's
Registration Statement on Form S-4/A, File No. 333-81149,
filed September 17, 1999).
(10.37) Purchase Agreement by and among Qwest, Slingshort Networks,
LLC and Anschutz Digital Media, Inc. dated September 26,
1999 (incorporated herein by reference to Qwest's quarterly
report on Form 10-Q for the quarter ended September 30,
1999).
10.38 Unit Purchase Agreement dated June 21, 2000 by and among
U.S. Telesource, Inc. and Anschutz Digital Media, Inc.
10.39 Second Amended and Restated Operating Agreement of
Slingshort Networks, LLC entered into as of June 21, 2000
between Anschutz Digital Media, Inc. and U.S. Telesource,
Inc.
(10.40) Employee Matters Agreement between MediaOne Group and U S
WEST dated June 5, 1998 (incorporated herein by reference to
U S WEST's Current Report on Form 8-K/A dated June 26, 1998,
File No. 1-14087).
(10.41) Tax Sharing Agreement between MediaOne Group and U S WEST,
dated June 5, 1998 (incorporated herein by reference to U S
WEST's Current Report on Form 8-K/A dated June 26, 1998,
File No. 1-14087).
(10.42) 364-Day $4.0 Billion Credit Agreement, dated as of May 5,
2000, among U S WEST, Inc., U S WEST Capital Funding, Inc.,
U S WEST Communications, Inc., the banks listed therein, and
Morgan Guaranty Trust Company of New York, as administrative
agent (incorporated herein by reference to U S WEST's
quarterly report on Form 10-Q for the quarter ended March
31, 2000).
10.43 Purchase Agreement dated July 3, 2000 among Qwest Capital
Funding, Inc. and Qwest Communications
International Inc.
10.44 Paying Agent Agreement made as of the 7th day of July, 2000
between The Bank of New York and
Qwest Capital Funding, Inc.
10.45 Calculation Agency Agreement dated as of July 7, 2000
between Qwest Capital Funding, Inc. and The Bank of New
York.
(10.60) 1998 U S WEST Stock Plan (incorporated herein by reference
to U S WEST's Form S-4 Registration Statement, File No.
333-45765, filed February 6, 1998, as amended).
(10.61)* U S WEST Executive Short-Term Incentive Plan (incorporated
herein by reference to U S WEST's Form S-4 Registration
Statement, File No. 333-45765, filed February 6, 1998, as
amended).
(10.62)* U S WEST 1998 Broad Based Stock Option Plan, dated June 12,
1998 (Exhibit 10(l) to Form 10-Q for the quarter ended
September 30, 1998, File No. 1-14087).
(10.63)* U S WEST Deferred Compensation Plan, amended and restated
effective as of June 12, 1998 (Exhibit 10(m) to Form 10-Q
for the quarter ended September 30, 1998, File No. 1-14087).
(10.64)* U S WEST 1998 Stock Plan, as amended June 22, 1998 (Exhibit
10(n) to Form 10-Q for the quarter ended September 30, 1998,
File No. 1-14087).
(10.65)* 1998 U S WEST Stock Plan, as amended August 6, 1999 (Exhibit
10-O.1 to Form 10-Q for the quarter ended September 30,
1999, File No. 1-14087).
(10.66)* 1999 U S WEST Stock Plan, as amended August 6, 1999 (Exhibit
10-O.2 to Form 10-Q for the quarter ended September 30,
1999, File No. 1-14087).
(10.67) Form of Agreement for Purchase and Sale of Telephone
Exchanges, dated as of June 16, 1999, between Citizens
Utilities Company and U S WEST Communications, Inc. (Exhibit
99 to Form 8-K, dated June 17, 1999, File No. 1-14087).
27 Financial Data Schedule
(99) Annual Report on Form 11-K for the U S WEST Savings
Plan/ESOP for the year ended December 31, 1999 (incorporated
by reference to U S WEST's Annual Report on Form 10-K, File
No. 1-14087, Paper Copy (P).
-------------------
<FN>
<F1>
( ) Previously filed.
<F2>
* Executive Compensation Plans and Arrangements.
<F3>
** Incorporated by reference in Form S-1 as declared effective on June 23,
1997 (File No. 333-25391).
<F4>
*** Incorporated by reference to exhibit 4.1 in Form S-4 as declared effective
on January 5, 1998 (File No. 333-42847).
<F5>
**** Incorporated by reference in Qwest's Form 10-K for the year ended December
31, 1997.
<F6>
+ Portions have been omitted pursuant to a request for confidential
treatment.
<F7>
</FN>
</TABLE>
(b) Reports on Form 8-K:
(i) On April 19, 2000, Qwest filed a Current Report on Form 8-K announcing
its financial results for the first quarter of 2000.
(ii) On July 3, 2000, Qwest filed a Current Report on Form 8-K announcing
the completion of the merger with U S WEST, Inc.
(iii) On July 7, 2000, Qwest filed a Current Report on Form 8-K regarding
a meeting with investors and financial analysts.
<PAGE>
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.
Qwest Communications International Inc.
By: /s/ ROBERT S. WOODRUFF
Robert S. Woodruff
Executive Vice President - Finance and
Chief Financial Officer
August 11, 2000
