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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
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 SPECIFIED IN ITS CHARTER)
DELAWARE 84-1339282
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(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER
ORGANIZATION) IDENTIFICATION NO.)
700 QWEST TOWER
555 SEVENTEENTH STREET
DENVER, COLORADO 80202
----------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(303) 992-1400
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
As of March 7, 2000, approximately 753 million shares of the Registrant's
Common Stock, $.01 par value, were issued and outstanding. The aggregate market
value of the Common Stock held by non-affiliates of the Registrant, based on the
closing price of the Common Stock as reported on the New York Stock Exchange on
March 7, 2000 was approximately $42.2 billion.
DOCUMENTS INCORPORATED BY REFERENCE
Document Where Incorporated
- -------- ------------------
Annual Report for the year ended Part II, Items 5, 6, 7, 7A, and 8
December 31, 1999
Proxy Statement for Qwest's Annual Meeting Part III, Items 10, 11, 12 and 13
of Stockholders to be held May 3, 2000
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QWEST COMMUNICATIONS INTERNATIONAL INC.
FISCAL YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
Page
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Part I
Item 1 Business................................................. 4
Item 2 Properties............................................... 20
Item 3 Legal Proceedings........................................ 20
Item 4 Submission of Matters to a Vote of Security Holders...... 21
Part II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters...................................... 22
Item 6 Selected Financial Data.................................. 22
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 22
Item 7A Quantitative and Qualitative Disclosures About
Market Risk.............................................. 22
Item 8 Financial Statements and Supplementary Data.............. 22
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... 22
Part III
Item 10 Directors and Executive Officers of the Registrant....... 22
Item 11 Executive Compensation................................... 22
Item 12 Security Ownership of Certain Beneficial Owners and
Management............................................... 22
Item 13 Certain Relationships and Related Transactions........... 22
Part IV
Item 14 Exhibits, Financial Statement Schedules, and Reports
on Form 8-K.............................................. 23
Signature Page........................................... 26
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Information Regarding Forward-Looking Statements
This report contains or incorporates by reference "forward-looking
statements" as that term is used in federal securities laws about Qwest's
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 document, or may be
incorporated by reference to other documents Qwest has filed with the Securities
and Exchange Commission ("SEC"). You can find many of these statements by
looking for words such as "believes", "expects", "anticipates", "estimates", or
similar expressions used in this report or incorporated by reference in this
report.
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 these
statements. The risks and uncertainties include those risks, uncertainties and
risk factors identified, among other places, under "Risk Factors" in Qwest's
registration statement on Form S-4, SEC file number 333-81149.
The most important factors that could prevent Qwest from achieving its
stated goals include, but are not limited to, the following:
. operating and financial risks related to managing rapid growth,
integrating acquired businesses and sustaining operating cash flow to meet
Qwest's debt service requirements, make capital expenditures and fund
operations;
. potential fluctuation in quarterly results;
. volatility of stock price;
. intense competition in the communications services market;
. dependence on new product development;
. Qwest's ability to achieve year 2000 compliance;
. rapid and significant changes in technology and markets;
. adverse changes in the regulatory or legislative environment affecting
Qwest's business;
. failure to maintain necessary rights of way; and
. failure to complete the merger with U S WEST or achieve the projected
synergies and financial results timely or at all and difficulties in
combining the operations of Qwest and U S WEST.
Qwest cautions you not to place undue reliance on the statements, which
speak only as of the date of this report or, in the case of documents
incorporated by reference, the date of the document.
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
undertakes no 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 report or to reflect
the occurrence of unanticipated events.
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Part I.
Item 1. Business
Qwest Communications International Inc. ("Qwest") is a leading broadband
Internet communications company engaged in two core businesses: communications
services and construction services.
Communications services includes Internet, multimedia, data and voice
services sold to business, consumer and government customers. Internet and
multimedia services include Internet Protocol ("IP")-enabled services such as
dedicated and dial up Internet access, web hosting, co-location access, voice
over IP, application hosting and mass storage services. Qwest also provides
high-volume voice and conventional private line services to other communications
providers, as well as to Internet service providers ("ISPs"), and other data
service companies.
Qwest's network uses both Internet communications technology and traditional
telephone communications technology. Communications on the Internet are governed
by Internet Protocol, a standard that allows communication across the Internet
regardless of the hardware and software used.
Construction services constructs and installs fiber optic systems for other
communications providers, as well as for Qwest's own use.
Qwest is developing Internet and multimedia services in alignment with
existing and anticipated market demand in partnership with leading information
technology companies, including the following:
. Microsoft Corporation for business applications and service;
. KPMG LLP (through the Qwest Cyber.Solutions joint venture) for application
service provider, application hosting and application management services;
. SAP America, Inc. and Hewlett Packard Company for hosting and systems
management services;
. Covad Communications Group, Inc. ("Covad") and Rhythms NetConnections Inc.
("Rhythms") for digital subscriber line ("DSL") technology for high-speed
local network connectivity;
. Oracle Corporation and Siebel Systems, Inc. for application hosting services;
and
. Hewlett Packard Company for high-end data storage.
Qwest's principal asset is its high-capacity fiber optic network. The
network reaches over 25,500 miles in North America, and is designed to allow
customers to seamlessly exchange multimedia content - images, data and voice
over the public circuit switched telephone network without the need to dial
access codes or follow other similar special procedures. The technologically
advanced network is designed to instantaneously re-route traffic in the event of
a fiber cut to prevent interruption in service to Qwest's customers. This is
accomplished by automatically re-routing traffic in the opposite direction
around the Sonet ring. The network is equipped with technologically advanced
fiber and state-of-the-art transmission electronics. At full capacity, Qwest's
network could transmit two trillion bits of multimedia information per second.
Qwest's network is designed to support Internet Protocol, as well as traditional
circuit-switched services, and alternative information transfer standards used
for data transmission.
The network connects approximately 150 metropolitan areas coast-to-coast.
Qwest was the first network service provider to complete a transcontinental
Internet Protocol fiber network when it activated the Qwest network from Los
Angeles to San Francisco to New York in April 1998.
KPNQwest, a European joint venture of Qwest and KPN, the Dutch
telecommunications company, is building and will operate a high-capacity
European fiber optic, Internet-based network that is currently expected to
connect 46 cities throughout Europe when it is completed.
Qwest has also built a 1,400 route-mile network in Mexico, and is part of a
consortium of communications companies that is building a 13,125-mile underwater
cable network connecting the United States to Japan.
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In addition to significant advantages in speed, reliability, scalability,
and security, the Qwest network's advanced technologies should also provide a
cost advantage over older fiber systems generally in commercial use today. Qwest
received an additional cost benefit from the sale of dark fiber along the
network, which reduced its net cost in the network retained for its own use.
Mergers and Acquisitions
Qwest continually evaluates opportunities to become a stronger competitor and
to accelerate the growth of its business. A key strategy has been to add
strength through investments in or acquisitions of businesses, facilities or
other assets that build on Qwest's service and technology base.
In July 1999, Qwest entered into a definitive merger agreement with U S WEST,
Inc ("U S West"). Under the terms of the merger agreement, Qwest will issue
shares of its common stock having a value of $69.00 for each share of U S WEST
common stock, subject to a "collar" on Qwest's average stock price between
$28.26 and $39.90 per share. The number of Qwest shares to be issued for each U
S WEST share will be determined by dividing $69.00 by the average of the daily
volume weighted average prices of Qwest common stock for 15 randomly selected
trading days over a 30-day measurement period ending three days before the
closing of the transaction, provided that Qwest will not issue more than 2.44161
shares for each U S WEST share or less than 1.72932 shares for each U S WEST
share. The transaction will be accounted for as a purchase with U S WEST deemed
the accounting acquiror and is structured to be tax-free to U S WEST shareowners
to the extent of the Qwest stock delivered in the transaction.
If Qwest's average stock price is below $38.70 per share, the obligation
under the "collar" for the amount which the price is below $38.70 per share may
be satisfied in whole or in part with cash. In determining the cash amount for
the collar, Qwest and U S WEST will consider Qwest's desire to reduce dilution
to its stockholders, U S WEST's potential desire to provide a cash element to
its stockholders and both companies' desire to maintain the combined company's
strong financial condition. If the companies decide to provide cash as part of
the collar consideration, the minimum exchange ratio would be 1.783.
U S WEST may terminate the merger agreement if the closing price of Qwest's
shares is below $22.00 for 20 consecutive trading days before the closing, or if
the average Qwest share price during the measurement period is less than $22.00.
The Boards of Directors and stockholders of both Qwest and U S WEST have
approved the proposed transaction. The transaction is subject to federal and
state regulatory approvals and other customary closing conditions. Closing of
the transaction is expected in mid-2000.
As a result of the transaction, Qwest will become subject to the regulations
applicable to U S WEST, a Regional Bell Operating Company ("RBOC"). Generally,
effective as of the closing of the transaction, Qwest may not provide inter-LATA
transport services within U S WEST's 14-state region until U S WEST receives
approval to provide such services under Section 271 of the Telecommunications
Act of 1996, as amended. Therefore, Qwest is in the process of divesting the
prohibited services.
In connection with the termination of the U S WEST and Global Crossing merger
agreement, U S WEST paid Global Crossing a break-up fee of $140.0 million in
cash and agreed to return $140.0 million in Global Crossing shares, valued at
$62.75 per share, purchased by U S WEST in connection with its agreement with
Global Crossing. Qwest advanced to U S WEST the $140.0 million cash payment and
agreed to purchase $140.0 million in services from Global Crossing over four
years at the best commercially available prices.
In December 1998, Qwest acquired Icon CMT Corp. ("Icon"), a leading Internet
solutions provider, for approximately $254.1 million in Qwest common stock.
Qwest issued approximately 11.8 million shares of Qwest's common stock
(including outstanding Icon stock options and warrants assumed by Qwest). The
addition of Icon's sales channels, data centers and more than 400 information
technology professionals gave Qwest new resources for developing, integrating
and maintaining advanced web hosting services and electronic commerce solutions.
In June 1998, Qwest acquired LCI for approximately 259.8 million shares of
Qwest's common stock (including outstanding LCI stock options assumed by Qwest),
then valued at approximately $3.9 billion. LCI has brought to Qwest
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a nationwide customer base, sales, marketing and support facilities, an
intelligent network platform and customer care and billing system.
In April 1998, Qwest acquired Amsterdam-based EUnet International Limited for
approximately $4.2 million in cash and approximately 7.9 million shares of
Qwest's common stock, then valued at approximately $154.0 million. EUnet, a
leading European Internet service provider, had business operations in 14
European countries.
In March 1998, Qwest acquired Phoenix Network, Inc., a reseller of long
distance services, for approximately 1.6 million shares of Qwest's common stock,
then valued at approximately $27.2 million.
Strategic Investments and Other Alliances
Investment in Slingshot Networks LLC/ Purchase of Certain Assets of ADMI.
In September 1999, Qwest and Anschutz Digital Media, Inc. ("ADMI"), an affiliate
of Qwest's principal stockholder, Anschutz Company, entered into an agreement to
form a joint venture called Slingshot Networks LLC to provide advanced digital
production, post-production and transmission facilities, digital media storage
and distribution services, telephony-based data storage and enhanced services,
access and routing services. Qwest and ADMI each own 50% of the joint venture.
Qwest contributed approximately $84.8 million consisting of a promissory note
payable over nine years at an annual interest rate of 6%. Qwest's investment in
the joint venture is accounted for under the equity method. The agreement
between Qwest and ADMI also provided that Qwest would purchase certain
telephony-related assets and all of the stock of Precision Systems, Inc., a
telecommunications solutions provider, from ADMI in exchange for a promissory
note in the amount of $34 million. The promissory note is payable over nine
years and bears interest at an annual rate of 6%.
Investment in Advanced Radio Telecom Corp. In September 1999, Qwest invested
$90.0 million for an approximate 19% stake in Advanced Radio Telecom Corp.
("ART"), a facilities-based, broadband ISP that provides a direct connection
from customer location to the Internet, to help support the construction of
ART's fixed, high-speed wireless networks. In connection with this transaction,
a separate group of investors also invested $161.0 million.
Investment in Qwest Cyber.Solutions LLC. In June 1999, Qwest and KPMG LLP, a
leading professional services firm, formed a joint venture called Qwest
Cyber.Solutions LLC, to provide Internet-based end-to-end application service
provider, application hosting, and application management services. The venture
will offer customers a broad set of vendor products available for Enterprise
Resource Planning ("ERP"), Customer Relationship Management ("CRM") and back
office solutions, a state-of-the-art Internet Protocol ("IP") broadband network,
and technologically advanced CyberCenters. Qwest contributed approximately
$60.0 million consisting of cash and other assets, and owns a 51% stake in the
venture. The financial position and results of operation of the venture have
been consolidated in the accompanying financial statements from the date of
formation and the minority interest represents KPMG's stake in the venture.
Strategic Relationship With BellSouth. In April 1999, BellSouth Corporation
(together with its subsidiaries, "BellSouth") and Qwest announced a strategic
relationship whereby BellSouth invested approximately $3.5 billion for an
approximate 10% equity stake in Qwest. Qwest issued approximately 40.7 million
shares to BellSouth in exchange for approximately $1.9 billion in cash. Qwest's
principal stockholder, Anschutz Company, sold approximately 33.3 million
existing shares to BellSouth for approximately $1.6 billion. At the same time,
a BellSouth affiliate and Qwest entered into a commercial arrangement for
provisioning of a full range of integrated digital data, image and voice
communications services for customers. These services will include Qwest's
portfolio of data networking, Internet and voice services and BellSouth's local
networking services. Once BellSouth is allowed to enter the long distance
market, the companies will jointly develop and deliver a comprehensive set of
end-to-end, high-speed data, image and voice communications services to business
customers, with an emphasis on broadband and Internet-based data services.
KPNQwest Joint Venture. In April 1999, Qwest and KPN Telecom B.V. ("KPN"),
the Dutch telecommunications company, formed a joint venture to create a pan-
European IP-based fiber optic network, linked to Qwest's network in North
America, for data and multimedia services. Qwest and KPN each initially owned 50
percent of KPNQwest, which was initially governed by a six person supervisory
board to which Qwest and KPN had each named three members.. Upon formation of
KPNQwest, KPN contributed two partially completed bi-directional, self-healing
fiber optic rings (EuroRings(TM) 1 and 2) and certain communications services
contracts to KPNQwest. Qwest contributed Xlink Internet Service Gmbh ("Xlink"),
the operating subsidiaries of EUnet and cash. Also, Qwest and KPN contributed
transatlantic capacity that connects KPNQwest's European network with Qwest's
network in North America, and also contributed certain other assets. The net
book value of total assets contributed by Qwest totaled approximately $300.0
million.
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Qwest deconsolidated EUnet and Xlink in April 1999. Qwest's investment in
KPNQwest is accounted for under the equity method.
KPNQwest offers managed broadband services, IP transit, Internet connectivity
and value-added IP services, including consulting, hosting, and the transmission
of live events over the Internet. KPNQwest also sells dark fiber along its
network. Customers of KPNQwest include Internet services and content providers,
multinational firms in Europe and North America, as well as telecommunications
carriers, operators and others who want to purchase wholesale or retail network
capacity, fiber or services.
On November 12, 1999 KPNQwest consummated an initial public offering in which
50.6 million shares of common stock were issued generating approximately $1.0
billion in net proceeds. The consummation of KPNQwest's IPO has resulted in
approximately 11% of KPNQwest's shares being owned by the public and the
remainder of KPNQwest's shares being owned by each of Qwest and KPN equally. As
a result of the change in ownership structure of KPNQwest, two outside directors
were added to the supervisory board.
Also as a result of KPNQwest's initial public offering, Qwest recognized a
gain of $414.0 million, representing its proportionate share of the increase in
KPNQwest's equity. As of December 31, 1999, the fair market value of Qwest's
investment in KPNQwest was approximately $12.8 billion, based on the closing
price of KPNQwest's common stock on the Nasdaq stock market.
Investment in Rhythms. In April 1999, Qwest made an equity investment,
totaling $15.0 million in cash, in DSL local networks through an agreement with
Rhythms NetConnections Inc. ("Rhythms"), a packet-based Competitive Local
Exchange Carrier ("CLEC") that provides high-speed networking solutions for
remote access to private networks and the Internet. Under this agreement, Qwest
will have access to 29 metropolitan areas (10 of which are in addition to the
areas covered by an agreement that Qwest has with Covad Communications Group
Inc.), while further enhancing its ability to provide its customers with high-
speed DSL connectivity to its network. Qwest has committed to place a minimum
number of orders for DSL service over a seven-year term commencing on the date
that Rhythms is operational in the 29 metropolitan areas. In the event that
Qwest fails to meet the order target, Qwest is committed to pay Rhythms for the
difference between the order target and the number of actual orders placed.
Qwest's investment in Rhythms is accounted for under the cost method.
Investment in Covad. In January 1999, Qwest made an equity investment,
totaling $15.0 million in cash, in high-speed, DSL local networks through an
agreement with Covad Communications Group, Inc. ("Covad"), a packet-based CLEC.
Under this agreement, Qwest will have access to 22 metropolitan areas, while
enhancing its ability to provide its customers with high-speed DSL connectivity
to its network. Qwest has committed to purchase DSL services for approximately
$20.0 million over a five-year term commencing on the date that Covad's DSL
services are commercially available in all 22 metropolitan areas. Qwest's
investment in Covad is accounted for under the cost method.
Alliance With Microsoft. In December 1998, Qwest entered into a strategic
alliance with Microsoft that will enable businesses to utilize high-speed
network services that maximize network resources, reduce costs, generate new
sources of revenue and optimize management of computing operations. Qwest's
service, to be built on the Microsoft(R) operating systems and application
platforms, when integrated with Qwest's IP-based fiber optic network, is
designed for businesses of all sizes. Microsoft will license a broad range of
its software to Qwest. The parties will jointly market and sell the services. In
addition, Microsoft purchased 8.8 million shares of Qwest for $200.0 million.
Communications Industry Overview
Communications services consist primarily of local exchange services, long
distance services and Internet access services.
A local call is one that does not require the services of a long distance
carrier. It originates and terminates along a local exchange network. Local
exchange carriers connect end user customers within their local exchange areas
and also provide the local portion of most long distance calls.
A long distance telephone call originates with a customer within a local
exchange network and travels along the local exchange network to a long distance
carrier. The long distance carrier combines the call with other calls and sends
them along a long distance network to a different local exchange network where
the call terminates. Long distance
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carriers provide only the connection between the two local networks, and pay
access charges to local exchange carriers for originating and terminating calls.
The Internet is a global collection of interconnected computer networks that
allows commercial organizations, educational institutions, government agencies
and individuals to communicate electronically, access and share information and
conduct business.
Internet access services require a local network connection from a customer
to an Internet service provider's local facility. For large, communication-
intensive users, these connections are typically dedicated connections direct
from the customer to the Internet service provider. For residential and small
and medium sized business users, these connections are generally achieved by
cable modem, Digital Subscriber Line, or dial-up access into a local exchange.
Once a local connection is made to the Internet service provider's local
facilities, information can be transmitted and obtained over a packet-switched
data network. This network may consist of segments provided by many
interconnected networks operated by a number of Internet service providers.
This collection of interconnected networks makes up the Internet. Communications
on the Internet are governed by Internet Protocol, an inter-networking standard
that enables communication across the Internet regardless of the hardware and
software used.
In addition, businesses can utilize the facilities of communications service
providers for web hosting and Application Service Provider ("ASP") enabled
services. Through web hosting, customers can outsource the maintenance and
connectivity to accommodate businesses multimedia, corporate intranet/extranet
and e-commerce applications. ASP services allows independent service vendors
and systems integrators to deliver software and technical media from
centralized, secured locations.
Switching is the critical process of selecting paths for the transmission of
data, voice and images to a specific recipient. Switches on a network route
traffic to the designated recipient. There are two widely used switching
technologies in communications networks: circuit-switching systems, generally
used in traditional telephone communication, and packet-switching systems,
generally used to provide communication services over the Internet, such as
Qwest's services. Circuit-switch based communications systems establish a
dedicated channel for each communication (such as a telephone call for voice or
fax), maintain the channel for the duration of the call, and disconnect the
channel at the conclusion of the call. Packet-switch based communications
systems format the information to be transmitted, such as e-mail, voice, fax and
data, into a series of shorter digital messages called "packets," and a single
dedicated channel between communication points is never established. Each
packet consists of a portion of the complete message plus the addressing
information to identify the destination and return address.
Packet-switch based systems offer several advantages over circuit-switch
based systems, particularly the ability to commingle packets from several
communications sources together simultaneously onto a single channel. For most
communications, particularly those with bursts of information followed by
periods of "silence," the ability to commingle packets provides for superior
network use and efficiency, resulting in more information being transmitted
through a given communication channel. There are, however, certain
disadvantages to packet-switch based systems as currently implemented. Rapidly
increasing demands for data, in part driven by the Internet traffic volumes, are
straining capacity and contributing to delays and interruptions in
communications transmissions. With current technology, the desired voice
quality and real-time communications features of a traditional telephone call
can only be achieved by having in place a substantial network capacity.
The Qwest network allows the transmission of traffic seamlessly between an
Internet Protocol network and the circuit-based traditional telephone
communication network, providing the Qwest network with the same comprehensive
coverage as the traditional telephone communication network. Specifically,
Qwest is able to (1) originate traditional telephone communication network
traffic from a local exchange carrier's switch (when the origination point is
not on Qwest's network), (2) route the traffic over the Qwest network and (3)
deliver the traffic either (a) directly to its destination (if the destination
is on the Qwest network) or (b) to an interconnection point where the traffic is
transferred back to the traditional telephone communication network. The
routing of traffic to this interconnection point is determined based on a least-
cost routing criteria. This gives Qwest the ability to obtain the benefits of
packet-switch based communications protocols on its network, while allowing its
customers to use their existing equipment, telephone numbers and dialing
procedures, without additional access codes, for routing the call to the Qwest
network.
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Qwest's Macro Capacity(SM) Fiber Network
Qwest's Macro Capacity(SM) Fiber Network has approximately 350 Internet
protocol routers, 150 data switches and 26 voice switches in various locations
across the United States. Qwest expects to activate approximately 1,500
additional Internet protocol routers and 75 additional data switches in 2000.
As of December 31, 1999, Qwest's network assets and physical components
included:
. High-density polyethylene conduits, which is hollow tubing 1 1/2 to 2
inches in diameter;
. Each fiber optic cable contains 96 to 288 fiber strands, which is placed
inside the conduits and strengthened by metal, and at least 2 to 8 fibers
activated on Qwest's behalf; Each fiber strand is capable of transmitting
information at an OC-192 level.
. Electronic equipment necessary to activate the fiber for transmission;
. Data and voice switches that enable Qwest to provide a variety of basic
and enhanced data, voice and image services to customers; and
. Approximately 150 points of presence.
With the completion of its network, Qwest is providing communications
services nationally to its customers primarily over its own network, using
leased facilities in those portions of the country not covered by its network.
Qwest's approach to building its network, and the features of the network
itself, offer a range of competitive performance and cost advantages.
Qwest is expanding its worldwide broadband services portfolio to include end-
to-end connectivity for Qwest local internet services to large and multi-
location enterprises and carriers in key metropolitan U.S. markets. Qwest is
leveraging the many completed metropolitan area fiber rings and right-of-ways
that were built as part of the nationwide backbone build. Qwest expects to
complete construction of extensive fiber and DSL networks in 25 major cities by
2001. Eleven major cities are expected to be completed by the end of 2000 and
the remainder by the end of 2001.
Qwest also continues to evaluate opportunities to acquire or invest in
businesses, facilities and other assets that would allow it to improve and
expand services, compete more effectively and create new opportunities for
growth.
Advanced Technology. Using advanced technologies, Qwest installed
technologically advanced fiber optic cable and electronic equipment throughout
its network, and is testing the next generation equipment for deployment in the
latter half of 2000. Qwest's network uses Dense Wavelength Division Multiplexing
capable fiber and electronic technologies in a bi-directional line switch ring
topology to give the network transmission capacity and high reliability levels.
Qwest's network is designed for superior security and reliability, based on:
. Two-way ring architecture, known as "Sonet rings", a self-healing system that
allows for nearly instantaneous re-routing and virtually eliminates downtime
in the event of a fiber cut by automatically re-routing traffic in the
opposite direction around the ring;
. Fiber cable installed in high-density polyethylene conduit generally buried
48-60 inches below the ground;
. Extensive use of railroad rights of way. This approach typically offers
greater protection of the fiber system than systems built over more public
rights of way, such as highways, telephone poles or overhead power
transmission lines.
Qwest's network is also designed for expandability and flexibility. It
contains two conduits along virtually the entire route. The first conduit
contains a cable generally housing 96 to 288 fibers. The second conduit serves
as a spare, allowing for future technology upgrades and capacity expansion at
costs far below the cost of new construction.
Network Management. Qwest monitors its network 24 hours a day, seven days a
week from its Network Management Centers in Denver, Colorado, Dublin, Ohio and
Arlington, Virginia. These facilities provide network surveillance,
troubleshooting and customer service, using technology that enables Qwest to
reduce service costs and customer downtime. The system currently allows Qwest
technicians to detect a component malfunction in the network, quickly re-route
the customer to an available alternate path and handle the repair. When the
network is completed, two-way ring architecture will allow the re-routing to be
fully automated.
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In addition, Qwest has placed more network control in the hands of large
business customers. Customers will be able to monitor and instantly reconfigure
their leased capacity from their own network management centers. The system's
software allows management of equipment inventory, bandwidth inventory,
configuration and fault isolation, as well as "point-and-click" supply of
communications services and alarm monitoring.
Rights of Way. As of December 31, 1999, Qwest has in place agreements for
all of the rights of way needed on its network. Approximately 70% of the
domestic network is installed on railroad rights of way. In addition to greater
security and protection than afforded systems built along public rights of way,
railroad rights of way also generally provide the network with a direct,
continuous route between cities. This eliminates the time and costs typically
needed to piece together rights of way using a combination of agreements with
private owners and state or municipal agencies. Also, railroad rights of way
typically extend into downtown areas of strategically important cities. Qwest's
right-of-way agreements provide for cash payments, exchanges of rights of way
for network capacity or a combination of both.
Qwest has other right-of-way agreements in place, where necessary or
economically preferable, with highway commissions, utilities, political
subdivisions and others.
Network Installation. Qwest employs experienced construction personnel and
uses its own fleet of equipment, as well as leased equipment, and supplements
these resources with independent contractors.
Dark Fiber Sales. Qwest entered into agreements with three significant
customers (during 1996 and 1997) and with others for the purchase of dark fiber
along Qwest's network. The proceeds from these contracts for the sale of dark
fiber provide cash for a significant portion of the total estimated costs to
construct the network and to provide the dark fiber that is being sold.
Qwest believes that there continue to be opportunities to sell additional
dark fiber throughout its network, and management continues to explore these
opportunities with potential customers. However, Qwest does not expect to enter
into additional agreements of the size and scope of the three significant
contracts entered into during 1996 and 1997. Potential new customers include
other inter-exchange carriers, cable, entertainment and data transmission
companies, federal and state governments, Internet service providers, local
exchange carriers and competitive local exchange carriers. To meet the needs of
a diverse group of existing and potential customers, Qwest offers a wide variety
of pricing and system options to meet specific needs of each customer. Customers
may purchase or lease dark fiber or purchase capacity on a short- or long-term
basis.
Significant Customers
Two customers accounted for 31.2% and 36.6% of consolidated revenue,
respectively, in 1997 primarily from construction contracts for the sale of dark
fiber. No individual customer accounted for 10% or more of such revenue in
1998 or 1999.
Business Segments
Qwest has two distinct business segments: communications services and
construction services. Communications services provides a full array of
traditional telecommunications, Internet protocol communications, web-based
multimedia services and other data products and services to customers.
Construction services provides turnkey fiber optic systems for major inter-
exchange carriers and for Qwest's own use.
Communications Services
Total revenue from communications services was approximately $3,703.1
million, $1,554.3 million and $115.3 million in 1999, 1998 and 1997,
respectively.
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Business Services. Qwest markets the following products and services to
businesses:
. Dedicated Internet Access -- offer a premium level of performance and
security because traffic is transmitted over a nationwide OC-48 Internet
Protocol network at the highest rates available with nearly zero percent
packet loss. Public and private peering arrangements are extensive for inter-
provider data transmission
. DSL -- Digital Subscriber Line technology utilizes the copper wire between a
customer's business and the Regional Bell Operating Company's (RBOC's)
central office, to allow data transfer faster. Qwest offers a suite of
solutions for accessing both the public Internet and private intranets
. Dedicated Hosting -- locates customer servers and equipment in secure,
state-of- the-art Qwest CyberCenters(SM), which are supported 24/7 by highly
trained staff. Applications are protected with redundant HVAC air filtration,
fire suppression systems, UPS power protection, and diesel generator backup
. Virtual Private Network -- private network systems provided over Qwest's
network, and includes customized dialing plans, routing and calling
privileges and customized billing features
. Online Commerce -- Qwest's Q.commerce(sm) retail offers a complete e-commerce
solution for retailers, business-to-business companies and direct mail
outlets
. Private Line -- dedicated point-to-point voice, data, video and fax in a
range of products, packages and speeds
. ATM -- comprehensive, state-of-the-art networking technology that leverages
the power of the Qwest Macro CapacityO Fiber Network to handle Internet,
data, images and voice traffic
. Frame Relay -- a proven high-speed data packet service. Ideal for LAN-to-LAN
connectivity allowing geographically dispersed locations to exchange
Internet, data, images and voice communications
. Switched Voice -- voice service throughout the U.S. and to 230 countries
. Operator Services -- services covering intra-LATA, intrastate, interstate and
international automated (0+) and operator assisted (0-) calls
. Qwest Professional Services -- taps into Qwest's industry-leading
strategists, interactive designers and engineers to collaborate with
customers to define and implement corporate information infrastructures
. Enhanced Services:
. Text Messaging -- local, regional and nationwide coverage
. Broadcast Fax -- standard and totally-automated service
. Teleconferencing -- conference calling for an unlimited number of
participants, and customized options
. Campus Talk -- customized calling plans for higher education institutions
. Worldcard -- toll-free access from domestic and international locations.
These and other services can be bundled into service packages:
. Q.guaranteed(SM) -- allows customers to combine domestic and
international voice, data and Internet protocol services under a single
plan, with rate advantages, rate and service guarantees and a single
monthly invoice
. Q.biz(SM) -- combined voice, data and Internet protocol services for
small businesses
. Q.integrity(SM) -- a major national account plan designed for large
national and international businesses, offering voice and data service
and integrated pricing, billing, reporting and support.
Consumer Services. Qwest's Consumer Services group provides a full range
of voice, data, video and related services and products geared to consumers and
home business markets. In 1999, Qwest introduced a new line of web-
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based services for consumers under the name Q.home (sm) Internet Service. The
service is delivered through an alliance with AOL/Netscape, which houses the
service on its Internet portal. These services include:
. Q.home Internet Access -- offering national dial-up Internet access for a
competitive flat monthly rate for unlimited access, e-mail and news. The
access software is provided by Netscape. Subscribers to Qwest long
distance services receive a reduced fee
. Q.home Send-A-Page -- a web-based paging service that allows customers to
send text or numeric pages to other subscribers of the Qwest paging
service. Subscribers enter the number, message and return number right on
the Qwest paging web site
. Q.home Click-to-Fax -- offers U. S. and international fax service through
a web browser - just like an email. The recipient can receive the
document through the fax or download it to a hard drive
. Long distance -- competitive rates and simple terms on U. S. long
distance, international, calling card and home 800 service, with all
calls billed to the exact second after the first full minute
. Prepaid calling cards -- toll-free connections billed in six-second
increments.
Wholesale Services. Products offered by Wholesale Services fall into the
following four categories:
. High-Volume Capacity -- Qwest provides high-volume transmission through
lease and service agreements for terms of one year or longer. Qwest is
targeting potential large users in the long distance market that may seek
to augment their own networks or provide more diverse routing in
strategic areas of their systems.
. Dedicated Private Line -- Qwest provides dedicated private line services
to a wide range of customers, generally for terms of one year or less.
Qwest expects to offer these services over a significantly expanded
geographic area now that its network is completed. In addition, Qwest
provides high-speed voice and data services to carriers, Internet service
providers and other communications entities.
. Switched -- Qwest provides originating and terminating switched services
over its switched services network to long distance carriers. This
business increases volume on Qwest's switched services network and allows
for more efficient utilization of circuits between switches. While
carrier switched services generate revenue at lower margins than
dedicated private line services, they contribute to the overall
profitability of Qwest's network.
. Other -- Wholesale Services also offers Dedicated Internet Access,
Dedicated Hosting and Professional Services. These services are discussed
in greater detail under Business Services.
Customers are typically billed on a monthly basis and also may incur an
installation or equipment charge. After contracts expire, they may be renewed
or the services may be provided on a month-to-month basis. Switched services
agreements are generally offered on a month-to-month basis, and the service is
billed on a minutes-of-use basis.
QwestLink. This new division is responsible for Qwest's local market
expansion throughout the U. S., including the 25 cities recently announced. The
Qwestlink division is creating a local access network for use by Qwest's
customers by constructing or swapping fiber facilities in targeted markets.
Qwestlink will also be responsible for overall procurement and management of
access services from Incumbent Local Exchange Carriers ("ILECs"), Competitive
Local Exchange Carriers ("CLECs"), and Data Local Exchange Carriers ("DLECs") on
behalf of all Qwest groups.
Construction Services
Construction Services builds fiber optic and conduit systems for other
carriers and for its own use and sells dark fiber to other communications
entities. Qwest used its Construction Services resources to implement its
strategic plan to complete its network, in addition to providing Construction
Services to third-party customers along the network routes. Total revenue from
Construction Services was approximately $224.5 million, $688.4 million and
$581.4 million in 1999, 1998 and 1997, respectively.
Competition
The telecommunications industry is highly competitive. Any of Qwest's
existing and potential competitors particularly in its communications services
markets, compete with significantly greater financial, personnel, marketing and
other resources, and have other competitive advantages.
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The telecommunications industry is in a period of rapid technological
evolution, marked by increasing fiber, wireless and satellite transmission
capacity, new technologies and the introduction of new products and services.
Recent technological advances enable substantial increases in transmission
capacity of both new and existing fiber, which could affect capacity supply and
demand. Also, the introduction of new products or emergence of new technologies
may reduce the cost or increase the supply of certain services similar to those
provided by Qwest.
High initial network cost and low marginal costs of carrying long distance
traffic have led to a trend among non-facilities-based carriers to consolidate
in order to achieve economies of scale. Such consolidation could result in
larger, better-capitalized competitors. However, Qwest believes that owning its
own network will offer an advantage over carriers that lease network capacity.
Increased consolidation and strategic alliances in the industry resulting
from the Telecommunications Act of 1996 (the "Telecommunications Act") have
allowed significant new competitors to enter the industry, including local
exchange carriers, previously prohibited from the inter-exchange market.
In recent years, competition has increased dramatically in all areas of
Qwest's communications services market. Qwest's primary competitors include
AT&T, Sprint and MCI WorldCom, all of whom have extensive experience in the
traditional long distance market. The impact of continuing consolidation in the
industry, such as last year's merger of MCI and WorldCom and the pending merger
between Sprint and MCI WorldCom, is uncertain. In addition, the
Telecommunications Act will eventually allow the local exchange carriers and
others to enter the long distance market.
As Qwest expands its business into Internet Protocol services, it also
competes with a wide range of companies besides AT&T, Sprint and MCI WorldCom
that provide web hosting, Internet access and other Internet Protocol products
and services. Significant competitors include GTE, UUNet (a subsidiary of MCI
WorldCom), Digex, Abovenet, Intel and Exodus. In addition, many smaller
companies have entered the market for web site design. Qwest's main advantage
in this market is offering a complete line of Internet Protocol services,
hosting offers, web development services and application provider service offers
through the Company's joint venture with KPMG, combined with the advantages of
its comprehensive network.
Qwest's disadvantages in the Internet protocol services market vary by type
of competitor and the specific needs of individual customers. Some customers
may choose larger competitors, such as IBM, Sprint or GTE, due to their scale
and name recognition. Smaller companies may have an advantage through their
concentration in just one segment of the Internet protocol market. Such
companies may appeal to smaller, more specialized companies.
In addition to Qwest, there are currently three other principal facilities-
based long distance fiber optic networks (AT&T, Sprint and MCI WorldCom). Others
are building or planning additional networks that, if constructed, could employ
advanced technology similar to Qwest's network. Global Crossing, GTE, Broadwing
and Williams Communications each may have a fiber network smaller in geographic
scope and similar in potential operating capability to Qwest's network. Level 3
Communications may have a fiber network similar in geographic scope and
potential operating capability to Qwest's network. However, Qwest's network was
completed in mid-1999, at least a year ahead of the planned completion of the
other networks mentioned above. Also, Qwest will be able to extend and expand
the capacity of its network along secured rights of way, using the additional
fibers retained by Qwest and the empty conduit installed along the initial
build-out.
Additionally, competitors such as MCI WorldCom and Level 3 have announced
plans to construct local networks connected to their inter-city networks similar
to the network Qwest is building. The opportunity to provide customers with
end-to-end broadband capacity increases the value of the inter-city network.
Global Crossing, which recently acquired Frontier Communications, announced
major international fiber optic cable construction projects to expand high
capacity access around the globe. Coupled with Frontier's domestic assets,
Global Crossing will have significant reach into key market segments. Qwest,
through its KPNQwest venture, is developing a pan-European network that combines
both local broadband access and inter-city capabilities, which will utilize the
multiple cables Qwest has capacity on across the Atlantic. The broadband
access, both domestically and with KPNQwest, plus the expansion into Canada
provide Qwest with broad geographic reach and scale. Both Level 3 and MCI
WorldCom have announced international broadband networks that will compete with
Qwest.
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Research and Development
In connection with the acquisitions of LCI, EUnet and Icon in 1998, Qwest
expensed $760.0 million for in-process research and development projects since
the development of these projects had not yet reached technological feasibility
and the in-process research and development had no alternative future uses as of
the acquisition date. These projects relate to the development of advanced
voice and data services as well as sophisticated network management and
administration functions. (See "Management's Discussion and Analysis of
Financial Condition and Results of Operations") Research and development costs
incurred in the normal course of business are expensed as incurred. The Company
incurred approximately $36.3 million and $ 27.7 million of such costs in 1999
and 1998, respectively. R&D costs were insignificant in 1997.
Regulatory Matters
Qwest's communications services business is subject to federal, state, local,
and international regulation.
Regulatory Background. The telecommunications industry is in the process of
fundamental change set in motion by the rise of digital technology and the
Internet and the Telecommunications Act of 1996. These developments are
breaking down traditionally distinct communications market categories, such as
long distance and local, that had served as clear regulatory boundaries. As a
result, there has been a lot of activity in recent years both at the state and
federal levels to accommodate existing regulatory regimes to new legislative
directives and technological and market imperatives.
Historically, AT&T monopolized telecommunications services in the United
States and the present structure of the U.S. telecommunications market, though
now changing, is largely the result of the AT&T break-up. The break-up created
seven Regional Bell Operating Companies (RBOCs), which continue to provide local
exchange service in their geographically defined areas, and a single, national
long distance carrier, which kept the AT&T name. The RBOCs were not permitted
under the terms of the break-up to provide long distance telephone service
between Local Access Transport Areas (LATAs) in the regions they serve. The
breakup resulted in the creation of two distinct telecommunications market
segments, which are only beginning to break down: the local exchange segment and
the long distance segment. Over time, the long distance market has become
competitive while the local exchange markets continue to be dominated by the
RBOCs and other incumbent carriers.
In 1996, Congress enacted the Telecommunications Act of 1996, which amended
the Communications Act of 1934 in a manner intended to promote competition and
deregulation in all U.S. communications markets. Among other things, the Act
ordered the FCC to make rules requiring the RBOCs and other incumbent local
exchange carriers to take steps to open their local networks to competition. The
Act requires incumbent local exchange carriers to give nondominant carriers:
. the ability to lease facilities, features, and functions of the incumbent
local exchange carriers' local exchange networks;
. the ability to interconnect nondominant carrier facilities with the
incumbent local exchange carriers' networks; and
. the ability to purchase and resell certain services provided by the
incumbent local exchange carriers.
The Telecommunications Act also included provisions allowing the RBOCs to
enter the inter-LATA long distance market in the regions they serve once they
have opened their local markets to competition. The Telecommunications Act has
been the subject of many court challenges.
Federal Regulation. The Federal Communications Commission (FCC) is the
federal entity responsible for regulating interstate and international
telecommunications services under the Communications Act of 1934, as amended.
The Communications Act imposes more extensive requirements on incumbent common
carriers that have some degree of market power, such as the RBOCs and other,
longstanding independent local exchange carriers, than it imposes on nondominant
common carriers that lack market power, such as Qwest. The FCC permits
nondominant carriers to provide domestic long distance services without prior
authorization. However, the FCC requires such carriers to obtain authorizations
to construct and operate telecommunications facilities, and to provide or resell
telecommunications services, between the United States and international points.
Qwest has obtained FCC authorization to provide international services.
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State Regulation. Intrastate telecommunications services (including local
exchange services) are regulated primarily by the state public utility
commissions. Qwest must obtain and maintain certificates of authority from
regulatory bodies in most states in which it offers intrastate services. In
most states, Qwest also must file and obtain prior regulatory approval of
tariffs for its intrastate services. State regulatory authorities can
condition, modify, terminate or revoke certificates of authority for failure to
comply with state law or the rules, regulations and policies of the state
regulatory authorities. State regulatory authorities also may impose fines and
other penalties for violations.
Foreign Regulation. To the extent Qwest, its affiliates or its joint
ventures have authorizations to provide telecommunications services in foreign
countries, it is subject to the regulatory, licensing, operational, and other
requirements in those countries.
Access Charge Reform. Qwest's costs of providing long distance services
could be affected by changes in the rules controlling the form and amount of
"access charges" local exchange carriers (LECs) are permitted to impose on
inter-exchange carriers (IXCs) to originate and terminate long distance calls
over local networks. There has been a great deal of regulatory activity over
the past three years at the federal level, and in some states, to reform the
access charge system. There were several significant developments in 1999 in
ongoing proceedings and litigation surrounding access charge reform.
First, the US Court of Appeals for the DC Circuit remanded to the FCC for
"further explanation" the agency's calculation of a key productivity factor in
the formula price cap LECs use to calculate per minute access charges. The FCC
has not yet responded to the Court, but did ask for and receive a stay of the
Court's order, which expires on March 31, 2000. The stay permitted the
productivity factor being questioned by the Court to be used in LEC access
tariff filings made in June, 1999, which generally had the effect of reducing
the per minute rates for interstate switched access. Second, a group of LECs
and IXCs submitted a proposal to the FCC for further reform of access charges.
If adopted as proposed, interstate access charges paid by Qwest would be reduced
in future years more quickly than is currently planned. The FCC has sought
comment on the proposal and has indicated that final action on it is a high
priority for 2000. Third, in August 1999, the FCC issued an Order permitting
LECs greater flexibility in pricing certain interstate access services and
establishing a framework for further pricing relief once greater competition for
access services develops. The Order also allows LECs to charge access rates
that more closely approximate the true cost of providing access service in a
given geographic area.
Changes in the interstate access charge structure also could affect the costs
of providing long distance "phone-to-phone" voice services using Internet
Protocol technology. Traditionally, providers of long distance voice services
over the Internet and companies that use Internet protocol technology to provide
long distance services have been exempt from access charges. The FCC has
suggested, however, that access charges might appropriately be imposed on long
distance phone-to-phone voice services that use the Internet Protocol. If the
FCC allows local exchange carriers to levy access charges on carriers providing
such services, Qwest's costs to provide such services could increase.
Qwest cannot predict the outcome of the ongoing access charge proceedings or
whether they will have a material impact on the company.
Universal Service. Qwest also incurs costs through its payments to state and
federal universal service funds. These universal service funds generally
provide subsidies to qualified providers of local exchange service to ensure
that low-income customers and those living in areas that are expensive to serve
have affordable basic phone service. The federal Universal Service Fund,
through the Schools and Libraries Program ("E-Rate") and the Rural Health Care
Program, also helps subsidize telecommunications and Internet connections to
qualified schools, libraries and rural health care providers. Qwest's payments
to the funds are based on a percentage of its telecommunications revenues.
Individual states generally assess for universal service support based on
revenues from intrastate services, while the federal fund bases all
contributions on revenues from interstate and international telecommunications
services.
Several recent regulatory and legal developments may affect the amount of
Qwest's universal service liability. First, the US Court of Appeals for the
Fifth Circuit ruled in July 1999 that the FCC does not have authority to include
intrastate revenues in the revenue base for calculating carriers' federal
universal service contributions. The Court's ruling may tend to increase the
universal service contributions of carriers that are primarily long distance
providers, like Qwest. In that decision, the Court also upheld the "E-Rate."
The FCC announced in May its intention to fund the program fully at $2.25
billion per year for the second funding year. Second, the FCC adopted a new
high-cost universal service support mechanism for non-rural local carriers. The
new mechanism, which includes a $230 million increase in
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the federal universal Service Fund, went into effect January 1, 2000, although
the FCC has deferred provision of forward-looking high-cost support for non-
rural carriers until the third quarter of 2000. At that time, Qwest's payments
to the USF are likely to increase, although the amount of the increase cannot be
predicted at this time. Qwest is unable to predict the effect on its operations
of future action in FCC proceedings or pending judicial appeals concerning
universal service.
FCC Inquiry into Flat-Rate Charges on Long Distance Bills. In July, 1999,
the FCC initiated an inquiry into the impact of flat-rate charges on long
distance customers who make fewer calls, including charges to recover carriers'
costs related to access charges, universal service and other federal regulatory
action. The inquiry is not a rulemaking proceeding. However, the adoption of
rules by the FCC in the future that limit or prohibit IXCs' from charging flat
monthly fees to customers could negatively impact Qwest.
Local Exchange Carrier Applications to Provide Long Distance Service. The
Telecommunications Act permits RBOCs to enter the inter-LATA long distance
markets within their service areas when the FCC determines that they have
complied with the requirements of the Telecommunications Act and opened their
local exchange networks to competition. On December 22, 1999, the FCC granted
Bell Atlantic's application to provide inter-LATA services originating in New
York. On January 10, 2000, SBC, Inc. filed an application with the FCC to
provide inter-LATA services originating in Texas. Although other RBOCs have
filed applications in the past, this is the only application pending before the
FCC. Qwest is unable to predict when RBOCs will receive authority to compete in
the long distance markets in other in-region states. Qwest expects, however,
that the RBOCs will gain a significant share of the long distance markets in
their service territories at the expense of current IXCs, including Qwest, once
they obtain long distance authority.
Supreme Court Decision on FCC Rules Implementing the Telecommunications Act.
On January 25, 1999, the U.S. Supreme Court issued a decision that upheld many
of the rules the FCC had promulgated to implement the portions of the
Telecommunications Act that are designed to bring competition to local exchange
markets. In the decision, the Supreme Court upheld the FCC's authority to
implement the Telecommunications Act through rules binding on the states. The
Supreme Court also upheld the FCC's regulations regarding state review of
interconnection agreements, the granting of certain exemptions to rural
incumbent local exchange carriers, and dialing parity. "Dialing parity" means
that consumers can use nondominant carriers by dialing as they normally do,
rather than having to dial extra access codes.
The Supreme Court upheld several prior FCC rulings. First, the Court upheld
the FCC's ruling that competitors need not own facilities in order to lease
network elements from incumbent local exchange carriers. Second, it upheld the
ruling that incumbent local exchange carriers may not separate combinations of
network elements before providing them to nondominant carriers unless requested
to do so. Third, the FCC was upheld in its ruling that network elements include
the features, functions, and capabilities provided by means of network
equipment. The Supreme Court also held that nondominant carriers may adopt
particular provisions of another carrier's interconnection agreement without
adopting the entire agreement.
In the January 25, 1999 decision, however, the Supreme Court vacated the
FCC's rules setting forth a national list of unbundled network elements (UNEs)
which incumbents must provide, at a minimum, to competitors. The Court
instructed the FCC to reconsider the list in light of the statutory criteria for
defining UNEs. The FCC subsequently did so and completed its reconsideration in
September 1999. In the new rules, the FCC required ILECs to make available five
basic network elements that had been included in the 1996 list of network
elements (local loops, network interface devices, interoffice transmission
facilities, signaling networks and call-related databases, and operations
support systems). The new rules include elements not on the original list,
specifically subloops, dark fiber loops, and dark fiber transport. A sixth
element on the original list, local circuit switching, will be restricted when
used to serve business customers with four or more lines in the densest portions
of the top 50 metropolitan statistical areas (MSAs). The seventh original
element, operator services and directory assistance, is eliminated as a network
element under the new rules.
The Commission generally declined to designate as network elements those
ILEC facilities used to provide data services, such as digital subscriber line
access multiplexers (DSLAMs) and packet switches. The FCC did require ILECs to
unbundle DSLAMs only when a requesting carrier is unable to install its DSLAM at
the ILEC's remote terminal and when the ILEC provides packet switching for its
own use. The unbundling rules adopted in the FCC's decision apply nationwide.
State commissions may require ILECs to unbundle additional elements as long as
the obligations are consistent with the requirements of Section 251 and the
national policy framework established by the Commission. Neither the FCC nor
state commissions can remove elements from the national list on a state-by-state
basis. The FCC will reevaluate the list of elements in three years. Qwest is
unable to predict how these new rules will affect its business. In
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addition, these new rules may be appealed to federal court. Qwest cannot predict
the outcome of such a court challenge to the rules.
The US Court of Appeals for the Eighth Circuit still must review the method
adopted by the FCC in 1996 for establishing prices for network elements and
interconnection. Qwest is unable to predict what actions the court will take on
pricing.
The Supreme Court's decision is likely to have an impact on interconnection
agreements between nondominant carriers and incumbents, the rules the states
have adopted concerning local exchange competition, and the RBOCs' applications
for entry into the inter-LATA long distance market. Qwest is unable to predict,
however, how the decision will impact those matters or how the decision will
affect competition.
"Slamming" -- Unauthorized Changes of Consumers' Presubscribed Carriers. In
1997, the FCC began drafting rules designed to prevent "slamming," which is
defined as the intentional, unauthorized switching of a customer's chosen local
or long-distance carrier. In December 1998, the FCC released new rules governing
slamming. These rules include: more stringent requirements for verifying a
consumer's consent to change carriers, stronger liability provisions for
carriers responsible for slamming, and procedures for determining customer and
carrier liability after slamming has occurred. The FCC's new rules also broaden
the scope of the prior carrier switch rules to cover not only switching of long
distance services, but also the switching of local exchange and other services.
In addition to issuing new rules, the FCC also sought comment on more proposed
changes to the carrier change rules. These proposed changes include: the use of
electronic and Internet procedures for verifying a consumer's consent to change
carriers, modification of the procedures for using third parties to verify a
consumer's consent to change carriers, and other carrier liability issues.
The new slamming rules, except those dealing with liability, became effective
in April of 1999. The effectiveness of the rules dealing with liability has
been stayed indefinitely by the US Court of Appeals for the DC Circuit while the
FCC considers petitions for reconsideration. In addition, an industry group
has filed a proposal with the FCC that would establish an independent third
party administrator to resolve carrier switch disputes.
Qwest has taken steps to implement the new slamming rules that have gone into
effect. However, Qwest is unable to predict the outcome of ongoing FCC
proceedings or the impact of these rules.
In October, 1999, the FCC issued a Notice of Apparent Liability for
Forfeiture (NAL) for $2.08 million against Qwest, thereby initiating an
enforcement action against Qwest for "apparently willfully or repeatedly
violating section 258 of the Communications Act of 1934, as amended (the Act),
as well as Commission rules and orders, by changing the designated preferred
carriers of thirty consumers without their authorization." Qwest has issued a
public response to the NAL and held settlement discussions with the FCC, but
there has been no final resolution of the matter.
Truth-in-billing. In April 1999, the FCC adopted guidelines governing the
format and content of telephone bills. These guidelines, which became effective
on November 12, 1999, require carriers to (1) clearly identify the service
provider responsible for each charge on the bill; (2) clarify when customers may
withhold payment to dispute a charge without risking the loss of their basic
local service; (3) identify on the bill the carrier to whom a customer should
direct his or her complaint about a particular charge; and (4) utilize uniform
descriptions for line item charges related to federal regulatory action. The
adoption of these new rules will impact the way Qwest presents its bills to
customers and Qwest expects to incur costs in complying with the new rules. The
FCC also sought public comment on the uniform descriptions it should adopt for
line item charges related to regulatory action, but no final determination has
been made.
Advanced Telecommunications Services. Advanced telecommunications services
provide high-speed, switched, broadband telecommunications capability that
enables users to originate and receive high-quality voice, data, graphics, and
video telecommunications using any technology.
In March of 1999, the FCC issued an Order intended to facilitate competitors'
ability to lease space in the incumbent's central office (collocation space).
The Commission adopted rules to strengthen collocation requirements and reduce
the costs and delays associated with collocation. In particular, the Commission
required incumbent LECs to make new collocation arrangements, including cageless
and shared collocation, available to competing carriers.
In November 1999, the FCC amended its unbundling rules to require incumbent
LECs to provide unbundled access to a new network element, the high frequency
portion of the local loop. The purpose is to enable "line sharing," which
permits a competitive LEC to offer advanced services such as digital subscriber
line service over the same line an incumbent offers voice service. The FCC
hopes linesharing will enable competitive LECs to compete with incumbent LECs to
provide xDSL-based services. In the same order, the FCC adopted spectrum
management policies and rules to
17
<PAGE>
facilitate the competitive deployment of advanced services.
The steps taken by the FCC with respect to line sharing may benefit Qwest by
facilitating the provision of advanced local telecommunications services by new
entrants in the local markets.
Also in November 1999, the FCC clarified that digital subscriber line
services (xDSL) used to provide high-speed Internet service are not subject to
the discounted resale obligations of the 1996 Telecommunications Act when sold
in bulk to Internet Service Providers (ISPs).
Qwest is unable to predict the affect of matters pending in the advanced
services proceedings. Qwest also is unable to predict what impact FCC action in
this area would have on the nature of competition.
Several companies also asked the FCC to require cable television companies to
provide competitors with access to high capacity cable television lines, such as
those used to provide Internet access services to cable television subscribers.
To date, the FCC has declined to address this issue.
Reciprocal Compensation for Internet Service Provider Transmissions. The
Telecommunications Act requires local exchange carriers to pay each other
reciprocal compensation for transporting and terminating each others' local
calls. In June 1997, however, the incumbent local exchange carriers asserted
that they were not required to pay reciprocal compensation to nondominant
carriers for the transport and termination of calls to Internet service
providers because they were not "local calls." On February 25, 1999, the FCC
ruled that calls to Internet service providers are interstate calls, not local
calls. However, the FCC said that state commissions could examine whether
existing contracts specifically required ILECs to pay reciprocal compensation on
calls destined for ISPs. A number of state commissions have concluded that
existing interconnection contracts do require ILECs to pay reciprocal
compensation for such calls. The FCC's ruling has been appealed in the courts.
The FCC has sought comment on proposed federal rules that would govern the
payment of reciprocal compensation for such calls, but no final action has been
taken.
1+ Dialing Parity. In many states, consumers wishing to use carriers other
than the incumbent local exchange carrier for intra-LATA long distance services
have had to dial special access codes to do so. The need to dial extra digits
in these states makes it more difficult for Qwest to attract customers for its
intra-LATA long distance service. If a nondominant carrier's customer attempts
to make one of these calls by simply dialing "1" plus the desired number, the
call will automatically be routed to the incumbent local exchange carrier in
those states that have not required 1+ dialing parity. The Supreme Court's
January 25, 1999 decision, which is discussed above, upheld the FCC's original
rule requiring states to implement intra-LATA toll dialing parity by February 8,
1999. Due to the timing of the Supreme Court decision, the FCC permitted
additional time, until the late summer of 1999, for states to complete
implementation. With the exception of a few limited, rural areas for which
incumbents were granted extensions, dialing parity should now be implemented
nationwide. Qwest expects to benefit from the implementation of this 1+ calling
capability.
Federal Tariff Requirements. Qwest is required to file tariffs for its
interstate and international long distance services with the FCC. In October
1996, the FCC adopted an order concluding that nondominant carriers, such as
Qwest, would no longer be permitted to maintain tariffs on file with the FCC for
domestic interstate services. This order applies to all nondominant interstate
carriers, including AT&T. The order does not apply to local exchange providers.
The FCC order was issued based on a provision in the Telecommunications Act,
which generally permits the FCC to "forbear" from a given regulation if the FCC
determines that forbearance will serve the public interest. In February 1997,
the U.S. Court of Appeals for the District of Columbia Circuit halted
implementation of the FCC order pending the Court's review of the order.
Implementation of the order remains halted. If the FCC order is allowed to
become effective, telecommunications carriers such as Qwest would no longer be
able to rely on the filing of tariffs with the FCC as a means of providing
notice to customers of prices, terms, and conditions on which they offer their
interstate services. Instead, carriers such as Qwest would be required to
maintain and make publicly available their rate and service information. In
that situation, Qwest would rely on its sales force and direct marketing to
provide pricing information to its customers.
Qwest Joint Marketing Agreements. Based upon a complaint brought by AT&T,
MCI WorldCom and other long distance carriers, the FCC in September 1998
disapproved two separate joint marketing agreements entered into by Qwest with
US West and Ameritech. The FCC disapproved these agreements because it found
that under those agreements, US West and Ameritech would be providing long
distance services outside of their local areas in violation of the
Telecommunications Act. The FCC did not find that Qwest had engaged in any
unlawful conduct. Qwest, US West and Ameritech appealed the FCC's decision to
the U.S. Court of Appeals for the District of Columbia Circuit, arguing that the
agreements were lawful efforts under the Telecommunications Act to jointly
market the local services of US West and
18
<PAGE>
Ameritech with the long distance services of Qwest, and did not involve US West
or Ameritech providing long distance service in their local areas. In June 1999,
the court ruled against Qwest, US West, and Ameritech. Petitions by US West and
Ameritech for re-hearing and for writ of certiori were subsequently denied.
State Regulation. As discussed above, Qwest's local and intrastate long
distance telecommunications operations are subject to various state laws and
regulations. Many of these state laws and regulations address competition in
the local exchange and intrastate long distance markets even though the FCC also
has authority to implement rules governing competition in these markets. The
U.S. Supreme Court's January 25, 1999 decision upholding many of the FCC's local
competition rules and the FCC's subsequent adoption of new local competition
rules, will likely impact many of the regulations the states have implemented
and are in the process of implementing. Qwest is unable to predict, however,
exactly what this impact will be or what actions the various states will take in
light of the Supreme Court's decision.
Municipal and Other Local Regulation. Municipalities occasionally require
Qwest to obtain street use and construction permits and licenses or franchises
in order to install and expand its fiber optic network using municipal rights-
of-way. A municipality's decision to terminate existing franchise or license
agreements before they expire or a municipality's decision to not renew
franchise or license agreements could adversely affect Qwest. A municipality's
decision to require Qwest to remove its facilities or abandon its network in
place also could adversely affect Qwest. In some municipalities where Qwest has
installed or expects to construct networks, it will be required to pay license
or franchise fees based on a percentage of gross revenue or on a per-linear-foot
basis. There is no guarantee that franchise fees will remain at their current
levels after existing franchises expire. In addition, Qwest could be placed at
a competitive disadvantage if its competitors do not pay the same level of fees
as Qwest. However, the Telecommunications Act requires municipalities to manage
public rights-of-way in a competitively neutral and non-discriminatory manner.
Regulation of International Services. In April, 1999, the FCC approved reform
of the longstanding international settlements policy, deregulating inter-carrier
settlement arrangements between U.S. carriers and foreign non-dominant carriers
on competitive routes. The international settlements policy, which prohibits
U.S. carriers from accepting discriminatory terms and conditions for the
termination of traffic in overseas markets, was originally designed to prevent
monopoly foreign carriers from taking advantage of the competitive marketplace
in the United States by playing one carrier off against another. The reform
eliminated the international settlements policy for arrangements with foreign
carriers that lack market power and for all arrangements on routes where rates
to terminate U.S. calls are sufficiently low.
Merger Applications. Qwest and U S WEST have stated their intention to merge
and have filed applications with federal and state agencies seeking approval for
the merger. Applications have been filed at the FCC and with the Public Service
Commissions in the following nine states in the U S WEST region: Arizona,
Colorado, New Mexico, Utah, Washington, Montana, Wyoming, Minnesota, and Iowa.
Applications for merger approval were not required to be filed in the remaining
five states in the US WEST region. In addition, Qwest has filed applications in
connection with its merger in certain other states outside the US WEST service
territory. All of these applications are currently under review by the
appropriate federal and state government officials. On January 7, 2000, the
Colorado Public Utility Commission issued a decision unanimously approving the
merger application. The only condition adopted imposes a periodic audit
requirement with respect to local network investment and maintenance.
Other. Qwest monitors compliance with federal, state, and local regulations
governing the discharge and disposal of hazardous and environmentally sensitive
materials. These materials include the emission of electromagnetic radiation.
Qwest believes that it is in compliance with such regulations. However, a
discharge, disposal or emission of hazardous or environmentally sensitive
materials could expose Qwest to claims or actions that could adversely affect
Qwest.
Employees
As of December 31, 1999, Qwest employed approximately 10,000 employees.
None of Qwest's employees are currently represented by a collective bargaining
agreement. Qwest believes that its relations with its employees are good.
Corporate and Other Information
Qwest is a Delaware corporation, organized in 1997 to hold the stock of its
indirect principal subsidiary, Qwest Communications Corporation, which started
its telecommunications business in 1988.
19
<PAGE>
Qwest's principal executive offices are located at 700 Qwest Tower, 555
Seventeenth Street, Denver, Colorado 80202, and its telephone number is (303)
992-1400. Qwest's web site is http://www.qwest.com.
Item 2. Properties
Qwest's network and its component assets are the principal properties owned
by Qwest. Qwest owns substantially all of the telecommunications equipment
required for its business. Qwest's installed fiber optic cable is laid under
the various rights of way held by Qwest. Other fixed assets are located at
various locations in geographic areas served by Qwest.
Qwest leases sales offices for its communications services business unit in
major metropolitan locations in the United States and internationally.
Qwest's executive and administrative offices are located at its principal
office in Denver, Colorado. Qwest leases this space from an affiliate of
Anschutz Company at market rates under an agreement that expires in October
2004. Qwest leases additional space in the following locations: Arlington,
Virginia, housing a network operating center, customer service operations and
administrative offices; Dublin, Ohio, Weehawken, New Jersey and San Francisco,
California, each housing administrative offices and data centers; and Dallas,
Texas, housing the headquarters for operation of Qwest's microwave system.
Qwest has network management centers in the following locations: its
principal office in Denver, Colorado, Dublin, Ohio, Weehawken, New Jersey,
Arlington, Virginia, and San Antonio, Texas, all of which are leased. Qwest's
communications services business unit has customer service operations in Denver,
Colorado, Dublin, Ohio, Greenville, South Carolina, San Antonio, Texas, and
Weehawken, New Jersey.
Item 3. Legal Proceedings
Qwest has been named as a defendant in Drawhorn v. Qwest Communications
International Inc. et al., Hudson v. Qwest Communications International Inc.,
Hord v. Qwest Communications International Inc. et al., and Cirese Construction
v. Qwest Communications, et al. The cases are purported class actions, filed in
Texas, Indiana, Tennessee and Missouri, respectively, which involve the
Company's right to install its fiber optic cable network in easements and right-
of-ways crossing the plaintiff's land. In general, the Company obtained the
rights to construct its network from railroads, utilities, and others, and
installed its network along the rights of way so granted. Plaintiffs in the
purported class actions assert that they are the owners of lands over which
Qwest's fiber optic cable network passes, and that the railroads, utilities, and
others who granted to Qwest the right to construct and maintain its 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 Qwest's network
passes; the Tennessee and Missouri actions purport to be on behalf of a class of
such owners in Tennessee and Missouri. The complaints seek damages on theories
of trespass and unjust enrichment, and punitive damages as well. Qwest has
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. Management believes that the Company has substantial
defenses to the claims asserted in these actions, and intends to defend them
vigorously.
On September 15, 1998, in an action captioned Aaron Parnes v. Scott A.
Baxter, Wayne B. Weisman, Richard M. Brown, Scott Harmolin, Samuel A. Plum, Icon
CMT Corp. and Qwest Communications International Inc., the plaintiff filed a
putative class action complaint in the Court of Chancery of the State of
Delaware in and for New Castle County (the "Court") against Icon, its directors
and Qwest. In the suit, the plaintiff alleged that consummation of the Icon
merger would subject the Icon stockholders to the control of the principal
stockholder of Qwest after the consummation of the merger. The plaintiff
further alleged that the Icon merger would constitute a change in control of
Icon and impose heightened fiduciary duties on the members of the Icon board of
directors to maximize stockholder value. The plaintiff also alleged that the
members of the Icon board of directors violated their fiduciary duties by
failing to auction Icon or to undertake an active "market check" for other
potential bidders. The plaintiff sought, among other things, to have the Court
declare the suit a proper class action, enjoin the Icon merger and require the
members of the Icon board of directors to auction Icon and/or conduct a "market
check," and to award monetary damages, together with costs and disbursements.
The defendants filed answers denying the allegations of the complaint. No
proceedings occurred in the case. On
20
<PAGE>
February 17, 2000, the plaintiff filed a Notice of Dismissal, voluntarily
dismissing the action without prejudice. Pursuant to the Notice, the Court
ordered dismissal of the case on February 18, 2000.
On April 3, 1998, in an action captioned Lionel Phillips v. LCI International
Inc. and H. Brian Thompson, the plaintiffs filed a putative class action
complaint in the United States District Court for the Eastern District of
Virginia against LCI and H. Brian Thompson, the Chairman and Chief Executive
Officer of LCI. The plaintiffs brought the action as a class action purportedly
on behalf of stockholders of LCI who sold LCI Common Stock between February 17,
1998 and March 9, 1998. The plaintiffs alleged, among other things, that the
defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated
thereunder by making materially false and misleading statements that LCI was not
for sale at a time when negotiations between Qwest and LCI regarding a potential
merger were allegedly ongoing. On June 25, 1998, defendants moved to dismiss
the complaint on the grounds that it failed to state a claim against defendants.
The complaint was dismissed, an amended complaint was filed and, on September
30, 1998, the District Court granted defendants' motion to dismiss the amended
complaint. In a decision dated September 15, 1999, the United States Court of
Appeals for the Fourth Circuit affirmed the lower court's dismissal of the
amended complaint. Judgment was entered on October 13, 1999.
Qwest also has been named as a defendant in various other litigation matters.
Management intends to vigorously defend these outstanding claims. Qwest
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 Qwest's results of operations or financial position.
Item 4. Submission of Matters to a Vote of Security Holders
On November 2, 1999, the Qwest held a special shareholder meeting to vote on
the approval of the merger and the adoption of the merger agreement between
Qwest and U S WEST, Inc., and the approval and ratification of the Qwest
Communications International, Inc. Equity Incentive Plan. There were
746,444,769 shares of Common Stock of Qwest that could be voted at the meeting,
and 85.67%, or 639,479,234 shares, of Common Stock were represented at the
meeting, in person or by proxy, which constituted a quorum. The results were as
follows:
1. Approval and adoption of the merger and the Agreement and Plan of Merger
dated as of July 18, 1999 between Qwest and U S WEST, Inc., as amended:
For Against Abstain
--- ------- -------
611,830,544 20,116,831 7,531,859
2. Approval and ratification of the Qwest Communications International Inc.
Equity Incentive Plan:
For Against Abstain
--- ------- -------
597,355,907 32,728,560 9,394,767
21
<PAGE>
Part II.
Item 5. Market for the Registrant's Common Stock and Related Shareholder
Matters
The information under the caption "Market for the Registrant's Common Stock
and Related Shareholder Matters" on page 51 of Qwest's 1999 Annual Report is
incorporated herein by reference.
Item 6. Selected Financial Data
The financial information in the table under the caption "Selected Financial
Data" on page 21 of Qwest's 1999 Annual Report is incorporated herein by
reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" on pages 22-30 of Qwest's 1999
Annual Report is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information under the caption "Quantitative and Qualitative Disclosures
About Market Risk" on page 31 of Qwest's 1999 Annual Report is incorporated
herein by reference.
Item 8. Financial Statements and Supplementary Data
Qwest's Consolidated Financial Statements and related Notes thereto and the
Independent Auditors' Report on pages 32-50 of Qwest's 1999 Annual Report, as
well as the unaudited information set forth in Note 15 - Selected Consolidated
Quarterly Financial Data on page 50 of Qwest's 1999 Annual Report, are
incorporated herein by reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
Part III.
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
The information required by Items 10, 11, 12 and 13 of Part III of this
annual report on Form 10-K is incorporated by reference from and will be
contained in Qwest's definitive proxy statement for its annual meeting of
stockholders to be filed with the commission by April 30, 2000.
22
<PAGE>
Part IV.
Item 14. Exhibits, Financial Statements, and Reports on Form 8-K
(a) List of documents filed as part of this report:
<TABLE>
<CAPTION>
1. Financial Statements:
The following items are incorporated herein by reference from the pages indicated in the Company's 1999 Annual Report:
<S> <C>
Page
----
Consolidated Statements of Operations for the three years ended December 31, 1999 33
Consolidated Balance Sheets as of December 31, 1999 and 1998 34
Consolidated Statements of Stockholders' Equity for the three years ended December 31, 1999 35
Consolidated Statements of Cash Flows for the three years ended December 31, 1999 36
Notes to Consolidated Financial Statements 37
</TABLE>
<TABLE>
<C> <S>
2.1 Agreement and Plan of Merger dated as of July 18, 1999 between U S WEST, Inc. and Qwest, as
amended (incorporated herein by reference to Amendment No. 2 to Qwest's Registration
Statement on Form S-4/A filed September 17, 1999
3.1** Amended and Restated Certificate of Incorporation of Qwest.
3.2***** Certificate of Amendment of Amended and Restated Certificate of Incorporation of Qwest.
3.3 Certificate of Amendment to the Amended and Restated Certificate of Incorporation, as amended
(incorporated herein by reference to Qwest's quarterly report on Form 10-Q for the quarter
ended March 31, 1999).
3.4 Amended and Restated Bylaws (incorporated by reference to Qwest's Annual Report on Form 10-K
for the year ended December 31, 1998).
4.1(a)*** 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).
4.1(b)**** 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).
4.1 (c)**** 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).
4.1(d) 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).
4.1(e) 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 an
exhibit thereto) (incorporated by reference to Qwest's Registration Statement on Form S-4
(File No. 333-71603) filed February 2, 1999).
4.2(b) 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).
4.3 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).
4.4 Credit Agreement, dated as of March 31, 1999, among Qwest Communications International Inc.,
as Borrower, NationsBank, N.A., as Administrative Agent, and the Lenders party thereto
(incorporated herein by reference to Qwest's quarterly report on Form 10-Q for the quarter
ended March 31, 1999).
10.1** Growth Share Plan, as amended, effective October 1, 1996.*
10.2 Equity Incentive Plan, as amended.* (incorporated herein by reference to Qwest's quarterly
report on Form 10-Q for the quarter ended June 30, 1999)
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.3 Qwest Communications International Inc. Employee Stock Purchase Plan (incorporated 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 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 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.*
10.13**** Employment Agreement dated September 19, 1997 with Larry Seese.*
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 by reference to LCI's
Registration Statement No. 33-60558).*
10.20 LiTel Communications, Inc. 1993 Stock Option Plan (incorporated by reference to LCI's
Registration Statement No. 33-60558).*
10.21 LCI International, Inc. 1994/1995 Stock Option Plan (incorporated 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 (incorporated 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 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 by reference to LCI's
Annual Report on Form 10-K for the year ended December 31, 1996).*
10.25(a) 1995 Stock Option Plan of Icon CMT Corp. (incorporated by reference to Icon CMT Corp.'s
Registration Statement on Form S-1/A, No. 333-38339).*
10.25(b) Amendment to Amended and Restated 1995 Stock Option Plan of Icon CMT Corp. (incorporated by
reference to Qwest's Annual Report on Form 10-K for the year ended December 31, 1998).*
10.26 U.S. Long Distance Corp. 1990 Employee Stock Option Plan (incorporated by reference to
Qwest's Annual Report on Form 10-K for the year ended December 31, 1998).*
10.27+ Contractor Agreement dated January 18, 1993 by and between LCI International Telecom Corp.
and American Communications Network, Inc. (incorporated by reference to LCI's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1995).
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 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 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 by reference to LCI's Annual Report on Form 10-K
for the year ended December 31, 1996).
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
<S>
<C>
10.31 Common Stock Purchase Agreement dated as of December 14, 1998 with Microsoft Corporation
(incorporated 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 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 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 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 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
Current Report on Form 8-K dated July 20, 1999)
10.37 Agreement entered into as of July 18, 1999 between Qwest and Global Crossing Ltd.
(incorporated herein by reference to Qwest's Current Report on Form 8-K dated July 20, 1999)
10.38 Agreement dated as of July 18, 1999 between Qwest and Global Crossing Holdings Ltd.
(incorporated by reference to Qwest's quarterly report on Form 10-Q for the quarter ended
June 30, 1999).
10.39 Purchase Agreement by and among Qwest, Slingshot 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).
10.40 Amended and Restated Operating Agreement of Slingshot Networks, LLC dated October 22, 1999
(incorporated herein by reference to Qwest's quarterly report on Form 10-Q for the quarter
ended September 30, 1999).
21.1 Subsidiaries of the Registrant (incorporated herein by reference to Qwest's quarterly report
on Form 10-Q for the quarter ended March 31, 1999).
23.1 Consent of Independent Public Accountants
23.2 Consent of Independent Auditors
27 Financial Data Schedule
* Indicates executive contracts, compensation plans and arrangements.
** Incorporated by reference in Form S-1 as declared effective on June 23, 1997 (File No.
333-25391).
*** Incorporated by reference to exhibit 4.1 in Form S-4 as declared effective on January 5, 1998
(File No. 333-42847).
**** Incorporated by reference in Qwest's Form 10-K for the year ended December 31, 1997.
***** Incorporated by reference to the exhibit of the same number to Qwest's Registration Statement
on Form S-3 (File No. 333-58617) filed July 7, 1998.
+ Portions have been omitted pursuant to a request for confidential treatment.
</TABLE>
(b) Reports on Form 8-K:
During the quarter ended December 31, 1999, Qwest filed the following
Current Reports on Form 8-K:
(i) On October 27, 1999, Qwest filed a Current Report on Form 8-K
announcing its third quarter 1999 results of operations.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Qwest Communications International Inc.,
a Delaware corporation
By: /s/ Robert S. Woodruff
---------------------------------
Robert S. Woodruff
Executive Vice President--Finance
and Chief Financial Officer
(Principal Accounting Officer)
March 17, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Titles Date
--------- ------ ----
/s/ Philip F. Anschutz Chairman of the Board of Directors March 17, 2000
- ----------------------
Philip F. Anschutz
/s/ Joseph P. Nacchio Director, Chairman and Chief March 17, 2000
- --------------------- Executive Officer
Joseph P. Nacchio
/s/ Robert S. Woodruff Director, Executive Vice President - March 17, 2000
- ---------------------- Finance and Chief Financial Officer
Robert S. Woodruff (Principal Accounting Officer)
/s/ Cannon Y. Harvey Director March 17, 2000
- --------------------
Cannon Y. Harvey
/s/ Jordan L. Haines Director March 17, 2000
- --------------------
Jordan L. Haines
/s/ Douglas M. Karp Director March 17, 2000
- -------------------
Douglas M. Karp
/s/ Vinod Khosla Director March 17, 2000
- ----------------
Vinod Khosla
/s/ Douglas L. Polson Director March 17, 2000
- ---------------------
Douglas L. Polson
/s/ Craig D. Slater Director March 17, 2000
- -------------------
Craig D. Slater
/s/ W. Thomas Stephens Director March 17, 2000
- ----------------------
W. Thomas Stephens
26
<PAGE>
SELECTED PORTIONS OF QWEST'S 1999 ANNUAL REPORT TO SHAREHOLDERS
Following is the financial section of Qwest's 1999 Annual Report. Our 1999
Annual Report will be available on the Internet beginning April 15, 2000. To
view the annual report online, visit our website at
www.qwest.net/ir/shareholder.html.
You may also request that a printed copy be mailed to you in one of three
ways:
1) by completing the literature request form at
www.qwest.net/ir/invreq.html,
2) by calling 877-877-7978 and responding to the recorded prompts or
3) by writing to Investor Relations, Qwest Communications International
Inc., 700 Qwest Tower, 555 Seventeenth Street, Denver, Colorado 80202.
FINANCIAL CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
F-2 F-3 F-12 F-13 F-14 F-18 F-32
Selected Management's Quantitative Independent Financial Statements Notes to Market for the
Financial Discussion and and Qualitative Auditors' Report Consolidated Statements Consolidated Registrant's Common
Data Analysis of Disclosures About of Operations Financial Stock and Related
Financial Market Risk for the Three Years Ended Statements Shareholder Matters
Condition December 31, 1999
and Results of
Operations Consolidated
Balance Sheets
as of December 31, 1999
and 1998
Consolidated Statements
of Stockholders' Equity
for the Three Years Ended
December 31, 1999
Consolidated Statements
of Cash Flows
for the Three Years Ended
December 31, 1999
</TABLE>
These materials may contain forward-looking statements that involve risks and
uncertainties. These statements may differ materially from actual future
events or results. Readers are referred to the documents filed by Qwest with
the SEC, specifically the most recent reports which identify important risk
factors that could cause actual results to differ from those contained in the
forward-looking statements, including potential fluctuations in quarterly
results, dependence on new product development, rapid technological and market
change, failure to complete the network on schedule and on budget, financial
risk management and future growth subject to risks, Qwest's ability to achieve
Year 2000 compliance, and adverse changes in the regulatory or legislative
environment. Qwest undertakes no 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 hereof or
to reflect the occurrence of unanticipated events.
<PAGE>
Selected Financial Data
The selected financial data related to the Company's financial condition and
results of operations for each of the years in the five-year period ended
December 31, 1999 are summarized as follows and should be read in conjunction
with the discussion under "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and the Consolidated Financial Statements
of the Company and the notes thereto, appearing elsewhere in this Annual Report.
<TABLE>
<CAPTION>
Year Ended December 31,
(In Millions, Except Per Share Information) 1999(1) 1998(1) 1997 1996 1995
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS:
Total revenue .......................................... $ 3,927.6 $ 2,242.7 $ 696.7 $ 231.0 $ 125.1
Total operating expenses ............................... 3,604.0 2,996.4 673.2 243.0 161.2
Earnings (loss) from operations ........................ 323.6 (753.7) 23.5 (12.0) (36.1)
Earnings (loss) before income taxes .................... 583.5 (849.8) 23.6 (10.1) (38.5)
Net earnings (loss) .................................... $ 458.5 $ (844.0) $ 14.5 $ (6.9) $ (25.1)
Net earnings (loss)
per share - basic .................................. $ 0.63 $ (1.51) $ 0.04 $ (0.02) $ (0.08)
Net earnings (loss)
per share - diluted ................................ $ 0.60 $ (1.51) $ 0.04 $ (0.02) $ (0.08)
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
(In Millions) 1999 1998 1997 1996 1995
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SUMMARY BALANCE SHEET DATA:
Total assets ........................................... $11,058.1 $ 8,067.6 $ 1,398.1 $ 262.6 $ 184.2
Long-term debt ......................................... $ 2,368.3 $ 2,307.1 $ 630.5 $ 109.3 $ 68.8
Total stockholders' equity(2) .......................... $ 7,001.3 $ 4,238.2 $ 381.8 $ 9.5 $ 26.4
</TABLE>
<TABLE>
<CAPTION>
Year of December 31,
(In Millions) 1999 1998 1997 1996 1995
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
EBITDA(3) .............................................. $ 759.2 $ 294.5 $ 43.7 $ 6.9 $ (26.0)
Net cash provided by
(used in) operating activities ..................... $ (38.2) $ 44.5 $ (36.4) $ 32.5 $ (56.6)
Net cash used in investing
activities ......................................... $(2,138.0) $(1,438.8) $ (356.8) $ (52.6) $ (58.9)
Net cash provided by
financing activities ............................... $ 2,062.6 $ 1,477.3 $ 766.1 $ 25.5 $ 113.9
Capital expenditures ................................... $ 1,900.2 $ 1,413.2 $ 345.8 $ 57.1 $ 48.7
</TABLE>
(1) The selected financial and operating data for the years ended and as of
December 31, 1999 and 1998 include the effect of the acquisitions of LCI
International, Inc., Icon CMT Corp., EUnet International Limited and
Phoenix Network, Inc., which occurred during 1998. The financial and
operating data for the year ended and as of December 31, 1999 include the
effect of the divestiture of EUnet International Limited in conjunction
with the formation of the KPNQwest joint venture, which occurred In April
1999. (See further discussion of these acquisitions in "Management's
Discussion and Analysis of Financial Condition and Results of
Operations.")
(2) The Company has not paid cash dividends on its Common Stock since becoming
a public company in June 1997. The merger agreement between U S WEST and
Qwest provides that the Company initially will pay a dividend of $0.0125
per share per quarter after completion of the merger. The payments of
dividends by the combined company after the merger will depend on business
conditions, the combined company's financial condition and earnings, as
well as other factors.
(3) EBITDA represents earnings (loss) from operations before interest, income
tax expense (benefit), depreciation and amortization. EBITDA excludes the
following non-recurring items: an expense of $2.7 million in the year
ended December 31, 1996 to restructure operations; merger-related expenses
of $864.5 million in the year ended December 31, 1998; and merger-related
expenses of $31.5 million in the year ended December 31, 1999. EBITDA does
not represent cash flow for the periods presented and should not be
considered as an alternative to net earnings (loss) as an indicator of the
Company's operating performance or as an alternative to cash flows as a
source of liquidity, and may not be comparable with EBITDA as defined by
other companies.
F-2
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion and analysis should be read in conjunction with the
Company's accompanying audited consolidated financial statements and the notes
thereto.
OVERVIEW
Qwest Communications International Inc. ("Qwest" or the "Company") is a leading
broadband Internet communications company engaged in two core businesses:
Communications Services and Construction Services.
Communications Services includes Internet, multimedia, data and voice services
sold to business, consumer and government customers. Internet and multimedia
services includes Internet Protocol ("IP") -- enabled services such as dedicated
and dial-up Internet access, web hosting, co-location access, voice over IP,
application hosting and mass storage services. Qwest also provides high-volume
voice and conventional private line services to other communications providers,
as well as to Internet Service Providers ("ISPs"), and other data service
companies. Internet and multimedia services are being developed in alignment
with existing and anticipated market demand in partnership with leading
information technology companies, including the following:
o Microsoft Corporation for business applications and service;
o KPMG LLP (through the Qwest Cyber.Solutions joint venture) for application
service provider, application hosting and application management services;
o SAP America, Inc. and Hewlett Packard Company for hosting and systems
management services;
o Covad Communications Group, Inc. ("Covad") and Rhythms NetConnections Inc.
("Rhythms") for digital subscriber line ("DSL") technology for high-speed
local network connectivity;
o Oracle Corporation and Siebel Systems, Inc. for application hosting
services; and
o Hewlett Packard Company for high-end data storage
Construction Services constructs and installs fiber optic systems for other
communications providers, as well as for the Company's own use.
Central to Qwest's strategy is the Qwest Macro CapacitySM Fiber Network, a
high-capacity IP-based fiber optic network designed to allow customers to
seamlessly exchange multimedia content -- images, data and voice. The
technologically advanced network spans over 25,500 route-miles in North America.
The network employs a self-healing SONET ring architecture. It is equipped with
advanced fiber and state-of-the-art transmission electronics. Qwest's network
architecture supports IP, Asynchronous Transfer Mode ("ATM") and frame relay
services, as well as circuit switched services.
In 1998, Qwest became the first network service provider to complete a
transcontinental IP-based fiber optic network when it activated its network from
Los Angeles to San Francisco to New York. The Company announced in late 1999
that it would be the first company in the year 2000 to build a nationwide
Internet Protocol OC-192 link carrying commercial traffic at 10
gigabits-per-second with the reliability of SONET architecture. Qwest also will
be the first company in 2000 to introduce an all-optical Internet network
coast-to-coast with maximum reliability. In addition, Qwest's European joint
venture, KPNQwest, is building and will operate an 11,800-mile network spanning
46 business markets in Europe. (See further discussion of the KPNQwest joint
venture below.)
Qwest is also expanding its network to carry international data and voice
traffic to Mexico and the Far East. The 1,400 route-mile Mexico network is
complete. The Company is also participating in a consortium of communications
companies that is building an underwater cable system connecting the United
States to Japan. Scheduled for completion by the fourth quarter of 2000, the
13,125-mile four-fiber pair cable will ultimately be capable of transmitting
information at the rate of 640 gigabits per second.
F-3
<PAGE>
U S WEST MERGER AGREEMENT
In July 1999, Qwest entered into a definitive merger agreement with U S WEST,
Inc. ("U S WEST"). Under the terms of the merger agreement, Qwest will issue
shares of its common stock having a value of $69.00 for each share of U S WEST
common stock, subject to a "collar" on Qwest's average stock price between
$28.26 and $39.90 per share. The number of Qwest shares to be issued for each U
S WEST share will be determined by dividing $69.00 by the average of the daily
volume weighted average prices of Qwest common stock for 15 randomly selected
trading days over a 30-day measurement period ending three days before the
closing of the transaction, provided that Qwest will not issue more than 2.44161
shares for each U S WEST share or less than 1.72932 shares for each U S WEST
share. The transaction will be accounted for as a purchase, with U S WEST deemed
the accounting acquiror and is structured to be tax-free to U S WEST shareowners
to the extent of the Qwest stock delivered in the transaction.
If Qwest's average stock price is below $38.70 per share, the obligation under
the "collar" for the amount which the price is below $38.70 per share may be
satisfied in whole or in part with cash. In determining the cash amount for the
collar, Qwest and U S WEST will consider Qwest's desire to reduce dilution to
its stockholders, U S WEST's potential desire to provide a cash element to its
stockholders and both companies' desire to maintain the combined company's
strong financial condition. If the companies decide to provide cash as part of
the collar consideration, the minimum exchange ratio would be 1.783.
U S WEST may terminate the merger agreement if the closing price of Qwest's
shares is below $22.00 for 20 consecutive trading days before the closing, or if
the average Qwest share price during the measurement period is less than $22.00.
The Boards of Directors and stockholders of both Qwest and U S WEST have
approved the proposed transaction. The transaction is subject to federal and
state regulatory approvals and other customary closing conditions. Closing of
the transaction is expected in mid-2000.
As a result of the transaction, Qwest will become subject to the regulations
applicable to U S WEST, a Regional Bell Operating Company ("RBOC"). Generally,
effective as of the closing of the transaction, Qwest may not provide inter-LATA
services within U S WEST's 14-state region until U S WEST receives approval to
provide such services under Section 271 of the Telecommunications Act of 1996,
as amended. Therefore, Qwest will be required to divest the prohibited services.
In connection with the termination of the U S WEST and Global Crossing LTD.
merger agreement, U S WEST paid Global Crossing a break-up fee of $140.0 million
in cash and agreed to return $140.0 million in Global Crossing shares, valued at
$62.75 per share, purchased by U S WEST in connection with its agreement with
Global Crossing. Qwest advanced to U S WEST the $140.0 million cash payment and
agreed to purchase $140.0 million in services from Global Crossing over four
years at the best commercially available prices.
STRATEGIC INVESTMENTS AND OTHER ALLIANCES
INVESTMENT IN SLINGSHOT NETWORKS LLC/ PURCHASE OF CERTAIN ASSETS OF ADMI. In
September 1999, Qwest and Anschutz Digital Media, Inc. ("ADMI"), an affiliate of
Qwest's principal stockholder, Anschutz Company, entered into an agreement to
form a joint venture called Slingshot Networks LLC to provide advanced digital
production, post-production and transmission facilities, digital media storage
and distribution services, telephony-based data storage and enhanced services,
access and routing services. Qwest and ADMI each own 50% of the joint venture.
Qwest contributed approximately $84.8 million consisting of a promissory note
payable over nine years at an annual interest rate of 6%. The agreement between
Qwest and ADMI also provided that Qwest would purchase certain telephony-related
assets and all of the stock of Precision Systems, Inc., a telecommunications
solutions provider, from ADMI in exchange for a promissory note in the amount of
$34.0 million. The promissory note is payable over nine years and bears interest
at an annual rate of 6%. Qwest's investment in the joint venture is accounted
for under the equity method.
INVESTMENT IN ADVANCED RADIO TELECOM CORP. In September 1999, Qwest invested
$90.0 million for an approximate 19% stake in Advanced Radio Telecom Corp.
("ART"), a facilities-based, broadband ISP that provides a direct connection
from customer location to the Internet, to help support the construction of
ART's fixed, high-speed wireless networks. In connection with this transaction,
a separate group of investors also invested $161.0 million. Qwest's investment
in ART is accounted for under the cost method.
INVESTMENT IN QWEST CYBER.SOLUTIONS LLC. In June 1999, Qwest and KPMG LLP, a
leading professional services firm, formed a joint venture called Qwest
Cyber.Solutions LLC, to provide
F-4
<PAGE>
Internet-based end-to-end application service provider, application hosting, and
application management services. The venture will offer customers a broad set of
vendor products available for Enterprise Resource Planning ("ERP"), Customer
Relationship Management ("CRM") and back office solutions, a state-of-the-art IP
broadband network, and technologically advanced Cybercenters. Qwest contributed
approximately $60.0 million consisting of cash and other assets, and owns a 51%
stake in the venture. The financial position and results of operation of the
venture have been consolidated in the accompanying financial statements from the
date of formation and KPMG's share in the venture is reflected as minority
interest.
STRATEGIC RELATIONSHIP WITH BELLSOUTH. In April 1999, BellSouth Corporation
(together with its subsidiaries, "BellSouth") and Qwest announced a strategic
relationship whereby BellSouth invested approximately $3.5 billion for an
approximate 10% equity stake in Qwest. Qwest issued approximately 40.7 million
shares to BellSouth in exchange for approximately $1.9 billion in cash. Qwest's
principal stockholder, Anschutz Company, sold approximately 33.3 million
existing shares to BellSouth for approximately $1.6 billion. At the same time, a
BellSouth affiliate and Qwest entered into a commercial arrangement for
provisioning of a full range of integrated digital data, image and voice
communications services for customers. These services will include Qwest's
portfolio of data networking, Internet and voice services and BellSouth's local
networking services. Once BellSouth is allowed to enter the long distance
market, the companies will jointly develop and deliver a comprehensive set of
end-to-end, high-speed data, image and voice communications services to business
customers, with an emphasis on broadband and Internet-based data services.
KPNQWEST. In April 1999, Qwest and KPN Telecom B.V. ("KPN"), the Dutch
telecommunications company, formed a joint venture ("KPNQwest") to create a
pan-European IP-based fiber optic network, linked to Qwest's network in North
America, for data and multimedia services. Qwest and KPN each initially owned 50
percent of KPNQwest which was initially governed by a six person supervisory
board to which Qwest and KPN had each named three members. Upon formation of
KPNQwest, KPN contributed two partially completed bi-directional, self-healing
fiber optic rings (EuroRings(TM) 1 and 2) and certain communications services
contracts to KPNQwest. Qwest contributed Xlink Internet Service Gmbh ("Xlink"),
the operating subsidiaries of EUnet International Limited ("EUnet") and cash.
Also, Qwest and KPN contributed transatlantic capacity that connects KPNQwest's
European network with Qwest's network in North America, and also contributed
certain other assets. The net book value of total assets contributed by Qwest
totaled approximately $300.0 million. Qwest deconsolidated EUnet and Xlink in
April 1999. Qwest's investment in KPNQwest is accounted for under the equity
method.
KPNQwest offers managed broadband services, IP transit, Internet connectivity
and value-added IP services, including consulting, hosting, and the broadcasting
of live events over the Internet. KPNQwest also sells dark fiber along its
network. Customers of KPNQwest include Internet services and content providers,
multinational firms in Europe and North America, as well as telecommunications
carriers, operators and others who want to purchase wholesale or retail network
capacity, fiber or services.
On November 12, 1999 KPNQwest consummated an initial public offering
("KPNQwest's IPO") which has resulted in approximately 11% of KPNQwest's shares
being owned by the public and the remainder of KPNQwest's shares being owned by
each of Qwest and KPN equally. As a result of the change in ownership structure
of KPNQwest, two outside directors were added to the supervisory board.
Also as a result of KPNQwest's IPO, Qwest recognized a gain of $414.0 million,
representing its proportionate share of the increase in KPNQwest's equity. Since
Qwest's investment in the foreign corporate joint venture is essentially
permanent in duration, Qwest did not record deferred income taxes on the excess
of its investment in KPNQwest over its tax basis in the joint venture.
INVESTMENT IN RHYTHMS. In April 1999, Qwest made an equity investment, totaling
$15.0 million in cash, in DSL local networks through an agreement with Rhythms,
a packet-based Competitive Local Exchange Carrier ("CLEC") that provides
high-speed networking solutions for remote access to private networks and the
Internet. Under this agreement, the Company will have access to the 29
metropolitan areas (10 of which are in addition to the areas covered by an
agreement that Qwest has with Covad Communications Group, Inc., as discussed
below) by the first quarter of 2000, while further enhancing its ability to
provide its customers with high-speed DSL connectivity to its network. The
Company has committed to place a minimum number of orders for DSL service over a
seven-year term commencing on the date that Rhythms is operational in the 29
metropolitan areas. In the event that the Company fails to meet the order
target, the Company is committed to pay Rhythms for the difference between the
order target and the number of actual orders placed. Qwest's investment in
Rhythms is accounted for under the cost method.
INVESTMENT IN COVAD. In January 1999, Qwest made an equity investment, totaling
$15.0 million in cash, in high-speed, DSL local networks through an agreement
with Covad, a packet-based CLEC. Under this agreement, the Company will have
access to 22 metropolitan areas, while enhancing its ability to provide its
customers with high-speed DSL connectivity to its network. The Company has
committed to purchase DSL services for approximately $20.0 million over a
five-year term commencing on the date that Covad's DSL services are commercially
available in all 22 metropolitan areas. Qwest's investment in Covad is accounted
for under the cost method.
ALLIANCE WITH MICROSOFT. In December 1998, the Company entered into a strategic
alliance with Microsoft that will enable businesses to utilize high-speed
network services that maximize network resources, reduce costs, generate new
sources of revenue and optimize management of computing operations. The
Company's service, to be built on the Microsoft(R) operating systems and
application platforms, when integrated with the Company's IP-based fiber optic
network, is designed for businesses of all sizes. Microsoft will license a broad
range of its software to Qwest. The parties will jointly market and sell the
services. In addition, Microsoft purchased 8.8 million shares of Qwest for
$200.0 million.
ACQUISITIONS
Each of the acquisitions discussed below was accounted for as a purchase. The
results of operations of each of these acquisitions have been included in the
accompanying consolidated statements of operations of the Company from the date
of acquisition.
ICON ACQUISITION. In December 1998, the Company completed its acquisition of
Icon CMT Corp. ("Icon"), a provider of integrated Internet solutions associated
with web hosting and IP integration, for approximately $254.1 million in Company
common stock, including approximately $3.5 million of direct acquisition costs.
At the close of the acquisition, the Company issued approximately 11.8 million
shares of the Company's common stock (including outstanding Icon stock options
and warrants assumed by the Company).
F-5
<PAGE>
In connection with the acquisition of Icon, the Company allocated $10.0 million
of the purchase price to in-process research and development ("R&D") projects,
$2.3 million to developed technology, $71.8 million to other intangible assets
and $194.0 million to goodwill. This allocation to the in-process R&D represents
the estimated fair value based on risk-adjusted cash flows related to the
incomplete projects. The in-process R&D was expensed at the date of acquisition
as the in-process R&D had not reached technological feasibility. The developed
technology, other intangible assets and goodwill are being amortized on a
straight-line basis from 4 to 15 years. (See further discussion of the Icon
acquisition in Results of Operations.)
LCI ACQUISITION. In June 1998, the Company acquired LCI International, Inc. and
subsidiaries ("LCI"), a communications services provider, for approximately $3.9
billion in Company common stock, including approximately $13.5 million in direct
acquisition costs. At the close of the acquisition, the Company issued
approximately 259.8 million shares of the Company's common stock (including
outstanding LCI stock options assumed by the Company).
In connection with the acquisition of LCI, the Company allocated $682.0 million
of the purchase price to in-process R&D projects, $318.0 million to developed
technology, $65.0 million to other intangible assets and $3,071.0 million to
goodwill. The allocation to the in-process R&D represents the estimated fair
value based on risk-adjusted cash flows related to the incomplete projects. The
in-process R&D was expensed at the date of acquisition as the in-process R&D had
not reached technological feasibility. The developed technology, other
intangible assets and goodwill are being amortized on a straight-line basis from
10 to 40 years. (See further discussion of the LCI acquisition in Results of
Operations.)
EUNET ACQUISITION. In April 1998, the Company acquired EUnet, a European ISP
with subsidiaries in 14 countries, for approximately $154.0 million in Company
common stock, including approximately $3.5 million in direct acquisition costs,
and $4.2 million in cash. At the close of the acquisition, the Company issued
approximately 7.9 million shares of Company common stock. The results of
operations for periods beginning April 1, 1999 exclude the operating results of
EUnet, which was contributed to the KPNQwest joint venture on April 1, 1999.
PHOENIX ACQUISITION. In March 1998, the Company acquired Phoenix Network, Inc.
("Phoenix"), a non-facilities-based reseller of long distance services.
Approximately 1.6 million shares of the Company common stock having a value of
approximately $27.2 million were exchanged for the outstanding shares of
Phoenix.
SUPERNET ACQUISITION. In October 1997, the Company acquired SuperNet, Inc.
("SNI"), an ISP, for $20.0 million in cash, including acquisition costs.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
The Company reported net earnings of $458.5 million for the year ended December
31, 1999, compared to a net loss of $844.0 million for the prior year. For the
comparative periods presented, the Company's results of operations include the
acquisitions of the following: Icon from January 1999; LCI from June 1998;
Phoenix from March 1998; and SNI from October 1997. The results of operations
for periods beginning April 1, 1999 exclude the operating results of EUnet,
which was contributed to KPNQwest on April 1, 1999. Excluding the effects of the
gain as a result of the KPNQwest IPO and merger-related costs related to the
pending merger with U S WEST, Inc. in 1999, merger-related costs and the
write-off of in-process R&D costs related to the LCI, EUnet and Icon
acquisitions and the charge for the redemption of a total of $87.5 million in
principal amount of the Company's 107/8% Senior Notes, due 2007 (the "107/8%
Notes") in 1998, the Company's reported net earnings would have been $72.6
million for the year ended December 31, 1999, compared to a net loss of $19.4
million for the same period of the prior year.
REVENUE. Components of revenue for the years ended December 31, 1999 and 1998
were as follows:
Year Ended December 31, Increase
(In Millions) 1999 1998 (Decrease)
-------------------------------------
Communications services ............. $3,703.1 $1,554.3 $2,148.8
Construction services ............... 224.5 688.4 (463.9)
-------------------------------------
Total revenue ................... $3,927.6 $2,242.7 $1,684.9
=====================================
F-6
<PAGE>
During the year ended December 31, 1999, as compared to the prior year,
Communications Services revenue increased due to the inclusion of the first full
year of revenue from the acquisitions discussed above, and to growth in all
aspects of Communications Services. Construction Services revenue decreased
during the year ended December 31, 1999, as compared to the prior year,
primarily as a result of the completion of the milestones for which the Company
had construction contracts.
OPERATING EXPENSES. Components of operating expenses for the years ended
December 31, 1999 and 1998 were as follows:
Year Ended December 31, Increase
(In Millions) 1999 1998 (Decrease)
------------------------------------
Access and network operations ....... $2,062.7 $ 961.8 $1,100.9
Construction services ............... 96.4 446.8 (350.4)
Selling, general and administrative . 1,009.3 539.6 469.7
Depreciation and amortization ....... 404.1 201.7 202.4
Merger-related costs ................ 31.5 846.5 (815.0)
------------------------------------
Total operating expenses ........ $3,604.0 $2,996.4 $ 607.6
====================================
Expenses for access and network operations primarily consist of the cost of
operating the Company's network, Local Exchange Carrier ("LEC") access charges
and the cost of leased capacity. The increase in access and network operations
for the year ended December 31, 1999 over the prior year was primarily
attributable to the first full year of additional expenses related to acquired
entities, as well as internally generated growth in Communications Services
revenue. As a result of the completion of the network in 1999, the Company was
able to serve more customer needs over its own network, thereby reducing leased
capacity costs as a percentage of revenue.
Expenses for Construction Services consist primarily of costs to construct the
Company's network, including conduit, fiber, cable, construction crews and
rights of way. Costs attributable to the construction of the network for the
Company's own use are capitalized. Expenses for Construction Services decreased
for the year ended December 31, 1999, as compared to the prior year, due to the
completion of the milestones for which the Company had construction contracts.
Selling, general and administrative ("SG&A") expense includes the cost of
salaries, benefits, occupancy costs, commissions, sales and marketing expenses
and administrative expenses. The increase in SG&A for the year ended December
31, 1999, as compared to the prior year, was due primarily to the following: the
first full year of additional expenses related to acquired entities; increased
sales and marketing efforts; additional bad debt expense related to the increase
in Communications Services revenues; increased payroll-related costs from the
recruiting and hiring of additional sales and administrative personnel;
increased commissions expense related to the growth in Communications Services
revenue; additional building rent expense related to increased space obtained in
response to the Company's infrastructure growth; and increased property taxes
and maintenance costs related to the expansion of the Company's network. During
the year ended December 31, 1999, as compared to the prior year, the number of
employees increased, due to expansion of the sales and customer support
infrastructure, from approximately 8,700 employees at December 31, 1998 to
approximately 10,000 employees at December 31, 1999. The Company expects SG&A
expense to increase as the Company continues expansion of its Communications
Services business.
The Company's depreciation and amortization expense increased due primarily to
activating additional segments of the Company's network during the year ended
December 31, 1999, purchases of assets to accommodate the Company's growth and
the first full year of depreciation and amortization of assets and goodwill
related to the Company's acquisitions. The Company expects that depreciation
expense will continue to increase in subsequent periods as the Company continues
to activate additional capacity on its network, and continues the build-out of
local networks and CyberCenters.
During the years ended December 31, 1999 and December 31, 1998, the Company
recorded $31.5 million and $846.5 million in merger-related costs, respectively.
The merger-related costs incurred in 1999 relate to the pending merger with U S
WEST, Inc. and are comprised primarily of fees for professional services. The
merger-related costs incurred in 1998 relate to the merger with LCI and Icon,
including $760.0 million of in-process R&D, $31.0 million of duplicate
facilities, $49.0 million of channel consolidation and duplicate commitments and
$6.5 million of other miscellaneous merger costs. Of these merger costs,
approximately $4.5 million remain accrued as of December 31, 1999.
OTHER EXPENSE (INCOME). Components of other expense (income) for the years ended
December 31, 1999 and 1998, were as follows:
Year Ended December 31,
(In Millions) 1999 1998 Change
------------------------------------
Interest expense, net ............... $ 151.0 $ 97.3 $ 53.7
Gain on KPNQwest investment ......... (414.0) -- (414.0)
Other expense (income), net ......... 3.1 (1.2) 4.3
F-7
<PAGE>
The increase in interest expense, net of capitalized interest during the year
ended December 31, 1999, as compared to the prior year, resulted from the senior
notes issued in 1998 being outstanding for the full fiscal year in 1999 (see
"Liquidity and Capital Resources" below). The gain on KPNQwest investment
represents Qwest's proportionate share of the increase in KPNQwest's equity as a
result of KPNQwest's IPO in November 1999. The change in other expense (income),
net, is due primarily to Qwest's share of losses from its equity investments,
partially offset by an increase in interest income, resulting from higher
average cash balances.
INCOME TAXES. Effective with the LCI merger, the Company is no longer included
in the consolidated federal income tax return of Anschutz Company ("Anschutz").
As a result, the tax-sharing agreement with Anschutz is no longer effective for
activity after June 5, 1998. The Company is still subject to the provisions of
the tax-sharing agreement for activity through June 5, 1998. The Company
previously recognized a deferred tax asset attributable to its net operating
loss carry forwards under the tax-sharing agreement. The Company currently
believes the tax benefits previously recognized under the tax-sharing agreement
may be realized through tax planning strategies.
The Company's effective tax rate for the year ended December 31, 1999 differed
from the statutory income tax rate primarily as a result of the exclusion of the
gain from the KPNQwest IPO and the non-deductibility of amortization of
acquisition-related goodwill. The effective tax rate for the year ended December
31, 1998 differed from the statutory rate primarily as a result of the
non-deductibility of R&D write-offs and amortization of acquisition-related
goodwill. After giving effect to non-deductible charges, the Company expects
that its combined provision for federal and state income tax will be
approximately 40%.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
The Company reported a net loss of $844.0 million in the year ended December 31,
1998, compared to net earnings of $14.5 million in the same period of the prior
year. For the comparative periods presented, the Company's results of operations
include the acquisitions of the following: LCI from June 1998; EUnet from April
1998; Phoenix from March 1998; and SNI from October 1997. Excluding the effects
of the merger-related costs and the write-off of in-process R&D costs related to
the LCI, EUnet and Icon acquisitions in 1998 and the charge for the redemption
of a total of $87.5 million in principal amount of the Company's 107/8% Notes,
the Company's reported net loss would have been $19.4 million for the year ended
December 31, 1998 compared to net earnings of $14.5 million for the same period
of the prior year.
REVENUE. Components of revenue for the years ended December 31, 1998 and 1997
were as follows:
Year Ended December 31,
(In Millions) 1998 1997 Increase
------------------------------------
Communications services ............. $1,554.3 $ 115.3 $1,439.0
Construction services ............... 688.4 581.4 107.0
------------------------------------
Total revenue ................... $2,242.7 $ 696.7 $1,546.0
====================================
During the year ended December 31, 1998, as compared to the prior year,
Communications Services revenue increased due to the addition of revenue from
the acquisitions discussed above, and due to growth in all aspects of
Communications Services. Construction Services revenue increased during the year
ended December 31, 1998, as compared to the prior year, primarily as a result of
additional dark fiber sales to other carriers and the completion of additional
milestones for which the Company had construction contracts.
OPERATING EXPENSES. Components of operating expenses for the years ended
December 31, 1998 and 1997 were as follows:
Year Ended December 31,
(In Millions) 1998 1997 Increase
------------------------------------
Access and network operations ....... $ 961.8 $ 86.0 $ 875.8
Construction services ............... 446.8 408.3 38.5
Selling, general and administrative . 539.6 158.7 380.9
Depreciation and amortization ....... 201.7 20.2 181.5
Merger-related costs ................ 846.5 -- 846.5
------------------------------------
Total operating expenses ........ $2,996.4 $ 673.2 $2,323.2
====================================
Expenses for access and network operations primarily consist of the cost of
operating the Company's network, LEC access charges and the cost of leased
capacity. The increase in access and network operations for the year ended
December 31, 1998 over the prior year was primarily
F-8
<PAGE>
attributable to growth in revenue from acquisitions, as well as internally
generated growth in Communications Services revenue.
Expenses for Construction Services consist primarily of costs to construct the
Company's network, including conduit, fiber, cable, construction crews and
rights of way. Costs attributable to the construction of the network for the
Company's own use are capitalized. Expenses for Construction Services increased
for the year ended December 31, 1998, as compared to the prior year, due to
additional contracts that were signed during 1998 and further completion of the
Company's network.
Selling, general and administrative ("SG&A") expense includes the cost of
salaries, benefits, occupancy costs, commissions, sales and marketing expenses
and administrative expenses. The increase in SG&A for the year ended December
31, 1998, as compared to the prior year, was due primarily to the following:
additional expenses related to acquired entities; increased sales and marketing
efforts; additional bad debt expense related to the increase in Communications
Services revenues; increased payroll-related costs from the recruiting and
hiring of additional sales and administrative personnel; increased commissions
expense related to the growth in Communications Services revenue; additional
building rent expense related to increased space obtained in response to the
Company's infrastructure growth; and increased property taxes and maintenance
costs related to the increase of fixed assets along the Company's network.
During the year ended December 31, 1998, as compared to the prior year, the
number of employees increased, due to acquisitions and the expansion of the
sales and customer support infrastructure, from approximately 1,600 employees at
December 31, 1997 to approximately 8,700 employees at December 31, 1998. The
increase in SG&A was partially offset by a decrease in expense recognized under
the Company's Growth Share Plan (the "Growth Share Plan"), which was established
in October 1996 for certain employees and directors of the Company.
The Company's depreciation and amortization expense increased due primarily to
activating additional segments of the Company's network during the year ended
December 31, 1998, purchases of assets to accommodate the Company's growth and
depreciation and amortization of assets and goodwill related to the Company's
acquisitions.
During the year ended December 31, 1998, the Company recorded $86.5 million in
merger-related costs related to the merger with LCI, including $31.0 million of
duplicate facilities, $49.0 million of channel consolidation and duplicate
commitments and $6.5 million of other miscellaneous merger costs. Of these
merger costs, approximately $6.0 million remain accrued as of December 31, 1998.
In connection with the acquisition of LCI, the Company allocated $682.0 million
of the purchase price to in-process R&D projects, $318.0 million to developed
technology, $65.0 million to other intangible assets and $3,071.0 million to
goodwill. The allocation to the in-process R&D represents the estimated fair
value based on risk-adjusted cash flows related to the incomplete projects. At
the date of the merger, the development of these projects had not yet reached
technological feasibility and the in-process R&D had no alternative future uses.
Accordingly, these costs were expensed as of the merger date. The developed
technology, other intangible assets and goodwill are being amortized on a
straight-line basis from 10 to 40 years.
The Company assessed and allocated values to the in-process R&D. The values
assigned to these assets were determined by identifying significant research
projects for which technological feasibility had not been established. These
assets consisted of a significant number of R&D projects grouped into three
categories: (1) next-generation network systems automation tools; (2) advanced
data services, including frame relay and Internet Protocol technologies; and (3)
new operational systems and tools. Taken together, these projects, if
successful, will enable the Company to provide advanced voice and data services
as well as sophisticated network management and administration functions. A
brief description of the three categories of in-process projects is presented
below:
o R&D RELATED TO NETWORK SYSTEMS AUTOMATION. These R&D projects are intended
to create a new method of automating LCI's service provisioning and
network management systems, and were valued at approximately $218.0
million. These proprietary projects include the development of data
warehousing and new interface technologies to enable the interchange of
data across disparate networks. As of the transaction date, the Company
believes that the overall project was 60% complete. As of December 31,
1999 these projects were substantially complete.
o R&D RELATED TO FRAME RELAY AND IP SERVICES. These projects involve R&D
related to the deployment of frame relay and IP technologies within the
LCI network, and were valued at approximately $155.0 million. With the
completion of this next-generation network, the Company will be able to
address emerging new demand trends for data services. Management considers
this a complex project due to the customized work required. As of the
transaction date, the Company believes the overall project was
approximately 60% to 70% complete. As of December 31, 1999 these projects
were substantially complete.
o R&D RELATED TO OPERATIONAL SYSTEMS AND TOOLS. These projects involve R&D
related to the development of new service and network management tools and
engineering functions, and were valued at approximately $309.0 million.
These proprietary projects are closely associated with LCI's deployment of
advanced data services. Applications enabled by these new technologies
include the ability to offer new products and service packages. As of the
acquisition date, the Company believes the projects were 60% to 70%
complete. As of December 31, 1999 these projects were substantially
complete.
The value assigned to purchased in-process technology was determined by
estimating the contribution of the purchased in-process technology to developing
commercially viable products, estimating the resulting net cash flows from the
expected product sales of such products, and discounting the net cash flows from
the expected product sales of such products to their present value using a
risk-adjusted discount rate.
The Company estimates total revenues from the specific acquired in-process
technology will peak in 2003 and will steadily decline from 2004 through 2009 as
other new product and service technologies are expected to be introduced by the
Company. These projections are based on management's estimates of market size
and growth, expected trends in technology, and the expected timing of new
product introductions. Discounting the net cash flows back to their present
values is based on the weighted average cost of capital ("WACC"). The business
enterprise comprises various types of assets, each possessing different degrees
of investment risk contributing to LCI's overall WACC. Intangible assets are
assessed higher risk factors due to their lack of liquidity and poor versatility
for redeployment elsewhere in the business. Reasonable returns on monetary and
fixed assets were estimated based on prevailing interest rates. The process for
quantifying intangible asset investment risk involved consideration of the
uncertainty associated with realizing discernible cash flows over the life of
the asset. A discount rate of 19% was used for valuing the in-process R&D. This
discount rate is higher than the implied WACC due to the inherent uncertainties
surrounding the successful development, the
F-9
<PAGE>
useful life and the profitability levels of the purchased in-process technology,
and the uncertainty of technological advances that are unknown at this time. As
is standard in the appraisal of high-growth markets, projected revenues,
expenses and discount rates reflect the probability of technical and marketing
successes.
The value of the in-process projects was adjusted to reflect value and
contribution of the acquired R&D. In doing so, consideration was given to the
R&D's stage of completion, the complexity of the work completed to date, the
difficulty of completing the remaining development, costs already incurred, and
the projected cost to complete projects.
The Company believes that the foregoing assumptions used in the forecasts were
reasonable at the time of the merger. The Company cannot assure, however, that
the underlying assumptions used to estimate expected project sales, development
costs or profitability, or the events associated with such projects, will
transpire as estimated. For these reasons, actual results may vary from the
projected results.
In connection with the acquisition of EUnet, the Company allocated $68.0 million
of the purchase price to in-process R&D projects. These projects include the
design and development of several new value-added Internet services as well as
the development of the necessary customer care and network management systems.
Since these projects had not yet reached technological feasibility and had no
alternative future use at the acquisition date, there was no guarantee as to the
achievability of the projects or their ascribed values. Accordingly, these costs
were expensed as of the acquisition date.
In connection with the acquisition of Icon, the Company allocated $10.0 million
of the purchase price to in-process R&D projects. These projects include the
design and development of several new value-added Internet services, including
end-to-end solutions methodology designed to provide system-wide solutions for
high-end corporate customers, a next-generation high-speed network system, and
an improved network management system with added features. Since these projects
had not yet reached technological feasibility and had no alternative future uses
as of the acquisition date, there was no guarantee as to the achievability of
the projects or their ascribed values. Accordingly, these costs were expensed as
of the acquisition date.
OTHER EXPENSE (INCOME). Components of other expense (income) for the years ended
December 31, 1998 and 1997, were as follows:
Year Ended December 31,
(In Millions) 1998 1997 Change
------------------------------------
Interest expense, net ............... $ 97.3 $ 18.8 $ 78.5
Other income, net ................... (1.2) (18.9) 17.7
The increase in interest expense, net of capitalized interest during the year
ended December 31, 1998, as compared to the prior year, resulted from an
increase in long-term indebtedness (see "Liquidity and Capital Resources"
below), partially offset by an increase in capitalized interest resulting from
construction of the Company's network. Other income, net, decreased due
primarily to decreases in interest income, resulting from lower average cash
balances, and a charge of $12.9 million for the redemption of a total of $87.5
million in principal amount of the 107/8% Notes. Additionally, in 1997, the
Company recorded a $9.3 million gain on sale of contract rights.
INCOME TAXES. Effective with the LCI merger, the Company is no longer included
in the consolidated federal income tax return of Anschutz. As a result, the
tax-sharing agreement with Anschutz is no longer effective for activity after
June 5, 1998. The Company is still subject to the provisions of the tax-sharing
agreement for activity through June 5, 1998. The Company previously recognized a
deferred tax asset attributable to its net operating loss carry forwards under
the tax-sharing agreement. The Company currently believes the tax benefits
previously recognized under the tax-sharing agreement may be realized through
tax planning strategies.
The Company's effective tax rate for the year ended December 31, 1998 differed
from the statutory income tax rate primarily as a result of the
non-deductibility of R&D write-offs and amortization of acquisition-related
goodwill. The effective tax rate for the year ended December 31, 1997 differed
from the statutory rate primarily as a result of the non-deductibility of a
portion of the Growth Share Plan expense and amortization of acquisition-related
goodwill. After giving effect to non-deductible charges, the Company expects
that its combined provision for federal and state income tax will be
approximately 40%.
F-10
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
For the year ended December 31, 1999, cash used in operations was $38.2 million;
cash used in investing activities was $2,138.0 million, including $1,900.2
million of capital expenditures; and cash provided by financing activities was
$2,062.6 million. Cash provided by financing activities includes an approximate
$1.9 billion equity investment by BellSouth and employee stock transactions of
$150.3 million.
The Company believes that its available cash and cash equivalent balances at
December 31, 1999, cash flow from operations, existing credit facilities and the
proposed credit limit increase on its revolving credit facility (described
below) will satisfy its currently anticipated cash requirements at least for the
next 12 months. The Company anticipates future capital expenditures during 2000
to support its growth in communications services, including continued expansion
of data products and services, activation of additional capacity along the
Company's network, new CyberCenter construction and local access initiatives to
be approximately $2.5 to $2.7 billion.
In March 1999, the Company entered into a $1.0 billion credit agreement with a
syndicate of banks. This credit agreement provides for two five-year revolving
credit facilities for a total of $500.0 million and one 364-day revolving credit
facility in the amount of $500.0 million. The credit facilities bear interest at
either the bank base rate of interest or LIBOR plus an applicable margin. As of
December 31, 1999, there were no borrowings outstanding under the credit
agreement.
The Company's credit agreement contains a provision whereby all amounts
outstanding under the agreement must be repaid as a result of a "change of
control" of the Company. While the Company does not believe that a change of
control will occur, the Company is currently negotiating an amendment to the
existing credit agreement and is taking other actions to ensure that the U S
WEST merger does not constitute a "change of control." The Company is also
taking such other actions necessary to permit the Company to consummate the
merger. Such amendment is expected to be in place prior to the end of the first
quarter of 2000. In addition, the Company is in the process of extending the
term of the existing $500 million 364-day revolving credit facility and adding
an additional $1.0 billion credit facility. Consummation of the additional
credit facility is conditioned, among other things, on the execution of a
mutually satisfactory credit agreement, which is expected to occur prior to the
end of the first quarter of 2000.
RECENT ACCOUNTING PRONOUNCEMENTS
On December 3, 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB
101"). SAB 101 summarizes certain of the staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
SAB 101 was effective upon issuance. The Company believes that the adoption of
this standard will not have a material effect on the Company's consolidated
results of operations or financial position.
YEAR 2000
The Company established a year 2000 program office to prepare for and monitor
the rollover to the year 2000 and related dates throughout the 2000 calendar
year ("Year 2000 Rollover Events"). Since its inception through December 31,
1999, the program office incurred $20 million in expenses to inventory, assess,
modify, test and deploy applications and hardware of the Company as well as to
develop contingency plans in the event of failure during a Year 2000 Rollover
Event. Costs anticipated to be incurred in 2000 for the continued monitoring of
Year 2000 Rollover Events are expected to be less than $1.0 million.
The most significant of the Year 2000 Rollover Events was the rollover from
December 31, 1999 to January 1, 2000. In preparation for this Rollover Event,
the Company established five command centers to monitor for events and
coordinate and communicate needed responses. While minor year 2000 issues arose
within certain of the Company's internal systems, there were no year 2000 issues
which caused disruptions of voice, data or Internet services to customers.
Although the Company has not identified a new year 2000 event since January 5,
2000, it is possible that the effects of some events have not yet been
identified or that future Year 2000 Rollover Events will have an impact. The
Company has contingency plans that can be enacted in the case of such future
failures, and additional customer service and technical support resources will
be deployed during future Year 2000 Rollover Event dates such as February 29,
2000 and January 1, 2001.
INFLATION
Inflation has not significantly affected the Company's operations during the
past three years.
F-11
<PAGE>
Quantitative and Qualitative Disclosures about Market Risk
During 1997 and 1998, the Company issued $250.0 million of 107/8% Senior Notes,
due 2007, $555.9 million of 9.47% Senior Discount Notes, due 2007, $450.5
million of 8.29% Senior Discount Notes, due 2008, $750.0 million of 7.50% Senior
Notes, due 2008, and $300.0 million of 7.25% Senior Notes, due 2008
(collectively "the Notes"). In connection with its acquisition of LCI in June
1998, the Company assumed LCI's existing debt instruments, including $350.0
million of 7.25% Notes, due 2007. On December 31, 1998, the Company exercised
its option to redeem 35%, or $87.5 million in principal amount, of the 107/8%
Notes at a redemption price of 110.875%.
The Company's long-term debt obligations are principally fixed interest rate and
non-trading in nature, and as a result, the Company is less sensitive to market
rate fluctuations. The Company does not use derivative financial instruments to
manage its interest rate risk and has no cash flow exposure due to general
interest rate changes for its fixed interest rate long-term debt. The table
below provides information about the Company's market risk exposure associated
with changing interest rates on its fixed rate debt and capital lease and other
obligations.
Collectively, the fixed rate debt, capital lease and other obligations, with a
carrying value of $2,369.7 million, had an estimated fair value of $2,361.5
million at December 31, 1999, based on current interest rates offered for debt
of similar terms and maturity.
The Company's European-country operations were not material to the Company's
consolidated financial position as of December 31, 1999, and results of
operations or cash flows for the year ended December 31, 1999. In addition,
foreign currency transaction gains and losses were not material to the Company's
results of operations for the year ended December 31, 1999, and the Company was
not subject to material foreign currency exchange rate risk from the effects of
exchange rate movements of foreign currencies on the costs or cash flows the
Company would receive from its share of the KPNQwest joint venture. To date, the
Company has not entered into any significant foreign currency forward exchange
contracts or other derivative financial instruments to hedge the effects of
adverse fluctuations in foreign currency exchange rates.
<TABLE>
<CAPTION>
Expected Maturity
--------------------------------------------------------------------------------------
Unamortized
2000 2001 2002 2003 2004 Thereafter Discount Total
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long-term fixed rate debt ......... $ -- $ -- $ -- $ -- $ -- $2,568.9 $ (224.8) $2,344.1
Capital lease and other obligations $ 1.4 $ 2.1 $ 2.6 $ 3.0 $ 3.6 $ 12.9 $ -- $ 25.6
Average interest rate ............. 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%
</TABLE>
F-12
<PAGE>
Report of Independent Public Accountants
To the Board of Directors and Stockholders of Qwest Communications International
Inc.:
We have audited the accompanying consolidated balance sheet of Qwest
Communications International Inc. (a Delaware corporation) and subsidiaries as
of December 31, 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Qwest Communications
International Inc. and subsidiaries as of December 31, 1999, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Denver, Colorado,
January 31, 2000.
Independent Auditors' Report
To the Board of Directors
Qwest Communications International Inc.:
We have audited the accompanying consolidated balance sheet of Qwest
Communications International Inc. and subsidiaries as of December 31, 1998, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for the years ended December 31, 1998 and 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Qwest Communications
International Inc. and subsidiaries as of December 31, 1998, and the results of
their operations and their cash flows for the years ended December 31, 1998 and
1997 in conformity with generally accepted accounting principles.
/s/ KPMG LLP
KPMG LLP
Denver, Colorado
February 2, 1999
F-13
<PAGE>
Consolidated Statements of Operations
For the Three Years Ended December 31, 1999
(In Millions, Except Per Share Information)
<TABLE>
<CAPTION>
1999 1998 1997
-----------------------------------
<S> <C> <C> <C>
Revenue:
Communications services ......................... $ 3,703.1 $ 1,554.3 $ 115.3
Construction services ........................... 224.5 688.4 581.4
-----------------------------------
Total revenue ................................ 3,927.6 2,242.7 696.7
-----------------------------------
Operating expenses:
Access and network operations ................... 2,062.7 961.8 86.0
Construction services ........................... 96.4 446.8 408.3
Selling, general and administrative ............. 1,009.3 539.6 158.7
Depreciation and amortization ................... 404.1 201.7 20.2
Merger costs .................................... 31.5 86.5 --
Provision for in-process research and development -- 760.0 --
-----------------------------------
Total operating expenses ..................... 3,604.0 2,996.4 673.2
-----------------------------------
Earnings (loss) from operations .............. 323.6 (753.7) 23.5
Other expense (income):
Interest expense, net ........................... 151.0 97.3 18.8
Gain on KPNQwest investment ..................... (414.0) -- --
Other expense (income), net ..................... 3.1 (1.2) (18.9)
-----------------------------------
Earnings (loss) before income taxes .......... 583.5 (849.8) 23.6
Income tax expense (benefit) ........................ 125.0 (5.8) 9.1
-----------------------------------
Net earnings (loss) ............................. $ 458.5 $ (844.0) $ 14.5
-----------------------------------
Net earnings (loss) per share - basic ............... $ 0.63 $ (1.51) $ 0.04
-----------------------------------
Net earnings (loss) per share - diluted ............. $ 0.60 $ (1.51) $ 0.04
-----------------------------------
Weighted average shares outstanding - basic ......... 727.8 558.2 381.0
-----------------------------------
Weighted average shares outstanding - diluted ....... 764.3 558.2 388.1
===================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-14
<PAGE>
Consolidated Balance Sheets
As of December 31, 1999 and 1998
(In Millions, Except Share Information)
<TABLE>
<CAPTION>
1999 1998
----------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................... $ 349.2 $ 462.8
Accounts receivable (net of allowance of
$68.3 million and $56.2 million) ..................... 1,136.7 628.1
Prepaid expenses and other current assets ............... 299.3 348.2
----------------------
Total current assets ................................. 1,785.2 1,439.1
Property and equipment, net ................................. 4,108.7 2,655.4
Excess of cost over net assets acquired (net of accumulated
amortization of $162.1 million and $59.8 million) ....... 3,290.1 3,402.0
Investment in KPNQwest ...................................... 680.0 --
Intangible and other assets (net of accumulated
amortization of $71.3 and $24.1 million) ................ 1,194.1 571.1
----------------------
TOTAL ASSETS ................................................ $11,058.1 $ 8,067.6
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................ $ 209.9 $ 205.1
Facility costs accrued and payable ...................... 275.4 300.2
Accrued expenses and other .............................. 753.1 732.2
----------------------
Total current liabilities ............................ 1,238.4 1,237.5
Debt and capital lease obligations, net of current portion .. 2,368.3 2,307.1
Other long-term liabilities ................................. 394.9 284.8
----------------------
Total liabilities .................................... 4,001.6 3,829.4
----------------------
Minority interest ........................................... 55.2 --
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.01 par value; authorized
200.0 million shares; no shares issued and outstanding -- --
Common stock - $.01 par value; authorized 5.0 billion
shares; 750.0 million shares and 694.0 million shares
issued and outstanding ............................... 7.5 6.9
Paid-in capital ......................................... 7,278.3 5,105.0
Accumulated other comprehensive income .................. 132.9 2.2
Accumulated deficit ..................................... (417.4) (875.9)
----------------------
Total stockholders' equity ........................... 7,001.3 4,238.2
----------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................. $11,058.1 $ 8,067.6
======================
</TABLE>
See accompanying notes to consolidated financial statements.
F-15
<PAGE>
Consolidated Statements of Stockholders' Equity
For the Three Years Ended December 31,1999
(In Millions)
<TABLE>
<CAPTION>
Common Stock Accumulated
-------------------- Additional Other Total
Number of Paid-in Comprehensive Accumulated Stockholders'
Shares Amount Capital Income Deficit Equity
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1997 .............................. 346.0 $ 3.4 $ 52.5 $ -- $ (46.4) $ 9.5
Issuance of common stock in initial public offering, net 62.1 0.8 318.8 -- -- 319.6
Issuance of common stock in employee stock
transactions, including related income tax benefits 5.2 -- 38.2 -- -- 38.2
Net earnings ........................................... -- -- -- -- 14.5 14.5
-------------------------------------------------------------------------
Balances, December 31, 1997 ............................ 413.3 4.2 409.5 -- (31.9) 381.8
Issuance of common stock in employee stock
transactions, including related income tax benefits 23.6 0.2 167.7 -- -- 167.9
Issuance of common stock, warrants
and options in acquisitions ........................ 248.3 2.5 4,327.8 -- -- 4,330.3
Issuance of common stock to Microsoft Corporation ...... 8.8 -- 200.0 -- -- 200.0
Comprehensive income:
Currency translation adjustments
(net of related taxes of $1.2) .................. -- -- -- 2.2 -- 2.2
Net loss ........................................... -- -- -- -- (844.0) (844.0)
-------------------------------------------------------------------------
Total comprehensive income ...................... -- -- -- 2.2 (844.0) (841.8)
-------------------------------------------------------------------------
Balances, December 31, 1998 ............................ 694.0 6.9 5,105.0 2.2 (875.9) 4,238.2
Issuance of common stock in employee stock
transactions, including related income tax benefits 14.6 0.2 244.7 -- -- 244.9
Issuance of common stock to BellSouth Corporation ...... 40.7 0.4 1,921.3 -- -- 1,921.7
Other .................................................. 0.7 -- 7.3 -- -- 7.3
Comprehensive income:
Currency translation adjustments (net of related tax
benefit of $0.9) ................................ -- -- -- (1.4) -- (1.4)
Net change in unrealized gain on marketable equity
securities (net of related taxes of $89.3) ...... -- -- -- 132.1 -- 132.1
Net earnings ....................................... -- -- -- -- 458.5 458.5
-------------------------------------------------------------------------
Total comprehensive income ...................... -- -- -- 130.7 458.5 589.2
-------------------------------------------------------------------------
Balances, December 31, 1999 ............................ 750.0 $ 7.5 $7,278.3 $ 132.9 $ (417.4) $7,001.3
=========================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-16
<PAGE>
Consolidated Statements of Cash Flows
For the Three Years Ended December 31, 1999
(In Millions)
<TABLE>
<CAPTION>
1999 1998 1997
--------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) ......................................... $ 458.5 $ (844.0) $ 14.5
Adjustments to reconcile net earnings (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ............................ 404.1 201.7 20.2
Provision for bad debts .................................. 192.6 82.8 7.8
Interest accretion on discount notes ..................... 66.3 58.4 6.9
Restructuring and merger non-cash charges ................ -- 846.5 --
Deferred income tax expense (benefit) .................... 124.7 (7.8) 9.0
Gain on KPNQwest investment .............................. (414.0) -- --
Equity in subsidiary losses .............................. 33.6 0.9 --
Changes in operating assets and liabilities,
net of effect of business combinations:
Accounts receivable ............................... (714.7) (317.0) (39.7)
Net securitization payment ........................ -- (100.7) --
Accounts payable .................................. 18.2 (33.2) 53.1
Facility costs accrued and payable ................ (24.8) 128.9 4.6
Accrued expenses and other ........................ (3) 210.7 88.0
Other long-term assets ............................ (285.1) (46.5) (2.9)
Other long-term liabilities ....................... (20.0) (71.4) (0.1)
Other changes ..................................... 125.4 (64.8) (197.8)
--------------------------------
Net cash provided by (used in) operating activities (38.2) 44.5 (36.4)
--------------------------------
Cash flows from investing activities:
Expenditures for property and equipment ..................... (1,900.2) (1,413.2) (345.8)
Acquisitions, investments and other ......................... (237.8) (25.6) (11.0)
--------------------------------
Net cash used in investing activities ............. (2,138.0) (1,438.8) (356.8)
--------------------------------
Cash flows from financing activities:
Proceeds from long-term debt ................................ -- 1,403.5 678.0
Repayments of long-term debt ................................ (4.1) (164.3) (200.2)
Net short-term debt activity ................................ (5.3) (105.6) --
Proceeds from issuance of common stock, net ................. 1,921.7 200.0 319.5
Proceeds from employee stock transactions, issuance of
stock warrants and other ................................. 150.3 143.7 (31.2)
--------------------------------
Net cash provided by financing activities ............ 2,062.6 1,477.3 766.1
--------------------------------
Net increase (decrease) in cash and cash equivalents . (113.6) 83.0 372.9
Cash and cash equivalents, beginning of period .............. 462.8 379.8 6.9
--------------------------------
Cash and cash equivalents, end of period .................... $ 349.2 $ 462.8 $ 379.8
================================
</TABLE>
See accompanying notes to consolidated financial statements.
F-17
<PAGE>
Notes to Consolidated Financial Statements
Three Years Ended December 31, 1999
NOTE 1 > BUSINESS AND BACKGROUND
Qwest Communications International Inc. ("Qwest" or the "Company") is a leading
broadband Internet communications company engaged in two core businesses:
Communications Services and Construction Services.
Communications Services includes Internet, multimedia, data and voice services
sold to business, consumer and government customers. In addition, it provides
high-volume voice and conventional private line services to other communications
providers, as well as to Internet Service Providers ("ISPs"), and other data
service companies.
Construction Services constructs and installs fiber optic systems for other
communications providers, as well as for the Company's own use. The Company
began operations in 1988 constructing fiber optic conduit systems primarily for
major long distance carriers in exchange for cash and capacity rights. The
Company has entered into construction contracts for the sale of dark fiber with
three major customers whereby the Company has agreed to install and provide dark
fiber to each along portions of the Company's network. In addition to these
contracts, the Company has signed agreements with other communications providers
and government agencies for the sale of dark fiber along the Company's network.
Revenue from Construction Services generally is recognized under the percentage
of completion method as performance milestones relating to the contract are
satisfactorily completed.
Qwest was wholly-owned by Anschutz Company ("Anschutz") until June 27, 1997,
when the Company issued common stock in an initial public offering (the "IPO").
As of December 31, 1999, Anschutz owned approximately 38.3% of the outstanding
common stock of the Company.
In July 1999, Qwest entered into a definitive merger agreement with U S WEST,
Inc. The transaction will be accounted for as a purchase with U S WEST deemed
the accounting acquiror and is structured to be tax-free to U S WEST shareowners
to the extent of the Qwest stock delivered in the transaction. The Boards of
Directors and stockholders of both Qwest and U S WEST have approved the proposed
merger. The merger is subject to federal and state regulatory approvals and
other customary closing conditions. Closing of the merger is expected by
mid-2000 (see Note 3).
NOTE 2 > SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial statements
as of December 31, 1999 and 1998 and for the years ended December 31, 1999, 1998
and 1997 include the accounts of the Company and all majority-owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.
COMMUNICATIONS SERVICES REVENUE. Revenue from communications services is
generally recognized monthly as the services are provided. Amounts billed in
advance of the service month are recorded as deferred revenue.
LONG-TERM CONSTRUCTION CONTRACTS. The Company accounts for long-term
construction contracts relating to the development of communications networks
using the percentage of completion method. Under the percentage of completion
method, progress is generally measured on performance milestones relating to the
contract where such milestones fairly refiect progress toward contract
completion.
Network construction costs include all direct material and labor costs and those
indirect costs related to contract performance. General and administrative costs
are charged to expense as incurred. When necessary, estimated losses on
uncompleted contracts are expensed in the period in which they are identified.
Contract costs are estimated using allocations of the total cost of constructing
the network. Revisions to estimated profits on contracts are recognized in the
period they become known.
RESEARCH AND DEVELOPMENT. In connection with the acquisitions of LCI
International, Inc. and subsidiaries ("LCI"), EUnet International Limited
("EUnet") and Icon CMT Corp. ("Icon") in 1998, the Company expensed $760.0
million for in-process R&D projects since the development of these projects had
not yet reached technological feasibility and the in-process R&D had no
alternative future uses as of the acquisition date. These projects related to
the development of advanced voice and data services as well as sophisticated
network management and administration functions (See Note 3).
F-18
<PAGE>
R&D costs incurred in the normal course of business are expensed as incurred.
The Company incurred approximately $36.3 million and $27.7 million of such costs
in 1999 and 1998, respectively. R&D costs were insignificant in 1997.
ADVERTISING COSTS. Costs for advertising are generally expensed as incurred
within the fiscal year. If it is determined that the advertising qualifies as
direct response advertising, the costs are deferred and amortized over the
period of benefit, not to exceed one year.
COMPREHENSIVE INCOME. Comprehensive income consists of unrealized gains and
losses on marketable equity securities, currency translation adjustments and net
earnings (loss).
CASH AND CASH EQUIVALENTS. The Company classifies cash on hand and deposits in
banks, including money market accounts, and any other investments with a
maturity of three months or less from the date of purchase, that the Company may
hold from time to time, as cash and cash equivalents.
SALES OF EQUITY SECURITIES BY EQUITY METHOD INVESTEES. Increases or decreases in
the Company's investments resulting from sales of equity securities by the
investee company are included as gains or losses in the accompanying
consolidated statements of operations (See Note 4).
UNREALIZED HOLDING GAIN (LOSS) ON EQUITY SECURITIES. The Company's equity
investments in certain publicly traded companies are classified as
available-for-sale securities. Accordingly, these investments are included in
other assets at fair market value of approximately $259.7 million and $4.0
million at December 31, 1999 and 1998, respectively. The unrealized holding gain
on these marketable equity securities, net of taxes, is included as a component
of stockholders' equity in the accompanying consolidated financial statements.
As of December 31, 1999, the gross unrealized holding gain on these securities
was $221.4 million. There were no sales of marketable equity securities for the
years ended December 31, 1999, 1998 and 1997.
PROPERTY AND EQUIPMENT. Property and equipment is stated at cost. Depreciation
of buildings and equipment is computed on a composite straight-line basis. The
cost of equipment retired in the ordinary course of business, less proceeds, is
charged to accumulated depreciation. Leasehold improvements are amortized over
the lesser of the useful lives of the assets or the lease term. Expenditures for
maintenance and repairs are expensed as incurred. Network construction costs,
including interest during construction, are capitalized. Interest capitalized in
the years ended December 31, 1999, 1998 and 1997 was approximately $53.1
million, $41.6 million and $17.7 million, respectively.
The useful lives of property and equipment are as follows:
Facility and leasehold improvements 5 - 30 years or lease term
Communications and construction equipment 3 - 10 years
Fiber optic network 10 - 25 years
Office equipment 3 - 7 years
Capital leases lease term
IMPAIRMENT OF LONG-LIVED ASSETS. The Company reviews its long-lived assets,
including the excess of cost over net assets acquired, for impairment when
events or changes in circumstances indicate that the carrying value of such
assets may not be recoverable. This review consists of a comparison of the
carrying value of the asset with the asset's or the acquired business's expected
future undiscounted cash flows without interest costs. If the expected future
cash flow exceeds the carrying value of the asset, no impairment is recognized.
If the carrying value of the asset exceeds the expected future cash flows, an
impairment exists and is measured by the excess of the carrying value over the
fair value of the asset. No impairment expense was recognized in 1999, 1998 or
1997.
EXCESS OF COST OVER NET ASSETS ACQUIRED, INTANGIBLE AND OTHER LONG-TERM ASSETS.
These assets include goodwill, deferred compensation and acquired intangibles
such as customer lists, work force and developed technology. Such costs are
amortized on a straight-line basis over periods ranging from 3 to 40 years.
Amortization is included in depreciation and amortization expense in the
accompanying consolidated statements of operations and totaled $154.2 million,
$46.5 million and $0.8 million for the years ended December 31, 1999, 1998 and
1997, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amounts of the Company's
financial instruments other than long-term borrowings approximate fair value.
The fair value of fixed rate debt is discussed in Note 7.
STOCK-BASED COMPENSATION. The Company accounts for stock-based compensation
using the intrinsic value method under which no expense is recognized for grants
with an exercise price equal to or greater than the fair value of the underlying
security.
MANAGEMENT ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
RECLASSIFICATIONS. Certain prior year balances have been reclassified to conform
to the 1999 presentation.
F-19
<PAGE>
NOTE 3 > MERGERS & ACQUISITIONS
U S WEST
In July 1999, Qwest entered into a definitive merger agreement with U S WEST,
Inc. Under terms of the merger agreement, Qwest will issue shares of its common
stock having a value of $69.00 for each share of U S WEST common stock, subject
to a "collar" on Qwest's average stock price between $28.26 and $39.90 per
share. The number of Qwest shares to be issued for each U S WEST share will be
determined by dividing $69.00 by the average of the daily volume weighted
average prices of Qwest common stock for 15 randomly selected trading days over
a 30-day measurement period ending three days before the closing of the
transaction, provided that Qwest will not issue more than 2.44161 shares for
each U S WEST share or less than 1.72932 shares for each U S WEST share. The
transaction will be accounted for as a purchase with U S WEST deemed the
accounting acquiror and is structured to be tax-free to U S WEST shareowners to
the extent of the Qwest stock delivered in the transaction.
If Qwest's average stock price is below $38.70 per share, the obligation under
the "collar" for the amount which the price is below $38.70 per share may be
satisfied in whole or in part with cash. In determining the cash amount for the
collar, Qwest and U S WEST will consider Qwest's desire to reduce dilution to
its stockholders, U S WEST's potential desire to provide a cash element to its
stockholders and both companies' desire to maintain the combined company's
strong financial condition. If the companies decide to provide cash as part of
the collar consideration, the minimum exchange ratio would be 1.783.
U S WEST may terminate the merger agreement if the closing price of Qwest's
shares is below $22.00 for 20 consecutive trading days before the closing, or if
the average Qwest share price during the measurement period is less than $22.00.
The Boards of Directors and stockholders of both Qwest and U S WEST have
approved the proposed transaction. The transaction is subject to federal and
state regulatory approvals and other customary closing conditions. Closing of
the transaction is expected in mid-2000.
As a result of the transaction, Qwest will become subject to the regulations
applicable to U S WEST, a Regional Bell Operating Company ("RBOC"). Generally,
effective as of the closing of the transaction, Qwest may not provide inter-LATA
transport services within U S WEST's 14-state region until U S WEST receives
approval to provide such services under Section 271 of the Telecommunications
Act of 1996, as amended. Therefore, Qwest is in the process of divesting the
prohibited services.
In connection with the termination of the U S WEST and Global Crossing LTD.
merger agreement, U S WEST paid Global Crossing a break-up fee of $140.0 million
in cash and agreed to return $140.0 million in Global Crossing shares, valued at
$62.75 per share, purchased by U S WEST in connection with its agreement with
Global Crossing. Qwest advanced to U S WEST the $140.0 million cash payment and
agreed to purchase $140.0 million in services from Global Crossing over four
years at the best commercially available prices.
OTHER ACQUISITIONS
Each of the acquisitions discussed below was accounted for as a purchase. The
results of operations of each of these acquisitions have been included in the
accompanying consolidated statements of operations of the Company from the date
of acquisition.
ICON ACQUISITION
In December 1998, the Company acquired Icon, a provider of integrated Internet
solutions associated with web hosting and IP integration, for approximately
$254.1 million in Company common stock, including approximately $3.5 million of
direct acquisition costs. At the close of the acquisition, the Company issued
approximately 11.8 million shares of the Company's common stock (including
outstanding Icon stock options and warrants assumed by the Company). In
connection with the acquisition of Icon, the Company allocated $10.0 million of
the purchase price to in-process R&D projects. These projects include the design
and development of several new value-added Internet services, including
end-to-end solutions methodology designed to provide system-wide solutions for
high-end corporate customers, a next-generation high-speed network system, and
an improved network management system with added features. Since these projects
had not yet reached technological feasibility and had no alternative future uses
at the acquisition date, there was no guarantee as to the achievability of the
projects or their ascribed values. Accordingly, these costs were expensed as of
the acquisition date.
The Company allocated $2.3 million of the purchase price to developed
technology, $71.8 million to other intangible assets and $194.0 million to
goodwill. The developed technology, other intangible assets and goodwill will be
amortized on a straight-line basis from 4 to 15 years.
F-20
<PAGE>
LCI ACQUISITION
In June 1998, the Company acquired LCI, a communications services provider, for
approximately $3.9 billion in Company common stock, including approximately
$13.5 million in direct acquisition costs. At the close of the acquisition, the
Company issued approximately 259.8 million shares of the Company's common stock
(including outstanding LCI stock options assumed by the Company).
In connection with the acquisition of LCI, the Company allocated $682.0 million
of the purchase price to in-process R&D projects, $318.0 million to developed
technology, $65.0 million to other intangible assets and $3,071.0 million to
goodwill. This allocation to the in-process R&D represented the estimated fair
value based on risk-adjusted cash flows related to the incomplete projects. The
developed technology, other intangibles and goodwill are being amortized on a
straight-line basis from 10 to 40 years.
The acquired R&D represented engineering and test activities associated with the
introduction of new services and information systems. Specifically, LCI had been
working on a variety of projects that were essential to delivering data
services, which are a significant departure in terms of technological complexity
from the Company's traditional voice products. These efforts were related to
redesigning and scaling the network infrastructure as well as developing the
requisite network management systems. These projects were time-consuming and
difficult to complete. Since these projects had not yet reached technological
feasibility and had no alternative future uses at the acquisition date, there
was no guarantee as to the achievability of the projects or their ascribed
values. Accordingly, these costs were expensed as of the acquisition date.
EUNET ACQUISITION
In April 1998, the Company acquired EUnet, a European ISP with subsidiaries in
14 countries, for approximately $154.0 million in Company common stock,
including approximately $3.5 million in direct acquisition costs, and $4.2
million in cash. At the close of the acquisition, the Company issued
approximately 7.9 million shares of Company common stock.
The Company allocated $68.0 million of the purchase price to in-process R&D
projects which were expensed as of the acquisition date. The remaining
intangibles represented developed technology. EUnet was contributed to KPNQwest
on April 1, 1999 and therefore the results of operations for periods beginning
April 1, 1999 exclude the operating results of EUnet.
PHOENIX ACQUISITION
In March 1998, the Company acquired Phoenix Network, Inc. ("Phoenix"), a
non-facilities-based reseller of long distance services, for approximately $27.2
million. At the close of the acquisition, the Company issued approximately 1.6
million shares of Company common stock. Goodwill is being amortized on a
straight-line basis over 15 years.
SUPERNET ACQUISITION
In October 1997, the Company acquired SuperNet, Inc. ("SNI"), a regional ISP,
for approximately $20.0 million in cash. Goodwill is being amortized on a
straight-line basis over 10 years.
MERGER COSTS
During the year ended December 31, 1999, the Company recorded $31.5 million in
merger costs related to the pending merger with U S WEST. During the year ended
December 31, 1998, the Company recorded $86.5 million in merger-related costs
due to the merger with LCI, including $31.0 million of duplicate facilities,
$49.0 million of channel consolidation and duplicate commitments and $6.5
million of other miscellaneous merger costs. Of these merger costs,
approximately $4.5 million remain accrued as of December 31, 1999.
PRO FORMA RESULTS AND SUMMARY INFORMATION (UNAUDITED)
The following pro forma operating results of the Company for the years ended
December 31, 1999 and 1998 have been prepared assuming the acquisitions of LCI,
Icon, Phoenix and SNI occurred on January 1, 1998. In addition, the following
pro forma operating results exclude the results of operations of EUnet, which
was acquired in April 1998 and later contributed to the KPNQwest joint venture
on April 1, 1999. On a pro forma basis, for the year ended December 31, 1999,
revenue was $3,902.7 million and net earnings was $464.3 million, or $0.64 and
$0.61 per basic and diluted share, respectively. For the year ended December 31,
1998, revenue was $3,028.9 million and net loss was ($826.6) million, or ($1.24)
per basic and diluted share. The pro forma results do not purport to represent
what the Company's results of operations would have actually been had the above
transactions occurred on the dates indicated and are not indicative of future
results.
NOTE 4 > INVESTMENTS
INVESTMENT IN SLINGSHOT NETWORKS LLC/PURCHASE OF CERTAIN ASSETS OF ADMI.
In September 1999, Qwest and Anschutz Digital Media, Inc. ("ADMI"), an affiliate
of Qwest's principal stockholder, Anschutz Company, entered into an agreement to
form a joint venture called Slingshot Networks LLC to provide advanced digital
production, post-production and transmission facilities, digital media storage
and distribution services, telephony-based data storage and enhanced services,
access and routing services. Qwest and ADMI each own 50% of the joint venture,
which is accounted for under the equity method. Qwest contributed approximately
$84.8 million consisting of a promissory payable over nine years at an annual
interest rate of 6%. The agreement between Qwest and ADMI also provided that
Qwest would purchase certain telephony-related assets and all of the stock of
Precision Systems, Inc., a telecommunications solutions provider, from ADMI in
exchange for a promissory note in the amount of $34.0 million. The promissory
note is payable over nine years and bears interest at an annual rate of 6%.
INVESTMENT IN ADVANCED RADIO TELECOM CORP.
In September 1999, Qwest invested $90.0 million for an approximate 19% stake in
Advanced Radio Telecom Corp. ("ART"), a facilities-based, broadband ISP that
provides a direct connection from customer location to the Internet, to help
support the construction of ART's fixed, high-speed wireless networks. In
connection with this transaction, a separate group of investors also invested
$161.0 million. Qwest's investment in ART is accounted for under the cost
method.
INVESTMENT IN QWEST CYBER.SOLUTIONS LLC.
In June 1999, Qwest and KPMG LLP, a leading professional services firm, formed a
joint venture called Qwest Cyber.Solutions LLC, to provide Internet-based
end-to-end application service provider, application hosting, and application
management services. The venture will offer customers a broad set of vendor
products available for Enterprise Resource Planning ("ERP"), Customer
Relationship Management ("CRM") and back office solutions, a state-of-the-art
Internet Protocol ("IP") broadband network, and technologically advanced
CyberCenters. Qwest contributed approximately $60.0 million consisting of cash
and other assets, and owns a 51% stake in the venture. The financial position
and results of operation of the venture have been consolidated in the
accompanying financial statements from the date of formation and the minority
interest represents KPMG's stake in the venture.
F-21
<PAGE>
KPNQWEST
In April 1999, Qwest and KPN Telecom B.V. ("KPN"), the Dutch telecommunications
company, formed a joint venture ("KPNQwest") to create a pan-European IP-based
fiber optic network, linked to Qwest's network in North America, for data and
multimedia services. Qwest and KPN each initially owned 50 percent of KPNQwest,
which was initially governed by a six person supervisory board to which Qwest
and KPN had each named three members. Upon formation of KPNQwest, KPN
contributed two partially completed bi-directional, self-healing fiber optic
rings (EuroRings(TM) 1 and 2) and certain communications services contracts to
KPNQwest. Qwest contributed Xlink Internet Service Gmbh ("Xlink"), the operating
subsidiaries of EUnet International Limited ("EUnet") and cash. Also, Qwest and
KPN contributed transatlantic capacity that connects KPNQwest's European network
with Qwest's network in North America, and also contributed certain other
assets. The net book value of total assets contributed by Qwest totaled
approximately $300.0 million. Qwest deconsolidated EUnet and Xlink in April
1999. Qwest's investment in KPNQwest is accounted for under the equity method.
KPNQwest offers managed broadband services, IP transit, Internet connectivity
and value-added IP services, including consulting, hosting, and the transmission
of live events over the Internet. KPNQwest also sells dark fiber along its
network. Customers of KPNQwest include Internet services and content providers,
multinational firms in Europe and North America, as well as telecommunications
carriers, operators and others who want to purchase wholesale or retail network
capacity, fiber or services.
On November 12, 1999 KPNQwest consummated an initial public offering
("KPNQwest's IPO") in which 50.6 million shares of common stock were issued
generating approximately $1.0 billion in net proceeds. The consummation of
KPNQwest's IPO has resulted in approximately 11% of KPNQwest's shares being
owned by the public and the remainder of KPNQwest's shares being owned by each
of Qwest and KPN equally. As a result of the change in ownership structure of
KPNQwest, two outside directors were added to the supervisory board.
Also as a result of KPNQwest's IPO, Qwest recognized a gain of $414.0 million,
representing its proportionate share of the increase in KPNQwest's equity.
Qwest's proportionate share of KPNQwest's losses for the nine months ended
December 31, 1999 of $31.2 million is included in other expense (income) in the
accompanying consolidated statement of operations.
At December 31, 1999, the carrying amount of the investment exceeded Qwest's
equity in the underlying net assets by approximately $41.0 million which is net
of accumulated amortization. As of December 31, 1999, the fair market value of
Qwest's investment in KPNQwest was approximately $12.8 billion, based on the
closing price of KPNQwest's common stock on the Nasdaq stock market.
Summarized financial information of KPNQwest as of and for the nine months ended
December 31, 1999 is as follows:
(In Millions)
Total assets ............................................ $2,574.6
Total liabilities ....................................... $1,169.9
Revenue ................................................. $ 199.0
Loss from operations .................................... $ 76.2
Net loss ................................................ $ 62.4
INVESTMENT IN RHYTHMS. In April 1999, Qwest made an equity investment, totaling
$15.0 million in cash, in DSL local networks through an agreement with Rhythms
NetConnections Inc. ("Rhythms"), a packet-based Competitive Local Exchange
Carrier ("CLEC") that provides high-speed networking solutions for remote access
to private networks and the Internet. Under this agreement, the Company will
have access to 29 metropolitan areas (10 of which are in addition to the areas
covered by an agreement that Qwest has with Covad Communications Group Inc.) by
the first quarter of 2000, while further enhancing its ability to provide its
customers with high-speed DSL connectivity to its network. The Company has
committed to place a minimum number of orders for DSL service over a seven-year
term commencing on the date that Rhythms is operational in the 29 metropolitan
areas. In the event that the Company fails to meet the order target, the Company
is committed to pay Rhythms for the difference between the order target and the
number of actual orders placed. Qwest's investment in Rhythms is accounted for
under the cost method.
INVESTMENT IN COVAD. In January 1999, Qwest made an equity investment, totaling
$15.0 million in cash, in high-speed, DSL local networks through an agreement
with Covad Communications Group, Inc. ("Covad"), a packet-based CLEC. Under this
agreement, the Company will have access to 22 metropolitan areas, while
enhancing its ability to provide its customers with high-speed DSL connectivity
to its network. The Company has committed to purchase DSL services for
approximately
F-22
<PAGE>
$20.0 million over a five-year term commencing on the date that Covad's DSL
services are commercially available in all 22 metropolitan areas. Qwest's
investment in Covad is accounted for under the cost method.
NOTE 5 > CONSTRUCTION SERVICES
Revenue from construction services generally is recognized under the percentage
of completion method as performance milestones relating to the contract are
satisfactorily completed. Progress billings are made upon customers' acceptance
of performance milestones. Costs and estimated earnings in excess of billings,
net of uncompleted contracts included in the accompanying consolidated balance
sheets were $41.1 million and $222.1 million at December 31, 1999 and December
31, 1998, respectively.
The Company has entered into various agreements to provide indefeasible rights
of use of multiple fibers along the network. Such agreements include contracts
with three major customers for an aggregate purchase price of approximately $1.0
billion. Construction Services revenue relating to the contracts with these
major customers was approximately $65.4 million, $356.6 million and $513.0
million for the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 6 > PROPERTY AND EQUIPMENT
Property and equipment, net consisted of the following:
December 31,
(In Millions) 1999 1998
-----------------------
Fiber optic network .............................. $2,295.7 $1,098.3
Communications and construction equipment ........ 116.8 72.9
Facility and leasehold improvements .............. 54.4 52.9
Office equipment ................................. 359.8 250.1
Capital leases ................................... 2.2 3.5
Work in progress ................................. 1,640.0 1,332.9
-----------------------
4,468.9 2,810.6
Accumulated depreciation ......................... (360.2) (155.2)
-----------------------
Property and equipment, net ...................... $4,108.7 $2,655.4
=======================
Depreciation expense was $249.9 million, $155.2 million and $19.4 million for
the years ended December 31, 1999, 1998 and 1997, respectively.
NOTE 7 > DEBT AND CAPITAL LEASE OBLIGATIONS
Debt and capital lease obligations consisted of the following:
December 31,
(In Millions) 1999 1998
-----------------------
Fixed rate debt at interest rates ranging
from 7.25% to 10 7/8%, net of discount ........... $ 2,344.1 $ 2,279.5
Capital lease and other obligations .................. 25.6 30.4
-----------------------
Total debt and capital lease obligations ............. 2,369.7 2,309.9
Less current portion ................................. (1.4) (2.8)
-----------------------
Debt and capital lease obligations, net
of current portion ............................... $ 2,368.3 $ 2,307.1
-----------------------
In March 1999, the Company entered into a $1.0 billion credit agreement with a
syndicate of banks. This credit agreement provides for two five-year revolving
credit facilities for a total of $500.0 million and one 364-day revolving credit
facility in the amount of $500.0 million. The credit facilities bear interest at
either the bank base rate of interest or LIBOR, plus an applicable margin. As of
December 31, 1999, there were no borrowings outstanding under the credit
agreement.
The Company's credit agreement contains a provision whereby all amounts
outstanding under the agreement must be repaid as a result of a "change of
control" of the Company. While the Company does not believe that a change of
control will occur, the Company is currently negotiating an amendment to the
existing credit agreement and is taking other actions to ensure that the U S
WEST merger does not constitute a "change of control." The Company is also
taking such other actions necessary to permit the Company to consummate the
merger. Such amendment is expected to be in place prior to the end of the first
quarter of 2000. In addition, the Company is in the process of extending the
term of the existing $500 million 364-day revolving credit facility and adding
an additional $1.0 billion credit facility. Consummation of the additional
credit facility is conditioned, among other things, on the execution of a
mutually satisfactory credit agreement, which is expected to occur prior to the
end of the first quarter of 2000.
The Company issued the following senior and senior discount notes during the
years ended December 31, 1998 and 1997: the 7.25% Senior Notes, due 2008 (the
"7.25% Notes Due 2008"), the 7.50% Senior Notes, due 2008 (the "7.50% Notes"),
the 8.29% Senior Discount Notes, due 2008 (the "8.29% Notes"), the 9.47% Senior
Discount Notes, due 2007 (the "9.47% Notes") and the 10 7/8% Senior Notes, due
2007 (the "10 7/8% Notes") (each described below, collectively "the Notes").
In November 1998, the Company issued and sold $750.0 million in principal amount
of its 7.50% Notes and $300.0 million in principal amount of its 7.25% Notes Due
2008, which together generated net proceeds of approximately $1,038.5 million,
after deducting offering costs. Interest on the 7.50% Notes and the 7.25% Notes
Due 2008 is payable semiannually in arrears on May 1 and November 1 of each
year, commencing May 1, 1999. The 7.50% Notes and the 7.25% Notes Due 2008 are
both subject to redemption at the option of the Company, in whole or in part, at
specified redemption prices.
In January 1998, the Company issued $450.5 million in principal amount at
maturity of its 8.29% Notes, generating net proceeds of approximately $299.2
million, after deducting offering costs. Interest on the 8.29% Notes is
compounded semiannually. The principal amount of the 8.29% Notes is due and
payable in full on February 1, 2008. The 8.29% Notes are redeemable at the
Company's
F-23
<PAGE>
option, in whole or in part, at any time on or after February 1, 2003 at
specified redemption prices. In addition, prior to February 1, 2001, the Company
may use the net cash proceeds from certain equity transactions to redeem up to
35% of the 8.29% Notes at specified redemption prices. Cash interest on the
8.29% Notes will not accrue until February 1, 2003, and thereafter will accrue
at a rate of 8.29% per annum, and will be payable semiannually in arrears
commencing on August 1, 2003, and thereafter on February 1 and August 1 of each
year. The Company has the option of commencing cash interest on an interest
payment date on or after February 1, 2001, in which case the outstanding
principal amount at maturity of the 8.29% Notes will, on such interest payment
date, be reduced to the then accreted value, and cash interest will be payable
on each interest payment date thereafter.
In October 1997, the Company issued its 9.47% Notes, having an aggregate
principal amount at maturity of $555.9 million, which mature on October 15,
2007. The 9.47% Notes will accrete at a rate of 9.47% per annum, compounded
semiannually, to an aggregate principal amount of $555.9 million by October 15,
2002. In March 1997, the Company issued its 10 7/8% Notes, having an aggregate
principal amount at maturity of $250.0 million, which mature on April 1, 2007.
On December 31, 1998, the Company exercised its option to redeem 35%, or $87.5
million in principal amount, of the 10 7/8% Notes at a redemption price of
110.875%. As a result, the Company recorded a charge of $12.9 million, included
in other (income) expense, net, primarily for the redemption premium incurred
and write-off of previously deferred debt issue costs.
In connection with the LCI merger, the Company assumed LCI's existing debt
instruments, including $350.0 million of 7.25% Senior Notes (the "7.25% Notes
Due 2007").
The indentures for the Notes (defined above) and the 7.25% Notes Due 2007
contain certain covenants that, among other things, limit the ability of the
Company and certain of its subsidiaries (the "Restricted Subsidiaries") to issue
preferred stock, pay dividends or make other distributions, repurchase capital
stock or subordinated indebtedness, create certain liens, enter into certain
transactions with affiliates, sell assets of the Company or its Restricted
Subsidiaries, issue or sell capital stock of the Company's Restricted
Subsidiaries or enter into certain mergers and consolidations.
The Company leases certain network construction equipment and buildings under
capital lease agreements. The amortization charge applicable to capital leases
is included in depreciation and amortization expense. Future minimum payments
under capital lease obligations are included in contractual maturities of
long-term debt, as summarized below.
Contractual maturities of debt and capital lease obligations as of December 31,
1999 were as follows:
December 31,
(In Millions) 1999
-----------
2000 ............................................................. $ 1.4
2001 ............................................................. 2.1
2002 ............................................................. 2.6
2003 ............................................................. 3.0
2004 ............................................................. 3.6
Thereafter ....................................................... $ 2,581.8
-----------
Total contractual maturities ..................................... 2,594.5
Less unamortized discount ........................................ (224.8)
-----------
Total contractual maturities, net of unamortized discount ........ $ 2,369.7
-----------
Collectively, the fixed rate debt, capital lease obligations and other debt had
a total carrying value of $2,369.7 million and $2,309.9 million and an estimated
fair value of $2,361.5 and $2,402.3 million at December 31, 1999 and 1998,
respectively, based on current interest rates offered for debt of similar terms
and maturity. Unamortized discounts on senior discount notes totaled $224.8
million and $291.1 million as of December 31, 1999 and 1998, respectively.
F-24
<PAGE>
NOTE 8 > INCOME TAXES
Income tax expense (benefit) for the years ended December 31, 1999, 1998 and
1997 was as follows:
(In Millions) 1999 1998 1997
----------------------------
Current:
Federal ...................................... $ 0.3 $ 2.0 $ --
State ........................................ -- -- 0.1
----------------------------
Total current income tax expense .......... 0.3 2.0 0.1
----------------------------
Deferred:
Federal ...................................... 111.5 (7.8) 9.0
State ........................................ 13.2 -- --
----------------------------
Total deferred income tax expense (benefit) 124.7 (7.8) 9.0
----------------------------
Total income tax expense (benefit) ........ $ 125.0 $ (5.8) $ 9.1
----------------------------
Total income tax expense (benefit) differed from the amounts computed by
applying the federal statutory income tax rate (35%) to earnings (loss) before
income taxes as a result of the following items for the years ended December 31,
1999, 1998 and 1997:
1999 1998 1997
----------------------------
Statutory income tax expense (benefit) ......... 35.0% (35.0%) 35.0%
State income taxes, net of
federal income tax expense .............. 2.3 -- 0.3
Goodwill amortization ...................... 5.3 2.0 1.3
In-process R&D ............................. -- 31.3 --
Foreign losses/joint ventures .............. (22.9) 0.8 --
Other, net ................................. 1.7 0.2 2.0
---------------------------
Total income tax expense (benefit) ...... 21.4% (0.7%) 38.6%
---------------------------
The tax effects of temporary differences that gave rise to significant portions
of the deferred tax assets and liabilities at December 31, 1999 and 1998 were as
follows:
(In Millions) 1999 1998
--------------------
Current deferred tax assets (liabilities):
Allowance for doubtful accounts .................. $ 31.8 $ 13.6
Accrued liabilities .............................. 2.9 27.4
Deferred compensation ............................ (3.8) 35.8
Other, net ....................................... (0.2) (1.8)
--------------------
Current deferred tax asset, net ............... 30.7 75.0
Long-term deferred tax assets (liabilities):
Deferred compensation ............................ 15.3 --
Net operating loss carryforwards ................. 527.4 261.3
Other ............................................ 22.1 22.8
Unrealized gains ................................. (88.6) --
Deferred revenue ................................. (192.3) --
Intangible assets ................................ (240.6) (246.1)
Property and equipment ........................... (150.0) (73.8)
--------------------
Non-current deferred tax liability, net ....... (106.7) (35.8)
--------------------
Net deferred tax asset (liability) ............... $ (76.0) $ 39.2
--------------------
The current deferred tax asset and non-current deferred tax liability is
included in prepaid expenses and other current assets and other long-term
liabilities, respectively, in the accompanying consolidated balance sheet.
The Company has analyzed the sources and expected reversal periods of its
deferred tax assets. The Company believes that the tax benefits attributable to
deductible temporary differences will be realized by recognition of future
taxable amounts.
As discussed in Note 4, the Company recognized a $414.0 million gain on its
investment in KPNQwest related to KPNQwest's IPO in November 1999. Since Qwest's
investment in the foreign corporate joint venture is essentially permanent in
duration, Qwest did not record deferred income taxes on the excess of its
investment in KPNQwest over its tax basis in the joint venture. Deferred taxes
not recognized were $165.6 million.
As of December 31, 1999, the Company had net operating loss carryforwards for
income tax purposes of approximately $1.4 billion. These net operating loss
carryforwards, if not utilized to reduce taxable income in future periods, will
expire in various amounts beginning in 2003 and ending in 2019.
F-25
<PAGE>
Effective with the LCI merger, the Company is no longer included in the
consolidated federal income tax return of Anschutz. As a result, the tax-sharing
agreement with Anschutz is no longer effective for activity after June 5, 1998.
The Company is still subject to the provisions of the tax-sharing agreement for
activity through June 5, 1998. The Company previously recognized a deferred tax
asset attributable to its net operating loss carryforwards under the tax-sharing
agreement. The Company currently believes the tax benefits previously recognized
under the tax-sharing agreement may be realized through tax planning strategies.
NOTE 9 > COMMITMENTS AND CONTINGENCIES
VENDOR AGREEMENTS
The Company has agreements with certain telecommunications inter-exchange
carriers and third party vendors that require the Company to maintain minimum
monthly and/or annual billings based on usage. The Company has historically met
all minimum billing requirements and believes the minimum usage commitments will
continue to be met.
CAPACITY PURCHASE COMMITMENT
In July 1999, Qwest and Global Crossing Ltd. ("Global") entered into a purchase
agreement under which Qwest agreed to purchase services from Global over a four
year period in a total amount of $140.0 million. This agreement was entered into
in connection with Qwest's definitive merger agreement with U S WEST and the
termination of the U S WEST and Global merger agreement. At the end of the two
year period following the signing of the agreement, Qwest must pay Global an
amount equal to the difference between $140.0 million and the amount of the
services purchased under the agreement at that time. The amount of the
differential payment will be credited by Global against all purchases by Qwest
of services from Global during the remaining two years of the agreement. Under
the agreement, Qwest is entitled to purchase services on any of Global's network
segments at the most favorable commercially available prices offered by Global.
LEASES AND COMMUNICATIONS SERVICES COMMITMENTS
The Company leases certain terminal locations and office space under operating
lease agreements. The Company has easement agreements with railroads and public
transportation authorities. Future minimum payments under non-cancelable
operating leases and right-of-way agreements, together with the present value of
the net minimum payments as of December 31, 1999, were as follows:
(In Millions) Operating Right-of-Way Total
-------------------------------
2000 ................................ $ 57.9 $ 4.9 $ 62.8
2001 ................................ 119.9 4.9 124.8
2002 ................................ 51.8 6.7 58.5
2003 ................................ 50.3 4.9 55.2
2004 ................................ 45.8 4.9 50.7
Thereafter .......................... 222.9 86.1 309.0
-------------------------------
548.6 112.4 661.0
Less amount representing interest -- (68.9) (68.9)
-------------------------------
Total minimum payments .......... $548.6 $ 43.5 $592.1
-------------------------------
Amounts expensed in the years ended December 31, 1999, 1998 and 1997 related to
operating leases were approximately $80.5 million, $22.7 million and $6.2
million, respectively. The present value of net minimum payments of the
right-of-way agreements is included in accrued expenses and other and in other
long-term liabilities.
PACIFIC RIM CABLE CONSORTIUM COMMITMENT
The Company is participating in a consortium of communications companies that is
building an underwater cable system connecting the United States to Japan. In
connection with this transaction, the Company is committed to purchase
approximately $56.0 million of fiber optic cable and other network assets of the
13,125-route-mile, four-fiber pair cable system to the Pacific Rim. The total
remaining commitment through January 2001 was approximately $28.2 million as of
December 31, 1999.
LEGAL MATTERS
The Company has been named as a defendant in various litigation matters.
Management intends to vigorously defend these outstanding claims. The Company
believes that 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 the Company's results of operations or financial position.
F-26
<PAGE>
NOTE 10 > BENEFIT PLANS
GROWTH SHARE PLAN
The Company has a Growth Share Plan (the "Plan") for certain of its employees
and directors. A "Growth Share" is a unit of value based on the increase in
value of the Company over a specified measurement period. All Growth Share
grants have been made based on a beginning Company value that was greater than
or equal to the fair value of the Company at the grant date. The total number of
Growth Shares is set at 10 million and the maximum presently available for grant
under the Plan is 850,000. All participants, except those granted Growth Shares
under the October 1996 Plan, vested fully upon completion of the Company's IPO
and settlement was made with 5,183,064 common shares, net of amounts relating to
tax withholdings of approximately $21.9 million.
Growth Shares granted under the October 1996 Plan vest at the rate of 20% for
each full year of service completed after the grant date subject to risk of
forfeiture and are to be settled with the Company's Common Stock. The future
compensation expense associated with the remaining shares has been capped at
$5.50 per share, or approximately $13.7 million, and is amortized as expense
over the remaining approximately three-year vesting period. At December 31,
1999, approximately $27.8 million is included in other long-term liabilities
related to outstanding Growth Shares. The Company does not presently intend to
make any additional Growth Share grants under this plan. Certain triggering
events, such as a change in control of the Company, cause immediate vesting of
the remaining Growth Shares and would result in accelerated expense recognition
of all unamortized compensation. Participants receive their vested portion of
the increase in value of the Growth Shares upon a triggering event, which
includes the end of a Growth Share performance cycle.
The Company estimated an increase in value of the Growth Shares during 1997 and
recorded approximately $73.5 million of compensation expense for this plan in
the year ended December 31, 1997. For the years ended December 31, 1999 and
1998, the Company recorded approximately $6.0 and $9.3 million of expense for
this plan, respectively.
The following table summarizes Growth Share grants, settlements, forfeitures and
Growth Shares outstanding:
Outstanding
Growth Shares
-------------
December 31, 1996 .................................... 275,400
1997 grants ...................................... 358,050
1997 settlements ................................. (253,950)
-------------
December 31, 1997 .................................... 379,500
1998 forfeitures ................................. (4,500)
1998 settlements ................................. (12,000)
-------------
December 31, 1998 .................................... 363,000
1999 forfeitures ................................. --
1999 settlements ................................. (12,000)
-------------
December 31, 1999 .................................... 351,000
-------------
401(K) PLAN
The Company sponsors defined contribution 401(k) plans (the "Plans") which
permit employees to make contributions to the Plans on a pre-tax salary
reduction basis in accordance with the provisions of Section 401(k) of the
Internal Revenue Code. After one year of service, the Company matches a portion
of the employee's voluntary contributions. Company contributions to the 401(k)
plans were $5.3 million, $2.1 million and $0.9 million for the years ended
December 31, 1999, 1998 and 1997, respectively.
NOTE 11 > STOCKHOLDERS' EQUITY
CAPITAL STOCK
In May 1999, Qwest's stockholders approved an increase in the number of
authorized common shares from 600 million to 2 billion. In November 1999,
Qwest's stockholders approved an increase in the number of authorized common
shares from 2 billion to 5 billion, and an increase in the number of authorized
preferred shares from 25 million to 200 million. A total of 101.8 million common
shares are reserved for issuance under the Company's 401(k) plans, stock option
and incentive plans, the Growth Share Plan and for issuance upon exercise of
warrants as described below.
In May 1999 and February 1998, Qwest distributed separate two-for-one stock
splits in the form of stock dividends. All share and per share information
included in the consolidated financial statements and the notes hereto have been
adjusted to give retroactive effect to the change in capitalization.
In May 1999, Qwest issued approximately 40.7 million shares to BellSouth
Corporation (together with its subsidiaries, "BellSouth") in exchange for
approximately $1.9 billion in cash. Qwest's principal stockholder, Anschutz
Company, sold approximately 33.3 million existing shares to BellSouth for
approximately $1.6 billion. The investment by BellSouth represents an
approximate 10% equity stake in Qwest.
In December 1998, Microsoft Corporation ("Microsoft") purchased approximately
8.8 million shares of Qwest for $200.0 million. Microsoft has agreed not to
transfer the Common Stock it purchased for a period of two years except to
persons approved by the Company or to certain Microsoft controlled corporations.
Further, unless approved by the Company's board of directors, (i) Microsoft is
prohibited from acquiring more than 5% of the Company's Common Stock and from
becoming a member (with third parties) of a group that owns more than 5% and;
(ii) Microsoft may not take certain actions with respect to acquisition
proposals or contested proxy solicitations until the earlier of (A) such time as
the Company's officers, directors and affiliates own less than 33% of the voting
power of the Company, (B) Microsoft otherwise disposes of the Common Stock, (C)
the parties terminate the business relationship or (D) December 14, 2003.
On May 23, 1997, the Board of Directors declared a stock dividend to the
existing stockholder of approximately 346.0 million shares of Common Stock,
which was paid immediately prior to the effective date of the registration
statement on June 23, 1997. This dividend was accounted for as a stock split.
The Company completed the IPO of approximately 62.1 million shares of Common
Stock on June 27, 1997, raising net proceeds of approximately $319.5 million.
Effective May 23, 1997, the Company sold to an affiliate of Anschutz for $2.3
million in cash, a warrant to acquire 17.2 million shares of Common Stock at an
exercise price of $7.00 per share, exercisable on May 23, 2000. The warrant is
not transferable. Stock issued upon exercise of the warrant will be subject to
restrictions on sale or transfer for two years after exercise. In connection
with the acquisition of Icon, the Company issued approximately 0.6 million
warrants to acquire
F-27
<PAGE>
0.6 million shares of Common Stock at an average exercise price of $8.91 per
share, exercisable in 2007. The warrants are not transferable.
COMMON STOCK OPTIONS
Effective June 23, 1997, the Company adopted the Equity Incentive Plan, which
was amended and restated on June 1, 1998. This plan permits the grant of
non-qualified stock options, incentive stock options, stock appreciation rights,
restricted stock, stock units and other stock grants. A maximum of 70.0 million
shares of Common Stock may be subject to awards under the Equity Incentive Plan.
The Company's Compensation Committee determines the exercise price for each
option; however, stock options must have an exercise price that is at least
equal to the fair market value of the Common Stock on the date the stock option
is granted, subject to certain restrictions. Stock option awards generally vest
in equal increments over a five-year period, and awards granted under the Equity
Incentive Plan will immediately vest upon any change in control of the Company,
as defined, unless provided otherwise by the Compensation Committee at the time
of grant. Options granted in 1997, 1998 and 1999 have terms ranging from six to
ten years.
Stock option transactions during 1997, 1998 and 1999 were as follows:
Number Weighted
of Average
(in thousands) Options Exercise Price
-------------------------
Outstanding January 1, 1997 ................ -- $ --
Granted ................................ 27,916 $ 7.94
Exercised .............................. (24) $ 5.50
-------
Outstanding December 31, 1997 .............. 27,892 $ 7.95
Granted ................................ 26,278 $16.84
Assumed ................................ 31,540 $ 8.32
Exercised .............................. (23,314) $ 6.83
Cancelled .............................. (2,094) $13.29
-------
Outstanding December 31, 1998 .............. 60,302 $12.02
Granted ................................ 35,262 $31.69
Exercised .............................. (13,827) $ 9.68
Cancelled .............................. (12,826) $17.12
-------
Outstanding December 31, 1999 .............. 68,911 $21.48
-------
Exercisable December 31, 1997 .............. 2,680 $ 5.50
-------
Exercisable December 31, 1998 .............. 15,483 $ 8.71
-------
Exercisable December 31, 1999 .............. 11,383 $10.57
-------
In connection with the acquisitions of LCI and Icon, the Company assumed the
outstanding options on the date of acquisition for each of the acquired
companies. Pursuant to the terms of the LCI stock option plans, the acquisition
of LCI by the Company triggered a change in control of LCI. As such, all of the
outstanding options vested immediately.
The weighted average fair value of each option grant is estimated as of the date
of grant using the Black-Scholes option pricing model and the following weighted
average assumptions:
1999 1998 1997
----------------------------------------
Weighted average fair value .... $ 15.00 $ 7.59 $ 3.97
Risk-free interest rate ........ 6.0% 4.6% 5.8%
Expected option lives .......... 5.4 5.5 7.6
Dividend yield ................. 0.0% 0.0% 0.0%
Volatility ..................... 44.9% 41.2% 31.0%
F-28
<PAGE>
The following table summarizes certain information about the Company's stock
options at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------- -------------------------
Weighted
Average Weighted Weighted
Number of Remaining Average Number of Average
Options Contractual Exercise Options Exercise
Range of exercise prices Outstanding Life Price Exercisable Price
--------------------------------------------------------------------
(In Thousands) (In Years) (In Thousands)
--------------------------------------- ---------------------------
<S> <C> <C> <C> <C> <C>
$1.65 - $11.00......................... 13,669 4.1 $ 5.66 5,850 $ 5.96
$11.17 - $15.66........................ 14,156 7.8 $ 13.89 4,039 $ 13.70
$15.70 - $18.19........................ 4,200 8.0 $ 17.26 666 $ 17.25
$18.28 - $20.97........................ 1,567 8.0 $ 19.71 341 $ 19.37
$21.03 - $29.06........................ 20,637 9.4 $ 27.93 479 $ 24.50
$29.19 - $33.88........................ 4,248 9.4 $ 30.94 2 $ 30.09
$33.94 - $38.88........................ 6,778 9.5 $ 36.02 -- $ --
$39.03 - $48.06........................ 3,656 9.3 $ 41.33 6 $ 43.83
--------------------------------------------------------------------
68,911 7.9 $ 21.48 11,383 $ 10.57
--------------------------------------------------------------------
</TABLE>
Compensation expense recognized for grants under the Equity Incentive Plan was
not material in any period. If compensation expense for the Equity Incentive
Plan had been determined using the fair value method described in SFAS No. 123,
the Company's net earnings (loss) and net earnings (loss) per share for 1999,
1998 and 1997 would have been reduced to the pro forma amounts shown in the
following table:
<TABLE>
<CAPTION>
(In Millions, Except Per Share Information) 1999 1998 1997
-------------------------------------
<S> <C> <C> <C>
Net earnings (loss):
As reported ........................... $ 458.5 $ (844.0) $ 14.5
Pro forma ............................. $ 393.7 $ (866.6) $ 0.9
Net earnings (loss) per share - basic:
As reported ........................... $ 0.63 $ (1.51) $ 0.04
Pro forma ............................. $ 0.54 $ (1.55) $ 0.00
Net earnings (loss) per share - diluted:
As reported ........................... $ 0.60 $ (1.51) $ 0.04
Pro forma ............................. $ 0.52 $ (1.55) $ 0.00
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN
In October 1998, the Company instituted an Employee Stock Purchase Plan
("ESPP"). The Company is authorized to issue approximately 1.6 million shares of
Common Stock to eligible employees. Under the terms of the ESPP, eligible
employees may authorize payroll deductions of up to 15% of their base
compensation, as defined, to purchase Common Stock at a price of 85% of the fair
market value of the Company's Common Stock on the last trading day of the month
in which the Common Stock is purchased.
NOTE 12 > WEIGHTED AVERAGE SHARES OUTSTANDING
The weighted average number of shares used for computing basic net earnings
(loss) per share for the years ended December 31, 1999, 1998 and 1997 was 727.8
million, 558.2 million and 381.0 million, respectively. For the years ended
December 31, 1999 and 1997, the weighted average number of shares used for
computing diluted earnings per share was 764.3 million and 388.1 million,
respectively (including incremental common shares attributable to dilutive
securities related to warrants, options and growth shares of 36.5 million and
7.1 million, respectively). Because the Company had a net loss in 1998, the
effect of all options, warrants, and growth shares (28.5 million incremental
common shares) on loss per share was anti-dilutive, and therefore not included
in the computation of diluted loss per share.
F-29
<PAGE>
NOTE 13 > BUSINESS SEGMENT INFORMATION
The Company's two business segments are Communications Services and Construction
Services, each having a separate management team and infrastructure, offering
different products and services, and utilizing different marketing strategies to
target different types of customers. Communications Services provides multimedia
communications services to retail and wholesale customers. Construction Services
constructs and installs fiber optic systems for other communications entities,
as well as for the Company's own use.
The accounting policies of the business segments are the same as those described
in Note 2 -- Summary of Significant Accounting Policies. The Company evaluates
the performance of its business segments based on their respective earnings
(loss) from operations, before other (income) expense and income taxes. The
following table presents summarized financial information related to the
business segments for the years ended December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
(In Millions) Communications Construction Corporate/ Consolidated
Services Services Unallocated Total
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
1999
Revenue ....................... $ 3,703.1 $ 224.5 $ -- $ 3,927.6
Earnings (loss) from operations $ 651.8 $ 107.4 $ (435.6) $ 323.6
Assets ........................ $ -- $ -- $11,058.1 $11,058.1
Capital expenditures .......... $ 1,762.6 $ 0.6 $ 137.0 $ 1,900.2
1998
Revenue ....................... $ 1,554.3 $ 688.4 $ -- $ 2,242.7
Earnings (loss) from operations $ 91.9 $ 202.6 $(1,048.2) $ (753.7)
Assets ........................ $ -- $ -- $ 8,067.6 $ 8,067.6
Capital expenditures .......... $ 1,382.2 $ 2.2 $ 28.8 $ 1,413.2
1997
Revenue ....................... $ 115.3 $ 581.4 $ -- $ 696.7
Earnings (loss) from operations $ (102.9) $ 146.6 $ (20.2) $ 23.5
Assets ........................ $ -- $ -- $ 1,398.1 $ 1,398.1
Capital expenditures .......... $ 337.7 $ 2.0 $ 6.1 $ 345.8
</TABLE>
Corporate/unallocated operating expenses consist of the following:
1999 1998 1997
-------------------------------------
Depreciation and amortization $ 404.1 $ 201.7 $ 20.2
Merger costs ................ $ 31.5 $ 846.5 $ --
The Company's areas of operations are principally in the United States and
Europe, and the Company is developing network assets in Mexico. No single
European country or geographic area is significant to the Company's consolidated
operations. As discussed in Note 4, the Company has a significant investment in
Amsterdam-based KPNQwest. As of December 31, 1999, the carrying value of Qwest's
investment in KPNQwest was $680.0 million.
During the year ended December 31, 1997 two customers accounted for 10% or more
of the Company's total revenue; One customer accounted for 37% and the other for
31%. No customer accounted for 10% or more of the Company's total revenue during
the years ended December 31, 1999 or 1998.
F-30
<PAGE>
NOTE 14 > SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Year Ended December 31,
(In Millions) 1999 1998 1997
---------------------------------------
Cash paid for interest, net ...... $ 85.5 $ 70.7 $ 16.7
Non-cash assets contributed to
KPNQwest joint venture ....... $ 212.1 $ -- $ --
Note payable issued for investment $ 84.8 $ -- $ --
Common stock issued - acquisitions $ -- $4,332.7 $ --
NOTE 15 > SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (Unaudited)
1999
<TABLE>
<CAPTION>
(In Millions, Except Per Share Information) First Quarter Second Quarter Third Quarter Fourth Quarter
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue ................................... $ 878.4 $ 873.7 $ 1,018.1 $ 1,157.4
Gross profit .............................. 368.7 409.5 461.8 528.5
Earnings from operations .................. 59.5 94.0 63.8 106.3
Net earnings (loss) ....................... $ 4.8 $ 18.5 $ (1.8) $ 437.0
Net earnings (loss) per share - basic ..... $ 0.01 $ 0.03 $ -- $ 0.58
Net earnings (loss) per share - diluted ... $ 0.01 $ 0.02 $ -- $ 0.56
</TABLE>
1998
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue ................................... $ 177.1 $ 393.7 $ 806.8 $ 865.1
Gross profit .............................. 48.9 132.0 307.0 346.2
Earnings (loss) from operations ........... (3.5) (820.4) 37.7 32.5
Net loss .................................. $ (6.6) $ (808.9) $ (6.9) $ (21.6)
Net loss per share - basic ................ $ (0.02) $ (1.67) $ (0.01) $ (0.03)
Net loss per share - diluted .............. $ (0.02) $ (1.67) $ (0.01) $ (0.03)
</TABLE>
In connection with the pending merger with U S WEST, the Company expensed $25.0
million and $6.5 million in merger-related costs in the third and fourth quarter
of 1999, respectively.
In connection with the acquisitions of LCI and EUnet in the second quarter of
1998 and the acquisition of Icon in the fourth quarter of 1998, the Company
expensed $750.0 million and $10.0 million, respectively, for in-process R&D
projects, and $86.5 million in merger-related costs in the second quarter of
1998.
F-31
<PAGE>
> Market for the Registrant's Common Stock and Related Shareholder Matters
During 1999 the Company's Common Stock was listed on the Nasdaq National Market
under the trading symbol "QWST." Effective January 3, 2000 the Company moved its
listing to the New York Stock Exchange under the trading symbol "Q". As of March
7, 2000, there were approximately 753.1 million shares of Common Stock issued
and outstanding held by 6,893 stockholders of record.
The following table sets forth, for the periods indicated, the high and low
sales prices per share of Common Stock as reported on the Nasdaq National Market
(as adjusted to reflect the two-for-one stock splits effected on February 24,
1998 and May 24, 1999 as dividends):
High Low
--------------------
Fiscal 1998:
First Quarter ...................... $20.53 $14.81
Second Quarter ..................... $20.03 $13.94
Third Quarter ...................... $23.75 $11.00
Fourth Quarter ..................... $25.66 $13.38
High Low
--------------------
Fiscal 1999:
First Quarter ...................... $37.406 $25.625
Second Quarter ..................... $47.000 $32.875
Third Quarter ...................... $35.938 $26.250
Fourth Quarter ..................... $44.000 $29.875
The Company completed its initial public offering on June 27, 1997. The
Registrant has not paid cash dividends on its Common Stock since becoming a
public company in June 1997. The merger agreement between U S WEST and Qwest
provides that the Company initially will pay a dividend of $0.0125 per share per
quarter after completion of the merger. The payments of dividends by the
combined company after the merger will depend on business conditions, the
combined company's financial condition and earnings, as well as other factors.
The terms of the Indentures governing its outstanding notes restrict the
Company's ability to pay dividends. Any payment of future dividends will be at
the discretion of the Company's Board of Directors and will depend upon, among
other things, the Company's earnings, operations, capital requirements, level of
indebtedness, financial condition, contractual restrictions and other relevant
factors. (See "Management's Discussion and Analysis of Financial Condition and
Results of Operations.")
In April 1999, the Company entered into a strategic relationship with BellSouth
Corporation. An affiliate of BellSouth and the Company entered into a commercial
arrangement for provisioning of a full range of integrated digital data, image
and voice communications services for customers. In addition, in May 1999,
BellSouth purchased approximately 40.7 million shares of the Company's common
stock for $1.9 billion. BellSouth purchased approximately 33.3 million shares
from the Company's principal stockholder, the Anschutz Company, for $1.6
billion. As a result of these two purchases, BellSouth owns approximately 74.0
million shares of the Company's common stock, representing approximately 10% of
the Company's issued and outstanding shares.
Pursuant to the Common Stock Purchase Agreement, BellSouth agreed (1) to a
"standstill" provision under which BellSouth will not acquire more than 20% of
the outstanding shares of the Company's common stock, (2) not to transfer the
shares to third parties, subject to certain exceptions, and (3) not to take
certain actions with respect to the Company that may influence the Company.
These restrictions generally terminated upon the Company entering into the U S
WEST merger agreement.
BellSouth does not have an option or any other right to acquire additional
shares of the Company's common stock, and the Company has no obligation to issue
or otherwise sell any additional shares to BellSouth. In addition, the Common
Stock Purchase Agreement provides that BellSouth has the right, after it obtains
regulatory relief to provide inter-LATA service in certain states, to designate
one person to serve as a director of the Company.
On December 14, 1998, the Company and Microsoft Corporation, a Washington
corporation ("Microsoft"), announced that they had agreed to enter into a
business relationship to offer data and Internet services. In addition,
Microsoft purchased from the Company approximately 8.8 million shares of the
Company's common stock, at a price of $22.50 per share, for an aggregate
purchase price of $200.0 million.
Pursuant to the Common Stock Purchase Agreement, Microsoft has agreed not to
transfer the shares for a period of two years except to persons approved by the
Company or to certain Microsoft controlled corporations. Further, unless
approved by the Company's board of directors, (i) Microsoft is prohibited from
acquiring more than 5% of the Company's common stock and from becoming a member
(with third parties) of a group that owns more than 5% and (ii) Microsoft may
not take certain actions with respect to acquisition proposals or contested
proxy solicitations until the earlier of (A) such time as the Company's
officers, directors and affiliates own less than 33% of the voting power of the
Company, (B) Microsoft otherwise disposes of the shares, (C) the parties
terminate the business relationship or (D) December 14, 2003.
F-32
<PAGE>
Exhibit 23.1
Consent of Independent Public Accountants
As independent public accountants, we hereby consent to the incorporation of our
report dated January 31, 2000, incorporated by reference in this Form 10-K, into
the Company's previously filed Registration Statements on Form S-8 (File Nos.
333-84877, 333-47349, 333-50061, 333-56323, 333-60133, 333-61725, 333-65345, and
333-68267) and Form S-3 (File No. 333-58617).
Arthur Andersen LLP
Denver, Colorado
March 15, 2000
<PAGE>
Exhibit 23.2
Consent of Independent Auditors
The Board of Directors
Qwest Communications International Inc.:
We consent to incorporation by reference in the Registration Statements on Form
S-8 (No. 333-47349, No. 333-50061, No. 333-56323, No. 333-60133, No. 333-61725,
No. 333-65345 and No. 333-68267), and the Registration Statement on Form S-3
(No. 333-58617), of Qwest Communications International Inc. of our report dated
February 2, 1999, relating to the consolidated balance sheet of Qwest
Communications International Inc. and subsidiaries as of December 31, 1998, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the two-year period ended December 31, 1998,
which appears in the December 31, 1999 annual report on Form 10-K of Qwest
Communications International, Inc.
KPMG LLP
Denver, Colorado
March 15, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet as of December 31, 1999 and consolidated statement of
operations for the nine months ended December 31, 1999 included in the Company's
Form 10-K, and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 349
<SECURITIES> 0
<RECEIVABLES> 1,205
<ALLOWANCES> 68
<INVENTORY> 0
<CURRENT-ASSETS> 1,785
<PP&E> 4,469
<DEPRECIATION> 360
<TOTAL-ASSETS> 11,058
<CURRENT-LIABILITIES> 1,238
<BONDS> 2,344
0
0
<COMMON> 8
<OTHER-SE> 6,993
<TOTAL-LIABILITY-AND-EQUITY> 11,058
<SALES> 3,928
<TOTAL-REVENUES> 3,928
<CGS> 2,159
<TOTAL-COSTS> 3,604
<OTHER-EXPENSES> (411)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 151
<INCOME-PRETAX> 584
<INCOME-TAX> 125
<INCOME-CONTINUING> 459
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 459
<EPS-BASIC> 0.63
<EPS-DILUTED> 0.60
</TABLE>
