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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 1-14087
U S WEST, INC.
(FORMERLY "USW-C, INC.")
A DELAWARE CORPORATION 84-0953188
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1801 CALIFORNIA STREET, DENVER, COLORADO 80202
TELEPHONE NUMBER (303) 672-2700
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Securities registered pursuant to Section 12(b) of the Act:
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NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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U S WEST Common Stock New York Stock Exchange
($0.01 per share, par value) Pacific Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act:
None
At January 29, 1999, 503,189,703 shares of U S WEST common stock were
outstanding. At January 29, 1999, the aggregate market value of the U S WEST
voting stock held by non-affiliates was approximately $28,849,960,218.
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 ___
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Registrant's definitive Proxy Statement to be used in
connection with the 1999 Annual Meeting of Shareholders scheduled to be held on
May 11, 1999 are incorporated by reference into Parts II and III.
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].
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TABLE OF CONTENTS
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ITEM DESCRIPTION PAGE
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PART I
1. Business.................................................................. 2
2. Properties................................................................ 4
3. Legal Proceedings......................................................... 4
4. Submission of Matters to a Vote of Security Holders....................... 5
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters..... 6
6. Selected Financial Data................................................... 6
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 6
7A. Quantitative and Qualitative Disclosures about Market Risk................ 6
8. Consolidated Financial Statements and Supplementary Data.................. 6
9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.............................................................. 6
PART III
10. Directors and Executive Officers of the Registrant........................ 6
11. Executive Compensation.................................................... 7
12. Security Ownership of Certain Beneficial Owners and Management............ 7
13. Certain Relationships and Related Transactions............................ 7
PART IV
14. Financial Statement Schedules, Reports on Form 8-K and Exhibits........... 7
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U S WEST, INC.
FORM 10-K
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the information presented in this Annual Report on Form 10-K or
incorporated by reference constitutes "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"). Although U S WEST, Inc. ("U S WEST" or the "Company," which may also be
referred to as "we," "us" or "our") believes that its expectations are based on
reasonable assumptions within the bounds of its knowledge of its businesses and
operations, there can be no assurance that actual results will not differ
materially from our expectations. Factors that could cause actual results to
differ from expectations include:
- greater than anticipated competition from new entrants into the local
exchange, intraLATA (local access transport area) toll, wireless, data and
directories markets, causing loss of customers and increased price
competition;
- changes in demand for our products and services, including optional custom
calling features;
- higher than anticipated employee levels, capital expenditures and
operating expenses (such as costs associated with interconnection and Year
2000 remediation);
- the loss of significant customers;
- pending and future state and federal regulatory changes affecting the
telecommunications industry, including changes that could have an impact
on the competitive environment in the local exchange market;
- a change in economic conditions in the various markets served by our
operations;
- higher than anticipated start-up costs associated with new business
opportunities;
- delays in our ability to begin offering interLATA long-distance services;
- consumer acceptance of broadband services, including telephony, data,
video and wireless services; and
- delays in the development of anticipated technologies, or the failure of
such technologies to perform according to expectations.
These cautionary statements should not be construed by you as an exhaustive
list or as any admission by us regarding the adequacy of disclosures made by us.
We cannot always predict or determine after the fact what factors would cause
actual results to differ materially from those indicated by our forward-looking
statements or other statements. In addition, you are urged to consider
statements that include the terms "believes," "belief," "expects," "plans,"
"objectives," "anticipates," "intends," or the like to be uncertain and
forward-looking. All cautionary statements should be read as being applicable to
all forward-looking statements wherever they appear.
We do not undertake any obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed herein might not occur.
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PART I
ITEM 1. BUSINESS
GENERAL
We are incorporated under the laws of the State of Delaware and have our
principal executive offices at 1801 California Street, Denver, Colorado 80202,
telephone number (303) 672-2700. We are a diversified communications company
providing services principally to customers in a 14-state mountain and western
region of the United States, which is comprised of the states of Arizona,
Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota,
Oregon, South Dakota, Utah, Washington and Wyoming (collectively referred to as
the "Region" or "U S WEST Region"). Our services include telecommunications and
related services, wireless services, high-speed data and Internet services and
directory services. The largest component of our company is U S WEST
Communications, Inc. ("U S WEST Communications"), a wholly-owned subsidiary,
which provides communications services to more than 25 million residential and
business customers in our Region.
U S WEST Communications serves approximately 75% of our Region's population.
We and our subsidiaries had 54,483 employees at December 31, 1998. We have one
class of common stock, par value $.01 per share.
RECENT DEVELOPMENTS
On October 25, 1997, the Board of Directors of our former parent company
(herein referred to as "Old U S WEST"), adopted a proposal to separate Old U S
WEST into two independent companies (the "Separation"). Old U S WEST conducted
its businesses through two groups: (i) the U S WEST Communications Group (the
"Communications Group"), which included the communications businesses of Old U S
WEST, and (ii) the U S WEST Media Group (the "Media Group"), which included the
multimedia and directory businesses of Old U S WEST. On June 4, 1998,
stockholders of Old U S WEST voted in favor of the Separation, which became
effective June 12, 1998 (the "Separation Date"). As part of the Separation, Old
U S WEST contributed to us the businesses of the Communications Group and the
domestic directories business of Media Group known as U S WEST Dex, Inc.
("Dex"). The alignment of Dex with our Company is referred to in this document
as the "Dex Alignment." Old U S WEST has continued as an independent public
company comprised of the businesses of Media Group, other than Dex, and has been
renamed MediaOne Group, Inc. ("MediaOne").
The Separation was implemented under the terms of a separation agreement
(the "Separation Agreement") between us and MediaOne. In connection with the Dex
Alignment: (i) Old U S WEST distributed, as a dividend to holders of Media Group
common stock, approximately 16,341,000 shares of our common stock (net of the
redemption of approximately 305,000 fractional shares) with an aggregate value
of $850 million (the "Dex Dividend") and (ii) we refinanced $3.9 billion of Old
U S WEST debt, formerly allocated to Media Group, (the "Dex Indebtedness").
OPERATIONS
We are organized on the basis of our products and services and operate in
two segments: communications and related services and directory services.
COMMUNICATIONS AND RELATED SERVICES
The principal types of communications services we offer are: (i) local
exchange telephone services, (ii) exchange access services (which connect
customers to facilities of carriers, including long-distance providers and
wireless operators), (iii) long-distance network services within local access
and transport areas ("LATAs") in the Region, (iv) wireless services and (v)
high-speed data and Internet services.
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LOCAL EXCHANGE. Local exchange telephone services provide lines from
telephone exchange offices to customers' premises to originate and terminate
telecommunications services within our local exchange service territories as
defined by the state public utilities commissions. These services include basic
local exchange services provided through our regular switched network, dedicated
private line facilities for voice and special services, such as transport of
data, radio and video, switching services for customers' internal communications
through facilities owned by us, data transport services that include managing
and configuring special service networks and dedicated low-and high-capacity
public or private digital networks. Other local exchange revenue is derived from
directory assistance, public telephone service and various custom calling
features such as Caller ID, Call Waiting, Call Return and 3-Way Calling.
EXCHANGE ACCESS. We provide exchange access services by connecting the
equipment and facilities of our customers with the communications networks of
interexchange carriers and other local exchange carriers, including competitive
local exchange carriers. These connections are provided by linking these
carriers and customers through our public switched network or through our
dedicated private lines.
INTRALATA LONG-DISTANCE. We provide intraLATA long-distance services within
our Region. These services include intraLATA service beyond the local calling
area, Wide Area Telecommunications Service or "800" services for customers with
highly concentrated demand, and special services, such as transport of data,
radio and video. We intend to begin offering interLATA long-distance services in
our Region pursuant to the Telecommunications Act of 1996 (the
"Telecommunications Act" or the "Act") through the successful completion of
regulatory proceedings. We currently offer limited out-of-region long-distance
services.
We also provide other products and services, such as customer premises
equipment and enhanced services, including voice mail to residents, business
customers and governmental agencies.
WIRELESS SERVICES. We hold 10 MHz licenses to provide personal
communications services ("PCS") in 53 markets in our Region. These licenses,
which cover approximately 20 million POPs (I.E., potential customers), were
purchased in a Federal Communications Commission ("FCC") auction held in January
1997. In December 1997, we purchased additional licenses for a majority of the
Seattle market, which cover an additional 4 million POPs. Using these licenses,
we are constructing networks utilizing digital code division multiple access
technology. We launched wireless PCS services in Denver, Fort Collins, Greeley
and Colorado Springs, Colorado; Portland and Salem, Oregon; and Vancouver,
Washington in 1997 and in Phoenix and Tucson, Arizona; Minneapolis, St. Cloud,
St. Paul and Rochester, Minnesota; and Seattle, Olympia and Bremerton,
Washington in 1998 covering approximately 13 million POPs. These wireless
services, which are being marketed under the "U S WEST Advanced PCS" brand,
enable customers to use the same number for their wireless phone as for their
home or business phone.
HIGH-SPEED DATA AND INTERNET SERVICES. We offer high-speed data and
Internet services to customers inside and outside our Region. Through U S WEST
!INTERPRISE, our data division, and U S WEST !INTERPRISE America, Inc., one of
our subsidiaries, we provide high-speed data communications and network
services, including frame relay service, Transparent LAN service, ATM Cell Relay
Service, network integration solutions and other data-related services to
business customers. In 1997 and 1998, we introduced U S WEST Megabit Services, a
high-speed Internet access service, and U S WEST.net, a standard Internet access
service, in select markets and expect to launch these services in additional
markets in 1999. For factors which could cause actual results to differ from
expectations, you should read "Special Note Regarding Forward-Looking
Statements" on page 1.
At December 31, 1998, U S WEST Communications had over 16.5 million
telephone network access lines in service, an increase of 3.5% over 1997. On
January 15, 1999, we announced that U S WEST Communications plans to sell
approximately 500,000 access lines over the next 12-18 months. For the year
ended December 31, 1998, local exchange service, exchange access service and
high-speed data and Internet access services accounted for 43%, 21% and 10%,
respectively, of U S WEST's total revenue.
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IntraLATA long-distance service and wireless services each accounted for less
than 10% of total 1998 revenues. For financial information about segments of our
business, you should read Note 12 to the consolidated financial statements, on
pages F-25 through F-27.
DIRECTORY SERVICES
Through Dex, we publish approximately 270 White and Yellow Pages directories
in our Region. Dex's business scope includes all facets of directory-related
publishing services such as market identification, analysis and planning,
advertising and sales, customer service, directory design, printing and
distribution, billing and collection, and product service promotion. Dex's
customers include businesses that purchase advertising in its directories and
other related products, and consumers who use directories and other advertising
and information services. Dex also provides directory publishing services to
other telephone companies on a contract basis and electronic directory services.
Dex is expanding its directories business onto the Internet by marketing
innovative and interactive listings and advertising, primarily through existing
sales channels throughout our Region. Our revenue from the directory services
business accounted for 10% of 1998 revenues.
COMPETITION
We face increasing competition from a variety of sources, including other
local service providers, long-distance service providers, cable TV companies,
wireless service providers, Internet service providers and other entrants from
closely related industries. For a discussion of competition, you should read the
section entitled "Competition" under Management's Discussion and Analysis of
Financial Condition and
Results of Operations on page 22.
REGULATION
U S WEST Communications is subject to varying degrees of regulation by state
commissions with respect to intrastate rates and services and access charge
tariffs. We are also subject to the jurisdiction of the FCC with respect to
interstate access tariffs (that specify the charges for the origination and
termination of interstate communications) and other matters.
U S WEST Communications is currently working with regulators to gain
approval of various initiatives, including efforts to rebalance prices, achieve
accelerated capital recovery and eliminate subsidies.
State and local regulatory authorities may also regulate certain terms and
conditions of the offering of wireless services, such as the siting and
construction of transmitter towers, antennas and equipment shelters and zoning
and building permit approvals. For a further discussion, you should read the
section entitled "Regulation" under Management's Discussion and Analysis of
Financial Condition and Results of Operations on page 23.
ITEM 2. PROPERTIES
Our properties do not lend themselves to description by character and
location of principal units. At December 31, 1998, the majority of our property
was utilized by U S WEST Communications in providing telecommunications
services. Substantially all of U S WEST Communications' central office equipment
is located in owned buildings situated on land owned in fee, while many garages
and administrative and business offices are leased.
ITEM 3. LEGAL PROCEEDINGS
Our Company and its subsidiaries are subject to claims and proceedings
arising in the ordinary course of business. At U S WEST Communications, there
are pending certain regulatory actions in local
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regulatory jurisdictions that call for price decreases, refunds or both. For a
discussion of these actions, you should read Note 14 to the consolidated
financial statements on pages F-27 through F-28.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
EXECUTIVE OFFICERS OF U S WEST, INC.
In accordance with General Instruction G(3) for this Form 10-K, the
following information is included as an additional item in Part I:
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DATE ASSUMED
PRESENT
NAME POSITION AGE POSITION
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Solomon D. Trujillo........... President and Chief Executive Officer 47 1998(1)
Betsy J. Bernard.............. Executive Vice President - Retail Markets 43 1998(2)
Janet K. Cooper............... Vice President and Treasurer 45 1998(3)
John A. Kelley, Jr............ President of Wholesale - U S WEST Communications, Inc. 49 1998(4)
Oscar X. Munoz................ Vice President and Controller 40 1998(5)
Mark D. Roellig............... Executive Vice President - Public Policy, Human 43 1998(6)
Resources & Law, General Counsel and Secretary
James A. Smith................ Executive Vice President and President of U S WEST 46 1998(7)
Dex, Inc.
Allan R. Spies................ Executive Vice President and Chief Financial Officer 50 1998(8)
Gregory M. Winn............... Executive Vice President - Operations and Technology 49 1998(9)
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(1) As part of the Separation, Mr. Trujillo became the President and Chief
Executive Officer of U S WEST, Inc. Previously, Mr. Trujillo was President
and Chief Executive Officer of U S WEST Communications Group effective July
1, 1995, and Executive Vice President of Old U S WEST effective October 6,
1995. Mr. Trujillo was also previously President and Chief Executive Officer
of U S WEST Dex, Inc.
(2) Ms. Bernard became Executive Vice President - Retail Markets of U S WEST,
Inc. in July 1998. Before joining U S WEST, Ms. Bernard was head of AVIRNES,
an advanced international telecommunications services company. Prior to
that, Ms. Bernard was President and CEO of Pacific Bell Communications, the
long-distance subsidiary of Pacific Telesis Group. Before joining PacBell,
she worked for AT&T for eighteen years in a number of positions. Ms. Bernard
serves on the board of directors of Mile High United Way.
(3) As part of the Separation, Ms. Cooper became Vice President and Treasurer of
U S WEST, Inc. She has been the Vice President and Treasurer of U S WEST
Communications, Inc. since May of 1998. Before joining U S WEST, Ms. Cooper
was Vice President of Treasury and Tax Business of The Quaker Oats Company
from 1992 to 1998. Ms. Cooper joined The Quaker Oats Company in 1978 and
held various financial and managerial positions.
(4) Mr. Kelley became President of Wholesale - U S WEST Communications, Inc. in
April 1998. Prior to his current assignment, Mr. Kelley was Vice President -
Large Business and Government Accounts and President - Federal Services of U
S WEST Communications, Inc. since 1995. Prior to joining U S WEST, Mr.
Kelley was Area President for Mead Corporation's Zellerbach Southwest
businesses and Vice President and General Manager for Zellerbach's
Industrial Business Unit.
(5) As part of the Separation, Mr. Munoz became Vice President and Controller of
U S WEST, Inc. He served as Vice President and Controller of U S WEST
Communications Group from 1997 until the Separation. Mr. Munoz previously
served as a Vice President at Coca-Cola Enterprises, Inc., where for ten
years he held a number of financial positions and was instrumental in
reorganizing the firm's financial network.
(6) As part of the Separation, Mr. Roellig became Executive Vice President -
Public Policy, Human Resources and Law, General Counsel and Secretary of U S
WEST, Inc. Previously, Mr. Roellig was Vice President - Public Policy and
Regulatory Law of
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U S WEST Communications Group from 1997 until the Separation. Mr. Roellig
had served as a Vice President of Old U S WEST since 1994 and has held a
variety of positions in the Law Department of Old U S WEST since 1983.
(7) As part of the Separation, Mr. Smith became Executive Vice President of U S
WEST, Inc. He has served as President and Chief Executive Officer of U S
WEST Dex, Inc. since 1997. Mr. Smith had been a Vice President of Old U S
WEST since 1987 and has held a variety of operational, marketing and
management positions with Old U S WEST and its predecessors for 20 years.
Mr. Smith serves on the boards of the U S WEST Foundation, the Public
Education Network, The Children's Hospital and The Wigwam Club, Inc.
(8) As part of the Separation, Mr. Spies became Executive Vice President and
Chief Financial Officer of U S WEST, Inc. Previously, Mr. Spies was Vice
President and Chief Financial Officer of U S WEST Communications Group since
1997. Mr. Spies had been a Vice President of Old U S WEST since 1995 and has
held a variety of finance and management positions with Old U S WEST and its
predecessors for over 28 years.
(9) Mr. Winn became Executive Vice President - Operations and Technology in July
of 1998. Mr. Winn served as Executive Vice President - Retail Markets for U
S WEST Communications Group from 1997 to 1998 and for U S WEST from the
Separation date until July of 1998. Mr. Winn had been a Vice President of
Old U S WEST since 1994 and has held a variety of marketing and sales
positions with Old U S WEST and its predecessors for 28 years.
Executive Officers are not elected for a fixed term of office, but serve at
the discretion of the Board of Directors.
Except for Ms. Bernard, Ms. Cooper, Mr. Kelley and Mr. Munoz, each of the
above executive officers has held a managerial position with Old U S WEST or an
affiliate of Old U S WEST since 1994.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information required by this item can be found at Note 15 to the
consolidated financial statements on page F-30. The U. S. markets for trading in
U S WEST common stock are the New York Stock Exchange and the Pacific Stock
Exchange. As of January 29, 1999, our common stock was held by approximately
616,000 shareholders of record.
ITEM 6. SELECTED FINANCIAL DATA
For a discussion of the information required by this item, you should refer
to pages 11 and 12.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For a discussion of the information required by this item, you should refer
to pages 12 through 29.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion of the information required by this item, you should refer
to page 22.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For a discussion of the information required by this item, you should refer
to pages F-1 through F-30.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
We have nothing to report to you under this item.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For a discussion of our executive officers, you should refer back to Part I,
page 5, Item 4 under the caption "Executive Officers of U S WEST, Inc."
For a discussion of our Directors, you should refer to our definitive Proxy
Statement ("Proxy Statement") under "Election of Directors," which we
incorporate by reference into this Form 10-K.
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ITEM 11. EXECUTIVE COMPENSATION
For a discussion of the information required by this item, you should refer
to our Proxy Statement under "Compensation of Executive Officers" and "Director
Compensation," which we incorporate by reference into this Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For a discussion of the information required by this item, you should refer
to our Proxy Statement under "Security Ownership of Management," which we
incorporate by reference into this Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For a discussion of the information required under this item, you should
refer to Note 13 of the consolidated financial statements on page F-27, which we
incorporate by reference into this Form 10-K.
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, REPORTS ON FORM 8-K AND EXHIBITS
(a) Documents filed as part of this report:
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(1) Report of Independent Public Accountants..................................... F-1
(2) Consolidated Financial Statements:
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996............................................. F-2 and F-3
Consolidated Balance Sheets as of December 31, 1998 and 1997................. F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996............................................. F-5
Notes to Consolidated Financial Statements and Supplementary Data............ F-6 through F-30
(3) Consolidated Financial Statement Schedule:
Report of Independent Public Accountants..................................... F-31
Schedule II--Valuation and Qualifying Accounts............................... F-32
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Financial statement schedules other than those listed above have been omitted
because the required information is contained in the consolidated financial
statements and notes thereto or because such schedules are not required or
applicable.
(b) Reports on Form 8-K:
U S WEST filed the following reports on Form 8-K during the fourth
quarter of 1998 and through the filing of this Form 10-K:
(i) report dated October 21, 1998 providing notification of the release of
third quarter earnings of U S WEST.
(ii) report dated October 27, 1998 providing notification of a press release
entitled "U S WEST Reiterates Earnings Projections."
(iii) report dated November 2, 1998 providing notification of a press release
entitled "UNC President Hank Brown Named to U S WEST Board of
Directors."
(iv) report dated November 18, 1998 providing notification of U S WEST
Capital Funding, Inc. and U S WEST, Inc. closing of $400 million
debenture offering.
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(v) report dated January 12, 1999 providing notification of a press release
entitled "Jerry O. Williams Retires from U S WEST Board of Directors."
(vi) report dated January 15, 1999 providing notification of a press release
entitled "U S WEST To Sell 500,000 Access Lines."
(vii) report dated January 22, 1999 providing notification of the release of
fourth quarter earnings of U S WEST.
(c) Exhibits:
Exhibits identified in parentheses below are on file with the Securities and
Exchange Commission ("SEC") and are incorporated herein by reference. All other
exhibits are provided as part of this electronic submission.
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(3-A) --Restated Certificate of Incorporation of U S WEST, Inc. (Exhibit 3(i) to Form 10-Q for the
quarter ended September 30, 1998, File No. 1-14087).
(3-B) --Bylaws of U S WEST, Inc. (formerly "USW-C, Inc."), effective as of June 12, 1998 (Exhibit
3(ii) to Form 8-K/A dated June 26, 1998, File No. 1-14087).
(4-A) --Form of Rights Agreement between U S WEST, Inc. (formerly "USW-C, Inc.") and State Street Bank
and Trust Company, as Rights Agent (Exhibit 4-A to the Form S-4 Registration Statement No.
333-45765, filed February 6, 1998, as amended).
(4-B) --Form of Indenture among U S WEST Capital Funding, Inc., USW-C (renamed "U S WEST, Inc.") and
First National Bank of Chicago, as Trustee (Exhibit 4-A to Form S-3 Registration Statement No.
333-51907, filed May 6, 1998, as amended).
(10-A) --Separation Agreement between U S WEST, Inc. (renamed "MediaOne Group, Inc.") and USW-C, Inc.
(renamed "U S WEST, Inc."), dated June 5, 1998 (Exhibit 99.1 to Form 8-K/A dated June 26,
1998, File No. 1-14087).
(10-B) --Employee Matters Agreement between U S WEST, Inc. (renamed "MediaOne Group, Inc.") and USW-C,
Inc. (renamed "U S WEST, Inc."), dated June 5, 1998 (Exhibit 99.2 to Form 8-K/A dated June 26,
1998, File No. 1-14087).
(10-C) --Tax Sharing Agreement between U S WEST, Inc. (renamed "MediaOne Group, Inc.") and USW-C, Inc.
(renamed "U S WEST, Inc."), dated June 5, 1998 (Exhibit 99.3 to Form 8-K/A dated June 26,
1998, File No. 1-14087).
(10-D) --364-Day $3.5 Billion Credit Agreement, dated May 8, 1998, with Morgan Guaranty Trust Company
of New York, as Administrative Agent (Exhibit 10A to Form 10-Q for the quarter ended March 31,
1998, File No. 1-14087).
(10-E) --Five-Year $1.0 Billion Credit Agreement, dated May 8, 1998, with Morgan Guaranty Trust Company
of New York, as Administrative Agent (Exhibit 10B to Form 10-Q for the quarter ended March 31,
1998, File No. 1-14087).
(10-E-1) --Amendment No. 1 to Credit Agreements dated as of June 30, 1998 to the 364-Day $3.5 Billion
Credit Agreement and the Five-Year $1.0 Billion Credit Agreement, each dated as of May 8,
1998, among U S WEST Capital Funding, Inc., U S WEST, Inc., the Banks listed on the signature
pages thereto and Morgan Guaranty Trust Company of New York (Exhibit 10(e)(1) to Form 10-Q for
the quarter ended September 30, 1998, File No. 1-14087).
(10-F) --Change of Control Agreement for the President and Chief Executive Officer (Exhibit 10(f) to
Form 10-Q for the quarter ended June 30, 1998, File No. 1-14087).
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EXHIBIT
NUMBER
- ----------
<C> <S>
(10-G) --Form of Change of Control Agreement for Tier II Executives (Exhibit 10(g) to Form 10-Q for the
quarter ended June 30, 1998, File No. 1-14087).
(10-H) --Form of Executive Severance Agreement (Exhibit 10(h) to Form 10-Q for the quarter ended June
30, 1998, File No. 1-14087).
(10-I) --1998 U S WEST Stock Plan (Exhibit 10-A to the Form S-4 Registration Statement No. 333-45765,
filed February 6, 1998, as amended).
(10-J) --U S WEST Long-Term Incentive Plan (Exhibit 10-D to the Form S-4 Registration Statement No.
333-45765, filed February 6, 1998, as amended).
(10-K) --U S WEST Executive Short-Term Incentive Plan (Exhibit 10-E to the Form S-4 Registration
Statement No. 333-45765, filed February 6, 1998, as amended).
(10-L) --U S WEST 1998 Broad Based Stock Option Plan dated June 12, 1998 (Exhibit 10(l) to Form 10-Q
for the quarter ended September 30, 1998, File No. 1-14087).
(10-M) --U S WEST Deferred Compensation Plan, amended and restated effective as of June 12, 1998
(Exhibit 10(m) to Form 10-Q for the quarter ended September 30, 1998, File No. 1-14087).
(10-N) --U S WEST 1998 Stock Plan, as amended June 22, 1998 (Exhibit 10(n) to Form 10-Q for the quarter
ended September 30, 1998, File No. 1-14087).
(10-O) --Shareowner Investment Plan dated June 12, 1998 (Form S-3 Registration Statement No. 333-52781,
filed May 15, 1998).
10-P --Amendment to the Separation Agreement, dated June 5, 1998 between U S WEST, Inc. (renamed
"MediaOne Group, Inc.") and USW-C, Inc. (renamed "U S WEST, Inc."), dated June 12, 1998.
12 --Computation of Ratio of Earnings to Fixed Charges of U S WEST, Inc.
21 --Subsidiaries of U S WEST, Inc.
23 --Consent of Independent Public Accountants.
24 --Powers of Attorney.
27 --Financial Data Schedule.
99 --Annual Report on Form 11-K for the U S WEST Savings Plan/ESOP for the year ended December 31,
1998, to be filed by amendment.
</TABLE>
9
<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, in the City of Denver,
State of Colorado, on February 10, 1999.
<TABLE>
<S> <C> <C>
U S WEST, Inc.
By: /s/ ALLAN R. SPIES
-----------------------------------------
Allan R. Spies
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
</TABLE>
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 date indicated.
PRINCIPAL EXECUTIVE OFFICER
/s/ Solomon D. Trujillo President and Chief
Executive Officer
PRINCIPAL FINANCIAL OFFICER:
/s/ Allan R. Spies Executive Vice President
and Chief Financial
Officer
PRINCIPAL ACCOUNTING OFFICER:
/s/ Oscar X. Munoz Vice President and
Controller
DIRECTORS:
/s/ Richard D. McCormick Chairman of the Board
/s/ Linda G. Alvarado
/s/ Craig R. Barrett
/s/ The Honorable Hank Brown
/s/ Jerry J. Colangelo
/s/ George J. Harad
/s/ Peter S. Hellman
/s/ Allen F. Jacobson
/s/ Marilyn Carlson Nelson
/s/ Frank Popoff
/s/ Solomon D. Trujillo
Dated February 10, 1999
10
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
DOLLARS IN MILLIONS (EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Operating revenues................................... $ 12,378 $ 11,479 $ 11,168 $ 10,508 $ 10,132
Operating expenses................................... 9,329 8,703 8,356 7,931 7,616
Operating income..................................... 3,049 2,776 2,812 2,577 2,516
Income before extraordinary item and cumulative
effect of change in accounting principle(1)........ 1,508 1,527 1,501 1,431 1,403
Net income(2)........................................ 1,508 1,524 1,535 1,423 1,403
Pro forma income(3).................................. 1,436 1,365 1,339 * *
Historical earnings per share:(1,2,4)
Basic............................................ 3.05 3.16 3.21 3.02 3.09
Diluted.......................................... 3.02 3.12 3.17 2.98 3.03
Average common shares outstanding (thousands):
Basic............................................ 494,395 482,751 477,549 470,716 453,316
Diluted.......................................... 498,798 491,232 488,591 481,933 463,801
Pro forma earnings per share:(3)
Basic............................................ $ 2.86 $ 2.73 $ 2.71 * *
Diluted.......................................... 2.84 2.71 2.68 * *
Pro forma average common shares outstanding
(thousands):
Basic............................................ 501,827 499,092 493,890 * *
Diluted.......................................... 506,230 507,573 504,932 * *
Dividends per common share........................... $ 2.14 $ 2.14 $ 2.14 $ 2.14 $ 2.14
Total assets......................................... 18,407 17,667 17,279 16,960 16,317
Total debt(5)........................................ 9,919 5,715 6,545 6,782 6,147
Debt to total capital ratio.......................... 92.9% 56.7% 61.6% 65.0% 64.7%
Capital expenditures................................. $ 2,905 $ 2,672 $ 2,831 $ 2,770 $ 2,513
Telephone network access lines in service
(thousands)........................................ 16,601 16,033 15,424 14,795 14,299
Billed access minutes of use (millions):
Interstate......................................... 58,927 55,362 52,039 47,801 43,768
Intrastate......................................... 12,366 11,729 10,451 9,504 8,507
Total employees...................................... 54,483 51,110 51,477 54,552 55,246
Telephone company employees.......................... 46,310 43,749 45,427 47,934 47,493
Telephone company employees per 10,000 access
lines.............................................. 27.9 27.3 29.5 32.4 33.2
</TABLE>
- ------------------------------
(1) 1998 income includes Separation expenses of $68 ($0.13 per diluted share)
associated with the Separation of Old U S WEST into two independent
companies and an asset impairment charge of $21 ($0.04 per diluted share).
1997 income includes a $152 regulatory charge ($0.31 per diluted share)
related primarily to the 1997 Washington State Supreme Court ruling that
upheld a Washington rate order, a gain of $32 ($0.07 per diluted share) on
the sale of an interest in Bell Communications Research, Inc. and a gain of
$48 ($0.10 per diluted share) on the sales of local telephone exchanges.
1996 income includes a gain of $36 ($0.07 per diluted share) on the sales of
local telephone exchanges and the current effect of $15 ($0.03 per diluted
share) from adopting Statement of Financial Accounting Standards ("FAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." 1995 income includes a gain of $85 ($0.18 per
diluted share) on the sales of local telephone exchanges and costs of $8
($0.02 per diluted share) associated with the 1995 Recapitalization
discussed in footnote 4 below. 1994 income includes a gain of $51 ($0.11 per
diluted share) on the sales of local telephone exchanges.
11
<PAGE>
(2) 1997 net income was reduced by an extraordinary charge of $3 ($0.01 per
diluted share) for the early extinguishment of debt. 1996 net income
includes a gain of $34 ($0.07 per diluted share) for the cumulative effect
of the adoption of FAS No. 121. 1995 net income was reduced by an
extraordinary item of $8 ($0.02 per diluted share) for the early
extinguishment of debt.
(3) Pro forma income is before an extraordinary item in 1997 and the cumulative
effect of a change in accounting principle in 1996 and reflects the
incremental interest expense associated with the Dex Indebtedness from the
beginning through the end of each period presented up to the Separation
Date. The pro forma earnings per diluted share amounts also reflect the
issuance of approximately 16,341,000 shares of common stock (net of the
redemption of approximately 305,000 fractional shares) issued in connection
with the Dex Alignment as if the shares had been issued at the beginning of
each period indicated.
(4) The historical average shares outstanding assume a one-for-one conversion of
historical Communications Group common shares outstanding into shares of U S
WEST as of the Separation Date. The 1998 historical average common shares
outstanding include the issuance of approximately 16,341,000 shares of
common stock (net of redemption of approximately 305,000 fractional shares)
issued in connection with the Dex Alignment. Effective November 1, 1995,
each share of common stock of Old U S WEST was converted into one share each
of Communications Stock and Media Stock (the "1995 Recapitalization").
Earnings per common share and dividends per common share for 1995 and 1994
have been presented on a pro forma basis to reflect the two classes of stock
as if they had been outstanding since January 1, 1994.
(5) 1998 debt includes $3,900 of Dex Indebtedness.
* Information has not been presented.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Special Note: Certain statements set forth below under this caption
constitute "forward-looking statements" within the meaning of the Reform Act.
See "Special Note Regarding Forward-Looking Statements" on page 1 for additional
factors relating to such statements.
GENERAL
On October 25, 1997, the Board of Directors of our former parent company,
herein referred to as "Old U S WEST," adopted a proposal to separate Old U S
WEST into two independent companies. Old U S WEST had conducted its businesses
through two groups: (i) the Communications Group, which included the
communications businesses of Old U S WEST, and (ii) the Media Group, which
included the multimedia and directories businesses of Old U S WEST. On June 4,
1998, stockholders of Old U S WEST voted in favor of the Separation, which
became effective June 12, 1998. As part of the Separation, Old U S WEST
contributed to us the businesses of the Communications Group and the domestic
directories business of the Media Group known as Dex. Old U S WEST has continued
as an independent public company comprised of the businesses of Media Group
other than Dex and has been renamed MediaOne.
The Separation was implemented according to the terms of the Separation
Agreement between U S WEST and MediaOne. In connection with the Dex Alignment,
(i) Old U S WEST distributed, as the Dex dividend to holders of Media Group
common stock, approximately 16,341,000 shares of our common stock (net of the
redemption of approximately 305,000 fractional shares) with an aggregate of $850
in value and (ii) we refinanced $3,900 of Old U S WEST debt, formerly allocated
to Media Group.
The consolidated financial statements include the consolidated historical
results of operations, financial position and cash flows of the businesses that
comprise the Communications Group and Dex, as if such businesses operated as a
separate entity for all periods and as of all dates presented. However, certain
financial effects of the Separation and the Dex Alignment, including interest
expense associated with the refinancing of the Dex Indebtedness and the dilutive
effect of the Dex Dividend, are not reflected in the historical consolidated
statements of income prior to the Separation Date.
12
<PAGE>
RESULTS OF OPERATIONS
1998 COMPARED WITH 1997
Several non-recurring and non-operating items impacted net income in 1998
and 1997. Results of operations for the two years, normalized to exclude the
effects of such items, are as follows:
<TABLE>
<CAPTION>
INCREASE
1998 1997 (DECREASE)
--------- --------- --------------------
<S> <C> <C> <C> <C>
Net income.................................................................. $ 1,508 $ 1,524 $ (16) (1.0)%
Pro forma adjustment(1)..................................................... (72) (162) 90 55.6
--------- --------- --------- ---------
Pro forma net income........................................................ 1,436 1,362 74 5.4
Non-recurring and non-operating items....................................... 89 (77) 166 215.6
--------- --------- --------- ---------
Normalized pro forma income................................................. $ 1,525 $ 1,285 $ 240 18.7%
--------- --------- --------- ---------
--------- --------- --------- ---------
Pro forma diluted earnings per share(2)..................................... $ 2.84 $ 2.70 $ 0.14 5.2%
Non-recurring and non-operating items....................................... 0.17 (0.16) 0.33 206.3
--------- --------- --------- ---------
Normalized pro forma diluted earnings per share............................. $ 3.01 $ 2.55* $ 0.46* 18.0%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
- ------------------------------
* Amount does not foot due to the rounding of individual components.
(1) Reflects incremental (after-tax) interest expense associated with the Dex
Indebtedness from the beginning through the end of each period presented up
to the Separation Date.
(2) Reflects the issuance of approximately 16,341,000 shares of common stock
(net of the redemption of approximately 305,000 fractional shares) issued in
connection with the Dex Alignment as if the shares had been issued as of the
beginning of each period indicated.
Non-recurring and non-operating items in 1998 include:
- an after-tax charge of $68 or $0.13 per diluted share for Separation costs
and
- an after-tax charge of $21 or $0.04 per diluted share related to the
impairment of certain long-lived assets associated with our video
operations.
Non-recurring and non-operating items in 1997 include:
- an after-tax charge of $3 or $0.01 per diluted share relating to the early
extinguishment of debt and
- an after-tax gain of $80 or $0.17 per diluted share relating to the sales
of local telephone exchanges and our investment in Bell Communications
Research, Inc. ("Bellcore").
Normalized pro forma income increased $240 or 18.7% in 1998 and normalized
pro forma diluted earnings per share increased $0.46 or 18.0%. The increases
were primarily due to revenue growth associated with increased demand for
services and lower regulatory rate adjustments which unfavorably impacted
revenue. The 1997 regulatory rate adjustments include a $152 ($250 pretax)
charge primarily attributable to a state of Washington adjustment (the
"Washington Rate Order"). Partially offsetting the revenue increases were higher
operating costs driven by growth initiatives and interconnection activities.
The following sections provide a more detailed discussion of the changes in
revenues and expenses.
OPERATING REVENUES
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- ----------------------
<S> <C> <C> <C> <C>
Local service revenues......................................... $ 5,525 $ 5,016 $ 509 10.1%
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
13
<PAGE>
LOCAL SERVICE REVENUES. Local service revenues include basic monthly
service fees, fees for calling services, such as call waiting and caller
identification, public phone revenues and installation and connection charges.
Most local service rates are regulated by state public service commissions.
Local service revenues increased in 1998 due largely to access line growth
and increased sales of calling services. Second line additions by residential
and small business customers contributed to access line growth due to continuing
demand for Internet access and data transport capabilities. In 1998, we provided
a total of 568,000 additional access lines, an increase of 3.5% over 1997. Of
this increase, second line installations accounted for 241,000 lines, an
increase of 18.0% compared with 1997. In addition, regulatory rate increases in
various jurisdictions accounted for $53 or 10.4% of the increase in local
service revenues in 1998. Unfavorable regulatory rate adjustments and other
provisions for estimated state regulatory liabilities decreased $122 in 1998
compared to 1997, due in part, to the Washington Rate Order.
While the number of access lines, calling services and associated revenue
increased in 1998, the growth rate has declined from 1997. The decline in the
growth rate was partially attributable to our customer retention strategy of
offering customers bundles of services at lower prices in return for entering
into longer-term contracts. Some business customers have also opted to migrate
from multiple single lines to high capacity lines, which decreases local service
revenues but increases access service revenues. Lastly, the work stoppage in the
third quarter of 1998 negatively impacted revenue growth. We believe we will
continue to experience declining growth rates as the level of customer demand
slows and competition increases. Additionally, we are planning the sale of
approximately 500,000 access lines that accounted for approximately $270 of 1998
revenues. While the sale is expected to provide us with a one-time gain in 1999
or 2000, the loss of the lines will negatively impact future revenue growth.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- ----------------------
<S> <C> <C> <C> <C>
Interstate access service revenues......................... $ 2,816 $ 2,666 $ 150 5.6%
Intrastate access service revenues......................... 822 761 61 8.0
--
--
--------- --------- ---------
--------- --------- ---------
</TABLE>
INTERSTATE AND INTRASTATE ACCESS SERVICE REVENUES. Interstate and
intrastate access service revenues are derived primarily from charging
interexchange carriers, such as AT&T and MCI WorldCom, for use of our local
network to connect customers to their long-distance networks. We also collect
fees from telephone customers to connect to their long-distance carriers.
In 1998, interstate access service revenues were affected by a change in the
classification of fees paid into the universal service funds. In 1997 and prior
years, fees paid into the universal service funds were netted against interstate
access service revenues. In 1998, with the advent of the FCC's new universal
service fund structure and funding mechanism, these fees were recorded as access
expense within other operating expenses. Excluding the effects of the
reclassification, interstate access service revenues increased $65 or 2.4% in
1998 due to greater demand for interstate access services. The volume of access
minutes billed increased 6.4% in 1998. The increase in demand was substantially
offset by price reductions as mandated by the FCC. Commencing in 1999, the FCC
will allow us to recover non-recurring costs incurred in connection with
establishing local number portability.
The increase in intrastate access service revenues was primarily
attributable to a $68 charge recognized in 1997 resulting from the Washington
Rate Order. Greater demand also contributed to the increase. The volume of
access minutes of use increased 5.4% in 1998.
<TABLE>
<CAPTION>
1998 1997 DECREASE
--------- --------- ----------------------
<S> <C> <C> <C> <C>
Long-distance network services revenues........................ $ 779 $ 885 $ 106 12.0%
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
LONG-DISTANCE NETWORK SERVICES REVENUES. Long-distance network services
revenues are derived from customer calls to locations outside of their local
calling area but within the same LATA. The decrease in
14
<PAGE>
long-distance network services revenues was attributable to greater competition
and regulatory rate reductions in 1998, offset by a $51 charge recognized in
1997 resulting from the Washington Rate Order. As of December 31, 1998, in five
of the 14 states in which we operate, customers are able to choose an
alternative provider for intraLATA calls without dialing a special access code
when placing the call. Additionally, contributing to the revenue decline was the
expansion of multiple toll carrier plans ("MTCPs") in 1997, whereby other
telephone companies provide toll services previously provided by us. Although we
no longer receive these revenues, the revenue loss has been offset with
increased intrastate access service revenues and lower access expenses.
We believe we will continue to experience further declines in long-distance
network services revenues as regulatory actions provide for increased levels of
competition. We are responding to competition through competitive pricing of
intraLATA long-distance services and increased promotional efforts to retain
customers. See "Special Note Regarding Forward-Looking Statements" on page 1.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- -------------
<S> <C> <C> <C> <C>
Directory services.......................................... $ 1,277 $ 1,197 $ 80 6.7%
--
--
--------- --------- ---
--------- --------- ---
</TABLE>
DIRECTORY SERVICES. Directory services revenues are primarily derived from
selling advertising in our published directories. The increase in directory
services revenues was primarily attributable to a 7.5% increase in revenue per
local advertiser, resulting from price increases of 4.7% and an increase in
volume and additional features of advertisements sold.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- ----------------------
<S> <C> <C> <C> <C>
Other services revenues...................................... $ 1,159 $ 954 $ 205 21.5%
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
OTHER SERVICES REVENUES. Other services revenues include voice messaging,
inside wire installation and maintenance, wireless communications, billings and
collections for interexchange carriers, interconnection rent and customer
equipment sales. Other services revenues increased primarily as a result of
greater sales of wireless communications services, which commenced in 1997, and
inside wire installation and maintenance. Interconnection rent revenues,
continued market penetration in voice messaging services and increased sales of
other unregulated products and services also contributed to the increase.
EXPENSES
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Employee-related expenses........................................ $ 4,312 $ 3,953 $ 359 9.1%
--
--
--------- --------- ---------
--------- --------- ---------
</TABLE>
EMPLOYEE-RELATED EXPENSES. Employee-related expenses include salaries and
wages, benefits, payroll taxes and contract labor. Employee-related expenses in
1998 include $21 of net costs incurred in connection with the third-quarter work
stoppage, including incremental travel costs, contract labor costs and bonuses
paid to management for work performed during the strike. Partially offsetting
these additional costs were lower salaries and wages for occupational employees
not working during the strike. Excluding these costs, employee-related expenses
increased $338 or 8.6%.
Employee-related expenses increased because of growth in several sectors of
the business, primarily wireless and data communications, resulting in increased
employee levels. Across-the-board wage increases also contributed to the
increase in employee-related expenses. We also incurred higher contract labor
costs for systems development, including interconnection and year 2000 costs and
marketing and sales efforts. Additionally, approximately 530 employees were
transferred from Old U S WEST as part of the Separation.
15
<PAGE>
Prior to the Separation, these costs were allocated to us and included in other
operating expenses. Partially offsetting these increases was a $101 pension
credit in 1998 compared to a $33 pension credit in 1997.
Approximately 33,000 of our telephone company employees are represented by
the Communications Workers of America. In October 1998, members of the union
ratified a three-year contract providing for salary increases of 10.9% over
three years, effective in August of each year, and a cumulative pension increase
of 21% over three years.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Other operating expenses......................................... $ 2,818 $ 2,587 $ 231 8.9%
--
--
--------- --------- ---------
--------- --------- ---------
</TABLE>
OTHER OPERATING EXPENSES. Other operating expenses include access charges
paid to independent local exchange carriers for the routing of long-distance
traffic through their facilities, network software expenses, paper, printing,
delivery and distribution costs associated with publishing activities and other
selling, general and administrative costs. As discussed in "interstate and
intrastate access service revenues," universal service funding expenses were
netted against revenues in 1997 and prior years and have been classified to
other operating expenses in 1998. Excluding the effects of the reclassification,
other operating expenses increased $146 or 5.6% in 1998. The increase was
primarily attributable to the following:
- increased costs associated with growth initiatives, including wireless
handset costs and related marketing and advertising,
- higher interconnection and local number portability costs,
- costs of $94 that were directly attributable to the Separation, including
executive severance, legal and financial advisory fees, securities
registration fees, printing and mailing costs and internal systems and
rearrangement costs, and
- an asset impairment charge of $35 related to certain long-lived assets
used in our video operations in Omaha, Nebraska. Recent technological
advances have permitted us to pursue and use more economical DSL
technology in cable overbuild situations. Because the projected future
cash flows were less than the assets' carrying value, an impairment loss
was recognized. See Note 3 to the consolidated financial statements.
Partially offsetting the increase in other operating expenses was the effect
of transferring approximately 530 employees from Old U S WEST. Costs related to
these employees are now included in employee-related expenses. Previously, these
costs were allocated from Old U S WEST and included in other operating expenses.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- -----------
<S> <C> <C> <C> <C>
Depreciation and amortization expense............................. $ 2,199 $ 2,163 $ 36 1.7%
--
--
--------- --------- ---
--------- --------- ---
</TABLE>
DEPRECIATION AND AMORTIZATION EXPENSE. Depreciation and amortization
expense increased primarily due to higher overall property, plant and equipment
balances resulting from continued investment in our network.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Operating income:
Communications and related services segment...................... $ 5,092 $ 4,982 $ 110 2.2%
Directory segment................................................ 657 615 42 6.8
--
--
--------- --------- ---------
--------- --------- ---------
</TABLE>
16
<PAGE>
OPERATING INCOME. For segment reporting purposes, operating income excludes
certain costs and expenses, including depreciation and amortization, taxes other
than income and other non-recurring charges. See Note 12 to the consolidated
financial statements.
Operating income for the communications and related services segment
increased due to revenue growth, primarily from local service revenues. The
revenue increase was partially offset by the higher operating expenses driven by
growth initiatives and interconnection activities. Operating income from the
directory segment increased due to growth in directory services revenue
partially offset by increased printing, paper and sales support costs.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Other expense--net................................................. $ 630 $ 347 $ 283 81.6%
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
OTHER EXPENSE--NET. Interest expense was $543 in 1998 compared to $405 in
1997. The increase was primarily attributable to the Dex Indebtedness. On a pro
forma basis, assuming the Dex Indebtedness had occurred at the beginning of each
year presented, interest expense would have been $660 in 1998 compared to $667
in 1997. The decline in pro forma interest expense is attributable to overall
lower average pro forma debt balances in 1998 compared to 1997.
Also included in other expense--net, were other expenses of $87 in 1998
compared to other income of $58 in 1997. The 1998 other expenses resulted
primarily from interest expense on state regulatory liabilities whereas 1997
other income was derived primarily from sales of local telephone exchanges and
our investment in Bellcore, offset by interest expense on state regulatory
liabilities.
<TABLE>
<CAPTION>
1998 1997 INCREASE
--------- --------- ----------
<S> <C> <C> <C> <C>
Provision for income taxes............................................. $ 911 $ 902 $ 9 1.0%
-- --
-- --
--------- ---------
--------- ---------
</TABLE>
PROVISION FOR INCOME TAXES. On a pro forma basis assuming the Dex
Indebtedness had occurred at the beginning of each year presented, the effective
tax rate was 37.6% for 1998 compared to 37.0% for 1997. The increase in the
effective tax rate was primarily attributable to the non-deductibility of
certain Separation costs and lower amortization of investment tax credits.
1997 COMPARED TO 1996
Several non-recurring and non-operating items impacted reported net income
in 1997 compared to 1996. Results of operations for the two years, normalized to
exclude the effects of such items, are as follows:
<TABLE>
<CAPTION>
INCREASE
1997 1996 (DECREASE)
--------- --------- --------------------
<S> <C> <C> <C> <C>
Net income.................................................... $ 1,524 $ 1,535 $ (11) (0.7)%
Non-recurring and non-operating items......................... (77) (85) 8 9.4
--------- --------- --------- ---
Normalized income............................................. $ 1,447 $ 1,450 $ (3) (0.2)%
--------- --------- --------- ---
--------- --------- --------- ---
Diluted earnings per share.................................... $ 3.12 $ 3.17 $ (0.05) (1.6)
Non-recurring and non-operating items......................... (0.16) (0.17) 0.01 5.9
--------- --------- --------- ---
Normalized diluted earnings per share......................... $ 2.96 $ 2.99* $ (0.03)* (1.0)%
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
- ------------------------------
* Normalized diluted earnings per share does not foot due to rounding.
17
<PAGE>
Non-recurring and non-operating items in 1997 include:
- an after-tax charge of $3 or $0.01 per diluted share relating to the early
extinguishment of debt and
- an after-tax gain of $80 or $0.17 per diluted share relating to the sale
of local telephone exchanges and our investment in Bellcore.
Non-recurring and non-operating items in 1996 include:
- an after-tax gain of $36 or $0.07 per diluted share relating to the sale
of local telephone exchanges and
- an after-tax gain of $49 or $0.10 per diluted share relating to the
cumulative and current year effect of a change in accounting principle.
See Note 3 to the consolidated financial statements.
Normalized income decreased $3 or 0.2% in 1997 and normalized diluted
earnings per share decreased $0.03 or 1.0%. The decreases were primarily due to
the $152 after-tax regulatory charge ($250 pretax) relating primarily to the
Washington Rate Order. Absent the effects of this charge, normalized income
increased $149 or 10.3%. The increase was primarily due to strong demand for our
core business and directory services and a 1996 after-tax charge of $15 to
reorganize and reduce headcount in the directory services segment. Partially
offsetting the effects of increased demand were higher expenses for
interconnection, provisions for estimated regulatory liabilities other than in
Washington and start-up costs associated with growth initiatives.
The following section provides a more detailed discussion of the changes in
revenues and expenses.
OPERATING REVENUES
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Local service revenues........................................... $ 5,016 $ 4,770 $ 246 5.2%
--
--
--------- --------- ---------
--------- --------- ---------
</TABLE>
LOCAL SERVICE REVENUES. Local service revenues increased in 1997 due
largely to access line growth and increased demand for calling services. In
1997, we provided a total of 609,000 additional access lines, an increase of
3.9% over 1996. Of this increase, second line installations accounted for
294,000 lines, an increase of 28.2% compared with 1996. Additionally, regulatory
rate increases of $37 and interim per call compensation revenues from
interexchange carriers as a result of FCC payphone orders favorably impacted
revenue. While local service revenues increased in 1997, the rate of growth of
5.2% declined from a 9.8% growth rate in 1996. The decline in growth was
attributable to $181 in state regulatory charges, primarily related to the
Washington Rate Order and provisions for other state regulatory liabilities.
Lower wireless interconnection access prices caused by regulatory mandate and
the effects of local exchange sales also negatively impacted local service
revenue growth in 1997.
<TABLE>
<CAPTION>
INCREASE
1997 1996 (DECREASE)
--------- --------- --------------------
<S> <C> <C> <C> <C>
Interstate access service revenues.............................. $ 2,666 $ 2,507 $ 159 6.3%
Intrastate access service revenues.............................. 761 770 (9) (1.2)
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
INTERSTATE AND INTRASTATE ACCESS SERVICE REVENUES. The increase in
interstate access service revenues resulted from greater demand for private line
services, access line growth and an increase of 6.4% in billed interstate access
minutes of use. Additionally, 1997 was favorably impacted by lower accruals for
refunds to interexchange carriers in 1997 compared to 1996. Lower prices under
the FCC's price cap plan and a $25 charge for an FCC-ordered refund to
interexchange carriers partially offset the effects of greater demand.
18
<PAGE>
The decrease in intrastate access service revenues was primarily due to a
$68 charge recognized as part of the Washington Rate Order. A 12.2% increase in
billed access minutes of use, higher demand for private line services and $7 of
regulatory rate increases largely offset the effects of the Washington Rate
Order.
<TABLE>
<CAPTION>
1997 1996 DECREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Long-distance network services revenues........................ $ 885 $ 1,100 $ (215) (19.5)%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
LONG-DISTANCE NETWORK SERVICES REVENUES. The decrease in long-distance
network services revenues was partially attributable to a $51 charge resulting
from the Washington Rate Order. The effects of competition, the introduction of
MTCPs in various jurisdictions in 1997 and 1996 and $20 of regulatory rate
reductions also contributed to the revenue decrease.
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- -----------
<S> <C> <C> <C> <C>
Directory services................................................ $ 1,197 $ 1,120 $ 77 6.9%
--
--
--------- --------- ---
--------- --------- ---
</TABLE>
DIRECTORY SERVICES. The increase in directory services revenues was largely
a result of an average 7.3% increase in revenue per local advertiser, primarily
resulting from price increases of 4.6% and an increase in volume and additional
features of advertisements sold. These increases were offset slightly by
decreased revenue associated with exited product lines that were non-strategic
to the directories business.
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- -----------
<S> <C> <C> <C> <C>
Other services revenues............................................... $ 954 $ 901 $ 53 5.9%
--
--
--------- --------- ---
--------- --------- ---
</TABLE>
OTHER SERVICES REVENUES. Other services revenues increased primarily as a
result of continued market penetration of voice messaging services, greater
sales of inside wire installation and maintenance and other unregulated products
and services and the launch of wireless communications services. Partially
offsetting these increases was a reduction in contract revenues due to the
completion of a large federal government telephony project in 1996.
EXPENSES
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- -----------
<S> <C> <C> <C> <C>
Employee-related expenses......................................... $ 3,953 $ 3,893 $ 60 1.5%
--
--
--------- --------- ---
--------- --------- ---
</TABLE>
EMPLOYEE-RELATED EXPENSES. Employee-related expenses increased largely as a
result of growth in interconnection costs. Higher contract labor costs,
predominantly a result of increased systems development work (which includes
expenses related to interconnection and year 2000 costs) and marketing and sales
efforts, and increases in employee benefit costs also contributed to the total
growth in employee-related expenses. Partially offsetting these increases were
lower salaries and wages related to headcount reductions, lower conference and
travel expenses and decreases in overtime costs. A charge of $25 in 1996 to
reorganize and reduce headcount in the directories business also partially
offset the increase.
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Other operating expenses....................................... $ 2,587 $ 2,305 $ 282 12.2%
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
19
<PAGE>
OTHER OPERATING EXPENSES. The increase in other operating expenses was
attributable to the following:
- higher advertising expenses,
- increased interconnection expenses,
- increased costs associated with strategic and growth initiatives,
primarily wireless communications services,
- increased equipment rentals, and
- increased printing, paper and sales support costs in the directories
business which were associated with an increase in the volume and
complexity of advertisements sold.
Partially offsetting these increases were the effects of reduced access
expense, primarily related to the introduction of the MTCPs, the completion of a
large federal government telephony project in 1996 and lower material and
supplies expense. Additionally, the directory services segment's discontinuance
of various product development activities in 1996 and an $11 charge in 1996 to
discontinue the Omaha broadband video service trial partially offset the
increases.
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Operating income:
Communications and related services segment.................... $ 4,982 $ 4,850 $ 132 2.7%
Directory segment.............................................. 615 524 91 17.4
--------- --------- --------- ---
--------- --------- --------- ---
</TABLE>
OPERATING INCOME. For segment reporting purposes, operating income excludes
certain costs and expenses, including depreciation and amortization, taxes other
than income and other non-recurring charges. See Note 12 to the consolidated
financial statements.
Operating income for the communications and related services segment
increased due to revenue growth, primarily from local service revenues. The
revenue increase was partially offset by higher operating expenses driven by
interconnection and start-up costs associated with growth initiatives. Operating
income from the directory segment increased due to growth in directory services
revenue from both volume and price increases. Partially offsetting this revenue
growth were revenue declines associated with exited product lines that were
non-strategic to the directories business and increased printing, paper and
sales support costs.
<TABLE>
<CAPTION>
1997 1996 DECREASE
--------- --------- --------------------
<S> <C> <C> <C> <C>
Other expense--net................................................ $ 347 $ 435 $ (88) (20.2)%
--------- --------- --- ---------
--------- --------- --- ---------
</TABLE>
OTHER EXPENSE--NET. Interest expense was $405 in 1997 compared to $448 in
1996. The decrease was primarily attributable to a lower average debt level,
partially offset by a reduction in the amount of interest capitalized on assets
under construction.
Also included in other expense--net was other income of $58 in 1997 compared
to other income of $13 in 1996. Other income in 1997 was derived from sales of
local telephone exchanges and our investment in Bellcore, partially offset by
interest expense on state regulatory liabilities. The other income in 1996 was
also from the sale of selected local telephone exchanges offset by an adjustment
related to our equity investment in Bellcore.
<TABLE>
<CAPTION>
1997 1996 INCREASE
--------- --------- -----------
<S> <C> <C> <C> <C>
Provision for income taxes............................................ $ 902 $ 876 $ 26 3.0%
--
--
--------- --------- ---
--------- --------- ---
</TABLE>
20
<PAGE>
PROVISION FOR INCOME TAXES. The effective tax rate was 37.1% for 1997
compared to 36.9% for 1996. The increase in the effective tax rate was primarily
attributable to lower amortization of investment tax credits.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. Cash provided by operations was $3,927, $4,191 and
$3,614 in 1998, 1997 and 1996, respectively. The decrease in operating cash flow
in 1998 resulted from a reduction in payables, the effects of refunds paid
relating to regulatory rulings and an increase in accounts receivable. Partially
offsetting these items were the effects of business growth in both the core
communications and directories businesses and lower income tax payments.
Cash from operations increased $577 during 1997 primarily due to business
growth and efforts to manage working capital in the core communications
business. Lower restructuring expenditures, a decrease in funding postretirement
benefits and growth in the directories business also contributed to the
increase.
Future cash needs could increase with the pursuit of new business
opportunities, and be impacted by continued implementation of the requirements
of the Telecommunications Act. Interconnection, local number portability,
universal service and access charge reform will negatively impact cash flows to
the extent recovery mechanisms provided for by the FCC and state commissions are
inadequate. We expect that such cash needs will be funded through operations
and, when necessary, the issuance of debt securities.
INVESTING ACTIVITIES. Total capital expenditures, on a cash basis, were
$2,672, $2,168 and $2,444 in 1998, 1997 and 1996, respectively. Capital
expenditures have primarily been, and continue to be, focused on expanding
access line growth, modernization of the telecommunications network and meeting
the requirements of the Act, including interconnection and local number
portability. We are also continuing to expand our investment to compete in the
wireless, data communications and video markets. In addition to investments in
property, plant and equipment, we paid $18 in 1998 and $73 in 1997 to purchase
wireless PCS licenses in connection with our launch of PCS in various markets.
In 1999, we anticipate capital expenditures will approximate $3,300 to
$3,600, (including the impact of capitalizing software costs that were
previously expensed; see "New Accounting Standards") which include the launch of
PCS in additional markets, expansion of the Internet data business and
additional interconnection costs. See "Special Note Regarding Forward-Looking
Statements" on page 1.
We received cash proceeds of $67 in 1997 and $174 in 1996 from the sale of
local telephone exchanges. Also during 1997, we sold our equity interest in
Bellcore for proceeds of $65.
FINANCING ACTIVITIES. Cash used for financing activities was $1,136, $2,157
and $1,451 in 1998, 1997 and 1996, respectively. In 1998, total debt increased
by $4,204 to $9,919 at December 31, 1998, of which approximately $3,900 was
attributable to the Dex Indebtedness. The Dex Indebtedness was incurred at the
Separation Date to repay Old U S WEST debt.
During 1997, total debt decreased $830, partially driven by increased
operating cash flows and lower capital expenditures. During 1997, Old U S WEST
redeemed its zero coupon subordinated notes with a recorded value of $303
attributed to us. Floating-rate Old U S WEST debt, due on demand, financed the
redemption.
During 1996, total debt decreased $237 primarily due to growth in operating
cash flow.
Historically, prior to the Separation Date, Old U S WEST funded our
nonregulated activities, including Dex, with short-term advances. The net
(repayments of) proceeds from such Old U S WEST short-term advances were $(198),
$153 and $(42) during 1998, 1997 and 1996, respectively.
21
<PAGE>
We paid dividends on our common shares totaling $1,056, $992 and $939 in
1998, 1997 and 1996, respectively. Prior to the Separation, Dex paid dividends
to Old U S WEST equal to its net income, adjusted for the amortization of
intangibles, totaling $194, $336 and $303 in 1998, 1997 and 1996, respectively.
We maintain commercial paper programs to finance short-term cash flow
requirements, as well as to maintain a presence in the short-term debt market.
As of December 31, 1998, we had lines of credit with a total borrowing capacity
of $2,360.
RISK MANAGEMENT
Over time, we are exposed to market risks arising from changes in interest
rates. The objective of our interest rate risk management program is to manage
the level and volatility of our interest expense. We may employ derivative
financial instruments to manage our interest rate risk exposure. We have also
employed derivative instruments to hedge interest rate and foreign currency
exposures associated with particular debt issues in order to synthetically
obtain below-market interest rates. We do not use derivative financial
instruments for trading purposes.
As of December 31, 1998 and 1997, $951 and $62, respectively, of
floating-rate debt was exposed to changes in interest rates. This exposure was
primarily linked to the 30-day commercial paper rate. A hypothetical 10% change
in the 30-day commercial paper rate would not have had a material effect on our
annual earnings. As of December 31, 1998 and 1997, we also had $228 and $340,
respectively, of fixed-rate debt obligations maturing in the following fiscal
year. Any new debt obtained to refinance this debt would be exposed to changes
in interest rates. A hypothetical 10% change in the interest rates on this debt
would not have had a material effect on our earnings.
As of December 31, 1998 and 1997, we had entered into interest rate swaps
with a notional amount of $155. These swaps synthetically transform certain
floating rate issues into fixed-rate obligations. The swaps and associated debt
issues are indexed to two- and 10-year constant maturity U.S. Treasury rates.
Any gains (losses) on the swaps would be offset by losses (gains) on the
associated debt instruments.
As of December 31, 1998 and 1997, we had also entered into cross-currency
swaps with a notional amount of $204. The cross-currency swaps synthetically
transformed $182 and $171 of Swiss Franc borrowings at December 31, 1998 and
1997, respectively, into U.S. dollar obligations. Any gains (losses) on the
cross-currency swaps would be offset by losses (gains) on the Swiss Franc debt
obligations.
CONTINGENCIES
We have pending regulatory actions in local regulatory jurisdictions that
call for price decreases, refunds or both. See Note 14 to the consolidated
financial statements.
OTHER ITEMS
From time to time, we engage in discussions regarding restructurings,
dispositions, acquisitions and other similar transactions. Any such transaction
could include, among other things, the transfer, sale or acquisition of
significant assets, businesses or interests, including joint ventures, or the
incurrence, assumption or refinancing of indebtedness, and could be material to
our financial condition and results of operations. There is no assurance that
any such discussions will result in the consummation of any such transaction.
COMPETITION
When Congress passed the Telecommunications Act, its primary purpose was to
open the local markets of the telecommunications industry to competition. Now,
three years later, the Act's impact on the industry and on us can be seen. We
face increasing competition from a variety of sources, including other
22
<PAGE>
local service providers, long-distance service providers, cable TV companies,
wireless service providers, Internet service providers and other entrants from
closely related industries. As a result of these competitors' efforts, we are
experiencing an erosion of our market share as well as pressure on our profit
margins which could have a material adverse effect on our operations going
forward.
To date, the most significant competition has developed in the business
market where competitors have targeted high-volume business customers in densely
populated urban centers and selected businesses in smaller communities. In the
residential market, competitors are focusing on areas of highly concentrated
customers, such as multiple dwelling units. We are facing competition in
virtually all areas of our business: local calling, intraLATA long-distance,
wireless, Internet and data services. Our directory business is facing
competition from services provided by web-based electronic providers and
traditional directory publishers. We are also encountering competition from at
least two cellular providers as well as other PCS companies in each market where
we offer wireless service.
As part of the Act, we must provide interconnection to our network for
competitors and furnish number portability to our customers. Both of these areas
have, and will continue to increase our cost structure while providing others
with the means to effectively compete with us. We must meet all parts of a
14-point checklist and then receive FCC approval before we are allowed to enter
the interLATA long-distance market. The Act, as well as other state regulatory
proceedings, have also significantly impacted pricing and the speed with which
we may bring new products and services to market. For a further discussion of
regulatory matters, you should read the section entitled "Regulation" below.
Technological advancements will help to shape the competitive landscape of
the future. Examples include the wireless replacement of wireline capabilities,
migration from circuit-switched to packet-switched technology such as IP
telephony, the capabilities associated with xDSL (Digital Subscriber Line)
services versus hybrid fiber/coax abilities and the analog conversions to
digital. Also, the mega-mergers announced in recent years (SBC-Ameritech,
AT&T-TCI, GTE-Bell Atlantic and WorldCom-MCI) will give competitors greater
access to our markets and provide increased financial resources that can be used
to fund projects that will compete directly with us.
We are countering the competition by expanding and improving our product and
service offerings. In addition to enhancing current service offerings, including
PCS, high-speed data, Internet access, interconnection services and video
transmission, we will be investigating other services. We are also working to
ease the regulatory barriers we face for entry into the interLATA long-distance
market as well as addressing our needs to have increased pricing flexibility for
our products and services. We will also evaluate and form strategic alliances
that we believe will be beneficial as the competitive environment intensifies.
Finally, we believe that our ability to bundle and integrate a comprehensive
telecommunications package that can be made available through one-stop shopping
will provide a significant competitive advantage. For factors which could cause
actual results to differ from expectations, you should read "Special Note
Regarding Forward-Looking Statements" on page 1.
REGULATION
THE TELECOMMUNICATIONS ACT OF 1996. The Telecommunications Act
fundamentally changed the competitive landscape by permitting local telephone
companies, long-distance carriers and cable television companies to enter each
other's lines of business. Under the Telecommunications Act, the regional Bell
operating companies ("RBOCs") are permitted to provide interLATA long-distance
services by opening their local networks to competitors and satisfying a
detailed list of requirements, including providing interconnection and number
portability ("LNP"). The Telecommunications Act also lifts the ban on cross-
ownership between cable television and telephone companies. The
Telecommunications Act also reaffirmed the concept of universal service and
directed the FCC and state regulators to determine universal service funding
policies. The FCC and state regulators have been given the responsibility to
interpret and oversee implementation of the Telecommunications Act.
23
<PAGE>
The FCC issued an order (the "FCC Order") in August of 1996, establishing a
framework of rules that enable the states and the FCC to implement the local
competition provisions of the Telecommunications Act. Key provisions that relate
to us and other incumbent local exchange companies ("ILECs") include the
requirements that we:
- provide interconnection to any requesting telecommunications carrier under
certain terms and conditions;
- provide unrestricted access to network services on an unbundled basis;
- offer for resale at a discount any telecommunications services that the
ILECs provide at retail to subscribers;
- provide reciprocal compensation arrangements for wireline and wireless
local service providers;
- provide physical collocation of equipment necessary for interconnection at
ILECs' facilities, unless physical collocation is not practical for
technical reasons or because of space limitations; and
- meet a strict list of requirements, applicable only to RBOCs, to open
their networks prior to being allowed entry into the interLATA
long-distance business.
INTERCONNECTION. The FCC Order established interconnection costing and
pricing rules which, from our perspective, significantly impeded negotiations
with new entrants to the local exchange market, state public utility commission
interconnection rulemakings and interconnection arbitration proceedings.
We appealed the FCC Order and sought a stay of certain of its provisions,
including certain pricing provisions, pending appellate review. Litigation of
the FCC Order centered on the FCC's authority over pricing rules, unbundled
element requirements and pick and choose provisions. On January 25, 1999, the
U.S. Supreme Court ("Supreme Court") issued a ruling in this proceeding.
Although the decision stated that the 1996 Telecommunications Act was ambiguous
and self-contradictory, the Court ruled that:
- the FCC has authority to set pricing methodology;
- unbundled network elements must be provided in cases where necessary or
the lack of availability would impair competition;
- ILECs must sell on a bundled basis, at the Competitive Local Exchange
Carriers' ("CLECs") request, network elements the ILEC uses itself on a
bundled basis; and
- CLECs may pick and choose pricing or other terms and conditions from
multiple contracts within certain bounds.
The impact the Supreme Court order will have is unclear since state
regulatory commissions have generally followed the FCC's pricing and unbundling
requirements in setting unbundled network element prices. It is anticipated that
a new FCC rulemaking will be required to define the "necessary and impair"
standard in light of the Supreme Court decision and further review of the
legality of the FCC's pricing rules will occur at the Eighth Circuit Court of
Appeals. Additionally, we have established interconnection agreements with the
majority of carriers seeking interconnection. We have secured approximately 500
interconnection agreements with approximately 100 carriers as of December 31,
1998. In light of the Supreme Court decision and the need for further regulatory
and judicial proceedings, we cannot provide assurance that we will be able to
fully recover our costs related to providing interconnection services.
INTERLATA LONG-DISTANCE ENTRY. Several RBOCs have filed for entry into the
interLATA long-distance business. Although many of these applications have been
approved by state regulatory commissions, the FCC has rejected all applications
to date. These rejections and the FCC's interpretation of the checklist
provisions in the Telecommunications Act are driving up our costs and delaying
our entry into the interLATA long-distance business.
24
<PAGE>
We view entry into this segment as important to our strategy of providing an
integrated bundle of services to our customers. In 1998, we filed applications
to enter the interLATA long-distance business in Nebraska, Montana and Wyoming.
We expect to continue filing applications in other states during 1999. We cannot
predict when our applications to enter the interLATA long-distance markets will
be approved due to the extreme opposition of the incumbent long-distance
companies and the remaining uncertainty of how the FCC will interpret the
long-distance entry checklist requirements.
NUMBER PORTABILITY. In 1998, we deployed LNP capability, which allows
customers to change service providers while maintaining their existing telephone
number, in our top 10 markets. On December 14, 1998, the FCC issued its final
cost recovery rules for LNP. On January 25, 1999, we filed a tariff with the FCC
for a monthly surcharge on all LNP capable lines to be in place for 5 years. We
expect the FCC to issue a ruling on our LNP tariff in the first half of 1999.
Ultimately, the FCC will decide which LNP costs are allowable and a final
surcharge rate will be established. We also filed an Application for Review on
January 13, 1999, asking that several provisions of the FCC's LNP order be
changed to allow us to recover a larger portion of our LNP costs.
UNIVERSAL SERVICE. Under the FCC's 1997 Universal Service Order, all
providers of interstate telecommunications services will contribute to universal
service funding, which will be based on retail telecommunications revenues. The
FCC and the federal/state joint board have issued orders and recommendations
concerning this new explicit mechanism to support high-cost service in rural
areas, such as ours. An important aspect of these deliberations is the
recognition that certain states do not have the capability to fund high costs
areas solely at the state level and will need additional funding from a
nationwide fund. Important decisions still need to be issued by the FCC
concerning the ultimate size of any national fund and the criteria to determine
who may draw from the fund and the level of the draw. The FCC has stated its
intention to issue its final rules in time for a new high-cost fund to be
implemented on July 1, 1999. Given the substantial work that remains to be done
for implementation, the July 1, 1999 date appears at significant risk.
The FCC's Universal Service Order also established two separate funds to
help connect 1) eligible schools and libraries and 2) rural health care
providers to the global telecommunications network. These funds were initially
capped at $2,250 and $400, respectively. These funds were phased in during 1998
and will be funded at their maximum levels beginning July 1, 1999. These funds
are used to reimburse telecommunications service providers for discounts on
eligible services given to schools, libraries and rural health care providers.
On July 17, 1997, we filed a petition with the FCC for reconsideration and
clarification of certain issues in the Universal Service Order. Among other
things, we requested the FCC to reconsider: (i) establishing a national fund to
ensure high-cost support is sufficient and (ii) assessing contributions as
explicit end-user surcharges. Appeals of other issues addressed by the Universal
Service Order have been filed by various other companies. The petition for
reconsideration is still pending.
The FCC's Universal Service Order has also been appealed to the U.S. Court
of Appeals for the Fifth Circuit. We and other parties are claiming that the
FCC's order does not ensure all subsidies are explicit and competitively
neutral. Oral argument was heard on December 1, 1998 and a decision is expected
in 1999.
ACCESS REFORM. In its Access Reform Order, the FCC mandated a substantial
restructuring of interstate access pricing. A significant portion of the
services that were charged using minutes-of-use pricing are now being charged
using a combination of minutes-of-use rates, flat-rate pre-subscribed
interexchange carrier charges ("PICCs") and subscriber line charges ("SLCs").
Although an increase in the SLC to multi-line business users occurred on July 1,
1997, the bulk of the mandated pricing changes occurred on January 1, 1998.
Additional mandated pricing changes occurred on January 1, 1999 and more will be
implemented on January 1 of 2000 and 2001. The net effect of these changes will
be to decrease minutes-of-use charges and increase flat-rate charges (i.e.,
PICCs and SLCs).
25
<PAGE>
The Access Reform Order also continued in place the current rules by which
ILECs may not assess interstate access charges on information service providers
and purchasers of unbundled network elements.
Along with other ILECs, we appealed the Access Reform Order stating that the
FCC acted unlawfully by exempting purchasers of enhanced services from payment
of interstate access charges. In addition, interexchange carriers appealed the
FCC order contending the access charges had to be immediately set at cost. The
Eighth Circuit Court affirmed the Access Reform Order in July 1998.
PRICE CAP ORDER. Our interstate services have been subject to price cap
regulation since January 1991.
The FCC's May 1997 Price Cap Order required ILECs that were subject to price
cap regulation to increase their price cap index productivity factor. The order
eliminated the lower productivity factor options that required sharing of
earnings above a specified level.
On June 23, 1997, we petitioned the Tenth Circuit Court of Appeals (the
"Tenth Circuit") for a review of the Price Cap Order. The Tenth Circuit has
transferred review of the Price Cap Order to the District of Columbia Court of
Appeals. Among other things we, and other appellants, are requesting the
District of Columbia Court of Appeals to review the propriety of increasing the
productivity factor and its retroactive application. This case was heard on
January 20, 1999 and a decision is expected in 1999.
Our 1998 price cap filing resulted in rates designed to collect
approximately the same level of revenue as the previous year. This was primarily
caused by one-time adjustments to the price cap formulas that offset mandated
reductions due to the increased productivity factor. In our 1999 price cap
filing, which will go into effect July 1, 1999, we expect a reduction in
revenues. The Price Cap Order will, over time, significantly reduce the prices
we charge for interstate access.
ADVANCED TELECOMMUNICATIONS SERVICES. In August 1998, the FCC issued an
order and Notice of Proposed Rulemaking addressing the deployment of Advanced
Telecommunications Services ("ATS") by ILECs. In this order, the FCC proposed
strict separate subsidiary requirements for the provision of ATS, such as
high-speed data services, if an ILEC wishes to be treated as a CLEC in the
provision of these services. We oppose these requirements and believe they would
significantly increase cost and will impede the broad deployment of these
services. The FCC is expected to issue a further order in early 1999 that will
clarify its rules.
YEAR 2000 COSTS
BACKGROUND. During 1997 and 1998, we conducted a comprehensive review of
our computer-based systems and related software and began to take measures to
ensure that such systems will properly recognize the year 2000 and continue to
process beyond December 31, 1999. The systems we evaluated include (i) Public
Switched Telephone Network (the "Network"), (ii) Information Technologies ("IT")
and (iii) individual Business Units (the "Business Units").
The Network, which processes voice and data information relating to our core
communications business, relies on remote switches, central office equipment,
interoffice equipment, and loop transport equipment that is predominantly
provided to us by telecommunications network vendors. IT is comprised of our
internal business systems that employ hardware and software on an
enterprise-wide basis, including operational, financial and administrative
functions. The Business Units, which include internal organizations such as
finance, procurement, directory services, operator services, wireless, data
networks, real estate, etc., employ systems that support desktop and
departmental applications, as well as embedded computer chip technologies, which
relate specifically to each of our Business Unit's functions and generally are
not part of the Network or IT.
We have approached year 2000 remediation activities through five general
phases: (i) inventory/ assessment, (ii) planning, (iii) conversion, (iv)
testing/certification and (v) implementation. Additionally, we have monitored
and improved our year 2000 related activities and progress, communicated with
our
26
<PAGE>
customers and vendors, participated in cooperative testing with others and taken
steps to assure that we have contingency plans in place prior to the end of
1999. We plan to continue these activities during 1999.
NETWORK UPDATE. With regard to the Network, we are working with our
telecommunications network vendors to obtain and convert to compliant releases
of hardware and software. We also are testing, at our own initiative, in
cooperation with certain of our customers and vendors, and in cooperation with
other major wireline telecommunications companies, network equipment over
multiple configurations involving a broad spectrum of services. Toward this end,
we participate in the Telco Year 2000 Forum (the "Forum"), an organization that
addresses the year 2000 readiness of network elements and network
interoperability. The Forum has contracted with Bellcore, a former affiliate
engaged in telecommunications industry research, development and maintenance
activities, to engage in inter-region interoperability testing. We also
participate in the FCC's Network Reliability and Interoperability Council IV
working group, which is tasked to evaluate the year 2000 readiness of the public
telecommunications network, and in the Alliance for Telecommunications Industry
Solutions ("ATIS"), which is testing inter-network interoperability, and which,
in conjunction with the Cellular Telecommunications Industry Association
("CTIA"), is testing network interoperability with wireless networks. Our
inventory/assessment, planning and conversion phases for the Network are
complete. The network testing/certification phase was approximately 99% complete
as of December 31, 1998 and we anticipate that this phase will be complete
during the first quarter of 1999. Cooperative testing with certain customers,
vendors and other telecommunications companies is expected to continue during
1999. As of December 31, 1998 approximately 79% of our Network remediation
implementation was complete, with completion of the remainder anticipated by
July 1999. We have initiated Network contingency planning activities and
approximately 10% of the anticipated Network contingency planning activity was
complete as of December 31, 1998. We anticipate that the remainder of our
Network contingency planning activity will be complete by mid-1999.
IT UPDATE. Within IT, we have identified approximately 570 applications
that support our critical business processes, such as billing and collections,
network monitoring, repair and ordering. The inventory/ assessment and planning
phases for such IT applications are complete. As of December 31, 1998,
approximately 96% of IT conversion activities, 84% of IT testing activities and
81% of IT implementation had been completed. We anticipate that each of these
phases for IT will be complete by July 1999. IT contingency planning activity is
approximately 40% complete and we anticipate that the remainder will be complete
by mid-1999.
BUSINESS UNITS UPDATE. Within our Business Units, it is estimated that as
of December 31, 1998, approximately 95% of the inventory/assessment activity,
70% of the planning activity, 20% of the conversion activity and 5% of the
testing and remediation implementation activity were complete. We anticipate
that each of these phases will be complete in the Business Units for major
conversions and upgrades by the end of the third quarter of 1999. Some of our
Business Units, such as the retail markets organization, are at the beginning of
the conversion, testing and implementation phases, while other Business Units,
such as our finance organization, have substantially completed all of the
phases. We have recently initiated Business Unit contingency planning activities
and we anticipate those will be complete by mid-1999.
COSTS RELATING TO YEAR 2000. We have spent approximately $115 from the
beginning of 1997 through the end of 1998 on year 2000 projects and activities.
We estimate that additional costs for year 2000 related projects and activities
will be approximately $60 through the end of 1999. We estimate total spending on
year 2000 projects and activities from the beginning of 1997 through the end of
1999 will be approximately $175. Virtually all year 2000 related expenditures
are being funded through operations. Though year 2000 costs will directly impact
the reported level of future net income, we intend to control our total cost
structure, including deferral of non-critical projects to future years, in an
effort to mitigate the impact of year 2000 costs on our historical rate of
earnings growth. The estimates stated above are subject to change.
27
<PAGE>
The timing of our expenses may vary and is not necessarily indicative of
readiness efforts or progress to date.
CONTINGENCY PLAN. We cannot provide assurance that the results of our year
2000 compliance efforts or the costs of such efforts will not differ materially
from estimates. Accordingly, we are developing year 2000 specific business
continuity and contingency plans to address high risk areas as they are
identified. Our year 2000 contingency planning activities will include training
of crisis managers on year 2000 issues and potential business impacts to their
particular process areas, reviewing and modifying existing business continuity
plans to address year 2000 issues and establishing rapid response teams and
communications procedures for each of the major critical operations and
facilities to handle potential post-implementation year 2000 failures. These
year 2000 specific contingency planning activities are to be in place by the
third quarter of 1999. In addition, we have in place our standard overall
business continuity, contingency and disaster recovery plans (such as diesel
generator back-up power supply sources for our Network, Network rerouting
capabilities, computer data and records safe-keeping and back-up and recovery
procedures) which will be verified, and as appropriate, augmented for specific
year 2000 contingencies.
DEPENDENCIES. Within Network, we are highly dependent upon our
telecommunications network vendors to provide year 2000 compliant hardware and
software in a timely manner, and on third parties that are assisting us in the
focused testing and implementation phases regarding the Network. Because of
these dependencies, we have developed and implemented a vendor compliance
process whereby we have obtained written assurances of timely year 2000
compliance from most of our critical vendors (not only for Network, but also for
IT and the Business Units). In addition, we monitor and actively participate in
coordinated Network testing activities, as discussed above, with respect to the
Forum, ATIS and Bellcore. Within IT, we depend on the development of software by
experts, both internal and external, and the availability of critical resources
with the requisite skill sets. Because of this dependency, we have developed
detailed timetables, resource plans and standardized year 2000 testing
requirements for identified critical applications (irrespective of whether these
applications are used primarily by IT, the Network or the Business Units).
Within the Business Units, we are dependent on vendor supplied goods and
services and operability of the Network and critical IT and Business Unit
specific applications. Because of these dependencies, we are implementing the
same type of vendor compliance processes and application planning and testing
processes at the Business Units, as discussed above with respect to the Network
and IT. Overall, we have sought compliance assurances from approximately 6,750
vendors concerning approximately 28,900 products and have received assurances
for approximately 77% of those products as of December 31, 1998. During 1999, we
will continue to pursue assurances of timely year 2000 compliance for the
remaining critical vendors.
As with any large-scale computer-related project such as year 2000
remediation, the testing phase may require resources in excess of other project
phases and the other project phases may be affected by and dependent upon the
results of the testing phase.
SUMMARY. In management's view, the most reasonably likely worse case
scenario for year 2000 failure prospects we face is that a limited number of
important IT and/or Business Unit specific applications may unexpectedly fail.
In addition, there may be problems with the Network relating to the year 2000.
Our failure or the failure by certain of our vendors to remediate year 2000
compliance issues in advance of the year 2000 and to execute appropriate
contingency plans in the event that a critical failure is experienced, could
result in disruption of our operations, possibly impacting the Network and
impairing our ability to bill or collect revenues. However, while no assurance
can be given, management believes that our efforts at remediation and testing,
year 2000 specific contingency planning, and overall business continuity,
contingency and disaster recovery planning will likely be successful, and that
the aforementioned "worse case scenario" is unlikely to develop or significantly
disrupt our financial operations.
The above discussion regarding year 2000 contains many statements that are
"forward-looking" within the meaning of the Reform Act. Although we believe that
our estimates are based on reasonable
28
<PAGE>
assumptions, we cannot assure that actual results will not differ materially
from these expectations or estimates. See "Special Note Regarding
Forward-Looking Statements" on page 1.
NEW ACCOUNTING STANDARDS
On January 1, 1999, we adopted the accounting provisions required by the
American Institute of Certified Public Accountants' Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," issued in March 1998. SOP 98-1, among other things,
requires that certain costs of internal use software, whether purchased or
developed internally, be capitalized and amortized over the estimated useful
life of the software.
Based on information currently available, adoption of the SOP may result in
an initial increase in net income in 1999 of approximately $100-$150 or
$0.20-$0.29 per diluted share. Thereafter, in periods after adoption, if
software expenditures remain level, the impact on earnings will decline until
the amortization expense related to the capitalized software equals the software
costs expensed prior to the accounting change. The estimated net income impact
for 1999 and thereafter will be subject to change as further information becomes
available. See "Special Note Regarding Forward-Looking Statements" on page 1.
On June 15, 1998, the Financial Accounting Standards Board issued FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. FAS No. 133 requires, among other
things, that all derivative instruments be recognized at fair value as assets or
liabilities on the balance sheet and that changes in fair value generally be
recognized currently in earnings unless specific criteria are met. The standard
is effective for fiscal years beginning after June 15, 1999, though earlier
adoption is permitted. Financial statement impacts of adopting the new standard
depend upon the amount and nature of the future use of derivative instruments
and their relative changes in valuation over time. Had we adopted FAS No. 133 in
1998, its impact on the financial statements would not have been material.
29
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of U S WEST, Inc.:
We have audited the accompanying consolidated balance sheets of U S WEST,
Inc., formerly USW-C, Inc., (a Delaware corporation) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of income
and cash flows for each of the three years in the period ended December 31,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of U S WEST, Inc. and
subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado
January 22, 1999
F-1
<PAGE>
U S WEST, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
Operating revenues:
Local service.................................................................. $ 5,525 $ 5,016 $ 4,770
Interstate access service...................................................... 2,816 2,666 2,507
Intrastate access service...................................................... 822 761 770
Long-distance network services................................................. 779 885 1,100
Directory services............................................................. 1,277 1,197 1,120
Other services................................................................. 1,159 954 901
--------- --------- ---------
Total operating revenues..................................................... 12,378 11,479 11,168
Operating expenses:
Employee-related expenses...................................................... 4,312 3,953 3,893
Other operating expenses....................................................... 2,818 2,587 2,305
Depreciation and amortization.................................................. 2,199 2,163 2,158
--------- --------- ---------
Total operating expenses..................................................... 9,329 8,703 8,356
--------- --------- ---------
Operating income................................................................. 3,049 2,776 2,812
Other income (expense):
Interest expense................................................................. (543) (405) (448)
Gains on sales of local telephone exchanges...................................... -- 77 59
Gain on sale of investment in Bellcore........................................... -- 53 --
Other expense--net............................................................... (87) (72) (46)
--------- --------- ---------
Total other expense--net....................................................... (630) (347) (435)
--------- --------- ---------
Income before income taxes, extraordinary item and cumulative effect of change in
accounting principle........................................................... 2,419 2,429 2,377
Provision for income taxes....................................................... 911 902 876
--------- --------- ---------
Income before extraordinary item and cumulative effect of change in accounting
principle...................................................................... 1,508 1,527 1,501
Extraordinary item--early extinguishment of debt--net of tax..................... -- (3) --
--------- --------- ---------
Income before cumulative effect of change in accounting principle................ 1,508 1,524 1,501
Cumulative effect of change in accounting principle--net of tax.................. -- -- 34
--------- --------- ---------
Net income....................................................................... $ 1,508 $ 1,524 $ 1,535
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
<PAGE>
U S WEST, INC.
CONSOLIDATED STATEMENTS OF INCOME (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(DOLLARS IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
Basic earnings per share:
Income before extraordinary item and cumulative effect of change in
accounting principle..................................................... $ 3.05 $ 3.16 $ 3.14
Extraordinary item--early extinguishment of debt........................... -- (0.01) --
Cumulative effect of change in accounting principle........................ -- -- 0.07
---------- ---------- ----------
Basic earnings per share..................................................... $ 3.05 $ 3.16 $ 3.21
---------- ---------- ----------
---------- ---------- ----------
Basic average shares outstanding (in 000's).................................. 494,395 482,751 477,549
---------- ---------- ----------
---------- ---------- ----------
Diluted earnings per share:
Income before extraordinary item and cumulative effect of change in
accounting principle..................................................... $ 3.02 $ 3.13 $ 3.10
Extraordinary item--early extinguishment of debt........................... -- (0.01) --
Cumulative effect of change in accounting principle........................ -- -- 0.07
---------- ---------- ----------
Diluted earnings per share................................................... $ 3.02 $ 3.12 $ 3.17
---------- ---------- ----------
---------- ---------- ----------
Diluted average shares outstanding (in 000's)................................ 498,798 491,232 488,591
---------- ---------- ----------
---------- ---------- ----------
Dividends per share.......................................................... $ 2.14 $ 2.14 $ 2.14
---------- ---------- ----------
---------- ---------- ----------
Pro forma earnings per share before extraordinary item and cumulative effect
of change in accounting principle:
Basic earnings per share................................................. $ 2.86 $ 2.73 $ 2.71
Diluted earnings per share............................................... $ 2.84 $ 2.71 $ 2.68
Pro forma average shares outstanding (in 000's):
Basic...................................................................... 501,827 499,092 493,890
Diluted.................................................................... 506,230 507,573 504,932
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE>
U S WEST, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
(DOLLARS IN
MILLIONS,
EXCEPT SHARE
AMOUNTS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................................. $ 49 $ 27
Accounts receivable less allowance for uncollectibles of
$69 and $72, respectively............................................................... 1,743 1,717
Inventories and supplies.................................................................. 197 150
Deferred directory costs.................................................................. 274 257
Deferred tax assets....................................................................... 151 271
Prepaid and other......................................................................... 78 82
--------- ---------
Total current assets........................................................................ 2,492 2,504
Property, plant and equipment--net.......................................................... 14,908 14,308
Other assets--net........................................................................... 1,007 855
--------- ---------
Total assets................................................................................ $ 18,407 $ 17,667
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........................................................................... $ 1,277 $ 695
Accounts payable.......................................................................... 1,347 1,377
Accrued expenses.......................................................................... 1,702 1,791
Advance billings and customer deposits.................................................... 370 336
--------- ---------
Total current liabilities................................................................... 4,696 4,199
Long-term debt.............................................................................. 8,642 5,020
Postretirement and other postemployment benefit obligations................................. 2,643 2,534
Deferred income taxes....................................................................... 786 791
Unamortized investment tax credits.......................................................... 159 168
Deferred credits and other.................................................................. 726 588
Commitments and Contingencies
Stockholders' equity:
Preferred stock--$1.00 par value, 190,000,000 shares authorized, none issued and
outstanding............................................................................. -- --
Series A junior preferred stock--$1.00 par value 10,000,000 shares authorized, none issued
and outstanding......................................................................... -- --
Common stock--$0.01 par value, 2,000,000,000 shares authorized, 503,207,058 and
484,522,015 issued, 502,903,055 and 484,515,415 outstanding............................. 532 --
Retained earnings......................................................................... 223 --
Pre-separation equity..................................................................... -- 4,367
--------- ---------
Total stockholders' equity.................................................................. 755 4,367
--------- ---------
Total liabilities and stockholders' equity.................................................. $ 18,407 $ 17,667
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE>
U S WEST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
(DOLLARS IN MILLIONS)
OPERATING ACTIVITIES
Net income......................................................................... $ 1,508 $ 1,524 $ 1,535
Adjustments to net income:
Depreciation and amortization.................................................. 2,199 2,163 2,158
Gains on sales of local telephone exchanges.................................... -- (77) (59)
Gain on sale of investment in Bellcore......................................... -- (53) --
Asset impairment............................................................... 35 -- --
Cumulative effect of change in accounting principle............................ -- -- (34)
Deferred income taxes and amortization of investment tax credits............... 106 (15) 87
Changes in operating assets and liabilities:
Accounts receivable............................................................ (26) (60) 1
Inventories, supplies and other current assets................................. (12) (63) 18
Accounts payable, accrued expenses and advance billings........................ (13) 487 (70)
Other.......................................................................... 130 285 (22)
--------- --------- ---------
Cash provided by operating activities............................................ 3,927 4,191 3,614
--------- --------- ---------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment................................... (2,672) (2,168) (2,444)
Proceeds from (payments on) disposals of property, plant and equipment........... (30) 22 15
Proceeds from sales of local telephone exchanges................................. -- 67 174
Proceeds from sale of investment in Bellcore..................................... -- 65 --
Other............................................................................ (67) (73) --
--------- --------- ---------
Cash used for investing activities............................................... (2,769) (2,087) (2,255)
--------- --------- ---------
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term debt................................ 887 (640) 159
Net (repayments of) proceeds from issuance of Old U S WEST short-term debt....... (198) 153 (42)
Proceeds from issuance of long-term debt......................................... 3,781 29 23
Repayment of Old U S WEST debt in connection with the Dex Alignment.............. (3,829) -- --
Repayments of long-term debt..................................................... (442) (446) (483)
Proceeds from issuance of common stock........................................... 88 75 134
Dividends paid on common stock................................................... (1,056) (992) (939)
Dividends paid to Old U S WEST................................................... (194) (336) (303)
Payment to Old U S WEST for debt refinancing costs............................... (140) -- --
Return of capital from Old U S WEST.............................................. 13 -- --
Purchases of treasury stock...................................................... (46) -- --
--------- --------- ---------
Cash used for financing activities............................................... (1,136) (2,157) (1,451)
--------- --------- ---------
CASH AND CASH EQUIVALENTS
Increase (decrease).............................................................. 22 (53) (92)
Beginning balance................................................................ 27 80 172
--------- --------- ---------
Ending balance................................................................... $ 49 $ 27 $ 80
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 1: U S WEST SEPARATION
On October 25, 1997, the board of directors of our former parent company
(herein referred to as "Old U S WEST") adopted a proposal to separate Old U S
WEST into two independent companies (the "Separation"). Old U S WEST conducted
its businesses through two groups: (i) the U S WEST Communications Group (the
"Communications Group"), which included the communications businesses of Old U S
WEST, and (ii) the U S WEST Media Group (the "Media Group"), which included the
multimedia and directory businesses of Old U S WEST. Old U S WEST had
outstanding two separate classes of common stock. One class of stock, U S WEST
Communications Group Common Stock (the "Communications Stock"), reflected the
performance of the Communications Group and the other class of stock, U S WEST
Media Group Common Stock (the "Media Stock"), reflected the performance of the
Media Group.
On June 4, 1998, stockholders of Old U S WEST voted in favor of the
Separation, which became effective June 12, 1998 (the "Separation Date"). As
part of the Separation, Old U S WEST contributed the Communications Group
businesses and the domestic directories business of Media Group (known as U S
WEST Dex, Inc. ("Dex")) to us. We renamed the new entity U S WEST, Inc. ("U S
WEST"). The alignment of Dex with U S WEST is referred to herein as the "Dex
Alignment". Old U S WEST has continued as an independent public company
comprised of the businesses of Media Group other than Dex and has been renamed
MediaOne Group, Inc. ("MediaOne").
Under the terms of a separation agreement (the "Separation Agreement")
between U S WEST and MediaOne, Old U S WEST redeemed each issued and outstanding
share of Communications Stock (other than shares of Communications Stock held as
treasury stock) for one share of U S WEST common stock. Each outstanding share
of Media Stock remained outstanding and thereafter represented one share of
MediaOne common stock. Each share of Communications Stock held as treasury stock
by Old U S WEST was cancelled.
In connection with the Dex Alignment, under the Separation Agreement, (i)
Old U S WEST distributed, as a dividend to holders of MediaOne common stock,
approximately 16,341,000 shares of our common stock (net of the redemption of
approximately 305,000 fractional shares) with an aggregate of $850 in value (the
"Dex Dividend") and (ii) U S WEST refinanced $3,900 of Old U S WEST debt,
formerly allocated to Media Group (the "Dex Indebtedness").
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements include the
consolidated historical results of operations, financial position and cash flows
of the businesses that comprise the Communications Group and Dex, as if such
businesses operated as a separate entity for all periods and as of all dates
presented. However, certain financial effects of the Separation and the Dex
Alignment, including interest expense associated with refinancing the Dex
Indebtedness and the dilutive effect of the Dex Dividend, are not reflected in
the accompanying historical consolidated statements of income prior to the
Separation Date.
For periods prior to the Separation Date, the consolidated financial
statements include an allocation of certain costs, expenses, assets and
liabilities from Old U S WEST to us. We believe the allocations were reasonable;
however the amount of costs allocated to us were not necessarily indicative of
the costs that
F-6
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
would have been incurred if we had operated as a stand-alone company. The
consolidated financial statements may not necessarily reflect the financial
position, results of operations or cash flows in the future or what they would
have been had we been a separate, stand-alone company during such periods.
We are incorporated under the laws of the State of Delaware. The
consolidated financial statements include the accounts of U S WEST and its
majority-owned subsidiaries. All significant intercompany amounts and
transactions have been eliminated.
Certain reclassifications within the consolidated financial statements have
been made to conform to the current year presentation.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents include highly liquid
investments with original maturities of three months or less that are readily
convertible into cash and are not subject to significant risk from fluctuations
in interest rates.
INVENTORIES AND SUPPLIES. New and reusable materials of our regulated
business are carried at average cost, except for significant individual items
that are valued based on specific costs. Nonreusable material is carried at its
estimated salvage value. Inventories of our nonregulated businesses are carried
at the lower of cost or market on a first-in, first-out basis.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is carried at
cost. Property, plant and equipment of our regulated business is depreciated
using straight-line group methods. When the depreciable property, plant and
equipment is retired or sold, gross book cost less salvage value is generally
charged to accumulated depreciation; no gain or loss is recognized. The
nonregulated businesses provide for depreciation using the straight-line method
over the assets' estimated useful lives. When such depreciable property, plant
and equipment is retired or sold, the resulting gain or loss is included in
income. The average depreciable lives used for the major categories of property,
plant and equipment follow:
<TABLE>
<CAPTION>
CATEGORY LIFE (YEARS)
- ------------------------------------------------------------------------------------- -------------
<S> <C>
Buildings............................................................................ 19-40
Telecommunications network equipment................................................. 8-14
Telecommunications outside plant..................................................... 8-57
General purpose computers and other.................................................. 3-17
</TABLE>
Interest related to qualifying construction projects is capitalized and
reflected as a reduction of interest expense. Amounts capitalized were $25, $20
and $31 in 1998, 1997 and 1996, respectively.
COMPUTER SOFTWARE. The cost of computer software, whether purchased or
developed internally, is generally expensed as incurred; however, initial
operating systems software is capitalized and amortized
F-7
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
over the life of the related hardware and initial network applications software
is capitalized and amortized over three years. Subsequent upgrades to
capitalized software are charged to expense.
Capitalized computer software costs of $196 and $133 at December 31, 1998
and 1997, respectively, are recorded in property, plant and equipment.
Amortization of capitalized computer software costs totaled $84, $78 and $82 in
1998, 1997 and 1996, respectively.
FINANCIAL INSTRUMENTS. The objective of our interest rate risk management
program is to obtain the minimum total cost of debt over time consistent with an
acceptable level of interest rate volatility. This objective is achieved through
the type of debt issued, interest rate swaps that adjust the ratio of fixed- to
variable-rate debt, cross-currency swaps that convert foreign-denominated debt
to dollar-denominated debt and forward contracts to hedge future debt issues.
Under an interest rate swap, we agree with another party to exchange
interest payments, based on a notional amount, at specified intervals over a
defined term. Interest rate swaps are accounted for under the synthetic
instruments accounting model if the index, maturity and amount of the instrument
match the terms of the underlying debt. Net interest accrued is recognized over
the life of the instruments as an adjustment to interest expense and is a
component of cash provided by operating activities. Any gain or loss on the
termination of an instrument that qualifies for synthetic instrument accounting
would be deferred and amortized over the remaining life of the original
instrument.
Under a cross-currency swap, we agree with another party to exchange U. S.
dollars for foreign currency based on a notional amount, at specified intervals
over a defined term. Cross-currency swaps are accounted for under the synthetic
instruments accounting model if the index, maturity and amount of the
instruments match the terms of the underlying debt. The cross-currency swaps and
the foreign currency debt are combined and accounted for as if
dollar-denominated debt was issued directly.
Under a forward contract, we agree with another party to sell a specified
amount of U. S. Treasuries to hedge the treasury-rate component of future debt
issues. The gain or loss on the forward contract is recorded as part of the
carrying value of the related debt and is amortized as a yield adjustment.
REVENUE RECOGNITION AND DEFERRED DIRECTORY COSTS. Local telephone, wireless
and Internet services are generally billed in advance with revenues recognized
when services are provided. Revenues derived from exchange access, long-distance
network services and wireless airtime usage are recognized as services are
provided.
Directory advertising revenues and related directory costs are generally
deferred and recognized over the period directories are used, normally 12
months.
ADVERTISING COSTS. Costs related to advertising are expensed as incurred.
Advertising expense was $263, $214 and $117 in 1998, 1997 and 1996,
respectively.
INCOME TAXES. The provision for income taxes consists of an amount for
taxes currently payable and an amount for tax consequences deferred to future
periods. For financial statement purposes, investment tax credits are being
amortized over the economic lives of the related property, plant and equipment.
F-8
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS. Stock incentive plans are accounted for in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," under which no compensation expense is recognized for options
granted to employees at fair market value, except when the plan is determined to
be variable in nature.
NEW ACCOUNTING STANDARDS. On January 1, 1999, we adopted the accounting
provisions required by the American Institute of Certified Public Accountants'
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," issued in March 1998. SOP
98-1, among other things, requires that certain costs of internal use software,
whether purchased or developed internally, be capitalized and amortized over the
estimated useful life of the software.
Based on information currently available, adoption of the SOP may result in
an initial increase in net income in 1999 of approximately $100-$150 or
$0.20-$0.29 per diluted share. In periods after adoption, if software
expenditures remain level, the impact on earnings will decline until the
amortization expense related to the capitalized software equals the software
costs expensed prior to the accounting change. The estimated net income impact
for 1999 and thereafter may be subject to change as further information becomes
available. Please see Part I--"Special Note Regarding Forward-Looking
Statements."
In 1998, we adopted Statement of Financial Accounting Standards ("FAS") No.
130, "Reporting Comprehensive Income." FAS No. 130 requires that the components
and total amount of comprehensive income be displayed in the financial
statements beginning in 1998. Comprehensive income includes net income and all
changes in equity during a period that arise from nonowner sources, such as
foreign currency items and unrealized gains and losses on certain investments in
equity securities. We do not have any components of comprehensive income other
than net income.
On June 15, 1998, the Financial Accounting Standards Board issued FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. FAS No. 133 requires, among other
things, that all derivative instruments be recognized at fair value as assets or
liabilities on the balance sheet and changes in fair value are generally
recognized currently in earnings unless specific criteria are met. This standard
is effective for fiscal years beginning after June 15, 1999, although earlier
adoption is permitted. Financial statement impacts of adopting the new standard
depend upon the amount and nature of the future use of derivative instruments
and their relative changes in valuation over time. Had we adopted FAS No. 133 in
1998, its impact on the financial statements would not have been material.
F-9
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 3: PROPERTY, PLANT AND EQUIPMENT
The components of property, plant and equipment are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Land and buildings.......................................................... $ 2,491 $ 2,443
Telecommunications network equipment........................................ 14,750 13,513
Telecommunications outside plant............................................ 14,342 13,802
General purpose computers and other......................................... 3,374 3,280
Construction in progress.................................................... 681 613
--------- ---------
35,638 33,651
--------- ---------
Less accumulated depreciation:
Buildings................................................................. 748 690
Telecommunications network equipment...................................... 8,950 8,223
Telecommunications outside plant.......................................... 9,151 8,657
General purpose computers and other....................................... 1,881 1,773
--------- ---------
20,730 19,343
--------- ---------
Property, plant and equipment--net.......................................... $ 14,908 $ 14,308
--------- ---------
--------- ---------
</TABLE>
Effective January 1, 1996, we adopted FAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of,"
that requires long-lived assets and associated intangibles be written down to
fair value whenever an impairment review indicates that the carrying value
cannot be recovered on an undiscounted cash flow basis. Adoption of FAS No. 121
resulted in income of $34 (net of income tax expense of $22) in 1996 from the
cumulative effect of reversing depreciation expense related to local telephone
exchanges held for sale as recorded in prior years. Depreciation expense was
reversed from the date we formally committed to a plan to dispose of local
telephone exchange assets to January 1, 1996. The income was recorded as a
cumulative effect of change in accounting principle in accordance with FAS No.
121. As a result of adopting FAS No. 121, depreciation expense for 1996 was
reduced by $24.
ASSET IMPAIRMENT. During 1998, we recorded a non-cash charge of $21 (net of
a $14 income tax benefit) related to the impairment of certain long-lived assets
associated with our video operations in Omaha, Nebraska. These assets are
included in the communications and related services segment. The impaired assets
primarily consist of underground cable and hardware. Recent technological
advances have permitted us to pursue and use more economical DSL technology in
cable overbuild situations. Because the projected future cash flows were less
than the assets' carrying value, an impairment loss was recognized in accordance
with FAS No. 121. The amount of impairment was determined based on the net
present value of the expected future cash flows of the video operations,
discounted at our cost of capital. The pretax charge is recorded in "other
operating expenses" within the consolidated statements of income.
LEASING ARRANGEMENTS. Certain office facilities, real estate and equipment
used in operations are under operating leases. Rent expense under operating
leases for 1998, 1997 and 1996 was $210, $235 and
F-10
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 3: PROPERTY, PLANT AND EQUIPMENT (CONTINUED)
$208, respectively. At December 31, 1998, the future minimum rental payments
under noncancelable operating leases for the years 1999 through 2003 and
thereafter are $157, $148, $136, $102, $102 and $653, respectively.
NOTE 4: ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Employee compensation.......................................................... $ 434 $ 412
Dividends payable.............................................................. 269 259
Current portion of state regulatory liability.................................. 42 225
Accrued property taxes......................................................... 190 207
Other.......................................................................... 767 688
--------- ---------
Total accrued expenses......................................................... $ 1,702 $ 1,791
--------- ---------
--------- ---------
</TABLE>
NOTE 5: DEBT
SHORT-TERM DEBT
The components of short-term debt are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Commercial paper................................................................. $ 951 $ 62
Current portion of long-term debt................................................ 326 435
Allocated from Old U S WEST...................................................... -- 198
--------- ---------
Total............................................................................ $ 1,277 $ 695
--------- ---------
--------- ---------
</TABLE>
The weighted-average interest rate on commercial paper was 5.70% and 6.11%
at December 31, 1998 and 1997, respectively. The weighted-average interest rate
on the allocated Old U S WEST debt was 7.45% at December 31, 1997.
At U S WEST, we maintain commercial paper programs to finance short-term
cash flow requirements, as well as to maintain a presence in the short-term debt
market. We enter into lines of credit as backup facilities in issuing commercial
paper. We have lines of credit totaling $1,360, which expire in 1999. Commitment
fees on the unused portion of the lines range from .04% to .064%. As of December
31, 1998, there was no outstanding balance. To the extent we continue our
commercial paper programs, we plan to renew our lines of credit.
F-11
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 5: DEBT (CONTINUED)
LONG-TERM DEBT
Interest rates and maturities of long-term debt at December 31 are as
follows:
<TABLE>
<CAPTION>
MATURITIES
------------------------------------------------------- TOTAL
INTEREST RATES 2000 2001 2002 2003 THEREAFTER 1998
- -------------------------------------------------------- --------- --------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Up to 5%................................................ $ 90 $ -- $ 100 $ 50 $ -- $ 240
Above 5% to 6%.......................................... -- 50 -- -- 531 581
Above 6% to 7%.......................................... 257 133 750 43 4,490 5,673
Above 7% to 8%.......................................... -- -- -- 62 1,584 1,646
Above 8% to 9%.......................................... -- -- -- -- 250 250
Above 9% to 10%......................................... 175 -- -- -- -- 175
Variable-rate debt indexed to two- and ten-year constant
maturity U.S. Treasury rates.......................... -- -- -- -- -- --
--------- --------- --------- --------- ----------- ---------
$ 522 $ 183 $ 850 $ 155 $ 6,855 8,565
--------- --------- --------- --------- -----------
--------- --------- --------- --------- -----------
Capital lease obligations and other..................... 213
Unamortized discount--net............................... (136)
---------
Total................................................... $ 8,642
---------
---------
<CAPTION>
TOTAL
INTEREST RATES 1997
- -------------------------------------------------------- ---------
<S> <C>
Up to 5%................................................ $ 240
Above 5% to 6%.......................................... 261
Above 6% to 7%.......................................... 2,244
Above 7% to 8%.......................................... 1,646
Above 8% to 9%.......................................... 250
Above 9% to 10%......................................... 175
Variable-rate debt indexed to two- and ten-year constant
maturity U.S. Treasury rates.......................... 155
---------
4,971
Capital lease obligations and other..................... 173
Unamortized discount--net............................... (124)
---------
Total................................................... $ 5,020
---------
---------
</TABLE>
Long-term debt consists principally of debentures and medium-term notes.
During 1997, Old U S WEST redeemed its zero coupon subordinated notes, $303 of
which was attributed to us. The debt extinguishment resulted in an extraordinary
charge to income of $3, net of income tax benefits of $2, primarily related to
the write-off of deferred debt issuance costs.
In June 1998, U S WEST Capital Funding, Inc., a wholly owned financing
subsidiary, issued approximately $4,100 in new debt securities, of which
approximately $1,000 was short-term commercial paper. Approximately $3,830 in
proceeds from the issuance of these securities were used to repay Old U S WEST
debt in connection with the Dex Alignment. The remaining proceeds were primarily
used to fund our share of operating expenses and debt refinancing costs incurred
by Old U S WEST that were directly attributable to the Separation. In addition,
we refinanced approximately $200, including $70 of Dex debt, assumed in the Dex
Alignment.
Interest paid by us, net of amounts capitalized, was $640, $394 and $430 in
1998, 1997 and 1996, respectively.
We have a $1,000 line of credit which expires in 2003. The line has a
commitment fee on the unused portion of the line of .08%. As of December 31,
1998, there was no outstanding balance.
F-12
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 5: DEBT (CONTINUED)
FINANCIAL CONTRACTS
The following table summarizes the terms of outstanding interest rate and
cross-currency swaps at December 31, 1998 and 1997. Variable rates are indexed
to two- and ten-year constant maturity U. S. Treasuries. Cross-currency swaps
are tied to the Swiss franc.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
DECEMBER 31, 1998 -------------------------------------
------------------------------------------------ WEIGHTED-
WEIGHTED- AVERAGE RATE AVERAGE
RATE
NOTIONAL ---------------------- NOTIONAL -----------
AMOUNT MATURITIES RECEIVE PAY AMOUNT MATURITIES RECEIVE
----------- ----------- ----------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Variable to fixed..................... $ 155 1999 5.16 6.24 $ 155 1999 5.46
Cross-currency........................ 204 1999-2001 -- 6.55 204 1999-2001 --
<CAPTION>
PAY
---------
<S> <C>
Variable to fixed..................... 6.24
Cross-currency........................ 6.55
</TABLE>
At December 31, 1998, deferred credits of $8 and deferred charges of $49 on
closed forward contracts are included as part of the carrying value of the
underlying debt. The deferred credits and charges are recognized as yield
adjustments over the life of the debt that matures at various dates through
2043.
In the event we are owed money under the swap agreements, we could be
exposed to risk in the event of nonperformance by counterparties. We manage this
exposure by monitoring the credit standing of the counterparties and
establishing dollar and term limitations that correspond to the respective
credit rating of each counterparty. As of December 31, 1998, we do not believe
that we have any exposure to any individual counterparty and do not anticipate
nonperformance by any counterparty.
NOTE 6: FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair values of cash equivalents and current amounts receivable and payable
approximate carrying values due to their short-term nature.
The fair values of interest rate and cross-currency swaps are based on
estimated amounts we would receive or pay to terminate such agreements allowing
for current interest/foreign exchange rates and creditworthiness of the
counterparties.
The fair values of long-term debt are based on quoted market prices where
available or, if not available, based on discounting future cash flows using
current interest rates.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
1998 1997
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
----------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Debt (includes short-term portion)...................................... $ 9,919 $ 10,342 $ 5,715 $ 5,860
Swap agreements--liabilities............................................ -- 24 -- 28
----------- --------- ----------- ---------
Total Debt.............................................................. $ 9,919 $ 10,366 $ 5,715 $ 5,888
----------- --------- ----------- ---------
----------- --------- ----------- ---------
</TABLE>
F-13
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 7: STOCKHOLDERS' EQUITY
Activity in stockholders' equity is as follows:
<TABLE>
<CAPTION>
U S WEST PRE-
COMMON SEPARATION COMMON RETAINED
STOCK EQUITY STOCK EARNINGS TOTAL
----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
(SHARES IN
THOUSANDS)
BALANCE, JANUARY 1, 1996................................. 473,635 $ 3,657 $ -- $ -- $ 3,657
Net income............................................. -- 1,535 -- -- 1,535
Dividends declared on common stock..................... -- (1,024) -- -- (1,024)
Dividends declared to Old U S WEST..................... -- (286) -- -- (286)
Common stock issuances................................. 6,822 216 -- -- 216
Equity returned to Old U S WEST........................ -- (21) -- -- (21)
Other.................................................. -- 8 -- -- 8
----------- ----------- --------- ----- ---------
BALANCE, DECEMBER 31, 1996............................... 480,457 4,085 -- -- 4,085
Net income............................................. -- 1,524 -- -- 1,524
Dividends declared on common stock..................... -- (1,034) -- -- (1,034)
Dividends declared to Old U S WEST..................... -- (347) -- -- (347)
Common stock issuances................................. 4,058 138 -- -- 138
Other.................................................. -- 1 -- -- 1
----------- ----------- --------- ----- ---------
BALANCE, DECEMBER 31, 1997............................... 484,515 4,367 -- -- 4,367
Net income from January 1 to June 12, 1998............. -- 747 -- -- 747
Dividends declared on common stock..................... -- (528) -- -- (528)
Dividends declared to Old U S WEST..................... -- (159) -- -- (159)
Common stock issuances................................. 1,100 55 -- -- 55
Return of capital from Old U S WEST.................... -- 13 -- -- 13
Treasury stock purchases............................... (574) (32) -- -- (32)
Other.................................................. -- 2 -- -- 2
JUNE 12, 1998 SEPARATION:
Contributed capital from Old U S WEST upon Separation,
excluding assumption of debt......................... -- (4,465) 4,465 -- --
Repayment of Dex Indebtedness to MediaOne.............. -- -- (3,829) -- (3,829)
Issuance of common stock to MediaOne stockholders net
of repurchases....................................... 16,646 -- 850 -- 850
Distribution to MediaOne stockholders for Dex
Dividend............................................. -- -- (850) -- (850)
Dividend to MediaOne for share of Old U S WEST's debt
refinancing costs.................................... -- -- (140) -- (140)
Common stock issuances................................. 1,521 -- 58 -- 58
Treasury stock purchases............................... (305) -- (15) -- (15)
Net income from June 13 to December 31, 1998........... -- -- -- 761 761
Dividends declared on common stock..................... -- -- -- (538) (538)
Other.................................................. -- -- (7) -- (7)
----------- ----------- --------- ----- ---------
BALANCE, DECEMBER 31, 1998............................... 502,903 $ -- $ 532 $ 223 $ 755
----------- ----------- --------- ----- ---------
----------- ----------- --------- ----- ---------
</TABLE>
F-14
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 7: STOCKHOLDERS' EQUITY (CONTINUED)
COMMON STOCK. Prior to the Separation, Old U S WEST had two separate
classes of outstanding common stock; Communications Stock and Media Stock. In
conjunction with the Separation, on June 12, 1998, Old U S WEST redeemed each
issued and outstanding share of Communications Stock (other than shares of
Communications Stock held as treasury stock) for one share of U S WEST common
stock. Each share of Communications Stock held as treasury stock by Old U S WEST
was cancelled. For presentation purposes, Communications Stock shares
outstanding prior to June 12, 1998 are shown as U S WEST shares.
DIVIDENDS. We declared dividends of $2.14 per share of common stock during
1998, 1997 and 1996. Prior to the Separation Date, we paid dividends monthly to
Old U S WEST based on Dex's net income adjusted for the amortization of
intangibles.
LEVERAGED EMPLOYEE STOCK OWNERSHIP PLAN ("LESOP"). Prior to the Separation,
we participated in the defined contribution savings plan sponsored by Old U S
WEST (the "Old U S WEST Savings Plan") which covered substantially all
employees. Old U S WEST matched a percentage of the eligible employee
contributions with shares of Communications Stock and/or Media Stock in
accordance with participant elections. Old U S WEST maintained a LESOP to
provide shares of common stock for matching contributions. During 1998, prior to
the Separation, the outstanding debt of the LESOP which was used to acquire
common stock, was fully paid down. Contributions to the LESOP as well as
dividends on unallocated shares of common stock held by the LESOP were used for
debt service.
In connection with the Separation, the unallocated shares in the LESOP as of
June 12, 1998, were split between us and MediaOne. We received 342,814 and
196,014 shares of U S WEST and MediaOne common stock, respectively. We sold the
MediaOne common stock in the open market, the proceeds of which were used to
acquire shares of our common stock for matching contributions. As of December
31, 1998, all of such unallocated shares received by us from the LESOP had been
allocated to participant accounts.
As a result of the Separation, we assumed sponsorship of the Old U S WEST
Savings Plan which covers substantially all our employees (the "U S WEST Savings
Plan"), and MediaOne adopted a new plan ("MediaOne Savings Plan"), covering
eligible employees of MediaOne. Existing account balances of such MediaOne
employees were transferred from the Old U S WEST Savings Plan to the MediaOne
Savings Plan.
As of October 1998, we had utilized all the unallocated shares of the LESOP
for purposes of making matching contributions. Through this time period, we
recognized contribution expense based upon the cash payments method as specified
in SOP 76-3, "Accounting Practices for Certain Employee Stock Ownership Plans."
Subsequent to October 1998, we made $14 of cash contributions to the U S
WEST Savings Plan, which utilized the cash to purchase shares of common stock in
the open market. Compensation expense for
F-15
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 7: STOCKHOLDERS' EQUITY (CONTINUED)
this period was equal to our cash contributions. The following LESOP information
applies to the time period contributions were accounted for under SOP 76-3.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Benefit expense.............................................................. $ 84 $ 74 $ 59
Interest expense............................................................. 3 6 8
--- --- ---
Total expense................................................................ $ 87 $ 80 $ 67
--- --- ---
--- --- ---
Dividends for debt service................................................... $ 1 $ 3 $ 5
--- --- ---
--- --- ---
</TABLE>
STOCKHOLDERS RIGHTS PLAN. Our board of directors has adopted a stockholders
rights plan which, in the event of a takeover attempt, would entitle existing
stockholders to certain preferential rights. These rights expire on June 1, 2008
and are redeemable by us at any time prior to the date they become effective.
NOTE 8: EARNINGS PER SHARE
Certain of the financial effects of the Separation and the Dex Alignment,
including interest expense associated with the refinancing of the Dex
Indebtedness and the dilutive effects of the Dex Dividend, are not reflected in
the historical consolidated statements of income prior to the Separation Date.
As a result, earnings per share for 1998, 1997 and 1996 are presented on both a
pro forma and historical basis. The pro forma earnings per share amounts give
effect to the Dex Indebtedness and the issuance of approximately 16,341,000
shares (net of the redemption of 305,000 fractional shares) of common stock in
connection with the Dex Alignment as if such transactions had been consummated
as of January 1, 1998, 1997 and 1996, respectively.
The following reflects the computation of basic and diluted earnings per
share on a historical and pro forma basis. Income and earnings per share are
before an extraordinary item and the cumulative effect of change in accounting
principle. The earnings per share amounts presented on the consolidated
statements of income may not foot due to rounding of individual components.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
BASIC EARNINGS PER SHARE 1998 1997 1996
- ----------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
(SHARES IN THOUSANDS)
Income........................................................... $1,508 $1,527 $1,501
Pro forma adjustment(1).......................................... (72) (162) (162)
--------- --------- ---------
Pro forma income................................................. $1,436 $1,365 $1,339
--------- --------- ---------
--------- --------- ---------
Basic weighted average shares(2)................................. 494,395 482,751 477,549
Pro forma adjustment(3).......................................... 7,432 16,341 16,341
--------- --------- ---------
Pro forma basic weighted average shares.......................... 501,827 499,092 493,890
--------- --------- ---------
--------- --------- ---------
Basic earnings per share......................................... $3.05 $3.16 $3.14
Pro forma basic earnings per share............................... $2.86 $2.73 $2.71
</TABLE>
F-16
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 8: EARNINGS PER SHARE (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
DILUTED EARNINGS PER SHARE 1998 1997 1996
- ----------------------------------------------------------------- --------- --------- ---------
<S> <C> <C> <C>
(SHARES IN THOUSANDS)
Income........................................................... $1,508 $1,527 $1,501
Interest on convertible zero coupon subordinated notes, net of
tax............................................................ -- 9 13
--------- --------- ---------
Income used for diluted earnings per share....................... 1,508 1,536 1,514
Pro forma adjustment(1).......................................... (72) (162) (162)
--------- --------- ---------
Pro forma income................................................. $1,436 $1,374 $1,352
--------- --------- ---------
--------- --------- ---------
Basic weighted average shares(2)................................. 494,395 482,751 477,549
Effect of dilutive securities:
Stock options.................................................. 4,403 2,386 1,536
Convertible zero coupon subordinated notes..................... -- 6,095 9,506
--------- --------- ---------
Diluted weighted average shares.................................. 498,798 491,232 488,591
Pro forma adjustment(3).......................................... 7,432 16,341 16,341
--------- --------- ---------
Pro forma diluted weighted average shares........................ 506,230 507,573 504,932
--------- --------- ---------
--------- --------- ---------
Diluted earnings per share....................................... $3.02 $3.13 $3.10
Pro forma diluted earnings per share............................. $2.84 $2.71 $2.68
</TABLE>
- ------------------------------
(1) Reflects incremental (after-tax) interest expense associated with the Dex
Indebtedness from the beginning through the end of each period presented up
to the Separation Date.
(2) Historical average shares assume a one-for-one conversion of historical
Communications Stock outstanding into shares of U S WEST as of the
Separation Date.
(3) Reflects the issuance of approximately 16,341,000 shares of common stock
(net of the redemption of approximately 305,000 fractional shares) issued in
connection with the Dex Alignment as if the shares had been issued at the
beginning of each period indicated.
The dilutive securities represent the incremental weighted-average shares
from the assumed exercise of stock options and the assumed conversion of the
zero coupon subordinated notes redeemed in August 1997.
NOTE 9: STOCK INCENTIVE PLANS
We maintain stock incentive plans for employees and nonemployees, primarily
members of the board of directors. The 1998 U S WEST stock plan (the "Plan"),
under which we may grant awards in the form of stock options, stock appreciation
rights and restricted stock, as well as substitute stock options and restricted
stock awards, was approved by stockholders on June 12, 1998, in connection with
the Separation. The Plan is a successor plan to the Amended 1994 Stock Plan (the
"Predecessor Plan"), under which shares of Communications Stock were previously
issued. No further grants may be made under the Predecessor Plan.
F-17
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 9: STOCK INCENTIVE PLANS (CONTINUED)
Effective June 12, 1998, each outstanding Communications Group stock option
was converted into one U S WEST stock option, whether held by U S WEST or
MediaOne employees. Each option granted under the Plan has the same terms,
conditions, exercise price, vesting and restrictions as the Communications Group
stock awards it replaced.
Under the Plan, a maximum of 4.8 million shares could be granted in 1998.
Thereafter, the maximum aggregate number of shares of stock granted in any
calendar year for all purposes under the Plan is one percent (1.00%) of the
shares outstanding (excluding shares held in our treasury) on the first day of
such year. In the event that fewer than the full aggregate number of shares
available for issuance in any year are issued in any calendar year, the shares
not issued shall be added to the shares available for issuance in any subsequent
year or years. The options' exercise price is equal to the fair market value of
the common stock on the date of the grant. Options granted vest over periods up
to five years and may be exercised no later than 10 years after the grant date.
FAS No. 123, "Accounting for Stock-Based Compensation," requires the fair
value of stock options to be calculated using an option pricing model. We have
elected the "pro forma, disclosure only" option permitted under FAS No. 123,
instead of recording a charge to operations, as shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net income:
As reported........................................................ $ 1,508 $ 1,524 $ 1,535
Adjusted for FAS No. 123........................................... 1,479 1,511 1,533
Earnings per share:
As reported--basic................................................. $ 3.05 $ 3.16 $ 3.21
As reported--diluted............................................... 3.02 3.12 3.17
Adjusted for FAS No. 123--basic.................................... 2.99 3.13 3.21
Adjusted for FAS No. 123--diluted.................................. 2.97 3.10 3.14
</TABLE>
Because the FAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the pro forma compensation cost may not
represent that expected in future years.
Following are the weighted-average assumptions used with the Black-Scholes
option-pricing model to estimate the fair value of options granted during 1998,
1997 and 1996:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Risk-free interest rate.............................................. 5.5% 6.4% 6.5%
Expected dividend yield.............................................. 4.2% 5.8% 6.7%
Expected option life (years)......................................... 4.0 4.0 4.5
Expected stock price volatility...................................... 22.9% 25.0% 19.6%
Weighted average grant date fair value............................... $ 8.75 $ 5.70 $ 3.67
</TABLE>
F-18
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 9: STOCK INCENTIVE PLANS (CONTINUED)
Information on outstanding options is summarized as follows (shares in
thousands):
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVG. EXERCISE
SHARES PRICE
----------- -------------
<S> <C> <C>
Outstanding January 1, 1996............................................. 9,423 $ 24.39
Granted............................................................... 3,625 30.97
Exercised............................................................. (1,206) 22.37
Canceled or expired................................................... (429) 25.01
-----------
Outstanding December 31, 1996........................................... 11,413 26.67
Granted............................................................... 9,492 34.87
Exercised............................................................. (2,649) 25.41
Canceled or expired................................................... (637) 27.54
-----------
Outstanding December 31, 1997........................................... 17,619 31.23
Granted............................................................... 9,589 50.81
Exercised............................................................. (2,480) 23.03
Canceled or expired................................................... (700) 36.99
-----------
Outstanding December 31, 1998........................................... 24,028 38.45
-----------
-----------
</TABLE>
The outstanding options at December 31, 1998, have the following
characteristics (shares in thousands):
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
--------------------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER REMAINING EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ----------------------------------- ----------- ------------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
$16.08 - $26.11.................... 3,297 5.84 $ 22.21 3,057 $ 23.95
26.34 - 32.63...................... 3,395 7.01 31.05 2,197 30.84
32.75 - 36.13...................... 7,585 8.23 34.28 1,158 35.54
36.25 - 49.63...................... 2,795 8.79 46.12 699 46.14
49.75 - 63.94...................... 6,956 9.46 51.22 -- 50.31
----------- --- ----------- ----- -----------
Total............................ 24,028 8.15 $ 38.45 7,111 $ 30.15
----------- --- ----------- ----- -----------
----------- --- ----------- ----- -----------
</TABLE>
Options to purchase 5,299,955 and 3,881,100 shares of common stock at
weighted-average exercise prices of $25.72 and $25.71 were exercisable at
December 31, 1997 and 1996, respectively.
Approximately 2 million shares of common stock were available for grant at
December 31, 1998. Approximately 26 million shares of common stock were reserved
for issuance at December 31, 1998.
F-19
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS
PENSION, POSTRETIREMENT AND OTHER POST EMPLOYMENT BENEFITS
We have a noncontributory defined benefit pension plan (the "Pension Plan")
for substantially all management and occupational employees and postretirement
healthcare and life insurance plans for retirees. We also provide post
employment benefits for certain former employees.
Prior to the Separation, we participated in the defined benefit pension plan
and postretirement healthcare and life insurance plans sponsored by Old U S
WEST. Accordingly, our financial statements for periods prior to the Separation
Date reflect an allocation of costs from Old U S WEST for its employees and
retirees while they were included in Old U S WEST's plans.
On June 12, 1998, we assumed sponsorship of the Old U S WEST pension plan
and MediaOne established a new defined benefit pension plan for eligible
MediaOne employees (the "MediaOne Pension Plan"). In connection with the
Separation, a portion of the existing assets of the Old U S WEST pension plan
were transferred at fair value to the MediaOne Pension Plan such that the ratio
of plan assets to plan liabilities, calculated on a projected benefit obligation
basis as determined by independent actuaries, was the same for the Pension Plan
and the MediaOne Pension Plan. The pension benefit obligation and plan assets
transferred to the MediaOne Pension Plan at June 12, 1998 were approximately
$150 and $200, respectively.
In addition, on June 12, 1998, the three funded retiree medical and life
insurance benefits trusts, maintained by Old U S WEST under an employee welfare
benefit program for its employees, were split between us and MediaOne. One of
the trusts covered hourly employees only and was transferred in its entirety to
us. The remaining two trusts were transferred to us, and MediaOne established
new trusts. A portion of the assets of the latter two trusts was transferred to
MediaOne's trusts based upon the same methodology used to transfer assets of the
Pension Plan to the MediaOne Pension Plan, except that the liabilities were
calculated by independent actuaries using the accumulated postretirement benefit
obligation method. The accumulated postretirement benefit obligation and plan
assets transferred to MediaOne's trusts at June 12, 1998 were approximately $20
and $5, respectively.
Pension benefits for management employees are based upon their salary while
occupational employee benefits are based upon years of service and job
classification. Pension and postretirement costs are recognized over the period
in which the employee renders services and becomes eligible to receive benefits
as determined by using the projected unit credit method. Our funding policy is
to make contributions with the objective of accumulating sufficient assets to
pay all benefits when due. No pension funding was required in 1998, 1997 or
1996.
Since plan assets for pension and postretirement benefits were not
historically segregated into separate accounts or restricted to providing
benefits to employees of U S WEST, assets of the plan were used to provide
benefits to employees of both U S WEST and MediaOne. Therefore, the following
pension and postretirement benefits plan information for periods prior to June
12, 1998, reflects the pension cost (credit), postretirement benefit cost,
benefit obligation, assets and funded status of the Old U S WEST plans.
F-20
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS (CONTINUED)
The portion of the pension credit applicable to U S WEST was $33 in 1997 and
$5 in 1996. The components of the pension credit are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Details of pension cost (credit):
Service cost.......................................................... $ 189 $ 176 $ 192
Interest cost......................................................... 639 625 586
Expected return on plan assets........................................ (852) (759) (714)
Amortization of transition asset...................................... (79) (80) (80)
Amortization of prior service cost.................................... 2 2 (5)
Recognized actuarial loss............................................. -- -- 16
--------- --------- ---------
Net pension credit...................................................... $ (101) $ (36) $ (5)
--------- --------- ---------
--------- --------- ---------
</TABLE>
The portion of the postretirement benefit cost applicable to U S WEST was
$179 in 1997 and $166 in 1996. The components of the postretirement benefit cost
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Details of postretirement benefit cost:
Service cost.......................................................... $ 72 $ 66 $ 70
Interest cost......................................................... 319 296 259
Expected return on plan assets........................................ (213) (174) (157)
Amortization of prior service cost.................................... 19 19 3
Recognized actuarial gain............................................. (30) (28) (9)
--------- --------- ---------
Total postretirement benefit cost....................................... $ 167 $ 179 $ 166
--------- --------- ---------
--------- --------- ---------
</TABLE>
Since plan assets for pension and postretirement benefits were not
historically segregated into separate accounts or restricted to providing
benefits to employees of U S WEST, assets of the plan were used to provide
benefits to employees of both U S WEST and MediaOne. Therefore, the following
pension and postretirement benefit plan information for periods prior to June
12, 1998, reflects the benefit obligation, assets and funded status of the Old U
S WEST plans.
F-21
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS (CONTINUED)
Following is a reconciliation of the benefit obligation for the pension and
postretirement plans:
<TABLE>
<CAPTION>
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
YEAR ENDED DECEMBER YEAR ENDED DECEMBER
31, 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Benefit obligation at beginning of year.................... $ 9,167 $ 8,310 $ 4,406 $ 3,891
Service cost............................................... 189 176 72 66
Interest cost.............................................. 639 625 319 296
Actuarial gain............................................. 499 750 297 307
Plan amendments............................................ -- -- (105) --
Divestitures............................................... (224) -- (23) --
Benefits paid.............................................. (648) (694) (141) (154)
--------- --------- --------- ---------
Benefit obligation at end of year.......................... $ 9,622 $ 9,167 $ 4,825 $ 4,406
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
Following is a reconciliation of the change in the fair value of plan assets
for the pension and postretirement plans.
<TABLE>
<CAPTION>
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
YEAR ENDED DECEMBER YEAR ENDED DECEMBER
31, 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Fair value of plan assets at beginning of year.......... $ 12,260 $ 10,958 $ 2,413 $ 2,063
Actual return on plan assets............................ 1,579 1,996 264 394
Employer contributions.................................. -- -- 18 33
Divestitures............................................ (212) -- (4) --
Section 420 transfer.................................... (54) -- 54 --
Benefits paid........................................... (648) (694) (141) (77)
--------- --------- --------- ---------
Fair value of plan assets at end of year................ $ 12,925 $ 12,260 $ 2,604 $ 2,413
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
In December 1998, under provisions of section 420 of the Internal Revenue
Code, $54 of pension assets were transferred to the postretirement benefit plan
to pay for current year retiree health care benefits.
F-22
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 10: EMPLOYEE BENEFITS (CONTINUED)
The following table represents the funded status of the pension and
postretirement plans:
<TABLE>
<CAPTION>
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Funded (unfunded) status............................... $ 3,303 $ 3,093 $ (2,221) $ (1,993)
Unrecognized net actuarial gain........................ (2,195) (1,966) (482) (631)
Unamortized prior service cost......................... 4 6 140 160
Balance of unrecognized transition asset............... (466) (546) -- --
--------- --------- --------- ---------
Prepaid (accrued) benefit cost......................... $ 646 $ 587 $ (2,563) $ (2,464)
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The actuarial assumptions used to account for the plans are as follows:
<TABLE>
<CAPTION>
POSTRETIREMENT
PENSION BENEFITS
-------------------- --------------------
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted-average discount rate.............................. 6.75% 7.00% 6.75% 7.00%
Expected long-term rate of return on plan assets*........... 8.80% 8.50% 8.80% 8.50%
Weighted-average rate of compensation increase.............. 4.65% 5.50% N/A N/A
</TABLE>
- ------------------------------
* The expected long-term rate of return on plan assets for the pension and
postretirement plans was 8.5% for 1996.
For measurement purposes, an 8.0% annual rate of increase in the healthcare
cost trend rate for 1998 is assumed. The healthcare cost trend rate is assumed
to gradually decline to an ultimate rate of 5.0% in 2011.
A 1.0% change in the assumed healthcare cost trend rate would have had the
following effects in 1998:
<TABLE>
<CAPTION>
ONE-PERCENT CHANGE
------------------------
INCREASE DECREASE
----------- -----------
<S> <C> <C>
Effect on the aggregate of the service and interest cost components of net
periodic postretirement benefit cost....................................... $ 53 $ (43)
Effect on accumulated postretirement benefit obligation...................... 541 (451)
</TABLE>
In October 1998, the Communications Workers of America voting members (who
are our employees), ratified new three-year contracts. These contracts provide
for both salary increases of 10.9% and pension increases totaling 21% over three
years. These benefit changes are reflected in the above calculations.
We provide other post employment benefits, such as worker's compensation and
disability to former or inactive employees who are not eligible for retirement.
F-23
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 11: INCOME TAXES
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
FEDERAL:
Current............................................................. $ 685 $ 798 $ 697
Deferred............................................................ 103 (10) 93
Investment tax credits--net......................................... (13) (16) (28)
--------- --------- ---------
775 772 762
--------- --------- ---------
STATE AND LOCAL:
Current............................................................. 108 119 92
Deferred............................................................ 28 11 22
--------- --------- ---------
136 130 114
--------- --------- ---------
Provision for income taxes............................................ $ 911 $ 902 $ 876
--------- --------- ---------
--------- --------- ---------
</TABLE>
We paid $678, $906 and $814 for income taxes in 1998, 1997 and 1996,
respectively.
The effective tax rate differs from the statutory tax rate as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
(IN PERCENT)
Federal statutory tax rate.................................................. 35.0 35.0 35.0
Investment tax credit amortization.......................................... (0.4) (0.4) (0.7)
State income taxes--net of federal effect................................... 3.7 3.5 3.1
Other....................................................................... (0.6) (1.0) (0.5)
--- --- ---
Effective tax rate.......................................................... 37.7 37.1 36.9
--- --- ---
--- --- ---
</TABLE>
F-24
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 11: INCOME TAXES (CONTINUED)
The components of the net deferred tax liability are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Property, plant and equipment.................................................. $ 1,633 $ 1,574
State deferred taxes--net of federal effect.................................... 205 198
Other.......................................................................... 40 40
--------- ---------
Deferred tax liabilities..................................................... 1,878 1,812
--------- ---------
Postretirement benefits, net of pension........................................ 701 672
Restructuring and other........................................................ -- 21
Unamortized investment tax credit.............................................. 56 59
State deferred taxes--net of federal effect.................................... 135 141
Other.......................................................................... 351 399
--------- ---------
Deferred tax assets.......................................................... 1,243 1,292
--------- ---------
Net deferred tax liability..................................................... $ 635 $ 520
--------- ---------
--------- ---------
</TABLE>
TAX SHARING AGREEMENT. We entered into a tax sharing agreement with
MediaOne that governs the allocation of federal, state, local and foreign tax
liabilities and related tax matters such as the preparation and filing of tax
returns and the conduct of audits and other tax proceedings for taxable periods
up to the Separation. In general, the tax sharing agreement provides that (i) we
will be responsible for, and will indemnify MediaOne against, tax liabilities
relating to the Communications Group, for taxable periods ending on or prior to
the Separation and (ii) MediaOne will be responsible for, and will indemnify us
against, tax liabilities relating to the Media Group, for taxable periods ending
on or prior to the Separation.
NOTE 12: SEGMENT INFORMATION
We are organized on the basis of our products and service, operating in two
segments: communications and related services and directory services. The
communications and related services segment provides telecommunication services
to more than 25 million residential and business customers in Arizona, Colorado,
Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon,
South Dakota, Utah, Washington and Wyoming. The communications and related
services segment provides local telephone services, exchange access services,
that connect customers to the facilities of other carriers, long-distance
services within local access and transport areas, wireless personal
communications services and high speed data and Internet access services. The
directory services segment publishes approximately 270 White and Yellow Pages
telephone directories and provides electronic directory and other information
services.
F-25
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 12: SEGMENT INFORMATION (CONTINUED)
Segment financial information is as follows:
<TABLE>
<CAPTION>
COMMUNICATIONS
& RELATED DIRECTORY RECONCILING CONSOLIDATED
SERVICES SERVICES ITEMS TOTAL
--------------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
1998
Operating revenues........................................ $ 11,101 $ 1,277 $ -- $ 12,378
Operating income.......................................... 5,092 657 (2,700) 3,049(1)
Assets.................................................... 17,883 524 -- 18,407
Capital expenditures...................................... 2,863 42 -- 2,905
1997
Operating revenues........................................ 10,519 1,190 (230)(2) 11,479
Operating income.......................................... 4,982 615 (2,821) 2,776(1)
Assets.................................................... 17,246 516 (95)(3) 17,667
Capital expenditures...................................... 2,643 29 -- 2,672
1996
Operating revenues........................................ 10,053 1,115 -- 11,168
Operating income.......................................... 4,850 524 (2,562) 2,812(1)
Assets.................................................... 16,915 493 (129)(3) 17,279
Capital expenditures...................................... 2,806 25 -- 2,831
</TABLE>
- ------------------------------
(1) Represents income before income taxes, extraordinary item and cumulative
effect of change in accounting principle. Adjustments that are made to the
total of the segments' operating income in order to arrive at income before
income taxes, extraordinary item and cumulative effect of change in
accounting principle include the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Costs and adjustments excluded from segment data but included in the
consolidated total:
Separation costs..................................................... $ 94 $ -- $ --
Asset impairment charge.............................................. 35 -- --
Regulatory charges................................................... -- 230 --
Taxes other than income taxes........................................ 372 428 404
Depreciation and amortization........................................ 2,199 2,163 2,158
--------- --------- ---------
$ 2,700 $ 2,821 $ 2,562
--------- --------- ---------
--------- --------- ---------
</TABLE>
(2) Represents regulatory charges, primarily attributable to the state of
Washington.
(3) Represents intercompany receivables.
F-26
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 12: SEGMENT INFORMATION (CONTINUED)
In addition to the operating revenues disclosed above, intersegment
operating revenues of the communications and related services segment were $28,
$30 and $26 for 1998, 1997 and 1996, respectively. Intersegment operating
revenues of the directory services segment were $10, $6 and $5 for 1998, 1997
and 1996, respectively.
Certain costs relating to general and administrative services, including
executive management, legal, tax, accounting and auditing, treasury, strategic
planning and public policy services, have been directly assigned to the
communications and related services and the directory services segments based on
actual utilization or are allocated based on operating expense, number of
employees, external revenues, average capital and/or average equity.
SIGNIFICANT CONCENTRATIONS. The largest volume of the communications and
related services segment revenues are provided to AT&T Corp. ("AT&T"). During
1998, 1997 and 1996 revenues from services provided to AT&T were $900, $1,049
and $1,046, respectively. As of December 31, 1998, we are not aware of any other
significant concentration of business transacted with a particular customer that
could, if suddenly eliminated, severely impact operations.
At December 31, 1998, we had 54,483 employees, of which 46,310 are employees
of U S WEST Communications, Inc., a wholly owned subsidiary ("USWC") and 3,580
are employees of Dex. Approximately 72% of USWC employees and 63% of Dex
employees are represented by unions.
NOTE 13: RELATED PARTY TRANSACTIONS
BELL COMMUNICATIONS RESEARCH, INC. ("BELLCORE"). Charges relating to
research, development and maintenance of existing technologies performed by
Bellcore, in which we had a one-seventh ownership interest, were $118 and $97 in
1997 and 1996, respectively.
In 1997, we sold our interest in Bellcore. We received cash proceeds of $65
and recorded an after-tax gain of $32. Bellcore continues to provide research
and development and other services to us on a contract basis.
NOTE 14: COMMITMENTS AND CONTINGENCIES
COMMITMENTS
We have entered into an agreement with Olympic Properties of the United
States to sponsor the 2002 Salt Lake City Winter Olympics and the U.S. Olympic
Teams through 2004. As of December 31, 1998, we have a remaining commitment of
$55 to be paid in a combination of cash and services through 2004.
CONTINGENCIES
USWC has pending regulatory actions in local regulatory jurisdictions which
call for price decreases, refunds or both.
OREGON. On May 1, 1996, the Oregon Public Utilities Commission ("OPUC")
approved a stipulation terminating prematurely USWC's alternative form of
regulation ("AFOR") plan and it then undertook a review of USWC's earnings. In
May 1997, the OPUC ordered USWC to reduce its annual revenues by $97,
F-27
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 14: COMMITMENTS AND CONTINGENCIES (CONTINUED)
effective May 1, 1997 and to issue a one-time refund, including interest, of
approximately $102 to reflect the revenue reduction for the period May 1, 1996
through April 30, 1997. This one-time refund for interim rates became subject to
refund when USWC's AFOR plan was terminated on May 1, 1996.
USWC filed an appeal of the order and asked for an immediate stay of the
refund with the Oregon Circuit Court which granted USWC's request for a stay,
pending a full review of the OPUC's order. On February 19, 1998, the Oregon
Circuit Court entered a judgment in USWC's favor on most of the appealed issues.
The OPUC appealed to the Oregon Court of Appeals on March 19, 1998, and the
appeal remains pending. USWC continues to charge interim rates, subject to
refund, during the pendency of that appeal. The potential exposure, including
interest, at December 31, 1998, is not expected to exceed $315.
UTAH. The Utah Supreme Court has remanded a Utah Public Service Commission
("UPSC") order to the UPSC for hearing, thereby establishing two exceptions to
the rule against retroactive ratemaking: i) unforeseen and extraordinary events
and ii) misconduct. The UPSC's initial order denied a refund request from
interexchange carriers and other parties related to the Tax Reform Act of 1986.
The potential exposure, including interest at December 31, 1998, is not expected
to exceed $175.
NEW MEXICO. The New Mexico State Corporation Commission ("NMSCC") issued an
order on May 29, 1998, requiring USWC to reduce its annual revenues by
approximately $22. A rehearing before the NMSCC was denied. The NMSCC's order
was then removed to the New Mexico Supreme Court for review that effectively
stays the order. Oral arguments to the New Mexico Supreme Court are
preliminarily scheduled for February 1999. The potential exposure, including
interest, at December 31, 1998, is not expected to exceed $11.
STATE REGULATORY ACCRUALS. USWC has accrued $203 at December 31, 1998,
which represents its estimated liabilities for all state regulatory proceedings,
predominately the items discussed above. It is possible that the ultimate
liabilities could exceed the amounts accrued by up to approximately $300. USWC
will continue to monitor and evaluate the risks associated with its local
regulatory jurisdictions and will adjust estimates as new information becomes
available.
In addition to its estimated liabilities for state regulatory proceedings,
USWC has an accrued liability of approximately $38 at December 31, 1998 related
to refunds in the state of Washington.
OTHER CONTINGENCIES. In December 1998, we were informed of the possibility
of a claim by a purported class challenging the transfer of approximately $54
from the U S WEST pension trust to the U S WEST health care trust to pay retiree
medical expenses pursuant to Section 420 of the Internal Revenue Code of 1986,
as amended. We believe that this transfer complied with the applicable law and
the associated plan documents. We plan to vigorously defend any such claim if
and when it is asserted.
F-28
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 15: QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
QUARTERLY FINANCIAL DATA
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1998
Operating revenues......................................................... $ 3,009 $ 3,053 $ 3,112 $ 3,204
Net income................................................................. 434 327 379 368
Pro forma net income....................................................... 393 296 379 368
Earnings per share:
Basic.................................................................... 0.89 0.67 0.76 0.73
Diluted.................................................................. 0.89 0.67 0.75 0.73
Pro forma basic.......................................................... 0.78 0.59 0.76 0.73
Pro forma diluted........................................................ 0.78 0.59 0.75 0.73
1997
Operating revenues......................................................... $ 2,867 $ 2,830 $ 2,960 $ 2,822
Income before extraordinary item........................................... 420 416 423 268
Earnings per share before extraordinary item:
Basic.................................................................... 0.87 0.86 0.88 0.55
Diluted.................................................................. 0.86 0.85 0.87 0.55
Net income................................................................. 420 416 420 268
Earnings per share:
Basic.................................................................... 0.87 0.86 0.87 0.55
Diluted.................................................................. 0.86 0.85 0.86 0.55
Pro forma income before extraordinary item................................. 380 375 383 227
Pro forma earnings per share before extraordinary item:
Basic.................................................................... 0.76 0.75 0.77 0.45
Diluted.................................................................. 0.75 0.74 0.76 0.45
</TABLE>
1998 second-quarter net income includes Separation expenses of $68 ($0.13
per diluted share) and a $21 ($0.04 per diluted share) charge related to the
impairment of certain long-lived assets associated with our video operations.
1997 first-quarter net income includes $11 ($0.02 per diluted share) from
gains on the sales of local telephone exchanges. 1997 second-quarter net income
includes $18 ($0.04 per diluted share) from gains on the sales of local
telephone exchanges. 1997 third-quarter net income includes $19 ($0.04 per
diluted share) from gains on the sales of local telephone exchanges and an
extraordinary charge of $3 ($0.01 per diluted share) for the early
extinguishment of debt. 1997 fourth-quarter net income includes a $152 ($0.31
per
F-29
<PAGE>
U S WEST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
NOTE 15: QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
diluted share) regulatory charge related primarily to the 1997 Washington State
Supreme Court ruling that upheld a 1996 rate order and a $32 ($0.07 per diluted
share) gain on the sale of our investment in Bellcore.
<TABLE>
<CAPTION>
MARKET PRICE
----------------------------------
PER SHARE MARKET AND DIVIDEND DATA HIGH LOW CLOSE DIVIDENDS
- ------------------------------------------------------------------ ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
1998
First quarter................................................... $ 56.3125 $ 45.3750 $ 54.6250 $ 0.5350
Second quarter.................................................. 57.4375 46.8125 46.8125 0.5350
Third quarter................................................... 54.9375 48.4375 52.5000 0.5350
Fourth quarter.................................................. 65.0000 51.8750 64.6250 0.5350
1997
First quarter................................................... $ 37.2500 $ 31.7500 $ 33.8750 $ 0.5350
Second quarter.................................................. 38.5000 31.1250 37.6875 0.5350
Third quarter................................................... 39.4375 35.6250 38.5000 0.5350
Fourth quarter.................................................. 46.9375 36.8750 45.1250 0.5350
</TABLE>
Per share market and dividend data prior to June 12, 1998 represents data of
Communications Stock. Per share market and dividend data as of and subsequent to
June 12, 1998 represents data of U S WEST.
F-30
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of U S WEST, Inc.:
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements included in U S WEST, Inc.'s (the
"Company") Annual Report on Form 10-K for the year ended December 31, 1998, and
have issued our report thereon dated January 22, 1999 appearing on page F-1. Our
audits were made for the purpose of forming an opinion on those statements taken
as a whole. The schedule appearing on page F-32 of this Form 10-K is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects, the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Denver, Colorado
January 22, 1999
F-31
<PAGE>
U S WEST, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED CHARGED BALANCE
BEGINNING TO TO OTHER AT END OF
OF PERIOD EXPENSE ACCOUNTS DEDUCTIONS PERIOD
------------- ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Allowance for uncollectibles:
1998................................................... $ 72 $ 141(a) $ -- $ 144(b) $ 69
1997................................................... 60 126(a) -- 114(b) 72
1996................................................... 50 116(a) (3) 103(b) 60
Reserves related to 1993 business restructuring,
including workforce reductions and facility
consolidation:
1998................................................... $ 56 $ -- $ (24) $ 32 $ --
1997................................................... 126 -- -- 70 56
1996................................................... 368 -- -- 242 126
</TABLE>
- ------------------------------
(a) Does not include amounts charged directly to expense. These amounts were $5,
$8 and $7 for 1998, 1997 and 1996, respectively.
(b) Represents credit losses written off during the period, less collection of
amounts previously written off.
F-32
<PAGE>
EXHIBIT 10-P
AMENDMENT
to
the SEPARATION AGREEMENT,
Dated as of June 5, 1998
between U S WEST, INC.
(renamed as of the date hereof MEDIAONE GROUP, INC.)
and
USW-C, INC.
(renamed as of the date hereof U S WEST, INC.)
Dated as of June 12, 1998
AMENDMENT, (this "Amendment"), to the SEPARATION AGREEMENT, dated as of June
5, 1998 (the "Separation Agreement"), between U S WEST, Inc. ("U S WEST"), a
Delaware corporation renamed as of the date hereof "MEDIAONE GROUP, INC.," and
USW-C, Inc., a Delaware corporation and wholly owned subsidiary of U S WEST
("New U S WEST"), renamed as of the date hereof "U S WEST, INC." Capitalized
terms used but not defined herein shall have the meanings ascribed thereto in
the Separation Agreement.
W I T N E S S E T H:
WHEREAS, U S WEST and New U S WEST have entered into the Separation
Agreement, pursuant to which, among other things, (a) U S WEST is effecting a
restructuring of certain of its assets, liabilities and businesses, as a result
of which New U S WEST shall own the Directories Business and the businesses
currently attributed to the Communications Group and (b) U S WEST shall
distribute all of the outstanding capital stock of New U S WEST to its
stockholders, all on the terms and subject to the conditions described herein;
and
WHEREAS, U S WEST and New U S WEST desire to amend certain provisions of the
Separation Agreement to provide for the elimination of all intercompany accounts
between U S WEST and New U S WEST.
NOW, THEREFORE, in furtherance of the foregoing and in consideration of the
mutual promises and undertakings contained herein and in any other document
executed in connection with this Amendment, the parties agree as follows:
SECTION 1. Section 3.2(d) of the Separation Agreement is hereby deleted in
its entirety and in lieu thereof the following is added:
"U S WEST shall assume from Capital Funding the indebtedness owed by Capital
Funding to U S WEST Cellular Investments, Inc., a Mauritius corporation."
SECTION 2. Section 3.2(i) of the Separation Agreement is hereby deleted in
its entirety and in lieu thereof the following is added:
"FinanceCo shall loan to U S WEST all of the proceeds of the indebtedness
incurred by FinanceCo to fund the costs and expenses which are the
responsibility of the U S WEST Group in connection with the Refinancing.
Capital Funding shall loan to U S WEST an amount equal to the Pre-Separation
Adjustment. U S WEST shall contribute, as a capital contribution, to Capital
Funding the amount of funds necessary for Capital Funding to fund all of the
costs and expenses of the Refinancing payable by Capital Funding and Capital
Funding shall use such funds to pay such costs and expenses."
SECTION 3. Section 3.4(a) of the Separation Agreement is hereby amended by
adding immediately after paragraph 3.4(a) (x):
<PAGE>
"(xi) the indebtedness owed by U S WEST to Capital Funding, incurred
pursuant to Section 3.2(i) of the Separation Agreement, as amended by
Section 3 of this Amendment.
(xii) the indebtedness owed by U S WEST to Federal Relations."
SECTION 4. All other terms and conditions of the Agreement shall remain in
full force and effect.
SECTION 5. This Amendment shall be governed by, and construed in accordance
with, the laws of Colorado.
SECTION 6. This Amendment may be executed in one or more counterparts, each
of which shall be deemed an original, and all of which shall constitute one and
the same Amendment.
IN WITNESS WHEREOF, each of the parties has caused this Amendment to the
Separation Agreement to be duly executed on its behalf by its officers thereunto
duly authorized, all as of the day and year first above written.
U S WEST, INC.
(to be renamed MEDIAONE GROUP, INC.)
By: /s/ STEPHEN E. BRILZ
-----------------------------------------
Name: Stephen E. Brilz
Title: Assistant Secretary
USW-C, INC.
(to be renamed U S WEST, INC.)
By: /s/ THOMAS O. MCGIMPSEY
-----------------------------------------
Name: Thomas O. McGimpsey
Title: Assistant Secretary
<PAGE>
EXHIBIT 12
U S WEST, INC.
RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1998 1997 1996
----------- --------- --------- ---------
PRO
FORMA(1) ACTUAL
----------- -------------------------------
<S> <C> <C> <C> <C>
Income before taxes.................................................... $ 2,302 $ 2,419 $ 2,429 $ 2,377
Interest expense (net of amounts capitalized).......................... 660 543 405 448
Interest factor on rentals ( 1/3)...................................... 70 70 91 79
----------- --------- --------- ---------
Earnings available for fixed charges................................... $ 3,032 $ 3,032 $ 2,925 $ 2,904
----------- --------- --------- ---------
----------- --------- --------- ---------
Interest expense....................................................... $ 685 $ 568 $ 425 $ 479
Interest factor on rentals ( 1/3)...................................... 70 70 91 79
----------- --------- --------- ---------
Fixed charges.......................................................... $ 755 $ 638 $ 516 $ 558
----------- --------- --------- ---------
----------- --------- --------- ---------
Ratio of earnings to fixed charges..................................... 4.02 4.75 5.67 5.20
----------- --------- --------- ---------
----------- --------- --------- ---------
</TABLE>
- ------------------------------
(1) Giving pro forma effect to the refinancing of $3,900 of Dex Indebtedness as
if this transaction had been consummated as of the beginning of the period
presented.
<PAGE>
EXHIBIT 21
U S WEST, INC.
AND ITS SUBSIDIARIES
(as of February 8, 1999)
U S WEST, INC., A DELAWARE COMPANY
U S WEST Advanced Technologies, Inc., a Colorado company
U S WEST Business Resources, Inc., a Colorado company
U S WEST Business Resources, Inc., a Delaware company
U S WEST Capital Funding, Inc., a Colorado company
U S WEST Communications, Inc., a Colorado company
Block 142 Parking Garage Association, a Colorado Non-profit company
El Paso County Telephone Company, a Colorado company
Malheur Home Telephone Company, an Oregon company
Mubeta Development Co., a Colorado company
Training Partnerships, Inc., a Colorado Non-profit company
1200 Landmark Center Condominium Association, Inc., a Nebraska Non-profit
company
U S WEST Database Services, Inc., a Colorado company
U S WEST Wireless, L.L.C., a Delaware company
U S WEST Communications Federal Services, Inc., a Colorado company
U S WEST Communications Services, Inc., a Colorado company
Please Hold Promotions, Inc., an Arizona company
U S WEST Dex Holdings, Inc., a Delaware company
U S WEST Dex, Inc., a Colorado company
Interactive Video Enterprises, Inc., a Colorado company
LOCALTouch Holdings, Inc., a Colorado company
LOCALTouch Directory Services, Inc., a Colorado company
U S WEST Education Foundation, a Washington Non-profit company
U S WEST Enhanced Services, Inc., a Washington company
U S WEST Federal Relations, Inc., a Delaware company
U S WEST Foundation, a Colorado Non-Profit company
U S WEST Information Technologies, Inc., a Colorado company
U S WEST Internet Ventures, Inc., a Colorado company
U S WEST Interprise America, Inc., a Colorado company
U S WEST IP Holdings, Inc., a Delaware company
U S WEST Investment Management Company, a Colorado company
U S WEST Long Distance, Inc., a Colorado company
U S WEST SPF Co., a Colorado company
U S WEST Transoceanic, Inc., a Delaware company
Transoceanic Operations, Inc., a Delaware company
U S WEST Hong Kong, L.L.C., a Delaware company
U S WEST (Asia), Limited, a Hong Kong company
U S WEST Y2K, Inc., a Delaware company
Western Re, Inc., a Vermont company
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our reports dated January 22, 1999, on the consolidated balance sheets of U S
WEST, Inc. (formerly known as USW-C, Inc., the "Company") as of December 31,
1998 and 1997, and the related consolidated statements of income and cash flows
for each of the three years in the period ended December 31, 1998, and on
Schedule II, included in this Form 10-K, into the Company's previously filed
Registration Statements: the U S WEST, Inc. Deferred Compensation Plan on Form
S-8 (333-53569), the U S WEST, Inc. Long-Term Incentive Plan on Form S-8
(333-53567), the U S WEST, Inc. 1998 Stock Plan on Form S-8 (333-53565), the U S
WEST 1998 Broad-Based Stock Option Plan on the Post-Effective Amendment No. 1 to
Form S-8 (333-24283-99), the U S WEST, Inc. Savings Plan/ESOP on Form S-8
(333-53563) and the Shareowner Investment Plan on Form S-3 (333-52781).
[LOGO]
Denver, Colorado
February 10, 1999
<PAGE>
EXHIBIT 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
WHEREAS, U S WEST, Inc., a Delaware corporation (hereinafter referred to as
the "Company"), proposes to file with the Securities and Exchange Commission,
under the provisions of the Securities Exchange Act of 1934, as amended, an
annual report on Form 10-K for the fiscal year ended December 31, 1998; and
WHEREAS, each of the undersigned is a Director of the Company;
NOW THEREFORE, each of the undersigned constitutes and appoints ALLAN R.
SPIES, THOMAS O. MCGIMPSEY and JILL A. GILPIN, and each of them, as attorneys
for him or her and in his or her name, place, and stead, and in his or her
capacity as a Director of the Company, to execute and file such annual report,
and thereafter to execute and file any amendment or amendments thereto on Form
10-K, hereby giving and granting to said attorneys full power and authority to
do and perform all and every act and thing whatsoever requisite and necessary to
be done in and about the premises as fully, to all intents and purposes, as he
or she might or could do if personally present at the doing thereof, hereby
ratifying and confirming all that said attorneys may or shall lawfully do, or
cause to be done, by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney this 10th day of February, 1999.
/s/ LINDA G. ALVARADO /s/ ALLEN F. JACOBSON
- ----------------------------------- -----------------------------------
Linda G. Alvarado Allen F. Jacobson
/s/ CRAIG R. BARRETT /s/ RICHARD D. MCCORMICK
- ----------------------------------- -----------------------------------
Craig R. Barrett Richard D. McCormick
/s/ THE HONORABLE HANK BROWN /s/ MARILYN CARLSON NELSON
- ----------------------------------- -----------------------------------
The Honorable Hank Brown Marilyn Carlson Nelson
/s/ JERRY J. COLANGELO /s/ FRANK POPOFF
- ----------------------------------- -----------------------------------
Jerry J. Colangelo Frank Popoff
/s/ GEORGE J. HARAD /s/ SOLOMON D. TRUJILLO
- ----------------------------------- -----------------------------------
George J. Harad Solomon D. Trujillo
/s/ PETER S. HELLMAN
- -----------------------------------
Peter S. Hellman
<PAGE>
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
WHEREAS, U S WEST, Inc., a Delaware corporation (hereinafter referred to as
the "Company"), proposes to file with the Securities and Exchange Commission,
under the provisions of the Securities Exchange Act of 1934, as amended, an
annual report on Form 10-K for the fiscal year ended December 31, 1998, and
WHEREAS, the undersigned is an officer of the Company and holds the office,
or offices, in the Company as indicated below his name;
NOW THEREFORE, the undersigned hereby constitutes and appoints ALLAN R.
SPIES, THOMAS O. MCGIMPSEY and JILL A. GILPIN, and each of them, as attorneys
for him and in his name, place, and stead, and in each of his offices and
capacities in the Company, to execute and file such annual report, and
thereafter to execute and file any amendment or amendments thereto on Form 10-K,
hereby giving and granting to said attorneys full power and authority to do and
perform all and every act and thing whatsoever requisite and necessary to be
done in and about the premises as fully, to all intents and purposes, as he
might or could do if personally present at the doing thereof, hereby ratifying
and confirming all that said attorneys may or shall lawfully do, or cause to be
done, by virtue hereof.
IN WITNESS WHEREOF, the undersigned has executed this Power of Attorney this
10th day of February, 1999.
/s/ SOLOMON D. TRUJILLO
------------------------------------------
Solomon D. Trujillo
PRESIDENT AND CHIEF EXECUTIVE OFFICER
/s/ ALLAN R. SPIES
------------------------------------------
Allan R. Spies
EXECUTIVE VICE PRESIDENT & CHIEF FINANCIAL
OFFICER
/s/ OSCAR X. MUNOZ
------------------------------------------
Oscar X. Munoz
VICE PRESIDENT AND CONTROLLER
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 49
<SECURITIES> 0
<RECEIVABLES> 1,743
<ALLOWANCES> 0
<INVENTORY> 197
<CURRENT-ASSETS> 2,492
<PP&E> 35,638
<DEPRECIATION> 20,730
<TOTAL-ASSETS> 18,407
<CURRENT-LIABILITIES> 4,696
<BONDS> 8,642
0
0
<COMMON> 0
<OTHER-SE> 755
<TOTAL-LIABILITY-AND-EQUITY> 18,407
<SALES> 12,378
<TOTAL-REVENUES> 12,378
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 9,329
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 543
<INCOME-PRETAX> 2,419
<INCOME-TAX> 911
<INCOME-CONTINUING> 1,508
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,508
<EPS-PRIMARY> 3.05
<EPS-DILUTED> 3.02
</TABLE>
