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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 1-3040
U S WEST Communications, Inc.
A Colorado Corporation IRS Employer No. 84-0273800
1801 California Street, Denver, Colorado 80202
Telephone Number (303) 896-3099
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF U S WEST, INC., MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) and (b) OF FORM 10-Q AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION H(2).
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 __
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<PAGE>
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Form 10-Q - Part I U S WEST Communications, Inc.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
PART I - FINANCIAL INFORMATION
<S> <C> <C>
1. Financial Statements
Consolidated Statements of Income -
Three and Nine Months Ended September 30, 1998 and 1997 3
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
2. Management's Analysis of the Results of Operations - (Reduced
disclosure format pursuant to General Instruction H(2)) 11
PART II - OTHER INFORMATION
1. Legal Proceedings 18
5. Other Information 18
6. Exhibits and Reports on Form 8-K 18
</TABLE>
<PAGE>
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF U S WEST COMMUNICATIONS, INC.
INCOME (Unaudited)
<TABLE>
<CAPTION>
- ------------------------------------------------------- ---------------------------- ----------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
Dollars in millions 1998 1997 1998 1997
- ------------------------------------------------------- -------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Operating revenues:
Local service $1,398 $1,314 $4,117 $3,739
Interstate access service 693 663 2,102 2,028
Intrastate access service 208 208 616 608
Long-distance network services 199 231 595 721
Other services 241 193 673 548
-------------- ------------- ------------- --------------
Total operating revenues 2,739 2,609 8,103 7,644
Operating expenses:
Employee-related expenses 868 850 2,550 2,498
Other operating expenses 544 479 1,709 1,303
Taxes other than income taxes 81 100 260 300
Depreciation and amortization 544 528 1,580 1,574
-------------- ------------- ------------- --------------
Total operating expenses 2,037 1,957 6,099 5,675
-------------- ------------- ------------- --------------
Operating income 702 652 2,004 1,969
Interest expense 103 93 288 282
Gains on sales of rural telephone exchanges - 30 - 77
Other expense - net 20 11 76 51
-------------- ------------- ------------- --------------
Income before income taxes 579 578 1.640 1,713
Provision for income taxes 219 220 630 653
-------------- ------------- ------------- --------------
NET INCOME $360 $358 $1,010 $ 1,060
============== ============= ============= ==============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS U S WEST COMMUNICATIONS, INC.
(Unaudited)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------- ----------------- -------------------
September 30, December 31,
Dollars in millions 1998 1997
- ------------------------------------------------------------------------- ----------------- -------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $57 $ 26
Accounts and notes receivable - net 1,646 1,608
Inventories and supplies 200 124
Deferred tax asset 162 226
Prepaid and other 64 68
----------------- -------------------
Total current assets 2,129 2,052
Gross property, plant and equipment 34,265 33,182
Accumulated depreciation 19,967 19,041
----------------- -------------------
Property, plant and equipment - net 14,298 14,141
Other assets 899 815
----------------- -------------------
Total assets $17,326 $17,008
================= ===================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Form 10-Q - Part I
CONSOLIDATED BALANCE SHEETS U S WEST COMMUNICATIONS, INC.
(Unaudited), continued
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------- ------------------- --------------------
September 30, December 31,
Dollars in millions 1998 1997
- ---------------------------------------------------------------------- ------------------- --------------------
<S> <C> <C>
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities:
Short-term debt $850 $ 497
Accounts payable 1,231 1,439
Employee compensation 303 321
Dividends payable 360 192
Advanced billing and customer deposits 319 292
Other 958 982
------------------- --------------------
Total current liabilities 4,021 3,723
Long-term debt 4,831 5,019
Postretirement and other postemployment
benefit obligations 2,371 2,365
Deferred income taxes 923 891
Deferred credits and other 717 610
Contingencies
Shareowner's equity:
Common shares - one share without par value,
owned by parent 8,080 8,017
Cumulative deficit (3,617) (3,617)
------------------- --------------------
Total shareowner's equity 4,463 4,400
------------------- --------------------
Total liabilities and shareowner's equity $17,326 $17,008
=================== ====================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Form 10-Q - Part I
CONSOLIDATED STATEMENTS OF U S WEST COMMUNICATIONS, INC.
CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------- --------------- ---------------
Nine Months Ended September 30, 1998 1997
- ----------------------------------------------------------------------------- --------------- ---------------
Dollars in millions
<S> <C> <C>
OPERATING ACTIVITIES
Net income $1,010 $1,060
Adjustments to net income:
Depreciation and amortization 1,580 1,574
Gains on sales of rural telephone exchanges - (77)
Deferred income taxes and amortization
of investment tax credits 90 1
Changes in operating assets and liabilities:
Accounts receivable (38) 37
Inventories, supplies and other current assets (19) (55)
Accounts payable and accrued liabilities 16 247
Other - net 43 119
--------------- ---------------
Cash provided by operating activities 2,682 2,906
--------------- ---------------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (1,880) (1,291)
Proceeds from (payments on) disposals of property,
plant and equipment (14) 21
Purchase of PCS licenses (18) (51)
Proceeds from sales of rural telephone exchanges - 51
Other (6) -
--------------- ---------------
Cash used for investing activities (1,918) (1,270)
--------------- ---------------
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term debt 457 (700)
Repayments of long-term debt (411) (107)
Dividends paid on common stock (842) (1,009)
Equity infusions from U S WEST 63 260
--------------- ---------------
Cash used for financing activities (733) (1,556)
--------------- ---------------
CASH AND CASH EQUIVALENTS
Increase 31 80
Beginning balance 26 92
=============== ===============
Ending balance $57 $ 172
=============== ===============
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 1998 and 1997
(Dollars in millions)
(Unaudited)
A. Summary of Significant Accounting Policies
Basis of Presentation. U S WEST Communications, Inc. (the "Company") is
incorporated under the laws of the State of Colorado and is an indirect, wholly
owned subsidiary of U S WEST, Inc. ("U S WEST").
Certain reclassifications within the Consolidated Financial Statements have been
made to conform to the current year presentation.
The Consolidated Financial Statements have been prepared by the Company,
pursuant to the interim reporting rules and regulations of the Securities and
Exchange Commission ("SEC"). Certain information and footnote disclosures
normally accompanying financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
SEC rules and regulations. In the opinion of the Company's management, the
Consolidated Financial Statements include all adjustments, consisting of only
normal recurring adjustments, necessary to present fairly the financial
information set forth therein. It is suggested that these Consolidated Financial
Statements be read in conjunction with the financial statements and notes
thereto included in the Company's Form 10-K/A for the year ended December 31,
1997.
B. U S WEST Separation
On October 25, 1997, the Board of Directors of the former parent of U S WEST,
herein referred to as "Old U S WEST," adopted a proposal to separate Old U S
WEST into two independent companies (the "Separation"). Old U S WEST conducted
its businesses through two groups: the U S WEST Communications Group (the
"Communications Group"), which included the communications businesses of Old U S
WEST, and the U S WEST Media Group (the "Media Group"), which included the
multimedia businesses of Old U S WEST. On June 4, 1998, shareholders of Old U S
WEST voted in favor of the Separation, which became effective June 12, 1998 (the
"Separation Date"). At that time, the Communications Group became an independent
public company renamed "U S WEST, Inc." and Media Group's directory business
known as U S WEST Dex, Inc. ("Dex") was aligned with U S WEST (the "Dex
Alignment"). Old U S WEST has continued as an independent public company
comprised of the current businesses of Media Group other than Dex and has been
renamed "MediaOne Group, Inc." ("MediaOne Group").
<PAGE>
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
The Separation was implemented pursuant to the terms of a separation agreement
(the "Separation Agreement") between U S WEST and MediaOne Group. In connection
with the Dex Alignment, (i) U S WEST distributed, as a dividend to holders of
MediaOne Group common stock, an aggregate of $850 in value of U S WEST common
stock and (ii) $3.9 billion of Old U S WEST debt, formerly allocated to Media
Group, was refinanced by U S WEST (the "Dex Indebtedness").
Further information about the Separation is contained in Old U S WEST's proxy
statement mailed to all Old U S WEST shareowners on April 20, 1998.
C. Asset Impairment
During second-quarter 1998, the Company recorded a non-cash charge of $21 (net
of a $14 tax benefit) related to the impairment of certain long-lived assets
associated with the Company's video operations in Omaha, Nebraska. The impaired
assets primarily consist of underground cable and hardware. Recent technological
advances have permitted the Company to pursue and use more economical Video
Digital Subscriber Line ("VDSL") technology in cable overbuild situations.
Because the projected future cash flows were less than the carrying values, an
impairment loss was recognized in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The amount of
impairment was determined based on the net present value of the future cash
flows of the business, discounted at the Company's cost of capital. The pretax
charge is recorded in "other operating expenses" within the Consolidated
Statements of Income.
D. Contingencies
There are pending regulatory actions in local regulatory jurisdictions that call
for price decreases, refunds or both.
Oregon. On May 1, 1996, the Oregon Public Utilities Commission ("OPUC") approved
a stipulation terminating prematurely the Company's alternative form of
regulation ("AFOR") plan, and it then undertook a review of the Company's
earnings. In May 1997, the OPUC ordered the Company to reduce its annual
revenues by $97, effective May 1, 1997, and to issue a one-time refund,
including interest, of approximately $102 to reflect the revenue reduction for
the period May 1, 1996 through April 30, 1997. The one-time refund is for
interim rates which became subject to refund when the Company's AFOR plan was
terminated on May 1, 1996.
<PAGE>
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
The Company filed an appeal of the order and asked for an immediate stay of the
refund with the Oregon Circuit Court which granted the Company'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 the Company's favor on most of the
appealed issues. The OPUC appealed to the Oregon Court of Appeals on March 19,
1998, and the appeal is pending. The Company continues to charge interim rates,
subject to refund, during the pendency of that appeal. The potential refund
exposure, including interest, at September 30, 1998, is not expected to exceed
$280.
Utah. The Utah Supreme Court has remanded a Utah Public Service Commission
("UPSC") order to the UPSC for hearing, thereby establishing two exceptions to
the rule against retroactive ratemaking: 1) unforeseen and extraordinary events,
and 2) misconduct. The UPSC's initial order denied a refund request from
interexchange carriers ("IXCs") and other parties related to the Tax Reform Act
of 1986. The potential exposure, including interest, at September 30, 1998, is
not expected to exceed $170.
New Mexico. The New Mexico State Corporation Commission ("NMSCC") issued an
order on May 29, 1998, requiring the Company to reduce its annual revenues by
approximately $22. The Company sought a rehearing before the NMSCC which was
denied. The NMSCC's order was then removed to the New Mexico Supreme Court for
review which effectively stays the order. The potential for retroactive
exposure, at September 30, 1998, is remote.
State Regulatory Accruals. The Company has accrued $200 at September 30, 1998,
which represents its estimated liabilities for all state regulatory proceedings,
predominately the items discussed above. It is possible that the ultimate
liabilities could exceed the amounts accrued by up to approximately $265. The
Company 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, the
Company has an accrued liability of approximately $160 at September 30, 1998
related to refunds in the state of Washington. Approximately $80 was refunded to
IXCs and independent local exchange carriers during the nine-month period ended
September 30, 1998. The remaining liability is expected to be refunded to
ratepayers by the first half of 1999, with the majority of the refunds occurring
in fourth-quarter 1998.
<PAGE>
Form 10-Q - Part I
U S WEST COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions)
(Unaudited)
E. New Accounting Standards
On January 1, 1999, the Company will adopt the accounting provisions required by
the AICPA Statement of Position ("SOP") 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," issued in March 1998.
SOP 98-1, among other things, requires that certain costs of internal use
software, whether purchased or developed internally, be capitalized and
amortized over the estimated useful life of the software.
Based on information currently available, adoption of the SOP may result in an
initial increase in net income in 1999 of approximately $100-$150. Thereafter,
in periods after adoption, if software expenditures remain level, earnings will
decline until the amortization expense related to the capitalized software
equals the software costs expensed prior to the accounting change. The estimated
net income impact for 1999 and thereafter may be subject to change as further
information becomes available. Please see Part I - Item II- "Forward-Looking
Information."
On June 15, 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and for Hedging Activities." This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. SFAS No. 133 requires, among other
things, that all derivative instruments be recognized at fair value as either
assets or liabilities on the balance sheet and that changes in fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. The Standard is effective for fiscal years beginning after June 15, 1999,
though earlier adoption is permitted. The financial statement impacts of the
Company's adoption of the new standard are dependent upon the amount and nature
of future use of derivative instruments, and their relative changes in valuation
over time.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in millions)
Forward-Looking Information
Some of the information presented in or in connection with this report
constitutes "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Although the Company believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. Factors that could
cause actual results to differ from expectations include: (i) greater than
anticipated competition from new entrants into the local exchange, intraLATA
toll, data and wireless markets, (ii) changes in demand for the Company's
products and services, including optional custom calling features, (iii) higher
than anticipated employee levels, capital expenditures, and operating expenses
(such as costs associated with year 2000 remediation), (iv) the loss of
significant customers, (v) pending regulatory actions in state jurisdictions,
(vi) regulatory changes affecting the telecommunications industry, including
changes that could have an impact on the competitive environment in the local
exchange market, (vii) a change in economic conditions in the various markets
served by the Company's operations that could adversely affect the level of
demand for telephone, wireless, or other services offered by the Company, (viii)
greater than anticipated competitive activity requiring new pricing for
services, (ix) higher than anticipated start-up costs associated with new
business opportunities, (x) increases in fraudulent activity with respect to
wireless services, (xi) consumer acceptance of broadband services, including
telephony, data and wireless services, or (xii) delays in the development of
anticipated technologies, or the failure of such technologies to perform
according to expectations.
Results of Operations - Nine Months Ended September 30, 1998 Compared with 1997
Following are details of the Company's reported net income, normalized to
exclude the effects of certain and nonrecurring and nonoperating items.
<TABLE>
<CAPTION>
- ------------------------------------------------------------ ----------------------------- -------------------------- --
Nine Months Ended Increase
September 30,
(Decrease)
1998 1997 $ %
- ------------------------------------------------------------ ---------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Reported net income $1,010 $1,060 $(50) (4.7)
Adjustments to reported net income:
Separation costs 68 - 68 -
Asset impairment 21 - 21 -
Gains on sales of rural telephone exchanges - (48) 48 -
---------------- ------------- ------------ ------------
Normalized income $1,099 $1,012 $87 8.6
============================================================ ================ ============= ============ ============
</TABLE>
During 1998, the Company's normalized income increased $87, or 8.6 percent, to
$1,099. The increase is primarily due to higher demand for services partially
offset by interstate access rate reductions and higher operating costs,
including increased start-up costs associated with growth initiatives and higher
expenses related to interconnection.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Operating Revenues
<TABLE>
<CAPTION>
- ---------------------------------------------------------------- --------------------------- ------------------------
Nine Months Ended Increase
September 30, (Decrease)
1998 1997 $ %
- ---------------------------------------------------------------- ------------ -------------- ------------ -----------
<S> <C> <C> <C> <C>
Local service $4,117 $3,739 $378 10.1
Interstate access service 2,102 2,028 74 3.6
Intrastate access service 616 608 8 1.3
Long-distance network services 595 721 (126) (17.5)
Other services 673 548 125 22.8
============ ============== ============ ===========
Total $8,103 $7,644 $459 6.0
================================================================ ============ ============== ============ ===========
</TABLE>
Local Service Revenues. Local service revenues increased $378, or 10.1 percent,
to $4,117, during the nine-month period. Excluding the non-recurring impact of a
regulatory charge in last year's second quarter, local service revenues
increased by 8.2 percent for the nine-month period. Local service revenues
increased primarily as a result of access line growth and increased demand for
new products and services, and existing central office features. Total reported
access lines increased 579,000, or 3.7 percent, during the past 12 months, of
which 243,000 was attributable to second lines. Second line installations
increased 19.4 percent. Also contributing to the increase in revenues were the
effects of rate increases of $45 in various jurisdictions and interim
compensation revenues from IXCs as a result of Federal Communications Commission
("FCC") payphone orders, which took effect in April 1997.
Interstate Access Service Revenues. Interstate access service revenues increased
$74, or 3.6 percent, to $2,102, primarily due to the effects of a change in the
classification of universal service fundings, which increased revenues by $61.
In 1997 these fundings were offset against interstate access service revenues.
Beginning in 1998 these fundings are recorded as access expense within other
operating expenses. Excluding the effects of the reclassification, interstate
access revenues increased $13, or 0.6 percent. Increased demand for interstate
access services, as evidenced by a 6.8 percent increase in billed interstate
access minutes of use, was essentially offset by price reductions.
Intrastate Access Service Revenues. Intrastate access service revenues increased
by $8, or 1.3 percent, to $616, primarily due to higher demand, including
increased demand for private line services, partially offset by net rate
reductions. Net rate reductions aggregated $23, the majority of which were in
the state of Washington. Competitive effects are also adversely impacting
intrastate access revenue growth. Intrastate billed access minutes of use
increased by 5.8 percent during the nine-month period.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Long Distance Network Services Revenues. Long-distance network services revenues
decreased by $126, or 17.5 percent, to $595, primarily due to the effects of
competition and rate reductions of $37 in several jurisdictions, most
significantly in the state of Washington. Also contributing to the decline were
the implementation of multiple toll carrier plans ("MTCPs") in various
jurisdictions in 1997. The MTCPs essentially allow independent telephone
companies to act as toll carriers and are net income neutral to the Company,
with the reduction in toll revenues largely offset by increased intrastate
access service revenues and lower access expense.
Other Services Revenues. Revenues from other services increased by $125, or 22.8
percent, primarily as a result of greater sales of wireless communications
services and inside wire maintenance, interconnection rent revenues and
continued market penetration in voice messaging services.
Costs and Expenses
<TABLE>
<CAPTION>
- ---------------------------------------------------------------- --------------------------- ------------------------
Nine Months Ended Increase
September 30, (Decrease)
1998 1997 $ %
- ---------------------------------------------------------------- ------------ -------------- ------------ -----------
<S> <C> <C> <C> <C>
Employee-related expenses $2,550 $2,498 $52 2.1
Other operating expenses (1) 1,709 1,303 406 31.2
Taxes other than income taxes 260 300 (40) (13.3)
Depreciation and amortization 1,580 1,574 6 0.4
Interest expense 288 282 6 2.1
Gains on sales of rural telephone exchanges - 77 (77) -
Other expense - net 76 51 25 49.0
- ---------------------------------------------------------------- ------------ -------------- ------------ -----------
<FN>
<F1>
(1) Includes separation expenses of $94 and an asset impairment charge of $35
during second-quarter 1998.
</FN>
</TABLE>
Employee-Related Expenses. Total employee-related expenses increased $52, or 2.1
percent, to $2,550, during the nine-month period ended September 30, 1998.
Employee-related expenses include $16 of net costs incurred in conjunction with
the 1998 third-quarter work stoppage. These work stoppage costs include
incremental travel costs, contract labor costs and employee bonus costs paid to
management employees for work performed during the strike. Partially offsetting
these additional costs were lower salaries and wages and overtime savings
associated with occupational employees not working during the work stoppage.
Excluding these costs, employee-related expenses increased $36, or 1.4 percent,
primarily due to increased salaries an wages and higher contract labor costs.
The increase in salaries and wages was a result of workforce and wage increases
which were largely offset by the transfer of approximately 1,200 employees
during third-quarter 1997 to an unregulated affiliate. The higher contract labor
costs were largely a result of systems development work (which includes expenses
related to interconnection and year 2000 costs) and marketing and sales efforts.
Partially offsetting these increases were pension credits.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Other Operating Expenses. Excluding nonrecurring charges as described in Note 1
to the above table, other operating expenses increased by $277, or 21.3 percent,
during 1998. The increase is primarily due to increased affiliate expense as a
result of the above referenced transfer of employees to an unregulated
affiliate, interconnection expenses and costs associated with growth initiatives
(primarily PCS), including wireless handset costs and marketing and advertising
costs. Other operating expenses also increased $61 as compared to 1997 due to
the aforementioned change in classification of universal service funding
expenses. Partially offsetting the increases was a 1997 reserve adjustment
associated with billing and collection activities performed for IXCs.
Other operating expenses include $94 in costs incurred during second quarter
that are directly attributable to the Separation. These Separation costs include
executive severance, legal and financial advisory fees, securities registration
fees, printing and mailing costs, and internal systems and rearrangement costs.
During second quarter of 1998, the Company also recorded in other operating
expenses a pretax charge of $35 related to the impairment of certain long-lived
assets associated with the Company's video operations in Omaha, Nebraska. Recent
technological advances have permitted the Company to pursue and use more
economical VDSL technology in cable overbuild situations. Because the projected
future cash flows were less than the carrying values an impairment loss was
recognized in accordance with SFAS No. 121. (See "Note C - Asset Impairment" -
to the Consolidated Financial Statements.)
Taxes Other Than Income Taxes. Taxes other than income taxes decreased primarily
because of a third quarter property tax settlement in addition to adjustments
related to the 1997 property tax accrual.
Interest Expense. The increase in interest expense was primarily a result of
higher average debt levels.
Gains On Sales of Rural Telephone Exchanges. During the nine-month period ended
September 30, 1997, the Company sold selected rural telephone exchanges in
Minnesota, Iowa, Nebraska, and South Dakota for pretax gains of $77.
Other Expense - Net. Other expense increased primarily due to additional
interest expense associated with the Company's state regulatory liabilities.
Provision for Income Taxes
The effective tax rate for the first nine months of 1998 is 38.4 percent as
compared to 38.1 percent during the first nine months of 1997. The increase in
the effective tax rate is primarily due to the impact of certain expenses
related to the Separation, which are not deductible for tax purposes, and the
effects of lower amortization of investment tax credits. The effective tax rate
is expected to approximate 38.3 percent for the twelve months ended December 31,
1998.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Year 2000 Costs
During 1997 the Company conducted a comprehensive high level review of its
computer systems and related software to ensure that systems properly recognize
the year 2000 and continue to process data. The systems evaluated include (i)
the Public Switched Telephone Network (the "Network"), (ii) Information
Technologies ("IT") and (iii) individual Business Units (the "Business Units").
The Network, which processes voice and data information relating to the core
communications business, relies on remote switches, central office and
interoffice equipment, and loop transport equipment that is predominately
provided by telecommunications network vendors.
IT is comprised of the Company's internal business systems that employ hardware
and software with an enterprise-wide scope, including operational, financial and
administrative functions. The Business Units, which include internal
organizations such as finance, procurement, operator services, wireless, data
networks, real estate, etc., employ systems that support desktop and
departmental applications that relate specifically to their business and are not
generally part of the Network or IT.
The Company's approach to year 2000 remediation activities is broken down into
five general phases: (i) inventory/assessment, (ii) planning, (iii) conversion,
(iv) testing/certification and (v) implementation.
With regard to the Network, the Company is working with telecommunications
network vendors to obtain compliant releases of hardware and software. The
Company is also working on a focused testing approach given the requirement that
Network testing must be done over multiple equipment configurations involving a
broad spectrum of services. The inventory/assessment and planning phases for the
Network are complete and management expects that the testing/certification
phases will be completed by December 1998, with implementation completed by July
1999. To facilitate Network testing, the Company participates, along with other
major wireline providers of telecommunications services, as a member of the
Telco Year 2000 Forum (the "Forum"), an organization that addresses the year
2000 readiness of network elements and network interoperability. The Forum has
contracted with Bellcore, a former affiliate engaged in telecommunications
industry research, development and maintenance activities, to engage in
inter-region interoperability testing. The Company is also participating in the
FCC Network Reliability and Interoperability Council IV working group, which is
tasked to evaluate the Year 2000 readiness of the public telecommunications
network.
Within IT, the Company has identified the applications that support its critical
business processes such as billing and collection, network monitoring, repair
and ordering. The inventory/assessment and planning phases for IT are complete
and management expects that conversion will be completed by the end of 1998 or
shortly thereafter, with testing and implementation continuing through 1999.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
Within the Business Units, the Company is generally in the inventory/assessment
phase, though some Business Units have completed this phase and are into the
planning, conversion and testing/certification phases. Accordingly, a majority
of the Business Units have established project plans and associated schedules to
accomplish the remaining phases. The objective is to complete any major
conversions or upgrades by third-quarter 1999.
The Company has spent approximately $90 through the third quarter of 1998 on
year 2000 projects and activities. The estimated total incremental costs for
year 2000 related projects and activities are approximately $185 through 1999,
excluding capital expenditures. Additional incremental capital expenditures over
the same period will approximate $50-$70. Year 2000 project costs are being
funded through operations. Though year 2000 costs will directly impact the
reported level of future net income, the Company intends to manage its total
cost structure, including deferral of non-critical projects, in an effort to
mitigate the impact of year 2000 costs on its historical rate of earnings
growth. The estimate stated above may be subject to change.
Management cannot provide assurance that the result of its year 2000 compliance
efforts or the cost of such efforts will not differ materially from estimates.
Accordingly, year 2000 specific business continuity and contingency plans are
being developed to address high risk areas as they are identified. These year
2000 specific contingency plans will conform to detailed Company-wide
requirements now being established by the Company's Year 2000 Program Office.
These plans will be in place no later than third-quarter 1999. In addition, the
Company has in place its standard overall business continuity, contingency and
disaster recovery plans (such as diesel generator back-up power supply sources
for its Network, Network rerouting capabilities, and computer back-up and
recovery procedures) which will be verified, and if required, augmented for
specific year 2000 scenarios.
Within Network, the Company is highly dependent on the telecommunications
network vendors to provide compliant hardware and software in a timely manner,
and on third parties that are assisting the Company in the focused testing of
the Network. Because of these dependencies, the Company has developed and
implemented a vendor compliance process whereby the Company has obtained written
assurances of timely year 2000 compliance from most of its critical vendors (not
only for Network, but also for IT and the Business Units). The Company continues
to pursue such assurances from the remaining critical vendors. In addition, the
Company monitors and actively participates in coordinated Network testing
activities, as discussed above, with respect to the Forum and Bellcore. Within
IT, the Company is dependent on the development of software by experts, both
internal and external, and the availability of critical resources with the
requisite skill sets. Because of this dependency, the Company has developed
detailed timetables, resource plans and standardized year 2000 testing
requirements for all identified critical applications (irrespective of whether
these applications are used primarily by IT, the Network or the Business Units).
Within the Business Units, the Company is dependent on vendor supplied goods and
services, and operability of the Network, critical IT and business unit specific
applications. Because of these dependencies, the Company is implementing the
same type of vendor compliance process and application planning and testing
process at the Business Units, as discussed above with respect to the Network
and IT.
<PAGE>
Form 10-Q - Part I
Item 2. Management's Analysis of the Results of Operations (Dollars in
millions), continued
In management's view, the most reasonable worst case scenario for year 2000
failure prospects faced by the Company is that a limited number of important IT
and/or Business Unit specific applications may unexpectedly fail. In addition,
no assurance can be given that there may not be problems with the Network
relating to year 2000. Failure by the Company or by certain of its vendors to
remediate year 2000 compliance issues in advance of the year 2000 and to execute
appropriate contingency plans in the event that a critical failure is
experienced, could result in disruption of the Company's operations, possibly
impacting the Network and impairing the Company's ability to bill or collect
revenues. However, management believes that its efforts at advance remediation
and testing, obtaining written vendor assurances and advance vendor remediation,
year 2000 specific contingency planning, and overall business continuity,
contingency and disaster recovery planning will be successful, and that the
aforementioned "worst case scenario" is unlikely to develop or significantly
disrupt the Company's financial operations.
The above discussion regarding year 2000 contains statements that are
"forward-looking" within the meaning of the Private Securities Litigation Reform
Act of 1995. Although the Company believes that its estimates are based on
reasonable assumptions, there can be no assurance that actual results will not
differ materially from these estimates.
Union Contracts
On October 9, 1998, the Communications Workers of America ("CWA") informed the
Company that a majority of its voting members ratified new three-year contracts
for the Company and U S WEST Business Resources, Inc. employees. The contracts
provide for salary increases of 10.9 percent over three years, effective in
August of each year, and pension increases totaling 21 percent over three years.
The contract also provides employees with a $500 ratification bonus in lieu of
additional future wage increases. The agreement covers approximately 33,000 CWA
members.
Other Items
The Company from time to time engages in discussions regarding dispositions,
acquisitions and other similar transactions. Any such transaction may include,
among other things, the transfer, sale or acquisition of significant assets,
businesses or interests, including joint ventures, or the incurrence, assumption
or refinancing of indebtedness, and could be material to the financial condition
and results of operations of the Company. There is no assurance that any such
discussions will result in the consummation of any such transaction.
Contingencies
The Company has pending regulatory actions in local regulatory jurisdictions
that call for price decreases, refunds or both. (See "Note D - Contingencies" -
to the Consolidated Financial Statements.)
<PAGE>
Form 10-Q - Part II U S WEST Communications, Inc.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company and its subsidiaries are subject to claims and proceedings arising
in the ordinary course of business. At the Company, there are pending certain
regulatory actions in local regulatory jurisdictions that call for price
decreases, refunds or both. For a discussion of these actions, see "Note D -
Contingencies" - to the Consolidated Financial Statements.
Item 5. Other Information
On October 9, 1998 the Communications Workers of America informed the Company
that a majority of its voting members ratified both of the contracts for Company
and U S WEST Business Resources, Inc. employees. Both contracts are effective
August 16, 1998 and will continue in effect until August 18, 2001.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No.
12 Statement regarding computation of earnings to fixed charges ratio of
U S WEST Communications, Inc.
27 Financial Data Schedule
(b) Reports on Form 8-K Filed During the Third Quarter of 1998
(i) Form 8-K dated August 16, 1998 concerning a press release announcing
the work stoppage commenced by clerical and technical employees
represented by the Communications Workers of America.
(ii) Form 8-K dated August 31, 1998 concerning a press release announcing a
tentative agreement reached on the Labor Contract between U S WEST,
Inc. and the Communications Workers of America.
<PAGE>
Form 10-Q - Part II U S WEST Communications, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
U S WEST Communications, Inc.
/s/ ALLAN R. SPIES
By:___________________________________
Allan R. Spies
Vice President and Chief Financial Officer
November 6, 1998
Exhibit 12
U S WEST COMMUNICATIONS, INC.
RATIO OF EARNINGS TO FIXED CHARGES
(Dollars in Millions)
<TABLE>
<CAPTION>
Quarter Ended
9/30/98 9/30/97
- ------------------------------------------ ----------- --------
<S> <C> <C>
Income before income taxes $ 579$ 578
Interest expense (net of amounts
capitalized) 103 93
Interest factor on rentals (1/3) 14 16
----------- --------
Earnings $ 696 $ 687
Interest expense $ 109 $ 97
Interest factor on rentals (1/3) 14 16
----------- --------
Fixed charges $ 123 $ 113
Ratio of earnings to fixed charges 5.66 6.08
- ------------------------------------------ ----------- --------
Nine Months Ended
9/30/98 9/30/97
- ------------------------------------------ ----------- --------
Income before income taxes $ 1,640 $ 1,713
Interest expense (net of amounts
capitalized) 288 282
Interest factor on rentals (1/3) 46 48
----------- --------
Earnings $ 1,974 $ 2,043
Interest expense $ 305 $ 297
Interest factor on rentals (1/3) 46 48
----------- --------
Fixed charges $ 351 $ 345
Ratio of earnings to fixed charges 5.62 5.92
- ------------------------------------------ ----------- --------
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000068622
<NAME> U S WEST COMMUNICATIONS, INC.
<MULTIPLIER> 1,000,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JAN-01-1998 JAN-01-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 57 57
<SECURITIES> 0 0
<RECEIVABLES> 1,646 1,646
<ALLOWANCES> 0 0
<INVENTORY> 200 200
<CURRENT-ASSETS> 2,129 2,129
<PP&E> 34,265 34,265
<DEPRECIATION> 19,967 19,967
<TOTAL-ASSETS> 17,326 17,326
<CURRENT-LIABILITIES> 4,021 4,021
<BONDS> 4,831 4,831
0 0
0 0
<COMMON> 8,080 8,080
<OTHER-SE> (3,617) (3,617)
<TOTAL-LIABILITY-AND-EQUITY> 17,326 17,326
<SALES> 2,739 8,103
<TOTAL-REVENUES> 2,739 8,103
<CGS> 0 0
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<OTHER-EXPENSES> 2,037 6,099
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<INTEREST-EXPENSE> 103 288
<INCOME-PRETAX> 579 1,640
<INCOME-TAX> 219 630
<INCOME-CONTINUING> 360 1,010
<DISCONTINUED> 0 0
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<NET-INCOME> 360 1,010
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