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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 March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 1-3040
U S WEST Communications, Inc.
A Colorado Corporation IRS Employer No. 84-0273800
1801 California Street, Denver, Colorado 80202
Telephone Number (303) 672-2700
___________
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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1
<PAGE>
U S WEST Communications, Inc.
Form 10-Q
<TABLE>
<CAPTION>
<S> <C> <C>
TABLE OF CONTENTS
Item Page
PART I - FINANCIAL INFORMATION
1. Financial Statements
Consolidated Statements of Income -
Three months ended March 31, 1999 and 1998 3
Consolidated Balance Sheets -
March 31, 1999 and December 31, 1998 4
Consolidated Statements of Cash Flows -
Three months ended March 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 6
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
3. Quantitative and Qualitative Disclosures
About Market Risk 15
PART II - OTHER INFORMATION
1. Legal Proceedings 22
6. Exhibits and Reports on Form 8-K 22
</TABLE>
2
<PAGE>
U S WEST Communications, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
Quarter Ended March 31,
1999 1998
(dollars in millions)
<S> <C> <C>
Operating revenues:
Local services $1,867 $1,730
Access services 681 665
Long-distance services 171 201
Other services 74 73
--------------- ---------------
Total operating revenues 2,793 2,669
Operating expenses:
Employee-related expenses 893 822
Other operating expenses 629 604
Depreciation and amortization 585 518
--------------- ---------------
Total operating expenses 2,107 1,944
--------------- ---------------
Operating income 686 725
Other expense:
Interest expense (89) (91)
Other expense-net (12) (27)
--------------- ---------------
Total other expense-net (101) (118)
--------------- ---------------
Income before income taxes 585 607
Provision for income taxes 216 233
--------------- ---------------
Net income $369 $374
=============== ===============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
U S WEST Communications, Inc.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
(unaudited)
<S> <C> <C>
(dollars in millions)
ASSETS
Current assets:
Cash and cash equivalents $50 $68
Accounts receivable, less allowance for uncollectibles of
$48 and $55, respectively 1,582 1,619
Inventories and supplies 179 154
Deferred tax assets 120 113
Prepaid and other 110 61
----------------- ----------------
Total current assets 2,041 2,015
Property, plant and equipment-net 14,859 14,681
Other assets-net 921 882
----------------- ----------------
Total assets $17,821 $17,578
================= ================
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Short-term debt $864 $789
Accounts payable 1,397 1,411
Accrued expenses 1,551 1,383
Advanced billings and customer deposits 333 326
----------------- ----------------
Total current liabilities 4,145 3,909
Long-term debt 5,155 5,154
Postretirement and other postemployment benefit obligations 2,428 2,458
Deferred income taxes 941 898
Unamortized investment tax credits 159 159
Deferred credits and other 533 537
Commitments and Contingencies
Stockholder's equity:
Common stock-one share without par value, owned by parent 8,077 8,080
Cumulative deficit (3,617) (3,617)
----------------- ----------------
Total stockholder's equity 4,460 4,463
----------------- ----------------
Total liabilities and stockholder's equity $17,821 $17,578
================= ================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE>
U S WEST Communications, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Quarter Ended March 31,
1999 1998
(dollars in millions)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $369 $374
Adjustments to net income:
Depreciation and amortization 585 518
Deferred income taxes and amortization of investment tax credits 31 62
Changes in operating assets and liabilities:
Accounts receivable 37 76
Inventories, supplies and other current assets (86) (26)
Accounts payable, accrued expenses and advanced billings 145 97
Other (68) (12)
-------------- --------------
Cash provided by operating activities 1,013 1,089
-------------- --------------
INVESTING ACTIVITIES
Expenditures for property, plant and equipment (730) (550)
Proceeds from (payments on) disposals of property, plant and equipment (8) 19
Other - (18)
-------------- --------------
Cash used for investing activities (738) (549)
-------------- --------------
FINANCING ACTIVITIES
Net proceeds from (repayments of) short-term debt 216 (62)
Repayments of long-term debt (181) (23)
Dividends paid on common stock (328) (192)
-------------- --------------
Cash used for financing activities (293) (277)
-------------- --------------
CASH AND CASH EQUIVALENTS
Increase (decrease) (18) 263
Beginning balance 68 26
-------------- --------------
Ending balance $50 $289
============== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE>
U S WEST Communications, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the three months ended March 31, 1999
(unaudited)
(dollars in millions)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The consolidated financial statements include
accounts of U S WEST Communications, Inc. (the "Company"), and its wholly owned
subsidiaries. We are a wholly owned subsidiary of U S WEST, Inc. ("U S WEST").
The consolidated interim financial statements are unaudited. The financial
statements have been prepared in accordance with the instructions for Form 10-Q
and, therefore, do not necessarily include all information and footnotes
required by generally accepted accounting principles. In our opinion, all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly our consolidated financial position, results of operations and
cash flows as of March 31, 1999 and for all periods presented have been made.
The statements are subject to year-end audit adjustment. A description of our
accounting policies and other financial information are included in the audited
consolidated financial statements filed with the Securities and Exchange
Commission in our Form 10-K/A for the year ended December 31, 1998. The
consolidated results of operations for the quarter ended March 31, 1999 are not
necessarily indicative of the results expected for the full year.
Certain reclassifications of prior period revenue amounts have been made to
conform to the current year presentation.
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." 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.
Adoption of the SOP resulted in an increase in net income for the quarter ended
March 31, 1999 of $40.
6
<PAGE>
NOTE 2: SEGMENT INFORMATION
We operate in three segments: retail services, wholesale services and
network services. The retail services segment provides local telephone services,
including wireless, data and long-distance services. The wholesale services
segment provides access services that connect customers to the facilities of
interexchange carriers and interconnection to our telecommunications network to
competitive local exchange carriers. Our network services segment provides
access to our telecommunications network, including our information
technologies, primarily to our retail services and wholesale services segments.
We provide our 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.
Following is a breakout of our segments, which has been extracted from the
financial statements of U S WEST. Separate segment data is not provided to our
chief operating decision-maker for the Company. Certain revenues and expenses of
U S WEST are included in the segment data, which have been eliminated in the
reconciling items column. Additionally, because significant expenses of
operating the retail services and wholesale services segments are not allocated
to the segments for decision-making purposes, management does not believe the
segment margins are representative of the actual operating results of the
segments. The margin for the retail services and wholesale services segments
excludes network and corporate expenses. The margin for the network services
segment excludes corporate expense. The "other" category includes our corporate
expenses. Asset information by segment is not provided to our chief operating
decision-maker. The communications and related services column represents a
total of the retail services, wholesale services and network services segments.
Total
Communications
and
<TABLE>
<CAPTION>
Retail Wholesale Network Related Reconciling Consolidated
Services Services Services Services Other Items Total
<S> <C> <C> <C> <C> <C> <C> <C>
1999
Operating
revenues $2,169 $691 $50 $2,910 $- $(117) $2,793
Margin 1,505 530 (685) 1,350 (35) (730) 585(1)
Capital
expenditures 111(2) 31 638 780 - (50) 730
1998
Operating
revenues 2,067 635 45 2,747 - (78) 2,669
Margin 1,564 510 (676) 1,398 (108) (683) 607(1)
Capital
expenditures 118(2) - 391 509 7 34 550
</TABLE>
7
<PAGE>
(1) Represents income before income taxes. Adjustments that are made to the
total of the segments' margin to arrive at income before income taxes include
the following:
<TABLE>
<CAPTION>
Quarter Ended March 31,
------------------------------------------
1999 1998
------------------- -------------------
<S> <C> <C>
Costs and adjustments excluded from segment data but included in
the consolidated total:
Taxes other than income taxes $87 $93
Depreciation and amortization 585 518
Interest expense 89 91
Other expense-net 12 27
Other charges applicable to U S WEST, Inc. (43) (46)
------------------- -------------------
$730 $683
=================== ===================
</TABLE>
(2) Capital expenditures reported for the retail services segment include only
expenditures for wireless services. Additional capital expenditures relating to
those services are included in network services capital expenditures.
In addition to the operating revenues disclosed above, intersegment operating
revenues of the retail services segment were $6 and $6 for the quarters ended
March 31, 1999 and 1998, respectively. Intersegment operating revenues of the
network services segment were $17 and $18 for the quarters ended March 31, 1999
and 1998, respectively.
NOTE 3: 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 March 31, 1999, we have a remaining commitment of $49
to be paid in a combination of cash and services through 2004.
Contingencies
We have the following pending regulatory actions:
Oregon. On May 1, 1996, the Oregon Public Utilities Commission ("OPUC")
approved a stipulation terminating prematurely our alternative form of
regulation ("AFOR") plan and it then undertook a review of our earnings. In
May 1997, the OPUC ordered us to reduce our 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. This one-time refund for interim rates became subject to
refund when our AFOR plan was terminated on May 1, 1996.
We filed an appeal of the order and asked for an immediate stay of the
refund with the Oregon Circuit Court which granted our 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 our 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. We continue to charge interim rates, subject to refund,
during the pendency of that appeal. The potential exposure, including interest,
at March 31, 1999, is not expected to exceed $350.
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.
On April 19, 1999, the UPSC approved a settlement whereby we will refund $43 to
our Utah basic exchange service customers. In addition, the UPSC approved a
settlement with certain exchange carriers settling those carriers' claims for
$3.
8
<PAGE>
State Regulatory Accruals. We have accrued $253 at March 31, 1999, which
represents our estimated liabilities for all state regulatory proceedings. It is
possible that the ultimate liabilities could exceed the amounts accrued by
approximately $175. We will continue to monitor and evaluate the risks
associated with our regulatory jurisdictions and will adjust estimates as new
information becomes available.
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.
We are subject to other legal proceedings and claims that arise in the
ordinary course of business. Although there can be no assurance of the ultimate
disposition of these matters, it is management's opinion, based upon the
information available at this time, that the expected outcome, individually or
in the aggregate, will not have a material adverse effect on our results of
operations and financial position.
9
<PAGE>
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (dollars in millions) Special Note Regarding Forward-Looking
Statements
Some of the information presented in this Form 10-Q constitutes
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Although U S WEST Communications, Inc. (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:
o greater than anticipated competition from new entrants into the local
exchange, intraLATA (local access transport area) toll, wireless and data
markets, causing loss of customers and increased price competition;
o changes in demand for our products and services, including optional custom
calling features;
o higher than anticipated employee levels, capital expenditures and operating
expenses (such as costs associated with interconnection and Year 2000
remediation);
o the loss of significant customers;
o 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;
o a change in economic conditions in the various markets served by our
operations;
o higher than anticipated start-up costs associated with new business
opportunities;
o delays in our ability to begin offering interLATA long-distance services;
o consumer acceptance of broadband services, including telephony, data, and
wireless services; and
o 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 as an exhaustive list
or as any admission by us regarding the adequacy of the disclosures. 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, 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.
Results of Operations
Quarter Ended March 31, 1999 Compared with Quarter Ended March 31, 1998
Net income for the quarter ended March 31, 1999, was $369 compared to $374
for the quarter ended March 31, 1998. While the Company experienced a 4.6%
increase in revenues, the increase was substantially offset by increases in
expenses to support our growth initiatives, enhanced customer service and
greater network and interconnection costs.
The following sections provide a more detailed discussion of the changes in
revenues and expenses.
10
<PAGE>
Operating Revenues
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Increase
<S> <C> <C> <C> <C>
Local services revenues $1,867 $1,730 $137 7.9%
</TABLE>
Local services revenues. Local services revenues include basic monthly
service fees, fees for calling services, such as voice messaging and caller
identification, wireless revenues, subscriber access line charges, MegaBit
(Trademark) data services, public phone revenues, and installation and
connection charges. State public service commissions regulate most local service
rates.
Local services revenues increased in 1999 due largely to access line
growth, increased sales of calling services and increased wireless revenues.
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. As of the end of the first quarter of 1999, we had added
569,000 additional access lines, an increase of 3.5% over the first quarter of
1998. Of this increase, second line installations accounted for 251,000 lines,
an increase of 17.8% compared with the first quarter of 1998. Offsetting these
increases were net regulatory rate adjustments and related accruals of $6.
While the number of access lines, sales of calling services and associated
revenues increased in 1999, the growth rate has declined from 1998. The decline
in the growth rate was primarily attributable to increased competition as well
as our customer retention strategy of offering bundles of services to customers
at lower prices in return for entering into longer-term contracts. Additionally,
some business customers have opted to migrate from multiple single lines to high
capacity lines, which decreases local services revenues but increases access
services revenues. 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 3.8% of fiscal 1998 local services revenues. While the sale
is expected to provide us with a one-time gain in 1999 or 2000, the sale will
negatively impact future revenue growth.
11
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Increase
<S> <C> <C> <C> <C>
Access services revenues $681 $665 $16 2.4%
</TABLE>
Access services revenues. Access services 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. These
revenues are generated from both interstate and intrastate services.
Access services revenues increased due to greater demand for both
interstate and intrastate access services. The volume of interstate and
intrastate access minutes billed increased 6.6% and 5.2%, respectively, in the
first quarter of 1999 compared to the first quarter of 1998. Rate decreases of
$14 and $17 for interstate and intrastate access services, respectively, offset
increases in demand. The net impact of increased demand, offset by rate
reductions, was to increase interstate access services revenues by $41 or 5.9%
over the comparable quarter in 1998, while the intrastate access services
revenues decreased by $9 or 4.4% over the comparable quarter in 1998. While we
anticipate increased demand for access services will continue, the effect of
rate reductions is anticipated to continue to cause a decline in intrastate
access services revenues. Revenues from local number portability, which we began
billing in February 1999, accounted for an additional $5 increase. Additionally,
1998 revenues were favorably impacted by a $20 regulatory rate adjustment.
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Decrease
<S> <C> <C> <C> <C>
Long-distance services revenues $171 $201 $(30) (14.9)%
</TABLE>
Long-distance services revenues. Long-distance services revenues are
derived from customer calls to locations outside of their local calling area but
within the same LATA. The decrease in long-distance services revenues was
primarily attributable to greater competition, resulting in a $20 revenue
decline and rate reductions accounted for the remainder of the revenue loss. As
of March 31, 1999, in ten 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.
We believe we will continue to experience further declines in long-distance
services revenues as regulatory actions provide for increased levels of
competition. We are responding to competition through competitive pricing of
intraLATA long-distance services and increased promotional efforts to retain
customers. See "Special Note Regarding Forward-Looking Statements" on page 10.
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Increase
<S> <C> <C> <C> <C>
Other services revenues $74 $73 $1 1.4%
</TABLE>
12
<PAGE>
Other services revenues. Other services revenues include billings and
collections for interexchange carriers and customer equipment sales.
Operating Expenses
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Increase
<S> <C> <C> <C> <C>
Employee-related expenses $893 $822 $71 8.6%
</TABLE>
Employee-related expenses. Employee-related expenses include salaries and
wages, benefits, payroll taxes and contract labor.
Employee-related expenses increased because of growth in several sectors of
the business, primarily wireless communications, resulting in increased employee
levels. Additionally, increased commitments towards improving customer service,
including meeting requests for installation and repair services, resulted in
higher labor costs. Across-the-board wage increases also contributed to the
increase in employee-related expenses. Partially offsetting these increases was
a $19 pension credit in 1999 compared to a $10 pension credit in 1998. In
addition, $13 of employee-related expenses associated with developing internal
use software were capitalized in 1999 due to the adoption of AICPA Statement of
Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use", effective January 1, 1999.
13
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Increase
<S> <C> <C> <C> <C>
Other operating expenses $629 $604 $25 4.1%
</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 and other selling, general and administrative
costs.
The increase in other operating expenses was primarily attributable to the
following:
o increased costs of product sales associated with growth initiatives,
including wireless handset costs and costs applicable to our data
communication services,
o higher marketing and advertising costs for wireless data communication
services and calling services, such as caller identification,
o higher interconnection, local number portability and Year 2000 remediation
costs, and
o higher access charge expenses resulting from rulings that require us to pay
reciprocal compensation to other local exchange carriers for calls that
originate on our network and terminate on other local exchange carriers'
networks.
Partially offsetting the increase in other operating expenses was the
effect of capitalizing $51 of expenses associated with developing internal use
software in accordance with SOP 98-1. Additionally, we incurred lower property
taxes due to favorable settlement of outstanding assessments.
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Increase
<S> <C> <C> <C> <C>
Depreciation and amortization expense $585 $518 $67 12.9%
</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. Additionally, the
asset lives of certain assets were reduced, reflecting changes in technology,
causing greater depreciation expense.
14
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
March 31,
1999 1998 Decrease
<S> <C> <C> <C> <C>
Other expense-net $101 $118 $(17) (14.4)%
</TABLE>
Other expense-net. Interest expense remained consistent at $89 in 1999
compared to $91 in 1998. Also included in other expense-net, were other expenses
of $12 in 1999 compared to $27 in 1998. The reduction in 1999 was primarily
attributable to higher contributions to an affiliated foundation in 1998 and
higher interest on state tax audits in 1998.
<TABLE>
<CAPTION>
Quarter Ended
March-31, Increase
1999 1998 (Decrease)
<S> <C> <C> <C> <C>
Segment margin results:
Retail segment $1,505 $1,564 $(59) (3.8)%
Wholesale segment 530 510 20 3.9%
Network segment (685) (676) (9) (1.3)%
</TABLE>
Segment results. For segment reporting purposes, segment margins exclude
certain costs and expenses, including depreciation and amortization, corporate
expenses and taxes other than income. See Note 2 to the consolidated financial
statements.
Margin from the retail services segment decreased due to operating expenses
increasing at a greater rate than revenue growth. Revenue from the retail
services segment increased 4.9% for the first quarter of 1999 over the
comparable 1998 period, primarily due to growth in local services revenue. The
revenue increase was more than offset by the higher operating expenses driven by
growth initiatives and increased customer service costs. Margin from the
wholesale services segment increased as a result of greater demand for access
services, partially offset by price reductions as mandated by both federal and
state regulatory authorities and higher operating costs, including greater
interconnection costs and additional access charge expenses. Margin from the
network services segment decreased as a result of expenditures to support growth
in both the retail and wholesale services segments.
15
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
March-31,
1999 1998 Decrease
<S> <C> <C> <C> <C>
Provision for income taxes $216 $233 $(17) (7.3)%
</TABLE>
Provision for income taxes. The decrease in the provision for income taxes
corresponds with the decrease in income before income taxes.
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 financial derivatives to hedge interest rate and foreign currency
exposures associated with particular debt issues to synthetically obtain below
market interest rates. We do not use derivative financial instruments for
trading purposes.
As of March 31, 1999 and December 31, 1998, approximately $217 and $123,
respectively, of floating-rate debt was exposed to changes in interest rates.
This exposure is primarily linked to commercial paper rates. A hypothetical 10%
change in commercial paper rates would not have had a material effect on our
earnings. As of March 31, 1999 and December 31, 1998, we also had $74 and $228,
respectively, of long-term fixed rate debt obligations maturing in the following
12 months. Any new debt obtained to refinance this debt would be exposed to
changes in interest rates. A hypothetical 10% change in the interest rates on
this debt would not have had a material effect on our earnings.
As of December 31, 1998, we had interest rate swaps with notional amounts
of $155. The swaps synthetically transformed certain of the Company's floating
rate issues into fixed rate obligations. The swaps and associated debt issues
were indexed to two-and 10-year constant maturity U.S. Treasury rates. Any gains
(losses) on the swaps were offset by losses (gains) on the associated debt
instruments. As of March 31, 1999, all outstanding interest rate swaps and the
associated debt instruments have matured.
As of March 31, 1999 and December 31, 1998, we had also entered into
cross-currency swaps with notional amounts of $204. The cross-currency swaps
synthetically transform $169 and $182 of Swiss Franc borrowings at March 31,
1999 and December 31, 1998, 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.
16
<PAGE>
Recent Regulatory Developments
Interconnection. The Federal Communications Commission ("FCC") issued an
order (the "Order") in 1996 relating to the Telecommunications Act of 1996
("Act") that 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.
On January 25, 1999, the U.S. Supreme Court ("Supreme Court") issued a
ruling on our appeal of the Order. Although the decision stated that the Act was
ambiguous and self-contradictory, the Supreme Court ruled that:
o the FCC has authority to set pricing methodology;
o unbundled network elements must be provided in cases where necessary or the
lack of availability would impair competition;
o Incumbent local exchange companies ("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
o CLECs may pick and choose pricing or other terms and conditions from
multiple contracts within certain bounds.
The impact of the Supreme Court ruling is unclear since state regulatory
commissions generally follow the FCC's pricing and unbundling requirements in
setting unbundled network element prices. On April 16, 1999, the FCC issued a
Further Notice of Proposal Rulemaking ("FNPRM") to address how it should
interpret the "necessary and impair" standard and which specific network
elements the FCC should require ILECs to unbundle. We expect further review of
the legality of the FCC's pricing rules will occur at the Eighth Circuit Court
of Appeals.
InterLATA Long-Distance Entry. Several regional Bell operating companies
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.
We view entry into this business as important to our strategy of providing
an integrated bundle of services to our customers. In 1999, we withdrew our
applications to enter the interLATA long-distance business in Wyoming and
Montana but we filed an application in Arizona. In April 1999, the Nebraska
Public Service Commission indicated it needed additional information before
making a recommendation to the FCC. We expect our application to be forwarded to
the FCC for its review later 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 July 1, 1999 and 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).
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.
In February 1999, the FCC issued an order declaring that Internet traffic
is interstate and opened a proceeding to determine the appropriate regulatory
structure. The FCC allowed no change in the current agreements for reciprocal
compensation with CLECs until it rules on this matter. A ruling is expected in
the summer of 1999.
Advanced Telecommunications Services. On March 31, 1999, the FCC issued an
order establishing expanded collocation requirements for both conventional voice
and advanced services. The FCC also issued a FNPRM on "line sharing." Line
sharing allows a CLEC to provide advanced services over the same loop that the
ILEC uses to provide analog voice service. We are currently reviewing the legal
and regulatory ramifications of these orders.
17
<PAGE>
Contingencies
We have pending regulatory actions in local regulatory jurisdictions. See
Note-3 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.
Year 2000 Costs
Background. We have conducted a comprehensive review of our computer-based
systems and related software and are taking 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 systems within (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 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 are
continuously monitoring and improving our year 2000 related activities and
progress, communicating with our customers and vendors, participating in
cooperative testing with others and taking steps to assure that we have
contingency plans in place prior to the end of 1999. These activities will
continue throughout 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 Telcordia (formerly known as
Bellcore), a former affiliate engaged in telecommunications industry research,
development and maintenance activities, to engage in inter-region
interoperability testing and no significant issues have been found to date. 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 March 31, 1999 and we anticipate that this phase will be
complete during the second quarter of 1999. Cooperative testing with certain
customers, vendors and other telecommunications companies is expected to
continue during 1999. As of March 31, 1999, approximately 93% 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 50% of the anticipated Network contingency planning
activities were complete as of March 31, 1999. We anticipate that the remainder
of our Network contingency planning activities will be complete by mid-1999.
18
<PAGE>
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 March 31, 1999,
approximately 97% of IT conversion activities, 92% of IT testing activities and
89% of IT implementation had been completed. We anticipate that each of these
phases for IT will be complete by July 1999. IT contingency planning activities
are approximately 50% 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 March 31, 1999, approximately 100% of the inventory/assessment activity, 100%
of the planning activity, 80% of the conversion activity and 70% of the testing
and remediation implementation activities 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. 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 $169 from the
beginning of 1997 through the end of the first quarter of 1999 on year 2000
projects and activities. We estimate that additional costs for year 2000 related
projects and activities will be approximately $98. 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. 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 Telcordia. 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 91% of those products as of March 31, 1999. 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.
19
<PAGE>
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 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 10.
New Accounting Standards
On June 15, 1998, the Financial Accounting Standards Board issued Financial
Accounting Standards ("FAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities." This statement establishes accounting and reporting
standards for derivative instruments and for hedging activities. FAS No. 133
requires, among other things, that all derivative instruments be recognized at
fair value as assets or liabilities 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 1999, its impact on the financial statements would not
have been material.
20
<PAGE>
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. For a discussion
of these actions, see "Note 3 - Commitments and Contingencies" to the
Consolidated Financial Statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No.
(2a) Articles of Merger including the Plan of Merger between The Mountain States
Telephone and Telegraph Company (renamed U S WEST Communications, Inc.) and
Northwestern Bell Telephone Company. (Incorporated herein by this reference
to Exhibit 2a to Form SE filed on January 8, 1991, File No. 1-3040).
(2b) Articles of Merger including the Plan of Merger between The Mountain States
Telephone and Telegraph Company (renamed U S WEST Communications, Inc.) and
Pacific Northwest Bell Telephone Company. (Incorporated herein by this
reference to Exhibit 2b to Form SE filed on January 8, 1991, File No.
1-3040).
(3a) Restated Articles of Incorporation of the Registrant. (Incorporated herein
by this reference to Exhibit 3a to Form 10-K/A filed on April 13, 1998,
File No. 1-3040).
(3b) Bylaws of the Registrant, as amended. (Incorporated herein by this
reference to Exhibit 3b to Form 10-K/A filed on April 13, 1998, File
No. 1-3040).
4 No instrument which defines the rights of holders of long and intermediate
term debt of the Registrant is filed herewith pursuant to Regulation S-K,
Item 601(b) (4) (iii) (A). Pursuant to this regulation, the Registrant
hereby agrees to furnish a copy of any such instrument to the SEC upon
request.
(10a)Reorganization and Divestiture Agreement dated as of November 1, 1983,
between American Telephone and Telegraph Company, U S WEST Inc., and
certain of their affiliated companies, including The Mountain States
Telephone and Telegraph Company, Northwestern Bell Telephone Company,
Pacific Northwest Bell Telephone Company and NewVector Communications, Inc.
(Exhibit 10a to Form 10-K for the period ended December 31, 1983, File No.
1-3040).
(10b)Shared Network Facilities Agreement dated as of January 1, 1984, between
American Telephone and Telegraph Company, AT&T Communications of the
Midwest, Inc. and The Mountain States Telephone and Telegraph Company.
(Exhibit 10b to Form 10-K for the period ended December 31, 1983, File No.
1-3040).
(10c)Agreement Concerning Termination of the Standard Supply Contract effective
December 31, 1983, between American Telephone and Telegraph Company,
Western Electric Company, Incorporated, The Mountain States Telephone and
Telegraph Company and Central Services Organization (Exhibit 10d to Form
10-K for the period ended December 31, 1983, File No. 1-3040).
(10d)Agreement Concerning Certain Centrally Developed Computer Systems
effective December 31, 1983, between American Telephone and Telegraph
Company, Western Electric Company, Incorporated, The Mountain States
Telephone and Telegraph Company and Central Services Organization (Exhibit
10e to Form 10-K for the period ended December 31, 1983, File No. 1-3040).
(10e)Agreement Concerning Patents, Technical Information and Copyrights
effective December 31, 1983, between American Telephone and Telegraph
Company and U S WEST, Inc. (Exhibit 10f to Form 10-K for the period ended
December 31, 1983, File No. 1-3040).
21
<PAGE>
(10f)Agreement Concerning Liabilities, Tax Matters and Termination of Certain
Agreements dated as of November 1, 1983, between American Telephone and
Telegraph Company, U S WEST, Inc., The Mountain States Telephone and
Telegraph Company and certain of their affiliates (Exhibit 10h to Form 10-K
for the period ended December 31, 1983, File No. 1-3040).
(10g)Agreement Concerning Trademarks, Trade Names and Service Marks effective
December 31, 1983, between American Telephone and Telegraph Company,
American Information Technologies Corporation, Bell Atlantic Corporation,
BellSouth Corporation, Cincinnati Bell, Inc., NYNEX Corporation, Pacific
Telesis Group, The Southern New England Telephone Company, Southwestern
Bell Corporation and U S WEST, Inc. (Exhibit 10i to Form 10-K for the
period ended December 31, 1983, File No. 1-3040).
(10h)Shareholders' Agreement dated as of January 1, 1988, between Ameritech
Services, Inc., Bell Atlantic Management Services, Inc., BellSouth
Services, Incorporated, NYNEX Service Company, Pacific Bell, Southwestern
Bell Telephone Company, The Mountain States Telephone and Telegraph
Company, Northwestern Bell Telephone Company and Pacific Northwest Bell
Telephone Company (Exhibit 10h to Form SE dated March 5, 1992, File No.
1-3040).
27 Financial Data Schedule
___________________
( ) Previously filed.
(b) Reports on Form 8-K Filed During the First Quarter of 1999
(i) Form 8-K dated January 15, 1999 providing notification of a press release
entitled "U S WEST To Sell 500,000 Access Lines."
22
<PAGE>
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
May 7, 1999
23
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