-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ExuJbqr10JRXg65lw0KotJMRLVOmvKdWkryf5Zh9wCmy29mhnWi1iRrxwV5Jnerg YjKHKIMzcrh3JF6PVj9RYQ== 0000068622-97-000002.txt : 19970814 0000068622-97-000002.hdr.sgml : 19970814 ACCESSION NUMBER: 0000068622-97-000002 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970813 SROS: NYSE SROS: PSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: U S WEST COMMUNICATIONS INC CENTRAL INDEX KEY: 0000068622 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 840273800 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-03040 FILM NUMBER: 97659248 BUSINESS ADDRESS: STREET 1: 1801 CALIFORNIA ST CITY: DENVER STATE: CO ZIP: 80202 BUSINESS PHONE: 3038963099 MAIL ADDRESS: STREET 1: 1801 CALIFORNIA ST CITY: DENVER STATE: CO ZIP: 80202 FORMER COMPANY: FORMER CONFORMED NAME: MOUNTAIN STATES TELEPHONE & TELEGRAPH CO DATE OF NAME CHANGE: 19910109 10-Q 1 2 ===================================================================== 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 June 30, 1997 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 __ - ===================================================================== - ------ 25 - -- Form 10-Q - Part I U S WEST Communications, Inc. FORM 10-Q TABLE OF CONTENTS
Item Page - ---- ---- PART I - FINANCIAL INFORMATION 1. Financial Statements Consolidated Statements of Operations - Three and Six Months Ended June 30, 1997 and 1996 3 Consolidated Balance Sheets - June 30, 1997 and December 31, 1996 4 Consolidated Statements of Cash Flows - Six Months Ended June 30, 1997 and 1996 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)) 10 PART II - OTHER INFORMATION 1. Legal Proceedings 20 6. Exhibits and Reports on Form 8-K 20
Form 10-Q - Part I CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) U S WEST COMMUNICATIONS, INC.
Three Three Six Six Months Months Months Months Ended Ended Ended Ended June 30, June 30, June 30, June 30, Dollars in millions 1997 1996 1997 1996 - ------------------------------------------- ---------- --------- ---------- ---------- Operating revenues: Local service $ 1,151 $ 1,179 $ 2,382 $ 2,324 Interstate access service 678 626 1,365 1,248 Intrastate access service 200 189 400 379 Long-distance network services 240 278 490 568 Other services 219 168 398 329 ---------- --------- ---------- ---------- Total operating revenues 2,488 2,440 5,035 4,848 Operating expenses: Employee-related expenses 842 864 1,648 1,677 Other operating expenses 374 373 824 762 Taxes other than income taxes 95 97 200 192 Depreciation and amortization 524 513 1,046 1,024 ---------- --------- ---------- ---------- Total operating expenses 1,835 1,847 3,718 3,655 ---------- --------- ---------- ---------- Income from operations 653 593 1,317 1,193 Interest expense 93 101 189 204 Gains on sales of rural telephone exchanges 29 49 47 49 Other income (expense) - net (18) 2 (40) (15) ---------- --------- ---------- ---------- Income before income taxes and cumulative effect of change in accounting principle 571 543 1,135 1,023 Provision for income taxes 218 208 433 391 ---------- --------- ---------- ---------- Income before cumulative effect of change in accounting principle 353 335 702 632 Cumulative effect of change in accounting principle - net of tax - - - 34 ---------- --------- ---------- ---------- NET INCOME $ 353 $ 335 $ 702 $ 666 ========== ========= ========== ==========
See Notes to Consolidated Financial Statements. Form 10-Q - Part I CONSOLIDATED BALANCE SHEETS (Unaudited) U S WEST COMMUNICATIONS, INC.
June 30, December 31, Dollars in millions 1997 1996 - ----------------------------------------- --------- ------------- ASSETS Current assets: Cash and cash equivalents $ 98 $ 92 Accounts and notes receivable - net 1,537 1,550 Inventories and supplies 131 109 Deferred tax asset 177 152 Prepaid and other 64 57 --------- ------------- Total current assets 2,007 1,960 --------- ------------- Gross property, plant and equipment 32,583 32,451 Less accumulated depreciation 18,954 18,522 --------- ------------- Property, plant and equipment - net 13,629 13,929 Other assets 821 743 --------- ------------- Total assets $ 16,457 $ 16,632 --------- -------------
See Notes to Consolidated Financial Statements. Form 10-Q - Part I CONSOLIDATED BALANCE SHEETS (Unaudited), continued U S WEST COMMUNICATIONS, INC.
June 30, December 31, Dollars in millions 1997 1996 - -------------------------------------------------- ---------- -------------- LIABILITIES AND SHAREOWNER'S EQUITY Current liabilities: Short-term debt $ 159 $ 834 Accounts payable 1,036 998 Employee compensation 268 308 Dividends payable 354 307 Advanced billing and customer deposits 278 250 Other 1,026 754 ---------- -------------- Total current liabilities 3,121 3,451 ---------- -------------- Long-term debt 5,320 5,375 Postretirement and other postemployment benefit obligations 2,349 2,347 Deferred income taxes 827 807 Deferred credits and other 569 592 Contingencies (See Note C to the Consolidated Financial Statements) Shareowner's equity: Common shares - one share without par value, owned by parent 7,888 7,677 Cumulative deficit (3,617) (3,617) ---------- -------------- Total shareowner's equity 4,271 4,060 ---------- -------------- Total liabilities and shareowner's equity $ 16,457 $ 16,632 ========== ==============
See Notes to Consolidated Financial Statements. Form 10-Q - Part I CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) U S WEST COMMUNICATIONS, INC.
Six Months Ended Six Months Ended June 30, June 30, Dollars in millions 1997 1996 - ---------------------------------------------------------- ------------------ ------------------ OPERATING ACTIVITIES Net income $ 702 $ 666 Adjustments to net income: Depreciation and amortization 1,046 1,024 Gains on sales of rural telephone exchanges (47) (49) Cumulative effect of change in accounting principle - (34) Deferred income taxes and amortization of investment tax credits (14) (4) Changes in operating assets and liabilities: Restructuring payments (45) (74) Postretirement medical and life costs, net of cash fundings 5 (30) Accounts receivable 12 45 Inventories, supplies and other current assets (40) (23) Accounts payable and accrued liabilities 310 (83) Other adjustments - net 77 18 ------------------ ------------------ Cash provided by operating activities 2,006 1,456 ------------------ ------------------ INVESTING ACTIVITIES Expenditures for property, plant and equipment (831) (1,259) Proceeds from sales of rural telephone exchanges 28 111 Proceeds from (payments on) disposals of property, plant, and equipment 4 (7) ------------------ ------------------ Cash (used for) investing activities (799) (1,155) ------------------ ------------------ FINANCING ACTIVITIES Net (repayments of) proceeds from short-term debt (669) 302 Repayments of long-term debt (85) (245) Dividends paid on common stock (656) (630) Equity infusions from U S WEST Communications Group 209 148 ------------------ ------------------ Cash (used for) financing activities (1,201) (425) ------------------ ------------------ CASH AND CASH EQUIVALENTS Increase (decrease) 6 (124) Beginning balance 92 191 ------------------ ------------------ Ending balance $ 98 $ 67 ================== ==================
See Notes to Consolidated Financial Statements. Form 10-Q - Part I U S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Six Months Ended June 30, 1997 and 1996 (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"). 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 ("GAAP") 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 the Consolidated Financial Statements be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 1996. Financial Instruments. Synthetic instrument accounting is used for interest rate and foreign currency swaps if the index, maturity, and amount of the instrument match the terms of the underlying debt. Net interest accrued is recognized over the life of the instruments as an adjustment to interest expense and is a component of cash provided by operating activities. Any gain or loss on the termination of an instrument, which qualifies for synthetic instrument accounting, would be deferred and amortized over the remaining life of the original instrument. Hedge accounting is used for forward contracts which qualify as hedges of future debt issues. To qualify for hedge accounting, the contracts must have a high inverse correlation to the exposure being hedged, and reduce the risk or volatility associated with changes in interest rates. Qualified contracts are carried at market value with gains and losses recorded with the related debt and amortized as yield adjustments. Any gain or loss on the termination of a contract, which qualifies for hedge accounting, would be deferred and accounted for with the related transaction. The Company does not use derivative financial instruments for trading purposes. Form 10-Q - Part I U S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions) (Unaudited) New Accounting Standards. In 1998, U S WEST will adopt Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 130 requires that the components of and the total amount for comprehensive income be displayed in the financial statements. Comprehensive income includes net income and all changes in equity during a period that arise from nonowner sources, such as foreign currency items and unrealized gains and losses on certain investments in equity securities. Among other things, SFAS No. 131 requires detailed operating segment information of an enterprise on an annual and interim period basis. The effects of adopting both SFAS No. 130 and 131 are being evaluated. B. Rural Telephone Exchanges Held for Sale In conjunction with its rural telephone exchange sales program, the Company sold certain rural telephone exchanges for pretax gains of $47. The carrying value of the remaining rural telephone exchanges held for sale approximates $75 at June 30, 1997. The remaining rural telephone exchanges held for sale are expected to be disposed of in the latter half of 1997 and first-quarter 1998. In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company has stopped depreciating the exchanges held for sale. C. Contingencies There are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. 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. 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 for the County of Marion ("Oregon Circuit Court"). On June 26, 1997, the Oregon Circuit Court granted the Company's request for a stay, pending a full review of the OPUC's order. The Oregon Circuit Court is scheduled to hear arguments on the appeal in December 1997. The one-time refund and cumulative amount of revenues collected subject to refund, including interest, as of June 30, 1997, totals approximately $121. In 1996, the Washington State Utilities and Transportation Commission ("WUTC") acted on the Company's 1995 rate request. The Company had sought to increase revenues by raising rates primarily for basic residential services over a four-year period. Instead of granting the Company's request, the WUTC ordered $91.5 in annual net revenue reductions, effective May 1, 1996. Based on the WUTC ruling, the Company filed a lawsuit with the King County Superior Court (the "Court") for an appeal of the order, a temporary stay of the ordered rate reduction and an authorization to implement a revenue increase. The Court declined to change the WUTC order. The Company appealed the Court's decision to the Washington State Supreme Court (the "State Supreme Court") which, on January 22, 1997, granted a stay of the order, pending the State Supreme Court's full review of the appeal. Oral arguments were heard in June 1997. The Company is waiting a decision by the State Supreme Court. Effective May 1, 1996, the Company began collecting revenues subject to refund. The cumulative amount of revenues collected subject to refund as of June 30, 1997, including interest, is approximately $135. In another proceeding, the Utah Supreme Court remanded a Utah Public Service Commission ("PSC") order to the PSC for hearing, thereby establishing two exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from interexchange carriers and other parties related to the Tax Reform Act of 1986. The potential exposure, including interest, at June 30, 1997, is approximately $160. The Company has accrued $113 at June 30, 1997, which represents its estimated liability for state regulatory proceedings. It is possible that the ultimate liability could exceed the recorded liability by an amount up to $300. The Company continues to monitor and evaluate the risks associated with its state regulatory environment, and will adjust estimates as new information becomes available. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions) 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) different than anticipated competition from new entrants into the local exchange and intraLATA toll markets, (ii) changes in demand for the Company's products and services, including optional custom calling features, (iii) different than anticipated employee levels, capital expenditures, and operating expenses as a result of unusually rapid, in-region growth, (iv) the gain or loss of significant customers, (v) pending regulatory actions in state jurisdictions, and (vi) regulatory changes affecting the telecommunications industry, including changes that could have an impact on the competitive environment in the local exchange market. RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1997 COMPARED WITH 1996 Following are details of the Company's reported net income, normalized to exclude the effects of certain nonoperating items.
Six Six Months Months Ended Ended Increase Increase June 30, June 30, (Decrease) (Decrease) 1997 1996 Dollars Percent ---------- ---------- ----------- ---------- Reported net income $ 702 $ 666 $ 36 5.4 Adjustments to reported net income: Gains on sales of rural telephone exchanges (29) (30) 1 (3.3) Cumulative effect of change in accounting principle (1) - (34) 34 - Current year effect of change in accounting principle (1) - (10) 10 - ---------- ---------- ----------- ---------- Normalized income $ 673 $ 592 $ 81 13.7 ========== ========== =========== ========== (1) Effective January 1, 1996, the Company adopted 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."
During 1997, the Company's normalized income increased $81, or 13.7 percent, to $673. Earnings before interest, taxes, depreciation, amortization and other ("EBITDA") increased $146, or 6.6 percent, to $2,363. EBITDA excludes gains on sales of certain rural telephone exchanges. The Company believes EBITDA is an important indicator of the operational performance of its businesses. EBITDA, however, should not be considered as an alternative to operating or net income as an indicator of the performance of the Company's business or as an alternative to cash flows from operating activities as a measure of liquidity, in each case determined in accordance with GAAP. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued The increases are primarily due to higher demand for services and continued cost control efforts which accelerated in the latter half of 1996. These increases were partially offset by an accrual to recognize the Company's estimated state regulatory liabilities. (See "Contingencies") The Company anticipates net income growth will continue to be partially offset by increased costs related to growth initiatives and interconnection requirements, and the impacts of access reform and price cap regulation. (See "Regulatory Environment") Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which, among other things, requires that companies no longer record depreciation expense on assets held for sale. Adoption of SFAS No. 121 resulted in a 1996 one-time gain of $34 (net of tax of $22), related to the cumulative effect of change in accounting principle. Operating Revenues An analysis of operating revenues follows:
Six Six Months Months Ended Ended Increase Increase June 30, June 30, Price Lower (Decrease) (Decrease) 1997 1996 Demand Changes Refunds Other Dollars Percent Local service $ 2,382 $ 2,324 $ 198 $ (14) $ 17 $ (143) $ 58 2.5 Interstate access 1,365 1,248 138 (10) 3 (14) 117 9.4 Intrastate access 400 379 25 5 - (9) 21 5.5 Long-distance network 490 568 (47) (5) - (26) (78) (13.7) Other services 398 329 - - - 69 69 21.0 --------- --------- -------- --------- -------- ------- ----------- ---------- Total $ 5,035 $ 4,848 $ 314 $ (24) $ 20 $ (123) $ 187 3.9 ========= ========= ======== ========= ======== ======= =========== ==========
Local Services Revenues. Local service revenues increased $58, or 2.5 percent, to $2,382, primarily as a result of access line growth and increased demand for new product and service offerings, and existing central office features. Total reported access lines increased 616,000, or 4.1 percent, during the past 12 months, of which 249,000 was attributable to second lines. Second line installations increased 26.7 percent. Access lines grew 686,000, or 4.6 percent, when adjusted for sales of approximately 70,000 rural telephone access lines during the past twelve months. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued Partially offsetting the increase is a $91 accrual to recognize the Company's estimated state regulatory liabilities. (See "Contingencies") Also partially offsetting the increase was a $30 reclassification of public telephone revenues to other services revenues. The reclassification was in conjunction with the Federal Communications Commission's ("FCC") payphone orders, which took effect April 15, 1997, as mandated by the Telecommunications Act of 1996 (the "Telecommunications Act"). Lower wireless interconnection access prices, also mandated by the Telecommunications Act, reduced local service revenues by $27. Excluding the non-recurring effects of the regulatory accrual and the public telephone revenues reclassification, local service revenues increased 6.8 percent. (See "Contingencies") Interstate Access Revenues. Higher interstate access revenues resulted from increased demand for private line services, access line growth and an increase of 6.3 percent in billed interstate access minutes of use. The increase was partially offset by the effects of price reductions and accruals of $22 for refunds to interexchange carriers. The refunds relate to a one-time $22 exogenous cost adjustment ordered by the FCC as a condition of granting the Company's waiver from price cap sharing rules for the first half of 1997. (See "Regulatory Environment") True-ups of $18 to the 1996 price cap sharing accruals partially offset the one-time $22 exogenous cost adjustment. The Company anticipates future interstate access revenue growth will be negatively impacted by the FCC's recent orders to restructure the access charge system and its current price cap plan. (See "Regulatory Environment") Intrastate Access Revenues. Intrastate access revenues increased largely as a result of an increase of 10.5 percent in billed intrastate minutes of use and increased demand for private line services. Long-distance Network Service Revenues. Long-distance network service revenues decreased 13.7 percent primarily due to the effects of competition and the implementation of multiple toll carrier plans ("MTCPs") in Iowa and Nebraska in 1996, and in Iowa, Oregon and Washington in first-quarter 1997. The MTCPs essentially allow independent telephone companies to act as toll carriers. During 1997, the MTCPs reduced long-distance revenues by $29, which was offset by increased intrastate access revenues of $3, and decreased other operating expenses (i.e., access expense) of $23. Excluding the effects of the MTCPs, long-distance network service revenues decreased by 8.6 percent. Erosion of long-distance network service revenues will continue due to the loss of exclusivity of 1+ dialing in Minnesota and Arizona, effective in February and April 1996, respectively, and continued dial-around activity in other states within the Company's 14 state region. The Company is responding to competitive losses through competitive pricing of intraLATA long-distance services and increased promotional efforts to retain customers. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued Other Services Revenues. Other services revenues increased largely due to the second-quarter 1997 $30 reclassification of public telephone revenues from local service revenues. Also contributing to the increase was interim compensation revenue from interexchange carriers as a result of the FCC's payphone orders which took effect April 15, 1997. The amount of interim compensation may change as a result of the District of Columbia Court of Appeals recent review and remand of the FCC's payphone orders. Increases in voice messaging, inside wire maintenance and billing and collection services revenues also contributed to higher other services revenues. Future revenues may be affected by pending regulatory actions in federal and local regulatory jurisdictions. Costs and Expenses
Six Six Months Months Increase Increase Ended Ended (Decrease) (Decrease) June 30, June 30, Dollars) Percent 1997 1996 Employee-related expenses $ 1,648 $ 1,677 (29) (1.7) Other operating expenses 824 762 62 8.1 Taxes other than income taxes 200 192 8 4.2 Depreciation and amortization 1,046 1,024 22 2.1 Interest expense 189 204 (15) (7.4) Gains on sales of rural telephone exchanges 47 49 (2) (4.1) Other expense 40 15 25 - - ------------------------------------------- --------- --------- ---------- ----------
Employee-Related Expenses. Employee-related expenses decreased $29, or 1.7 percent, primarily due to lower salaries and wages, overtime, and conference and travel expenses. Salaries and wages decreased primarily as a result of employee reductions totaling 3,795 during the last twelve months. However, this decrease was largely offset by the effects of inflation-driven wage increases. The reduction in overtime, and conference and travel expenses is primarily the result of continued cost control efforts which accelerated in the latter half of 1996. Partially offsetting the decreases were higher contract labor costs and an increase in the postretirement benefits accrual. The increase in contract labor is primarily due to additional costs for system development work and the launch of new products and services, and sales efforts associated with a first-quarter 1997 promotion of caller identification. Other Operating Expenses. Other operating expenses increased $62, or 8.1 percent. The increase was predominantly a result of higher advertising costs, of which approximately $30 is attributable to a advertising promotion of caller identification in first-quarter 1997, and a reserve adjustment associated with billing and collection activities performed for interexchange carriers. Also contributing to the increase was additional network software purchases, increased professional Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued fees and repair costs associated with flooding in North Dakota. Costs related to the growth initiatives also contributed to the increase. Partially offsetting the increases were lower materials and supplies as a result of continued cost control efforts and reduced access expense (primarily related to the implementation of the MTCPs in 1996 and 1997). Taxes Other Than Income Taxes. Taxes other than income taxes increased primarily due to increased use and gross receipt taxes. Partially offsetting were decreased property taxes due to favorable tax valuations and mill levies, as compared with 1996. Depreciation and Amortization. Increased depreciation and amortization expense was attributable to the effects of a higher depreciable asset base partially offset by lower depreciation rates for certain classes of plant. Interest Expense. Interest expense decreased primarily due to lower average debt levels and interest rates as compared to 1996. Partially offsetting the decrease in interest expense was a decrease in the amount of interest capitalized resulting from a lower average balance of telecommunications plant under construction. Gains on Sales of Rural Telephone Exchanges. During 1997, the Company sold selected rural telephone exchanges in Iowa, South Dakota, Nebraska and Idaho for a pretax gain of $47 and an after tax gain of $29. The 1996 gains were a result of sales in North and South Dakota. Other Expense. Other expense increased primarily due to additional interest expense associated with the Company's interstate sharing liabilities and state regulatory liabilities. Provision for Income Taxes
Six Six Months Months Ended Ended June 30, June 30, Percent 1997 1996 Change ---------- ---------- ------- Provision for income taxes $ 433 $ 391 10.7 Effective tax rate 38.1% 38.2% - - -------------------------- ---------- ---------- -------
The increase in the provision for income taxes resulted primarily from higher pretax earnings and lower amortization of the investment tax credit. Restructuring Charge During the six-month period ended June 30, 1997, the restructuring reserve decreased $45 to a balance of $78. Reserve usage is primarily a result of expenditures for 380 employee separations during the first half of 1997 and systems development costs. The restructuring plan is expected to be substantially complete by the end of 1997. Management continues to evaluate the remaining reserve balance and employee separations. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued CONTINGENCIES There are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. 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. The Company filed an appeal of the order and asked for an immediate stay of the refund with the Oregon Circuit Court for the County of Marion ("Oregon Circuit Court"). On June 26, 1997, the Oregon Circuit Court granted the Company's request for a stay, pending a full review of the OPUC's order. The Oregon Circuit Court is scheduled to hear arguments on the appeal in December 1997. The one-time refund and cumulative amount of revenues collected subject to refund, including interest, as of June 30, 1997, totals approximately $121. In 1996, the Washington State Utilities and Transportation Commission ("WUTC") acted on the Company's 1995 rate request. The Company had sought to increase revenues by raising rates primarily for basic residential services over a four-year period. Instead of granting the Company's request, the WUTC ordered $91.5 in annual net revenue reductions, effective May 1, 1996. Based on the WUTC ruling, the Company filed a lawsuit with the King County Superior Court (the "Court") for an appeal of the order, a temporary stay of the ordered rate reduction and an authorization to implement a revenue increase. The Court declined to change the WUTC order. The Company appealed the Court's decision to the Washington State Supreme Court (the "State Supreme Court") which, on January 22, 1997, granted a stay of the order, pending the State Supreme Court's full review of the appeal. Oral arguments were heard in June 1997. The Company is waiting a decision by the State Supreme Court. Effective May 1, 1996, the Company began collecting revenues subject to refund. The cumulative amount of revenues collected subject to refund as of June 30, 1997, including interest, is approximately $135. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued In another proceeding, the Utah Supreme Court remanded a Utah Public Service Commission ("PSC") order to the PSC for hearing, thereby establishing two exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from interexchange carriers and other parties related to the Tax Reform Act of 1986. The potential exposure, including interest, at June 30, 1997, is approximately $160. The Company has accrued $113 at June 30, 1997, which represents its estimated liability for state regulatory proceedings. It is possible that the ultimate liability could exceed the recorded liability by an amount up to $300. The Company continues to monitor and evaluate the risks associated with its state regulatory environment, and will adjust estimates as new information becomes available. REGULATORY ENVIRONMENT The Telecommunications Act of 1996 The Telecommunications Act of 1996 (the "Telecommunications Act") replaces the Modification of Final Judgment, the antitrust consent decree entered into in 1984 in connection with the divestiture by AT&T of its local telephone business and the formation of U S WEST and the other Regional Bell Operating Companies ("RBOCs"). The Telecommunications Act permits local telephone companies, long-distance carriers and cable television companies to enter each others' lines of business. Among other things, the RBOCs will be permitted to provide interLATA long-distance services by opening their local networks to facilities-based competition and satisfying a detailed list of requirements, including providing interconnection and number portability. The Telecommunications Act also reaffirms the concept of universal service and directs the FCC and state regulators to determine universal service funding policy. The FCC and state regulators have been given the responsibility to interpret and oversee implementation of large portions of the Telecommunications Act. On August 8, 1996, the FCC issued an order (the "FCC Order") establishing a framework of minimum national rules that would enable the states and the FCC to begin implementing the local competition provisions of the Telecommunications Act. Among other things, the FCC Order established rigid costing and pricing rules which, from U S WEST's perspective, significantly impede negotiations with new entrants to the local exchange market, state public utility commission ("PUC") interconnection rulemakings, and interconnection arbitration proceedings. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued On July 18, 1997, the Eighth Circuit Court of Appeals ("Eighth Circuit") vacated significant portions of the FCC Order. Most significantly, the Eighth Circuit ruled that jurisdiction over local interconnection prices rests with the states, not the FCC. The effect of the Eighth Circuit's decision is to have interconnection and network unbundled element pricing be resolved through negotiations or state PUC arbitration proceedings. Some of the FCC's unbundling rules, as well as its "pick and choose" provision, were also vacated by the Eighth Circuit Court. On May 7, 1997, the FCC announced three decisions that will establish rules to implement the Universal Service provision of the Telecommunications Act of 1996 (the "Universal Service Order"), as well as rules to restructure the access charge system (the "Access Reform Order") and the FCC's current price cap plan (the "Price Cap Order"). UNIVERSAL SERVICE Under the Universal Service Order, all providers of interstate telecommunications services will contribute to universal service funding, which will be based on retail telecommunications revenues. The Universal Service Order deferred defining a new explicit mechanism to support high-cost service in areas served by non-rural telephone companies such as the Company until January 1, 1999. Until the explicit mechanism is put in place, the existing universal service support mechanisms were left intact, except to the extent modified by the FCC's Access Reform and Price Cap Orders discussed below. The FCC's Universal Service Order also includes the establishment of two separate funds to help connect eligible schools and libraries, and rural health care providers, to the global telecommunications network. These funds are capped at $2.25 billion and $400, respectively. On July 17, 1997, U S WEST filed a petition with the FCC for reconsideration and clarification of certain issues in the Universal Service Order. Among other things, U S WEST requested the FCC to reconsider: 1) establishing a national fund to ensure high-cost support is sufficient, and 2) assessing contributions as explicit end-user surcharges. Appeals of the Universal Service Order have been filed by various other companies. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued FEDERAL ACCESS REFORM The FCC has ordered a substantial restructuring of interstate access pricing. A significant portion of the pricing that has been charged using minutes-of-use pricing will now be charged using a combination of minutes-of-use rates, presubscribed 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 will occur on January 1, 1998. Additional mandated pricing changes will also occur on January 1, 1998 through 2001. The net effect of these changes will be to decrease minutes-of-use charges by over 60 percent and increase flat-rate charges (i.e., PICCs and SLCs). The Access Reform Order also continued in place the current rules by which incumbent local exchange carriers ("LECs") may not assess interstate access charges on information service providers and purchasers of unbundled network elements. The FCC will separately address issues surrounding information service providers' usage of the public switched network in a related notice of inquiry. The impacts of access reform will occur over a number of years and cannot be evaluated until the FCC resolves all remaining issues. Generally, however, the Access Reform Order will reduce the revenues the Company derives from interstate access charges. Competition from new entrant LECs will also affect the Company's access revenues. U S WEST has appealed the Access Reform Order. U S WEST's primary challenge is that the FCC acted unlawfully by exempting purchasers of unbundled network elements from payment of interstate access charges. PRICE CAP ORDER The FCC's Price Cap Order requires LECs that are subject to price cap regulation to increase their price cap index productivity factor to 6.5 percent. The order eliminates the lower productivity factor options (i.e., 4.0 percent and 4.7 percent) that required sharing of earnings above a specified level and will require LECs to set their 1997 price cap index assuming that the 6.5 percent factor had been in effect at the time of the 1996 tariff filing. Under the FCC's previous price cap plan, the Company had elected the lowest productivity factor, 4.0 percent, in its 1996 annual interstate tariff filing. As a result, the Company remained subject to the sharing requirements for the first half of 1997. In May 1997, the Company requested a waiver of the price cap sharing rules for the first half of 1997. On June 26, 1997, the FCC granted the waiver, resulting in the Company making a one-time exogenous cost adjustment of $22. The adjustment is reflected in the 1997 second-quarter interstate access revenues results (See "Operating Revenues"). The $22 adjustment was reflected in lower interstate access rates over twelve months beginning July 1, 1997. Form 10-Q - Part I Item 2. Management's Analysis of the Results of Operations (Dollars in millions), continued As mandated by the Price Cap Order, the price cap index in the Company's 1997 interstate access tariff filing was established assuming that the 6.5 percent productivity factor had been in effect at the time of the 1996 tariff filing. The access rate reductions have an on-going revenue impact of approximately $165 which will be reflected through lower interstate rates over twelve months beginning July 1, 1997. On June 23, 1997, U S WEST petitioned the Tenth Circuit Court of Appeals ("Tenth Circuit") for a review of the Access Reform Order and Price Cap Order. Among other things, the petition requested the Tenth Circuit to review the use of a 6.5 percent productivity factor and the retroactive application of the 6.5 percent productivity factor to July 1, 1996 when determining the price cap index for the 1997 price cap filing. Through the federal court multi-district litigation forum selection process, the Access Reform Order will be reviewed by the Eighth Circuit. The Tenth Circuit has now transferred review of the Price Cap Order to the District of Columbia Court of Appeals. 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. While complete assurance cannot be given as to the outcome of any contingent liabilities, in the opinion of the Company, any financial impact to which the Company and its subsidiaries are subject is not expected to be material in amount to the Company's operating results or its financial position. 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 Second Quarter of 1997: No reports on Form 8-K have been filed for the Company during the second quarter of 1997. 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. August 13, 1997 /s/ Allan R. Spies ----------------------- U S WEST Communications, Inc. Allan R. Spies Vice President and Chief Financial Officer EX-12 2 EXHIBIT 12-EFC EXHIBIT 12 U S WEST COMMUNICATIONS, Inc. RATIO OF EARNINGS TO FIXED CHARGES (Dollars in Millions)
Quarter Ended 6/30/97 6/30/96 - ------------------------------------------ -------- -------- Income before income taxes and cumulative effect of change in accounting principle $ 571 $ 543 Interest expense (net of amounts capitalized) 93 101 Interest factor on rentals (1/3) 16 15 -------- -------- Earnings $ 680 $ 659 Interest expense $ 98 $ 116 Interest factor on rentals (1/3) 16 15 -------- -------- Fixed charges $ 114 $ 131 Ratio of earnings to fixed charges 5.96 5.03 - ------------------------------------------ -------- -------- Year-to-Date 6/30/97 6/30/96 - ------------------------------------------ -------- -------- Income before income taxes and cumulative effect of change in accounting principle $1,135 $1,023 Interest expense (net of amounts capitalized) 189 204 Interest factor on rentals (1/3) 31 29 -------- -------- Earnings $1,355 $1,256 Interest expense $ 201 $ 232 Interest factor on rentals (1/3) 31 29 -------- -------- Fixed charges $ 232 $ 261 Ratio of earnings to fixed charges 5.84 4.81 - ------------------------------------------ -------- --------
EX-27 3 FINANCIAL DATA SCHEDULE
5 0000068622 U S WEST COMMUNICATIONS, INC. 1,000,000 3-MOS 6-MOS DEC-31-1997 DEC-31-1997 JUN-30-1997 JUN-30-1997 98 98 0 0 1,537 1,537 0 0 131 131 2,007 2,007 32,583 32,583 18,954 18,954 16,457 16,457 3,121 3,121 5,320 5,320 0 0 0 0 7,888 7,888 (3,617) (3,617) 16,457 16,457 2,488 5,035 2,488 5,035 0 0 0 0 1,835 3,718 0 0 93 189 571 1,135 218 433 353 702 0 0 0 0 0 0 353 702 0 0 0 0
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