MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Telephone and Data Systems, Inc. ("TDS" or the "Company") provides
high-quality telecommunications services to approximately 3.2 million cellular
telephone, telephone, personal communications services ("PCS") telephone and
radio paging customer units in 37 states and the District of Columbia.
The accompanying financial statements present the results of operations of
the Company's primary businesses: United States Cellular Corporation ("U.S.
Cellular"), an 81%-owned subsidiary, TDS Telecommunications Corporation ("TDS
Telecom"), a wholly owned subsidiary, Aerial Communications, Inc. ("Aerial"), an
83%-owned subsidiary, and American Paging, Inc. ("American Paging"), an
82%-owned subsidiary. See "Proposed Corporate Restructuring" and "Combination of
American Paging and TSR Paging."
TDS's long-term business development strategy is to expand its operations
through internal growth and acquisitions, and to explore and develop
telecommunications businesses that management believes utilize TDS's expertise
in customer-based telecommunications.
1997 OVERVIEW
TDS reported a net loss available to common and earnings per share--diluted
of $11.4 million, or $.19 per share, in 1997 compared to net income available to
common of $126.2 million, or $2.07 per share, in 1996 and $101.5 million, or
$1.74 per share, in 1995. Net income available to common from U.S. Cellular and
TDS Telecom increased 45% in 1997 and 23% in 1996. The excellent growth at U.S.
Cellular and steady growth at TDS Telecom in 1997 was overshadowed by large
start-up losses at Aerial due to the costs associated with the launch of service
in all six PCS markets. Net income included significant gains on the sale of
cellular interests and other investments in 1996 and 1995.
The table below summarizes the effects of the business units and gains
(along with the related impact of income taxes and minority interest) on net
income (loss) available to common and earnings per share--diluted.
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
NET INCOME (LOSS) AVAILABLE TO COMMON
U.S. Cellular and TDS Telecom........................................... $ 135.1 $ 93.4 $ 75.7
Aerial.................................................................. (129.4) (15.3) (6.7)
American Paging......................................................... (33.0) (16.4) (8.1)
Gains................................................................... 15.9 64.5 40.6
--------- --------- ---------
$ (11.4) $ 126.2 $ 101.5
--------- --------- ---------
--------- --------- ---------
EARNINGS PER SHARE--DILUTED
U.S. Cellular and TDS Telecom........................................... $ 2.25 $ 1.54 $ 1.30
Aerial.................................................................. (2.15) (.25) (.11)
American Paging......................................................... (.55) (.27) (.14)
Gains................................................................... .26 1.05 .69
--------- --------- ---------
$ (.19) $ 2.07 $ 1.74
--------- --------- ---------
--------- --------- ---------
U.S. Cellular continued its outstanding growth during 1997. Customer units
increased by 637,000 units, or 59% (442,000 units, or 41%, excluding customers
added through acquisitions), to 1.7 million customer units, following a 363,000
unit, or 51%, increase in 1996. The increase in customer units drove a 29%
increase in revenues, a 33% increase in cash flow and a 48% increase in
operating income. Capital expenditures to add cell sites, expand coverage and
add capacity totaled $318.7 million and expenditures for acquisitions totaled
$128.8 million.
TDS Telecom continued to provide steady growth in revenues and cash flow.
Telephone access lines increased 6% resulting in a 12% increase in operating
revenues and a 3% increase in cash flow. Operating income decreased 4% as TDS
Telecom incurred additional expenses related to the development and marketing of
its new business ventures, an Internet access provider, a structured wiring
business and a competitive local exchange company ("CLEC"). TDS Telecom's
investment in outside plant facilities and new digital switches to maintain and
enhance the quality of service and offer new revenue opportunities totaled
$151.5 million.
1
Aerial launched service in all of its markets prior to the end of the second
quarter. A total of 125,000 net customers were added by the end of 1997. Service
was launched across its markets with approximately 600 cell sites in place,
which provided wide-area metropolitan coverage in its Major Trading Areas
("MTAs"). By the end of 1997, it had 1,044 cell sites in service and had
extended coverage to approximately 80% of the population in its MTAs.
Aerial's operating results reflect the high cost of launching service.
Revenues totaled $56.0 million, operating cash flow, a negative $157.5 million
and operating loss totaled $196.6 million. Aerial's investment in property and
equipment, including network design and equipment, site acquisition and
information systems totaled $274.7 million in 1997.
RESULTS OF OPERATIONS
OPERATING REVENUES increased 25% ($291.7 million) during 1997 and 25%
($237.5 million) during 1996 primarily as a result of growth at U.S. Cellular
and TDS Telecom in 1997 and 1996 as well as the start-up of PCS operations at
Aerial in 1997.
U.S. Cellular revenues increased $196.9 million in 1997 and $199.8 million
in 1996 on 59% and 51% increases in customer units and 13% and 31% increases in
inbound roaming revenues, respectively. TDS Telecom revenues increased $48.6
million in 1997 and $40.8 million in 1996 as a result of recovery of increased
costs of providing long-distance services, internal access line growth,
acquisitions and increased network usage. Aerial revenues totaled $56.0 million
since start-up of operations in mid-1997. American Paging revenues decreased
$9.8 million in 1997 and $3.0 million in 1996 reflecting competitive pricing
declines.
U.S. Cellular contributed 60% of consolidated revenue in 1997, up from 51%
in 1995 reflecting revenue growth rates substantially higher than the other
business units. TDS Telecom and American Paging contributed 30% and 6% of
consolidated revenue in 1997 and 38% and 11% in 1995, respectively. Aerial
contributed 4% of consolidated revenue in 1997.
OPERATING EXPENSES rose 44% ($448.8 million) in 1997 and 27% ($216.1
million) in 1996. The increase in expenses includes Aerial's expenses subsequent
to the launch of service in 1997 as well as added expenses from the growth in
operations at U.S. Cellular and TDS Telecom in 1997 and 1996.
PCS operating expenses totaled $252.5 million in 1997 reflecting the costs
of operating Aerial's network, marketing, selling and advertising and promotion
expenses, cost of equipment sold, customer service expenses as well as general
and administrative expenses. U.S. Cellular operating expenses increased $154.7
million during 1997 and $155.1 million during 1996 due to the effects of
additional marketing and selling expenses to add new customers as well as the
costs of providing services to the larger customer base. TDS Telecom operating
expenses increased $52.7 million during 1997 and $36.3 million during 1996 due
to growth in internal operations, the development and start-up of new business
ventures and the effects of acquisitions. American Paging operating expenses
decreased $11.1 million in 1997 and increased $24.7 million in 1996.
OPERATING INCOME declined to a negative $3.7 million in 1997 from $153.4
million in 1996 reflecting strong growth at U.S. Cellular offset by Aeriel's
costs of launching service. Operating income increased to $153.4 million in 1996
from $132.0 million in 1995 reflecting growth in operations at U.S. Cellular,
offset somewhat by increased losses at American Paging. U.S. Cellular's
operating income increased 48% ($42.2 million) in 1997 and 104% ($44.6 million)
in 1996 reflecting the increase in customers and revenues. U.S. Cellular's
operating margin has increased steadily to 14.8% in 1997 from 12.8% in 1996 and
8.9% in 1995. TDS Telecom's operating income decreased $4.1 million in 1997 and
increased $4.5 million in 1996. The decrease in TDS Telecom's operating income
was primarily due to operating losses from new business ventures. TDS Telecom's
operating margin continued its decline to 22.2% in 1997 from 26.0% in 1996 and
27.7% in 1995 due primarily to the development of new business ventures which
have lower margins than traditional telephone operations as well as earnings
pressures on telephone operations from regulatory agencies and long-distance
providers. Aerial's operating loss
2
totaled $196.6 million in 1997, reflecting the costs associated with launching
service in all six markets. American Paging's operating loss decreased $1.3
million in 1997 and increased $27.6 million in 1996.
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
------------ ----------- -----------
(DOLLARS IN THOUSANDS)
Operating Income (Loss)
U.S. Cellular................................................... $ 129,543 $ 87,366 $ 42,755
TDS Telecom..................................................... 98,613 102,708 98,240
Aerial.......................................................... (196,551) -- --
American Paging................................................. (35,307) (36,626) (8,997)
------------ ----------- -----------
$ (3,702) $ 153,448 $ 131,998
------------ ----------- -----------
------------ ----------- -----------
Management expects Aerial to generate significant losses in 1998 as it
continues to build its customer base. Upon completion of a December 1997
agreement between TDS and TSR Paging, Inc. to combine their respective paging
businesses, TDS will follow the equity method of accounting for its 30% interest
in the new combined company and will report these results as a component of
Investment and Other Income. This combination is expected to be completed in the
first half of 1998. See "Combination of American Paging and TSR Paging."
INVESTMENT AND OTHER INCOME (EXPENSE) totaled $114.0 million in 1997, $141.2
million in 1996 and $103.9 million in 1995. Investment and other income
(expense) includes interest and dividend income, cellular investment income,
gain on sale of cellular interests and other investments, PCS development costs
and minority share of income.
CELLULAR INVESTMENT INCOME, the Company's share of income of cellular
markets in which the Company has a minority interest and follows the equity
method of accounting, increased 42% ($22.8 million) in 1997 and 35% ($14.1
million) in 1996. Cellular investment income is net of amortization of license
costs relating to these minority interests. Cellular investment income is
expected to decrease in 1998 as a result of the transfer of certain minority
interests to BellSouth Corporation ("BellSouth") in the fourth quarter of 1997
and the pending transfer of certain other minority interests to AirTouch
Communications, Inc. in 1998. See "Financial Resources--Acquisitions, Trades and
Sales."
GAIN ON SALE OF CELLULAR INTERESTS AND OTHER INVESTMENTS totaled $41.4
million in 1997, $138.7 million in 1996 and $86.6 million in 1995. TDS and U.S.
Cellular continue to assess the makeup of cellular holdings in order to maximize
the benefits derived from clustering markets. Certain markets, identified as
non-strategic, were sold or traded in the past few years resulting in the
recognition of gains.
PCS DEVELOPMENT COSTS totaled $21.6 million in 1997, $43.9 million in 1996
and $7.8 million in 1995. Expenses incurred by Aerial prior to the launch of
operations in March 1997 to recruit an experienced management team, develop and
execute a business plan, raise capital and design and construct its PCS networks
were recorded in Other Income (Expense). Revenues and expenses incurred
subsequent to the launch of service have been included as a component of
operating income.
MINORITY SHARE OF INCOME includes the minority shareholders' share of U.S.
Cellular's, Aerial's and American Paging's net income or loss, the minority
partners' share of U.S. Cellular's operating markets net income or loss and
other minority shareholders' and partners' share of subsidiaries' net income or
loss. The change in 1997 is primarily
3
related to the increased losses of Aerial allocated to its minority
shareholders. Minority shareholders of American Paging are not allocated losses
in 1997 as American Paging's shareholders' equity is negative.
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Minority Share of (Income) Loss
U.S. Cellular
Minority Shareholders' Share.................................... $ (21,264) $ (25,179) $ (19,046)
Minority Partners' Share........................................ (12,298) (13,743) (7,902)
---------- ---------- ----------
(33,562) (38,922) (26,948)
Aerial.......................................................... 43,038 4,944 --
American Paging................................................. -- 6,368 2,781
Telephone Subsidiaries and Other................................ (2,663) 920 (1,691)
---------- ---------- ----------
$ 6,813 $ (26,690) $ (25,858)
---------- ---------- ----------
---------- ---------- ----------
INTEREST EXPENSE increased 113% ($48.4 million) in 1997 and decreased 16%
($8.0 million) in 1996. Interest expense increased in 1997 due to increased
interest expense from larger short-term debt balances ($19.6 million), a smaller
amount of capitalized interest ($16.6 million), additional interest expense from
U.S. Cellular's sale of debt in 1997 and Aerial's zero coupon notes issued in
late 1996 ($11.7 million). Interest expense decreased in 1996 because of
increased capitalized interest ($14.4 million) which offset additional interest
from U.S. Cellular's sale of convertible debt in 1995 ($6.0 million).
TDS and Aerial capitalized interest totaling $11.0 million in 1997, $27.6
million in 1996 and $13.2 million in 1995 on expenditures for PCS licenses and
construction costs. The Company stops capitalizing interest on qualifying assets
when those assets are placed in service.
MINORITY INTEREST IN INCOME OF SUBSIDIARY TRUST totaled $1.5 million in
1997. In November 1997, TDS Capital I, a subsidiary trust (the "Trust") of TDS,
issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred
Securities (the "Preferred Securities") at $25 per Preferred Security. The sole
asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5%
Subordinated Debentures due December 31, 2037.
INCOME TAX EXPENSE decreased $95.1 million in 1997 to $28.6 million and
increased $42.6 million to $123.6 million in 1996, reflecting primarily the
changes in pretax income.
NET INCOME (LOSS) AVAILABLE TO COMMON was ($11.4 million) in 1997, $126.2
million in 1996 and $101.5 million in 1995. EARNINGS PER COMMON SHARE--DILUTED
was ($.19) in 1997, $2.07 in 1996 and $1.74 in 1995.
4
CELLULAR TELEPHONE OPERATIONS
TDS provides cellular telephone service through U.S. Cellular. Results of
operations include 1,710,000 customer units at the end of 1997 compared to
1,073,000 customer units at the end of 1996 and 710,000 customer units at the
end of 1995.
YEAR ENDED OR AT DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER
CUSTOMER AMOUNTS)
Operating Revenues
Local retail................................................... $ 568,578 $ 414,815 $ 277,439
Inbound roaming................................................ 217,499 193,278 148,020
Long-distance and Other........................................ 90,888 71,975 54,857
----------- ----------- -----------
876,965 680,068 480,316
----------- ----------- -----------
Operating Expenses
System operations.............................................. 153,137 117,368 70,442
Marketing and selling.......................................... 175,117 127,689 92,180
Cost of equipment sold......................................... 82,302 74,024 54,948
General and administrative..................................... 204,487 164,782 130,533
Depreciation................................................... 97,591 74,631 57,302
Amortization................................................... 34,788 34,208 32,156
----------- ----------- -----------
747,422 592,702 437,561
----------- ----------- -----------
Operating Income................................................. $ 129,543 $ 87,366 $ 42,755
----------- ----------- -----------
----------- ----------- -----------
Consolidated Markets:
Customers...................................................... 1,710,000 1,073,000 710,000
Markets........................................................ 134 131 137
Market penetration............................................. 7.11% 4.94% 3.18%
Cell sites in service.......................................... 1,748 1,328 1,116
Average monthly service revenue per customer................... $ 54.18 $ 63.69 $ 70.64
Churn rate per month........................................... 1.9% 1.9% 2.1%
Marketing cost per gross customer addition..................... $ 313 $ 327 $ 335
Employees...................................................... 4,600 3,800 3,175
----------- ----------- -----------
----------- ----------- -----------
OPERATING REVENUES increased 29% ($196.9 million) in 1997 and 42% ($199.8
million) in 1996. The revenue increases in 1997 and 1996 were driven by the 59%
(41% excluding customers added through acquisitions) and 51% growth in customer
units and the 13% and 31% growth in inbound roaming revenues, respectively.
Customer units grew by 637,000 units in 1997 as compared to 363,000 units in
1996. The units added in 1997 include 195,000 units from acquisitions, primarily
related to the exchange with BellSouth which occurred at the end of October
1997. Average monthly service revenue per customer was $54.18 in 1997, $63.69 in
1996 and $70.64 in 1995. Average monthly service revenue per customer continues
to decline due to roaming revenues increasing at a slower rate than the U.S.
Cellular customer base, competitive pricing pressures, incentive programs and
consumer market penetration. Management anticipates that average monthly service
revenue per customer will continue to decrease as local retail and inbound
roaming revenue per minute of use decline.
LOCAL RETAIL REVENUE (charges to U.S. Cellular's customers for local system
usage) increased 37% ($153.8 million) in 1997 and 50% ($137.4 million) in 1996
due primarily to the growth in customers. Average monthly local retail revenue
per customer was $36.11 in 1997, $39.87 in 1996 and $42.19 in 1995. Local
minutes of use averaged 103 per month in 1997, 107 per month in 1996 and 95 per
month in 1995. Average revenue per minute was $.35 in 1997, $.37 in 1996 and
$.44 in 1995. U.S. Cellular's use of incentive programs that encourage lower-
priced weekend and off-peak usage, in order to stimulate overall usage, and the
increased amounts of bill credits given to customers as incentive to become or
remain customers resulted in the decrease in average monthly local retail
revenue per minute which in turn caused the decrease in average monthly local
retail revenue per customer. The industry trend of declining average monthly
retail revenue per customer is believed to be related to the continued
penetration of the consumer market, which tends to include fewer peak business
hour usage customers and the effects of increased competition in the industry.
5
INBOUND ROAMING REVENUE (charges to customers of other systems who use U.S.
Cellular's cellular systems when roaming) increased 13% ($24.2 million) in 1997
and 31% ($45.3 million) in 1996 due to increased minutes of use offset somewhat
by negotiated reductions in roaming rates. Minutes of use increased 27% in 1997
and 38% in 1996. Average revenue per minute of use was $.83 in 1997, $.92 in
1996 and $.99 in 1995. Average monthly inbound roaming revenue per U.S. Cellular
customer was $13.81, $18.58 and $22.51 in 1997, 1996 and 1995, respectively. The
decrease is the result of U.S. Cellular's customer base growing at a faster rate
than roaming revenue and negotiated reductions in roaming rates.
LONG-DISTANCE AND OTHER REVENUE, including equipment sales, increased 26%
($18.9 million) in 1997 and 31% ($17.1 million) in 1996 primarily due to
increased long-distance revenue from the growth in the volume of long-distance
calls billed by U.S. Cellular.
OPERATING EXPENSES increased 26% ($154.7 million) in 1997 and 35% ($155.1
million) in 1996. The increase in operating expenses is primarily due to the
costs to expand the customer base ($55.7 million in 1997 and $54.6 million in
1996); increased administrative expenses ($39.7 million in 1997 and $34.2
million in 1996); the cost of providing service to the expanding customer base
($35.8 million in 1997 and $46.9 million in 1996); and additional depreciation
on the increased investment in cell sites and equipment ($23.0 million in 1997
and $17.3 million in 1996).
MARKETING AND SELLING EXPENSES (salaries, commissions and expenses of field
sales and retail personnel and offices; agent expenses; advertising and public
relations expenses) increased 37% ($47.4 million) in 1997 and 39% ($35.5
million) in 1996 due to the increase in customer activations. Gross customer
activations (excluding acquisitions) rose 33% in 1997 to 746,000 from 563,000 in
1996. The 1996 gross customer activations increased 44% to 563,000 from 392,000
in 1995. U.S. Cellular incurred significant increases in advertising costs to
promote the United States Cellular-Registered Trademark- brand name and to add
new customers. Cost of equipment sold increased 11% ($8.3 million) in 1997 and
35% ($19.1 million) in 1996 reflecting the increase in units sold offset
somewhat by falling manufacturer equipment prices per unit. Cost per gross
customer addition (marketing and selling expenses and cost of equipment sold
less equipment revenues, divided by gross customer additions) totaled $313 in
1997, $327 in 1996 and $335 in 1995.
GENERAL AND ADMINISTRATIVE EXPENSES (costs of local business offices and
corporate expenses) increased 24% ($39.7 million) in 1997 and 26% ($34.2
million) in 1996. The increases include the effects of an increase in expenses
required to serve the growing customer base and an expansion of both local
administrative office and corporate staff, resulting from growth in U.S.
Cellular's business. Employee-related expenses increased $19.4 million in 1997
and $15.6 million in 1996, primarily due to an increase in the number of
administrative employees in each year. Also, bad debt expense increased $8.0
million in 1997 and $5.0 million in 1996, primarily due to the increased
penetration of the consumer market.
SYSTEM OPERATIONS EXPENSES increased 30% ($35.8 million) in 1997 and 67%
($46.9 million) in 1996 as a result of increases in customer usage expenses and
costs associated with operating the increased number of cell sites.
Customer usage expenses (charges from other service providers for landline
connection, toll and roaming costs incurred by customers' use of systems other
than their local systems) grew 32% ($24.3 million) in 1997 and 116% ($40.4
million) in 1996. The increase was due primarily to roaming usage and increased
minutes of use. Net outbound roaming usage expense is a result of offering U.S.
Cellular's customers increasingly larger service footprints in which their calls
are billed at local rates. In certain cases these service footprints include
other operators' service areas. U.S. Cellular pays roaming rates to the other
carriers for calls its customers make in these areas, while charging these
customers a local rate which is usually lower than the roaming rate. The
increase in 1996 also relates to increases in fraud-related costs. These
fraud-related costs totaled $6.5 million in 1997, $18.0 million in 1996 and $4.1
million in 1995. U.S. Cellular continues to implement procedures in its markets
to combat this fraud, which is primarily related to roaming usage.
Maintenance, utility and cell site expenses grew 27% ($11.5 million) in 1997
and 18% ($6.5 million) in 1996 reflecting the 32% and 19% increase in the number
of cell sites, respectively. The number of cell sites operated increased to
1,748 in 1997 from 1,328 in 1996 and 1,116 in 1995.
Operating cash flow increased 33% to $261.9 million in 1997 compared to a
48% increase to $196.2 million in 1996. The improvement was primarily due to the
growth in customers and revenue. U.S. Cellular continues to provide increasing
operating cash flow to support its construction activities.
6
DEPRECIATION EXPENSE increased 31% ($23.0 million) in 1997 and 30% ($17.3
million) in 1996, reflecting increases in average fixed asset balances of 35%
and 34%, respectively.
OPERATING INCOME was $129.5 million in 1997 compared to $87.4 million in
1996 and $42.8 million in 1995. Operating margins improved to 14.8% in 1997 from
12.8% in 1996 and 8.9% in 1995. The improvement was primarily due to the
substantial growth in customers and revenue.
Management believes there exists a seasonality at U.S. Cellular in both
service revenues, which tend to increase more slowly in the first and fourth
quarters, and operating expenses, which tend to be higher in the fourth quarter
due to increased marketing activities and customer growth. This seasonality may
cause operating income to vary from quarter to quarter.
Competitors licensed to provide PCS services have initiated service in
certain U.S. Cellular markets in the past eighteen months. U.S. Cellular expects
PCS operators to complete initial deployment of PCS in portions of all its
market clusters by the end of 1998. U.S. Cellular's management continues to
monitor other wireless communications providers' strategies to determine what
effect this additional competition will have on U.S. Cellular's future
strategies and results. While the effects of additional wireless competition
have slowed customer growth in certain of U.S. Cellular's markets, the overall
effect on total customer growth to date has not been material.
7
TELEPHONE OPERATIONS
TDS provides landline telephone service through TDS Telecom. TDS Telecom
served 515,500 access lines at the end of 1997 compared to 484,500 access lines
at the end of 1996 and 425,900 access lines at the end of 1995 ("telephone
operations"). TDS Telecom also owns a long-distance provider, an Internet access
provider, a structured wiring business and a competitive local exchange company
("other services").
YEAR ENDED OR AT DECEMBER 31,
-----------------------------------
1997 1996 1995
----------- ----------- ---------
(DOLLARS IN THOUSANDS,
EXCEPT PER ACCESS LINE AMOUNTS)
Operating Revenues
Telephone Revenues
Local Service................................................... $ 122,826 $ 110,501 $ 95,184
Network Access and Long Distance................................ 235,725 213,113 195,575
Miscellaneous................................................... 53,829 48,299 41,528
----------- ----------- ---------
Total Telephone Revenues...................................... 412,380 371,913 332,287
Other Services.................................................... 33,516 24,747 23,764
Intercompany Revenues............................................. (1,693) (1,058) (1,210)
----------- ----------- ---------
Total Operating Revenues...................................... 444,203 395,602 354,841
----------- ----------- ---------
Operating Expenses
Telephone Expenses
Network Operations.............................................. 80,487 67,521 54,964
Depreciation and Amortization................................... 95,278 85,575 74,758
Customer Operations............................................. 65,167 53,764 46,818
Corporate Operations............................................ 68,454 62,276 58,998
----------- ----------- ---------
Total Telephone Expenses...................................... 309,386 269,136 235,538
Other Services.................................................... 37,897 24,816 22,273
Intercompany Expenses............................................. (1,693) (1,058) (1,210)
----------- ----------- ---------
Total Operating Expenses...................................... 345,590 292,894 256,601
----------- ----------- ---------
Operating Income.................................................... $ 98,613 $ 102,708 $ 98,240
----------- ----------- ---------
----------- ----------- ---------
Companies........................................................... 106 105 100
Access lines........................................................ 515,500 484,500 425,900
Growth in access lines from prior year-end:
Acquisitions...................................................... 3,200 33,100 13,500
Internal growth................................................... 27,800 25,500 19,900
Telephone plant in service per access line.......................... $ 2,488 $ 2,461 $ 2,356
Average monthly revenue per access line............................. $ 68.78 $ 67.10 $ 66.82
Employees........................................................... 2,350 2,160 1,925
----------- ----------- ---------
----------- ----------- ---------
OPERATING REVENUES totaled $444.2 million in 1997, up 12% ($48.6 million)
from 1996 and totaled $395.6 million in 1996, up 11% ($40.8 million) from 1995.
The increases were due to the growth in telephone revenues and other services
revenues.
Operating revenues from telephone operations increased 11% ($40.5 million)
in 1997 and 12% ($39.6 million) in 1996. Acquisitions increased telephone
revenues $8.1 million in 1997 and $18.8 million in 1996. Recovery of increased
costs of providing long-distance services resulted in increases in revenue of
$12.1 million in 1997 and $8.1 million in 1996. Internal growth and increases in
the sales of custom-calling features increased revenue by $8.7 million in 1997
and $8.0 million in 1996. Increased sales of customer premise equipment,
including digital broadcast satellites, increased revenues by $6.1 million in
1997 and $2.2 million in 1996. Increased network usage resulted in revenue
increases of $5.7 million in 1997 and $4.5 million in 1996. Average monthly
revenue per access line was $68.78 in 1997, $67.10 in 1996 and $66.82 in 1995.
Operating revenues from other services increased 35% ($8.8 million) in 1997
and 4% ($1.0 million) in 1996. The increase in 1997 is primarily due to
increases in the structured wiring business ($6.0 million) and the Internet
business ($2.8 million).
8
OPERATING EXPENSES totaled $345.6 million in 1997, up 18% ($52.7 million)
from 1996 and totaled $292.9 million in 1996, up 14% ($36.3 million) from 1995.
The increases were due to the growth in telephone expenses and additional other
services expenses.
Operating expenses from telephone operations increased 15% ($40.3 million)
in 1997 and 14% ($33.6 million) in 1996. The effects of acquisitions increased
expenses 2% ($6.2 million) in 1997 and 6% ($14.6 million) in 1996. Depreciation
and amortization expenses increased 11% ($9.7 million) in 1997 and 14% ($10.8
million) in 1996 due primarily to increased investment in plant and equipment.
Cost of goods sold for customer premise equipment, including digital broadcast
satellite, increased operating expenses by $5.2 million in 1997. Increased
marketing and advertising campaigns increased expenses by $4.7 million in 1997.
Increased investment in systems and systems support in 1997 resulted in an $8.4
million increase in expenses. The development of a centralized network
management center to provide more effective network monitoring and maintenance
increased expenses by $1.8 million in 1997 and $3.4 million in 1996. The costs
to explore new business increased expenses by $3.2 million in 1996. The
remaining increase in each year was due primarily to growth in internal
operations.
Operating expenses from other services increased 53% ($13.1 million) in 1997
and 11% ($2.5 million) in 1996. The increase in 1997 is primarily due to
increases in the structured wiring business ($7.6 million) and the Internet
business ($3.2 million) as well as costs related to the start-up of the CLEC
business.
OPERATING CASH FLOW increased 3% to $196.7 million in 1997 compared to an
increase of 9% to $191.2 million in 1996 due primarily to the growth in
telephone operations. TDS Telecom continues to provide steadily growing
operating cash flow to support its construction activities.
OPERATING INCOME decreased 4% ($4.1 million) in 1997 and increased 5% ($4.5
million) in 1996. Operating income from telephone operations increased $200,000
to $103.0 million in 1997 from $102.8 million in 1996 and increased $6.0 million
in 1996 from $96.7 million in 1995. The effects of acquisitions increased
operating income 2% ($1.9 million) in 1997 and 4% ($4.2 million) in 1996. The
telephone operating margin was 25.0% in 1997, 27.6% in 1996 and 29.1% in 1995.
The reduction in operating margin was caused by earnings pressures from
regulatory agencies and long-distance providers and expenses incurred in the
development of new business ventures. Operating loss from other services was
$4.4 million in 1997 and $100,000 in 1996 as compared to an operating income of
$1.5 million in 1995, reflecting the expenses associated with the start-up of
the Internet business in late 1995, the structured wiring business in mid-1996
and the CLEC business in 1997.
TDS Telecom is subject to the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain
Types of Regulation." The Company periodically reviews the criteria for applying
these provisions to determine whether continuing application of SFAS No. 71 is
appropriate. The Company believes that such criteria are still being met and
therefore has no current plans to change its method of accounting.
In analyzing the effects of discontinuing the application of SFAS No. 71,
management has determined that the useful lives of plant assets used for
regulatory and financial reporting purposes are consistent with generally
accepted accounting principles and therefore, any adjustments to
telecommunications plant would be immaterial, as would be the write-off of
regulatory assets and liabilities.
BROADBAND PERSONAL COMMUNICATIONS SERVICES
TDS manages its broadband personal communications services business through
Aerial. Aerial's licenses include the Major Trading Areas ("MTAs") of
Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and
Columbus. The preparation of each of its markets for initial service launch and
the development of its PCS business was Aerial's center of attention in 1997.
Aerial launched service in the first of its six markets on March 27, 1997 and
completed the launch of its last market in June. Across all six markets, Aerial
launched service with approximately 600 cell sites in service. At the end of
1997, Aerial served 125,000 customers and had 1,044 cell sites in service.
Operating results reflect the revenues and expenses of Aerial since the
initiation of service on March 27, 1997, when Aerial ceased to be a development
stage enterprise. Expenses for the periods prior to March 27 are reported
9
as PCS Development Expenses included in the "Investment and Other Income
(Expense)" section of the Income Statement.
YEAR ENDED OR AT DECEMBER 31,
------------------------------------
1997 1996 1995
------------ ---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT PER CUSTOMER AMOUNTS)
Operating Revenues................................................. $ 55,952 $ -- $ --
------------ ---------- ----------
Operating Expenses
Systems Operations............................................... 30,655 -- --
Marketing and selling............................................ 45,974 -- --
Cost of equipment sold........................................... 71,454 -- --
General and administrative....................................... 44,467 -- --
Customer service................................................. 20,882 -- --
Depreciation and amortization.................................... 39,071 -- --
------------ ---------- ----------
252,503 --
------------ ---------- ----------
Operating (loss)................................................... $ (196,551) $ -- $ --
------------ ---------- ----------
------------ ---------- ----------
Customers.......................................................... 125,000 -- --
Market penetration................................................. .45% -- --
Cell sites in service.............................................. 1,044 -- --
Average monthly service revenue per customer....................... $ 73.56 -- --
Churn rate per month............................................... 4.5% -- --
Employees.......................................................... 1,414 424 50
------------ ---------- ----------
------------ ---------- ----------
OPERATING REVENUES totaled $56.0 million in 1997. Service revenues
consisting of charges for access, airtime and value-added services provided to
Aerial's customers who use its network and charges for long-distance calls made
on its systems totaled $32.3 million. The average monthly service revenue per
customer was $73.56 in 1997. Equipment sales revenues consisting of units sold
to retailers, independent agents and customers totaled $23.6 million. The
average revenue per unit sold was $124.
OPERATING EXPENSES totaled $252.5 million in 1997 reflecting the costs of
operating Aerial's network, marketing, selling and advertising and promotion
expenses, cost of equipment sold, customer service expenses as well as general
and administrative expenses. SYSTEMS OPERATIONS expenses totaled $30.7 million
reflecting the costs of operating Aerial's network, primarily cell site
expenses, landline interconnection and toll charges and employee costs.
MARKETING AND SELLING EXPENSES totaled $46.0 million reflecting an aggressive
advertising campaign that accompanied the launch of service and continued
throughout 1997. Marketing and selling expenses primarily consist of salaries
and benefits of sales and marketing personnel, sales commissions, the cost of
promotions and the cost of print, radio and television advertising. COST OF
EQUIPMENT SOLD totaled $71.5 million reflecting the cost of equipment sold to
customers and independent retailers and agents. The average cost per unit sold
was $374. GENERAL AND ADMINISTRATIVE EXPENSES totaled $44.5 million reflecting
the expenses associated with the management and operating teams as well as
overhead expenses. CUSTOMER SERVICE EXPENSES totaled $20.9 million primarily for
customer service activity at Aerial's national operations center to support the
PCS markets. DEPRECIATION AND AMORTIZATION totaled $39.1 million.
OPERATING LOSS totaled $196.6 million in 1997. Management expects Aerial to
generate significant losses in 1998 as it continues to build its customer base.
RADIO PAGING OPERATIONS
TDS manages its radio paging business through American Paging. American
Paging provided wireless messaging communications through its digital radio
transmission systems to 811,100 pagers at the end of 1997 compared to 777,400
pagers at the end of 1996 and 784,500 pagers at the end of 1995.
COMBINATION OF AMERICAN PAGING AND TSR PAGING
In December 1997, TDS announced an agreement with TSR Paging, Inc. ("TSR")
to combine their respective paging businesses. On February 10, 1998 the board of
directors of American Paging approved a merger agreement providing for the
acquisition by TDS of all the issued and outstanding shares of American Paging
not owned by TDS
10
for cash in an amount equal to $2.50 per share, approximately $9.1 million in
total. Upon consummation of the merger, TDS will contribute substantially all of
the assets and certain, limited liabilities of American Paging, and TSR will
contribute all of its assets and liabilities to a new limited liability company.
The asset contribution agreement provides that, subject to adjustment, TDS will
have a 30% interest and TSR will have a 70% interest in the new company. The
formation of the new company, while subject to a number of conditions, including
consummation of the merger and regulatory approvals, is expected to occur in the
first half of 1998. TDS will adopt the equity method of accounting for its
investment in the new company. TDS will not have any funding requirements once
the combination is completed.
YEAR ENDED OR AT DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS,
EXCEPT PER UNIT AMOUNTS)
Operating revenue............................................. $ 94,413 $ 104,187 $ 107,150
----------- ----------- -----------
Costs and expenses
Cost of services............................................ 27,822 26,712 22,294
Selling, general and administrative......................... 62,089 70,441 55,064
Cost of goods sold.......................................... 7,769 9,883 14,097
Depreciation and amortization............................... 32,040 33,777 24,692
----------- ----------- -----------
129,720 140,813 116,147
----------- ----------- -----------
Operating (Loss).............................................. $ (35,307) $ (36,626) $ (8,997)
----------- ----------- -----------
----------- ----------- -----------
Pagers in service............................................. 811,100 777,400 784,500
Average monthly revenue per unit.............................. $ 9.17 $ 9.88 $ 10.57
Transmitters in service....................................... 1,049 1,048 1,018
Churn rate per month.......................................... 2.6% 3.1% 2.5%
Employees..................................................... 621 837 717
----------- ----------- -----------
----------- ----------- -----------
OPERATING REVENUES decreased 9% ($9.8 million) in 1997, primarily due to
competitive pricing declines. Operating revenues decreased 3% ($3.0 million) in
1996 primarily as a result of a 27% ($3.8 million) decline in equipment sales.
Average monthly revenue per unit declined 7% to $9.17 in 1997 and 7% to $9.88 in
1996.
OPERATING EXPENSES decreased 8% ($11.1 million) in 1997 and increased 21%
($24.7 million) in 1996 reflecting the effects of restructuring charges. In
1996, American Paging recorded restructuring expenses of $9.3 million related to
subleasing office space, employee severance, outplacement services and
consulting services ($4.0 million) and write-offs of certain assets ($5.3
million) compared to $2.9 million of restructuring charges in 1995. American
Paging experienced significant employee turnover as a result of the
restructuring in 1996 which resulted in increased costs to recruit and train new
employees. Also, in 1996, the cost of service increased primarily due to the
increase in third-party reseller expense related to the increase in nationwide
units in service and the costs to increase system capacity.
OPERATING LOSS was $35.3 million in 1997, $36.6 million in 1996 and $9.0
million in 1995. Upon the completion of the merger with TSR, TDS will adopt the
equity method of accounting for this investment.
INFLATION
Management believes that inflation affects TDS's business to no greater
extent than the general economy.
FINANCIAL RESOURCES
TDS and its subsidiaries operate relatively capital-intensive businesses.
Rapid growth has caused expenditures for construction, expansion and acquisition
programs to exceed internally generated cash flow. Accordingly, in recent years,
TDS and its principal subsidiaries have obtained substantial funds from external
sources to acquire PCS licenses, to finance PCS construction, start-up and
development costs and to fund acquisitions. Although the increasing internal
cash flow from U.S. Cellular and the steady internal cash flow from TDS Telecom
have reduced the need for external financing, Aerial's development and
construction activities have required substantial additional funds from external
sources.
11
CASH FLOWS FROM OPERATING ACTIVITIES. TDS is generating substantial internal
funds from the rapid growth in customer units and revenues at U.S. Cellular and
steady growth at TDS Telecom. The launch of PCS operations, however, required
substantial funds, thereby reducing cash flows from operating activities in
1997. Cash flows from operating activities totaled $206.5 million in 1997,
$295.0 million in 1996 and $210.9 million in 1995.
Aerial's market launch activities also substantially reduced operating cash
flow in 1997. Operating cash flow (operating income plus depreciation and
amortization) decreased 23% to $297.9 million in 1997 from $384.5 million in
1996 and $323.5 million in 1995. Aerial's operations reduced operating cash flow
by $157.5 million in 1997. U.S. Cellular's operating cash flow increased 33%
($65.7 million) to $261.9 million in 1997, and 48% ($64.0 million) to $196.2
million in 1996 while TDS Telecom's operating cash flow increased 3% ($5.5
million) to $196.7 million in 1997, and 9% ($15.6 million) to $191.2 million in
1996. Cash flows from other operating activities (investment and other income,
interest and income tax expense and changes in working capital and other assets
and liabilities) required $91.3 million in 1997, $89.5 million in 1996, and
$112.6 million in 1995.
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
------------ ----------- ------------
(DOLLARS IN THOUSANDS)
Operating cash flow
U.S. Cellular.................................................. $ 261,922 $ 196,205 $ 132,213
TDS Telecom.................................................... 196,679 191,167 175,595
Aerial......................................................... (157,480) -- --
American Paging................................................ (3,267) (2,849) 15,695
------------ ----------- ------------
297,854 384,523 323,503
Other operating activities..................................... (91,347) (89,529) (112,627)
------------ ----------- ------------
$ 206,507 $ 294,994 $ 210,876
------------ ----------- ------------
------------ ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES. TDS's long-term strategy is to
maintain a strong yet flexible financial foundation. Consolidated equity capital
(common equity, preferred stock, trust originated preferred securities and
minority interest) was 59% of total capitalization at December 31, 1997,
compared to 68% and 66% at December 31, 1996 and 1995, respectively. The reduced
equity capital percentage to total capitalization in 1997 is primarily a result
of increases in long-term debt at U.S. Cellular and Aerial and the increase in
TDS's short-term debt. TDS targets a ratio of equity to total capital in the
range of 55% to 65%.
Cash flows from financing activities totaled $547.6 million in 1997, $124.9
million in 1996 and $369.5 million in 1995. TDS has required significant funds
from external sources to finance PCS construction, start-up and development
activities in 1997 and 1996 and the purchase of the PCS licenses in 1995. TDS
has used short-term debt to finance these PCS expenditures, as well as to
finance its radio paging operations, for acquisitions and for general corporate
purposes.
TDS takes advantage of attractive opportunities to retire short-term debt
with proceeds from long-term debt and equity financing, including sales of debt
and equity securities by subsidiaries. Proceeds from the issuance of long-term
debt and equity securities totaled $392.0 million, $195.3 million and $260.7
million in 1997, 1996 and 1995, respectively. Proceeds from the sales of
non-strategic cellular and other investments from time to time in 1997, 1996 and
1995 have also been used to retire short-term debt. TDS has cash management
arrangements with its subsidiaries under which the subsidiaries may from time to
time deposit excess cash with TDS for investment under TDS's cash management
program. Deposits made under the arrangements are available to the subsidiaries
on demand and bear interest each month at the 30-day Commercial Paper Rate as
reported in The Wall Street Journal, plus 1/4%, or such higher rate as TDS may
at its discretion offer on such deposits.
In 1997, TDS received net proceeds of $144.8 million on the sale of 8.5%
Trust Originated Preferred Securities-SM-. U.S. Cellular received $247.0 million
on the sale of 10-year 7.25% notes and used the proceeds to repay existing
balances on the vendor financing arrangements, to finance the cash requirements
for the BellSouth exchange and for general corporate purposes. In 1996, Aerial
received $195.3 million in an initial public offering of Common Shares. In 1995,
U.S. Cellular received $221.5 million from the sale of 20-year 6% zero coupon
convertible debt and TDS sold $39.2 million of Medium-Term Notes.
- ----------
- -SM-"Trust Originated Preferred Securities" is a service mark of Merrill Lynch &
Co. Inc.
12
Aerial, TDS Telecom and U.S. Cellular have also used long-term debt to
finance their construction and development activities. In 1996, Aerial issued
10-year 8.34% zero coupon notes for $100 million of digital radio channel and
switching equipment. The $100 million proceeds of the sale of the notes were
paid to Nokia Telecommunications, Inc. ("Nokia") in satisfaction of all
outstanding obligations and future obligations up to $100 million under a $200
million Credit Agreement between Aerial and Nokia ("Nokia Credit Agreement").
TDS Telecom telephone subsidiaries borrowed $15.0 million in 1997, $12.2 million
in 1996 and $12.0 million in 1995 under the Rural Utility Service and the Rural
Telephone Bank long-term federal government loan programs to finance their
telephone construction programs. U.S. Cellular financed cellular system
equipment and construction costs totaling $59.5 million in 1995 under vendor
financing arrangements.
In 1997, TDS purchased 1.8 million TDS Common Shares for $69.9 million. In
December 1996, TDS authorized the repurchase of up to 3.0 million TDS Common
Shares over a period of three years. A total of 1.0 million shares were
subsequently reissued, primarily for acquisitions. TDS has paid dividends of
$.42, $.40 and $.38 per Common and Series A Common Share in 1997, 1996 and 1995,
respectively. Aggregate dividends paid on Common and Preferred Shares, excluding
dividends reinvested, totaled $27.2 million in 1997, $26.2 million in 1996 and
$24.0 million in 1995.
CASH FLOWS FROM INVESTING ACTIVITIES. TDS makes substantial investments each
year to acquire, construct, operate and maintain modern high-quality
communications networks and facilities as a basis for creating long-term value
for shareowners. In recent years, rapid changes in technology and new
opportunities have required substantial investments in revenue enhancing and
cost reducing upgrades of the Company's networks. In addition, the Company has
made substantial investments to enter the PCS business.
Cash flows from investing activities totaled $760.7 million in 1997, $417.4
million in 1996 and $550.0 million in 1995 primarily for capital expenditures,
the purchase of PCS licenses and acquisitions. Cash expenditures for capital
additions totaled $786.3 million in 1997, $550.2 million in 1996 and $360.0
million in 1995. The acquisition of broadband and narrowband PCS licenses
required $326.0 million in 1995. Cash used for acquisitions, excluding cash
acquired, totaled $129.0 million in 1997, $31.0 million in 1996 and $53.8
million in 1995. The sale of non-strategic cellular assets and other investments
provided net proceeds of $84.2 million in 1997, $221.5 million in 1996 and
$197.6 million in 1995. Distributions from partnerships totaled $56.4 million in
1997, $25.5 million in 1996 and $9.1 million in 1995.
13
CAPITAL EXPENDITURES
The primary purpose of TDS's construction and expansion program is to
provide for significant customer growth, to upgrade service, to expand into new
communication areas, and to take advantage of service-enhancing and
cost-reducing technological developments. The following table summarizes the
Company's investments in its communications networks and related facilities
during the past three years.
YEAR ENDED OR AT DECEMBER 31,
---------------------------------------
1997 1996 1995
------------- ----------- -----------
(DOLLARS IN THOUSANDS)
U.S. Cellular
Cell sites and equipment....................................... $ 238,797 $ 133,832 $ 150,340
Switching equipment............................................ 5,457 5,713 13,002
Systems development............................................ 40,949 28,753 10,148
Other.......................................................... 33,545 79,825 37,388
------------- ----------- -----------
318,748 248,123 210,878
------------- ----------- -----------
TDS Telecom
Central office................................................. 52,479 47,208 38,697
Outside plant.................................................. 60,974 53,130 55,569
Systems development............................................ 9,127 20,497 7,137
Other.......................................................... 28,880 23,605 2,969
------------- ----------- -----------
151,460 144,440 104,372
------------- ----------- -----------
Aerial
Cell sites and equipment....................................... 291,922 150,386 --
Switching equipment............................................ 38,428 53,170 --
Systems development............................................ 55,553 26,277 --
Other.......................................................... 1,815 12,436 8,521
Prepaid network infrastructure................................. (70,300) 70,300 --
------------- ----------- -----------
317,418 312,569 8,521
Less noncash items............................................. (42,709) (199,630) --
------------- ----------- -----------
274,709 112,939 8,521
------------- ----------- -----------
American Paging.................................................. 18,624 32,517 26,527
------------- ----------- -----------
Other.......................................................... 22,776 12,185 9,698
------------- ----------- -----------
$ 786,317 $ 550,204 $ 359,996
------------- ----------- -----------
------------- ----------- -----------
U.S. Cellular's capital additions include expenditures to add additional
cell sites and radio channels to expand coverage and add capacity. U.S. Cellular
constructed 331 cell sites in 1997, 242 in 1996 and 292 in 1995. TDS Telecom's
capital additions include expenditures for switch modernization and outside
plant facilities to maintain and enhance the quality of service and offer new
revenue opportunities. TDS Telecom installed 32 digital switches in 1997, 35 in
1996 and 39 in 1995. Aerial has completed the construction of the five planned
switching centers, the central Network Operations Center and has over 1,000 cell
sites in service.
The Company's expected 1998 property, plant and equipment additions reflect
the Company's construction and expansion programs and are anticipated to
aggregate approximately $545 million. In addition, Aerial's working capital and
operating expenses will require an estimated $175 million.
- The cellular capital additions budget totals approximately $330 million,
including about $240 million for new cell sites and about $90 million for
various information systems initiatives.
- The telephone capital additions budget totals approximately $140 million,
including about $50 million for new digital switches and other switching
facilities and $35 million for improvements to outside plant facilities.
- The PCS capital additions budget totals approximately $75 million,
including $20 million for cell sites, $25 million for switching equipment
and $15 million for systems development. In addition, Aerial's working
capital and operating expenses will require an estimated $175 million.
14
ACQUISITIONS, TRADES AND SALES
TDS continually reviews attractive opportunities for the acquisition of
additional telecommunications companies which add value to the organization. TDS
and U.S. Cellular continue to assess the makeup of cellular holdings in order to
maximize the benefits derived from clustering U.S. Cellular's markets. As the
number of opportunities for outright acquisitions of cellular interests has
decreased and as U.S. Cellular's clusters have grown to realize greater
economies of scale, U.S. Cellular's focus has shifted toward exchanges and sales
of non-strategic interests.
Cash expenditures (excluding cash acquired) for acquisitions totaled $129.0
million in 1997, $31.0 million in 1996 and $53.8 million in 1995. TDS completed
an exchange with BellSouth in 1997, completed the acquisition of controlling
interests in two cellular markets and one telephone company in 1997, two
cellular markets and five telephone companies in 1996 and eleven cellular
markets and five telephone companies in 1995 and increased its ownership of
certain cellular interests during the last three years for an aggregate
consideration (consisting of cash, TDS Common Shares, TDS Preferred Shares, and
U.S. Cellular Common Shares) totaling $174.7 million, $144.1 million and $194.4
million, respectively.
In October 1997, U.S. Cellular completed an exchange with BellSouth.
Pursuant to the exchange, U.S. Cellular received majority interests representing
approximately 4.0 million pops in exchange for majority interests representing
2.0 million pops, minority interests representing 1.2 million pops and a net
amount of $86.7 million in cash. The majority interests U.S. Cellular received
are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana
clusters.
In December 1997, U.S. Cellular announced that AirTouch will acquire
noncontrolling interests in 11 markets owned by U.S. Cellular and TDS. AirTouch
will issue approximately 5,000,000 shares of its common stock and pay
approximately $54.2 million in cash to U.S. Cellular and TDS in exchange for
these interests. Management expects that it will record a significant pretax
gain upon the completion of the sales transactions. The sales are expected to be
completed in the first half of 1998.
LIQUIDITY
The Company anticipates that the aggregate resources required for 1998 will
include approximately $545 million for capital spending, consisting of $330
million for cellular capital additions, $140 million for telephone capital
additions and $75 million for PCS capital additions. In addition, Aerial's
working capital and operating expenses will require an estimated $175 million.
U.S. Cellular plans to finance its construction program primarily with
internally generated cash supplemented by short-term financing. U.S. Cellular's
operating cash flow totaled $261.9 million in 1997 (approximately 82% of 1997
capital expenditures) up 33% ($65.7 million) from 1996. U.S. Cellular also
received $52.4 million in distributions from minority partnership interests and
$61.1 million from the proceeds of investment sales to supplement operating cash
flow. At December 31, 1997, U.S. Cellular had $500 million of bank lines of
credit for general corporate purposes, all of which was available.
TDS Telecom plans to finance its construction program using internally
generated cash supplemented by long-term financing from federal government
programs. Operating cash flow totaled $196.7 million in 1997 (approximately 130%
of 1997 capital expenditures) up 3% ($5.5 million) from 1996. At December 31,
1997, TDS Telecom telephone subsidiaries had $112.0 million in unadvanced loan
funds from federal government programs to finance the telephone construction
program. These loan commitments have a weighted average annual interest rate of
5.71%.
Aerial plans to finance its construction expenditures and working capital
requirements with borrowings under the TDS lines of credit and vendor financing.
Aerial issued 10-year 8.05% zero coupon notes for $100 million in February 1998
to finance digital radio channel and switching infrastructure equipment. The
$100 million proceeds from the sale were paid to Nokia in satisfaction of all
outstanding obligations and certain future obligations of Aerial under the Nokia
Credit Agreement.
TDS and its subsidiaries had cash and temporary investments totaling $75.6
million and longer-term investments totaling $32.6 million at December 31, 1997.
These investments are primarily the result of telephone operations' internally
generated cash. While certain regulated telephone subsidiaries' debt agreements
place limits on intercompany dividend payments, these restrictions are not
expected to affect the Company's ability to meet its cash obligations.
15
TDS had $644 million of bank lines of credit for general corporate purposes
at December 31, 1997 of which $118 million was unused. These line of credit
agreements provide for borrowings at negotiated rates up to the prime rate.
In February 1998, TDS received net proceeds of $145 million on the sale of
6.0 million 8.04% Trust Originated Preferred Securities at $25 per Preferred
Security. The net proceeds were used to repay certain short-term indebtedness.
Subject to the approval of the Tracking Stock Proposal by shareholders, the
Company intends to, among other things, offer and sell Telecom Group Shares in a
public offering for cash, and allocate the net proceeds to the Telecom Group.
The Company intends to file with the SEC a registration statement on Form S-3
relating to the registration of between 10,000,000 and 17,000,000 Telecom Group
Shares. This offering is expected to commence promptly after the approval of the
Tracking Stock Proposal by shareholders, subject to prevailing market conditions
and other factors. Management estimates proceeds of approximately $150 million
from the offering which the Telecom Group would use to repay obligations to TDS,
and which TDS would use to repay certain short-term indebtedness.
Management believes that TDS's internal cash flows and funds available from
cash and cash equivalents, lines of credit, and longer-term financing
commitments provide sufficient financial flexibility. However, the timing and
amounts of capital expenditures and acquisitions as well as working capital
requirements and amounts needed for general corporate purposes may vary
throughout the year. There can be no assurance that sufficient funds will be
available to the Company on terms or at prices acceptable to the Company. If
sufficient funding is not made available to the Company on terms and prices
acceptable to the Company, the Company would have to reduce its construction,
development and acquisition programs. TDS and its subsidiaries anticipate
accessing public and private capital markets to issue debt and equity securities
only when capital requirements, financial market conditions and other factors
warrant.
TDS has assessed, and continues to assess, the impact of the Year 2000 Issue
on its reporting systems and operations. The Company believes that modifying its
reporting systems and operations is not a material event and is taking steps to
make its systems Year 2000 compliant. The Year 2000 Issue exists because many
computer systems and applications abbreviate dates by eliminating the first two
digits of the year, assuming that these two digits would always be "19". Unless
corrected, this shortcut is expected to cause problems when the century date
occurs. On that date, some computer programs may recognize the date as January
1, 1900 instead of January 1, 2000. This may cause systems to incorrectly
process critical financial and operational information, or stop processing
altogether. The cost of addressing the Year 2000 Issue to date was not material
to the Company's results of operations or financial condition, and management
believes that the costs to be incurred in 1998 and 1999 will not be material to
future operating results or financial condition. If management's steps are not
successful in making the systems Year 2000 compliant, it could have a material
adverse effect on results of operations.
PROPOSED CORPORATE RESTRUCTURING
The Board of Directors of Telephone and Data Systems, Inc. (the "Board") has
adopted a proposal which, if approved by shareholders and implemented by the
Board, would authorize the Board to issue three new classes of common stock and
change the state of incorporation of TDS from Iowa to Delaware (the "Tracking
Stock Proposal"). The three new classes of stock are intended to separately
reflect the performance of TDS's cellular telephone, landline telephone and
personal communications services businesses ("Tracking Stocks").
The Tracking Stocks are intended to result in greater market recognition of
the value (individually and collectively) of TDS and of TDS's three principal
business groups ("Tracking Groups"), thereby enhancing shareholder value over
the long term, while at the same time enabling TDS's businesses to preserve the
benefits of being part of a consolidated enterprise. The Tracking Stock Proposal
is expected to:
- provide TDS with greater flexibility in raising capital and making
acquisitions, using equity securities specifically related to the Tracking
Groups;
- enable TDS to more effectively tailor employee benefit plans to provide
incentives to employees of the Tracking Groups;
- provide shareholders with the opportunity to invest in separate securities
that specifically reflect the underlying businesses, depending upon their
investment objectives;
16
- permit shareholders to continue to invest in all of the TDS businesses
through the Common Shares and the Series A Common Shares.
Pursuant to the Tracking Stock Proposal each issued Preferred Share, Common
Share and Series A Common Share of TDS would be converted into a new Preferred
Share, Common Share and Series A Common Share, respectively, of the new TDS
Delaware Corporation. In addition, the Tracking Stock Proposal would authorize
three new classes of common stock, to be designated as United States Cellular
Group Common Shares (the "Cellular Group Shares"), TDS Telecommunications Group
Common Shares (the "Telecom Group Shares") and Aerial Communications Group
Common Shares (the "Aerial Group Shares"). The Cellular Group Shares, when
issued, are intended to reflect the separate performance of the United States
Cellular Group (the "Cellular Group"), which consists of TDS's interest in
United States Cellular Corporation, a subsidiary of TDS operating and investing
in cellular telephone companies and properties ("U. S. Cellular"). The Telecom
Group Shares, when issued, are intended to reflect the separate performance of
the TDS Telecommunications Group (the "Telecom Group"), which primarily consists
of TDS's interest in TDS Telecommunications Corporation, a subsidiary of TDS
operating landline telephone companies ("TDS Telecom"). The Aerial Group Shares,
when issued, are intended to reflect the separate performance of the Aerial
Communications Group (the "Aerial Group"), which consists of TDS's interest in
Aerial Communications, Inc., a subsidiary of TDS providing broadband personal
communications services ("Aerial").
Subject to the approval of the Tracking Stock Proposal by shareholders, TDS
intends to:
- offer and sell Telecom Group Shares in a public offering for cash, subject
to prevailing market and other conditions (the "Telecom Public Offering"),
and allocate the net proceeds thereof to the Telecom Group,
- issue Cellular Group Shares in exchange for all of the Common Shares of
U.S. Cellular which are not owned by TDS, subject to approval by the
board of directors and the shareholders of U.S. Cellular, (the "U.S.
Cellular Merger"),
- issue Aerial Group Shares in exchange for all of the Common Shares of
Aerial which are not owned by TDS, subject to approval by the board of
directors and the shareholders of Aerial (the "Aerial Merger"), and
- distribute one Cellular Group Share, two-thirds of a Telecom Group Share
and two-thirds of an Aerial Group Share in the form of a stock dividend
with respect to each outstanding Series A Common Share and Common Share of
TDS (the "Distribution").
It is currently expected that the Distribution would take place in July 1998
or later, after the completion of the Telecom Public Offering, the U.S. Cellular
Merger and the Aerial Merger, although the Board reserves the right to effect
all or any part of the Distribution at any time after the approval of the
Tracking Stock Proposal, or not to make the Distribution, regardless of whether
or not such other transactions have taken place.
The shares of Tracking Stock which would be issued in the Distribution
would represent an approximately 75% interest in the common equity value of
TDS in each Tracking Group (the "Outstanding Interest"). When considering the
shares of Tracking Stock which would also be issued in the Telecom Public
Offering, the U.S. Cellular Merger and the Aerial Merger, as well as the
Distribution, the Outstanding Interest would initially represent in the
aggregate an approximately 80% interest in each Tracking Group. Upon
completion of all of the Transactions as contemplated, approximately 20% of
the common shareholders' value of each Tracking Group would initially be
retained (the "Retained Interest") in a residual group (the "TDS Group"),
along with all other interests held by TDS.
The TDS Series A Common Shares and Common Shares will continue to be
outstanding and are intended to reflect the performance of the Cellular Group,
the Telecom Group, and the Aerial Group to the extent of the Retained Interest
in the respective groups, and to reflect the performance of the other assets and
businesses attributed to the TDS Group.
Following the Distribution, subject to the legal and contractual
restrictions on the payment of dividends, the Board currently intends to
establish an annual dividend on the TDS Common Shares and Series A Common Shares
in an amount equal to $.11 per share. The Board also currently intends to
establish an annual dividend on the Telecom Group Shares in an amount equal to
$.50 per share. (Based on the expected distribution ratio of two-thirds of a
Telecom Group Share for each existing Common Share and Series A Common Share,
the dividend on Telecom Group shares would equate to a per share dividend of
$.33 per existing Common Share and Series A Common Share. The total of the
dividend on TDS Common Shares and Series A Common Shares of $.11 and the
equivalent dividend on Telecom Group Shares of $.33 equals the existing current
annual dividend on the existing Common Shares and Series A Common Shares of
$.44.) With regard to the Cellular Group and the Aerial Group Shares, the Board
currently intends to retain future earnings, if any, for the development of the
businesses of the Cellular Group
17
and Aerial Group, respectively, and does not anticipate paying dividends on the
Cellular Group or the Aerial Group Shares in the foreseeable future. Future
dividends on the shares of common stock will be payable when, as and if declared
by the Board out of the lesser of (1) all funds of TDS legally available
therefor and (2) the available dividend amount with respect to the relevant
Group.
Subject to the completion of the U.S. Cellular Merger and the Aerial Merger,
TDS intends to terminate certain intercompany agreements between TDS and U.S.
Cellular and Aerial, respectively. Thereafter, some or all of the policies
between TDS and such subsidiaries would be determined solely by methods that
management of TDS believes to be reasonable. Many of such policies would
continue the arrangements which presently exist between TDS and U.S. Cellular or
Aerial pursuant to the intercompany agreements, but TDS would have no
contractual obligation to continue such policies after the intercompany
agreements have been terminated.
If the Tracking Stock Proposal is approved by shareholders and implemented
by the Board, following the issuance of the Tracking Stocks, TDS will prepare
and file with the Securities and Exchange Commission consolidated financial
statements of TDS and financial statements of the Cellular Group, the Telecom
Group and the Aerial Group for so long as the respective Tracking Stock is
outstanding, and the TDS Group for as long as any Tracking Stock is outstanding.
Although the financial statements of the Cellular Group, the Telecom Group, the
Aerial Group, and the TDS Group will separately report the assets, liabilities
(including contingent liabilities) and shareholders' equity of TDS attributed to
the Cellular Group, the Telecom Group, the Aerial Group, and the TDS Group, such
attribution will not affect the legal title to such assets or responsibility for
such liabilities. Holders of the Cellular Group, the Telecom Group, and the
Aerial Group Common Shares will be, and holders of TDS Common Shares and Series
A Common Shares will continue to be, shareholders of TDS. TDS and its
subsidiaries will each continue to be responsible for their respective
liabilities.
LEGAL PROCEEDINGS. On December 29, 1997, a party, which claims to be a
holder of U.S. Cellular Common Shares, filed a putative class action complaint
on behalf of common stockholders of U.S. Cellular in the Court of Chancery of
the State of Delaware in New Castle County. The complaint names as defendants
TDS, U.S. Cellular, and the directors of U.S. Cellular. The complaint alleges a
breach of fiduciary duties by the defendants and seeks to have the U.S. Cellular
Merger enjoined or, if it is consummated, to have it rescinded and to recover
unspecified damages, fees and expenses. The defendants have been served with the
complaint in this case but have not yet responded to the complaint. The time for
the defendants to respond has been extended. The timing for a response will be
determined based on discussions between counsel for plaintiffs and defendants,
but a response is not expected to take place for at least one or more months. On
January 30, 1998, a virtually identical complaint has been filed by an
individual. None of the defendants have been served with this complaint. It is
expected that these cases will be consolidated.
On January 5, 1998, an individual who claims to be a holder of Aerial Common
Shares, filed a putative class action complaint on behalf of common stockholders
of Aerial in the Court of Chancery of the State of Delaware in New Castle
County. The complaint names as defendants TDS, Aerial and the directors of TDS
and Aerial. The complaint alleges a breach of fiduciary duties by the defendants
and seeks to have the Aerial Merger enjoined or, if it is consummated, to have
it rescinded and to recover unspecified damages, fees and expenses. The
defendants have been served with the complaint in this case but have not yet
responded to the complaint. The time for the defendants to respond has been
extended. The timing for a response will be determined based on discussions
between counsel for plaintiffs and defendants, but a response is not expected to
take place for at least one or more
18
months. On February 6, 1998, a virtually identical complaint has been filed by a
second individual. None of the defendants have been served with this complaint.
It is expected that these cases will be consolidated.
The Company intends to vigorously defend against these lawsuits. However,
there can be no assurance that such lawsuits will not have a material adverse
effect on the Company or the transactions contemplated by the Proxy
Statement/Prospectus.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY
STATEMENT
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION AND OTHER SECTIONS OF THIS ANNUAL REPORT CONTAIN
"FORWARD-LOOKING" STATEMENTS, AS DEFINED IN THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995, THAT ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND
PROJECTIONS. STATEMENTS THAT ARE NOT HISTORICAL FACTS, INCLUDING STATEMENTS
ABOUT THE COMPANY'S BELIEFS AND EXPECTATIONS ARE FORWARD-LOOKING STATEMENTS.
THESE STATEMENTS CONTAIN POTENTIAL RISKS AND UNCERTAINTIES AND THEREFORE,
ACTUAL RESULTS MAY DIFFER MATERIALLY. TDS UNDERTAKES NO OBLIGATION TO UPDATE
PUBLICLY ANY FORWARD-LOOKING STATEMENTS WHETHER AS A RESULT OF NEW
INFORMATION, FUTURE EVENTS OR OTHERWISE.
IMPORTANT FACTORS THAT MAY AFFECT THESE PROJECTIONS OR EXPECTATIONS INCLUDE,
BUT ARE NOT LIMITED TO: CHANGES IN THE OVERALL ECONOMY; CHANGES IN COMPETITION
IN MARKETS IN WHICH TDS OPERATES; ADVANCES IN TELECOMMUNICATIONS TECHNOLOGY;
CHANGES IN THE TELECOMMUNICATIONS REGULATORY ENVIRONMENT; PENDING AND FUTURE
LITIGATION; AVAILABILITY OF FUTURE FINANCING; START-UP OF PCS OPERATIONS; AND
UNANTICIPATED CHANGES IN GROWTH IN CELLULAR CUSTOMERS, PENETRATION RATES, CHURN
RATES AND THE MIX OF PRODUCTS AND SERVICES OFFERED IN OUR MARKETS. READERS
SHOULD EVALUATE ANY STATEMENTS IN LIGHT OF THESE IMPORTANT FACTORS.
19
TELEPHONE AND DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995
------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
OPERATING REVENUES
Cellular...................................................................... $ 876,965 $ 680,068 $ 480,316
Telephone..................................................................... 444,203 395,602 354,841
PCS........................................................................... 55,952 -- --
Radio paging.................................................................. 94,413 104,187 107,150
------------- ------------- -------------
1,471,533 1,179,857 942,307
------------- ------------- -------------
OPERATING EXPENSES
Cellular...................................................................... 747,422 592,702 437,561
Telephone..................................................................... 345,590 292,894 256,601
PCS........................................................................... 252,503 -- --
Radio paging.................................................................. 129,720 140,813 116,147
------------- ------------- -------------
1,475,235 1,026,409 810,309
------------- ------------- -------------
OPERATING INCOME (LOSS)......................................................... (3,702) 153,448 131,998
------------- ------------- -------------
INVESTMENT AND OTHER INCOME (EXPENSE)
Interest and dividend income.................................................. 13,660 15,569 13,024
Cellular investment income, net of license cost amortization.................. 77,620 54,799 40,666
Gain on sale of cellular interests and other investments...................... 41,438 138,735 86,625
PCS development costs......................................................... (21,614) (43,950) (7,829)
Other (expense) income, net................................................... (3,938) 2,727 (2,771)
Minority share of loss (income)............................................... 6,813 (26,690) (25,858)
------------- ------------- -------------
113,979 141,190 103,857
------------- ------------- -------------
INCOME BEFORE INTEREST AND INCOME TAXES......................................... 110,277 294,638 235,855
Interest expense................................................................ 89,744 42,853 50,848
Minority interest in income of subsidiary trust................................. 1,523 -- --
------------- ------------- -------------
INCOME BEFORE INCOME TAXES...................................................... 19,010 251,785 185,007
Income tax expense.............................................................. 28,559 123,646 81,029
------------- ------------- -------------
NET INCOME (LOSS)............................................................... (9,549) 128,139 103,978
Preferred Dividend Requirement.................................................. (1,892) (1,957) (2,509)
------------- ------------- -------------
NET INCOME (LOSS) AVAILABLE TO COMMON........................................... $ (11,441) $ 126,182 $ 101,469
------------- ------------- -------------
------------- ------------- -------------
WEIGHTED AVERAGE COMMON SHARES (000S)........................................... 60,211 60,464 57,456
EARNINGS PER COMMON SHARE--BASIC................................................ $ (.19) $ 2.09 $ 1.77
------------- ------------- -------------
------------- ------------- -------------
EARNINGS PER COMMON SHARE--DILUTED.............................................. $ (.19) $ 2.07 $ 1.74
------------- ------------- -------------
------------- ------------- -------------
DIVIDENDS PER COMMON AND SERIES A COMMON SHARE.................................. $ .42 $ .40 $ .38
------------- ------------- -------------
------------- ------------- -------------
The accompanying notes to consolidated financial statements are an integral part
of these statements.
20
TELEPHONE AND DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)................................................................. $ (9,549) $ 128,139 $ 103,978
Add (Deduct) adjustments to reconcile net income (loss) to net cash provided by
operating activities
Depreciation and amortization................................................... 301,556 231,075 191,504
Deferred taxes.................................................................. 17,236 75,015 19,603
Investment income............................................................... (83,395) (57,947) (43,188)
Minority share of income (loss)................................................. (6,813) 26,690 25,858
Gain on sale of cellular interests and other investments........................ (41,438) (138,735) (86,625)
Noncash interest expense........................................................ 24,289 17,042 12,761
Other noncash expense........................................................... 16,561 24,022 16,946
Change in accounts receivable................................................... (41,900) (28,687) (33,346)
Change in materials and supplies................................................ (25,827) (2,395) (2,999)
Change in accounts payable...................................................... 32,498 23,531 (11,630)
Change in accrued taxes......................................................... 7,612 (8,249) 6,252
Change in other assets and liabilities.......................................... 15,677 5,493 11,762
------------ ------------ ------------
206,507 294,994 210,876
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Long-term debt borrowings....................................................... 260,099 15,846 334,323
Repayment of long-term debt..................................................... (121,958) (34,200) (30,734)
Change in notes payable......................................................... 368,858 (27,133) 80,351
Trust preferred securities...................................................... 144,788 -- --
Dividends paid.................................................................. (27,193) (26,231) (23,972)
Proceeds from the issuance of subsidiaries' stock............................... -- 195,265 --
Repurchase of Common Shares..................................................... (69,942) -- --
Other financing activities...................................................... (7,064) 1,349 9,506
------------ ------------ ------------
547,588 124,896 369,474
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures............................................................ (786,317) (550,204) (359,996)
Investments in cellular investment entities and license costs................... (20,084) (23,134) (25,025)
Distributions from investments.................................................. 56,413 25,453 9,062
Investments in PCS licenses..................................................... (5,034) (26,548) (326,035)
Proceeds from investment sales.................................................. 84,230 221,542 197,558
Acquisitions, net of cash acquired.............................................. (128,979) (31,019) (53,770)
Change in temporary investments and marketable securities....................... 36,422 (30,797) 11,871
Other investing activities...................................................... 2,629 (2,666) (3,632)
------------ ------------ ------------
(760,720) (417,373) (549,967)
------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.............................. (6,625) 2,517 30,383
CASH AND CASH EQUIVALENTS
Beginning of period............................................................. 57,633 55,116 24,733
------------ ------------ ------------
End of period................................................................... $ 51,008 $ 57,633 $ 55,116
------------ ------------ ------------
------------ ------------ ------------
The accompanying notes to consolidated financial statements are an integral part
of these statements.
21
TELEPHONE AND DATA SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS--ASSETS
DECEMBER 31,
--------------------------
1997 1996
------------ ------------
(DOLLARS IN THOUSANDS)
CURRENT ASSETS
Cash and cash equivalents........................................................................ $ 51,008 $ 57,633
Temporary investments............................................................................ 24,559 61,664
Construction funds............................................................................... 775 1,405
Accounts receivable
Due from customers, less allowance of $15,102 and $6,090, respectively......................... 148,811 97,093
Other, principally connecting companies........................................................ 98,487 84,119
Materials and supplies, at average cost.......................................................... 55,127 29,125
Other............................................................................................ 29,517 15,031
------------ ------------
408,284 346,070
------------ ------------
INVESTMENTS
Cellular license costs, net of amortization...................................................... 1,190,917 1,088,409
Cellular minority interests...................................................................... 138,367 206,390
Broadband PCS license acquisition costs, net of amortization..................................... 319,918 322,420
Franchise and other costs in excess of the underlying book value of subsidiaries, net of
amortization.................................................................................... 180,669 181,845
Other investments................................................................................ 142,713 144,840
------------ ------------
1,972,584 1,943,904
------------ ------------
PROPERTY, PLANT AND EQUIPMENT
Cellular
In service and under construction................................................................ 1,212,575 846,005
Less accumulated depreciation.................................................................... 272,322 195,251
------------ ------------
940,253 650,754
------------ ------------
Telephone
In service and under construction, substantially at original cost................................ 1,420,890 1,293,779
Less accumulated depreciation.................................................................... 590,123 524,418
------------ ------------
830,767 769,361
------------ ------------
PCS
In service and under construction................................................................ 642,122 324,703
Less accumulated depreciation.................................................................... 38,018 1,980
------------ ------------
604,104 322,723
------------ ------------
Radio Paging
In service and under construction................................................................ 118,275 113,000
Less accumulated depreciation.................................................................... 75,045 61,528
------------ ------------
43,230 51,472
------------ ------------
Other
In service and under construction................................................................ 96,809 82,781
Less accumulated depreciation.................................................................... 49,510 48,202
------------ ------------
47,299 34,579
------------ ------------
2,465,653 1,828,889
------------ ------------
OTHER ASSETS AND DEFERRED CHARGES................................................................ 125,080 82,106
------------ ------------
$ 4,971,601 $ 4,200,969
------------ ------------
------------ ------------
The accompanying notes to consolidated financial statements are an integral part
of these statements.
22
TELEPHONE AND DATA SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS--LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31,
--------------------------
1997 1996
------------ ------------
(DOLLARS IN THOUSANDS)
CURRENT LIABILITIES
Current portion of long-term debt and preferred shares........................................... $ 16,115 $ 38,197
Notes payable.................................................................................... 527,587 160,537
Accounts payable................................................................................. 239,783 205,427
Advance billings and customer deposits........................................................... 33,640 32,434
Accrued interest................................................................................. 18,284 11,777
Accrued taxes.................................................................................... 6,961 3,194
Accrued compensation............................................................................. 23,386 10,279
PCS microwave relocation costs................................................................... 7,354 17,046
Other............................................................................................ 32,775 30,376
------------ ------------
905,885 509,267
------------ ------------
DEFERRED LIABILITIES AND CREDITS
Net deferred income tax liability................................................................ 202,680 183,792
Postretirement benefits obligation other than pensions........................................... 11,364 11,451
Other............................................................................................ 21,602 19,663
------------ ------------
235,646 214,906
------------ ------------
LONG-TERM DEBT, excluding current portion........................................................ 1,264,218 982,232
------------ ------------
REDEEMABLE PREFERRED SHARES, excluding current portion........................................... 180 280
------------ ------------
MINORITY INTEREST in subsidiaries................................................................ 416,566 432,343
------------ ------------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY
COMPANY SUBORDINATED DEBENTURES (a)............................................................. 150,000 --
------------ ------------
NONREDEEMABLE PREFERRED SHARES................................................................... 30,987 29,000
------------ ------------
COMMON STOCKHOLDERS' EQUITY
Common Shares, par value $1 per share; authorized 100,000,000 shares; issued and outstanding
54,443,260 and 54,237,180 shares, respectively.................................................. 54,443 54,237
Series A Common Shares, par value $1 per share; authorized 25,000,000 shares; issued and
outstanding 6,936,277 and 6,916,546 shares, respectively........................................ 6,936 6,917
Common Shares issuable, 10,480 and 30,977 shares, respectively................................... 499 1,461
Capital in excess of par value................................................................... 1,664,432 1,661,093
Treasury Shares, at cost, 794,576 shares......................................................... (30,682) --
Retained earnings................................................................................ 272,491 309,233
------------ ------------
1,968,119 2,032,941
------------ ------------
$ 4,971,601 $ 4,200,969
------------ ------------
------------ ------------
- ---------
(a) As described in Note 9, the sole asset of TDS Capital I is $154.6 million
principal amount of 8.5% subordinated debentures due 2037 from TDS.
The accompanying notes to consolidated financial statements are an integral part
of these statements.
23
TELEPHONE AND DATA SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
SERIES A COMMON CAPITAL IN
COMMON COMMON SHARES EXCESS OF TREASURY RETAINED
SHARES SHARES ISSUABLE PAR VALUE SHARES EARNINGS
--------- ----------- --------- ------------ ---------- -----------
(DOLLARS IN THOUSANDS)
BALANCE, DECEMBER 31, 1994.......................... $ 47,938 $ 6,887 $ 1,995 $ 1,288,453 $ -- $ 127,765
Net Income.......................................... -- -- -- -- -- 103,978
Dividends
Common and Series A Common Shares................. -- -- -- -- -- (21,910)
Preferred Shares.................................. -- -- -- -- -- (2,507)
Acquisitions........................................ 2,948 -- -- 125,231 -- --
Dividend reinvestment, incentive and benefit
plans.............................................. 186 18 -- 6,994 -- --
Conversion of Preferred Shares...................... 43 -- -- (2,962) -- --
Conversion of Series A Common Shares................ 12 (12) -- -- -- --
Shares issued pursuant to acquisition agreements.... 10 -- (499) 489 -- --
Other............................................... -- -- -- (692) -- --
--------- ----------- --------- ------------ ---------- -----------
BALANCE, DECEMBER 31, 1995.......................... 51,137 6,893 1,496 1,417,513 -- 207,326
Net Income.......................................... -- -- -- -- -- 128,139
Dividends
Common and Series A Common Shares................. -- -- -- -- -- (24,274)
Preferred Shares.................................. -- -- -- -- -- (1,958)
Acquisitions........................................ 2,635 -- 464 110,648 -- --
Dividend reinvestment, incentive and benefit
plans.............................................. 100 27 -- 4,487 -- --
Conversion of Preferred Shares...................... 352 -- -- 4,422 -- --
Conversion of Series A Common Shares................ 3 (3) -- -- -- --
Shares issued pursuant to acquisition agreements.... 10 -- (499) 489 -- --
Gain on sale of subsidiary stock.................... -- -- -- 114,056 -- --
Other............................................... -- -- -- 9,478 -- --
--------- ----------- --------- ------------ ---------- -----------
BALANCE, DECEMBER 31, 1996.......................... 54,237 6,917 1,461 1,661,093 -- 309,233
Net (Loss).......................................... -- -- -- -- -- (9,549)
Dividends
Common and Series A Common Shares................. -- -- -- -- -- (25,300)
Preferred Shares.................................. -- -- -- -- -- (1,893)
Acquisitions........................................ -- -- -- 3,601 39,084 --
Repurchase Common Shares............................ -- -- -- -- (69,942) --
Dividend reinvestment, incentive and benefit
plans.............................................. 122 19 -- 4,707 176 --
Conversion of Preferred Shares...................... 68 -- -- 1,419 -- --
Shares issued pursuant to acquisition agreements.... 16 -- (723) 707 -- --
Other............................................... -- -- (239) (7,095) -- --
--------- ----------- --------- ------------ ---------- -----------
BALANCE, DECEMBER 31, 1997.......................... $ 54,443 $ 6,936 $ 499 $ 1,664,432 $ (30,682) $ 272,491
--------- ----------- --------- ------------ ---------- -----------
--------- ----------- --------- ------------ ---------- -----------
The accompanying notes to consolidated financial statements are an integral part
of these statements.
24
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--PROPOSED CORPORATE RESTRUCTURING
The Board of Directors of Telephone and Data Systems, Inc. (the "Board")
has adopted a proposal which, if approved by shareholders and implemented by
the Board, would authorize the Board to issue three new classes of common
stock and change the state of incorporation of Telephone and Data Systems,
Inc. ("TDS" or "The Company") from Iowa to Delaware (the "Tracking Stock
Proposal"). The three new classes of stock are intended to separately reflect
the performance of the Company's cellular telephone, landline telephone and
personal communications services businesses ("Tracking Stocks").
The Tracking Stocks are intended to result in greater market recognition of
the value (individually and collectively) of the Company and of the Company's
three principal business groups ("Tracking Groups"), thereby enhancing
shareholder value over the long term, while at the same time enabling the
Company's businesses to preserve the benefits of being part of a consolidated
enterprise. The Tracking Stock Proposal is expected to:
- provide the Company with greater flexibility in raising capital and making
acquisitions, using equity securities specifically related to the Tracking
Groups,
- enable the Company to more effectively tailor employee benefit plans to
provide incentives to employees of the Tracking Groups,
- provide shareholders with the opportunity to invest in separate securities
that specifically reflect the underlying businesses, depending upon their
investment objectives, and
- permit shareholders to continue to invest in all of the TDS businesses
through the Common Shares and the Series A Common Shares.
The Cellular Group Shares, when issued, are intended to reflect the separate
performance of the Cellular Group, which consists of the Company's interest in
United States Cellular Corporation, a subsidiary of the Company. The Telecom
Group Shares, when issued, are intended to reflect the separate performance of
the Telecom Group, which primarily consists of the Company's interest in TDS
Telecommunications Corporation, a subsidiary of the Company. The Aerial Group
Shares, when issued, are intended to reflect the separate performance of the
Aerial Group, which consists of the Company's interest in Aerial Communications,
Inc., a subsidiary of the Company.
Subject to approval of the Tracking Stock Proposal by shareholders, the
Company intends to:
- offer and sell Telecom Group Shares in a public offering for cash, subject
to prevailing market and other conditions (the "Telecom Public Offering"),
and allocate the net proceeds thereof to the Telecom Group,
- issue Cellular Group Shares in exchange for all of the Common Shares of
U.S. Cellular which are not owned by the Company, subject to approval by
the board of directors and the shareholders of U.S. Cellular (the "U.S.
Cellular Merger"),
- issue Aerial Group Shares in exchange for all of the Common Shares of
Aerial which are not owned by the Company, subject to approval by the
board of directors and the shareholders of Aerial (the "Aerial Merger"),
and
- distribute one Cellular Group Share, two-thirds of a Telecom Group Share
and two-thirds of an Aerial Group Share in the form of a stock dividend
with respect to each outstanding Series A Common Share and Common Share of
the Company (the "Distribution").
It is currently expected that the Distribution would take place in July 1998
or later, after the completion of the Telecom Public Offering, the U.S. Cellular
Merger and the Aerial Merger.
The TDS Series A Common Shares and Common Shares will continue to be
outstanding and are intended to reflect the performance of the Cellular Group,
the Telecom Group and the Aerial Group to the extent of the Retained Interest in
the respective groups, and to reflect the performance of the other assets and
businesses attributed to the TDS Group.
Subject to the completion of the U.S. Cellular Merger and the Aerial
Merger, the Company intends to terminate certain intercompany agreements
between the Company and U.S. Cellular and Aerial, respectively. Thereafter,
some or all of the policies between the Company and such subsidiaries would
be determined solely by methods that management of the Company believes to be
reasonable. Many of such policies would continue the arrangements which
presently exist between the Company and U.S. Cellular or Aerial pursuant to
the intercompany agreements, but the Company would have no contractual
obligation to continue such policies after the intercompany agreements have
been terminated.
If the Tracking Stock Proposal is approved by the shareholders and
implemented by the Board, following the issuance of the Tracking Stocks, the
Company will prepare and file with the Securities and Exchange Commission,
consolidated financial statements of the Company and financial statements of
the Cellular Group, the Telecom Group and the Aerial Group for so long as the
respective Tracking Stock is outstanding and the TDS Group for as long as any
Tracking Stock is outstanding.
For additional information regarding the Tracking Stock Proposal, see
"Proposed Corporate Restructuring" in Management's Discussion and Analysis of
Results of Operations and Financial Condition.
25
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Telephone and Data Systems, Inc. is a diversified telecommunications
company which, at December 31, 1997, provided high-quality telecommunications
services to approximately 3.2 million cellular telephone, telephone, personal
communications services ("PCS") and radio paging customers in 37 states and
the District of Columbia. The Company conducts substantially all of its
cellular telephone operations through its currently 81.1%-owned subsidiary,
United States Cellular Corporation, its telephone operations through its
currently wholly owned subsidiary, TDS Telecommunications Corporation, its
PCS operations through its currently 82.5%-owned subsidiary, Aerial
Communicatons, Inc., and its radio paging operations through its currently
81.9%-owned subsidiary, American Paging, Inc. ("American Paging"). See Note
14--Business Segment Information for summary financial information on each
business segment.
The Company has an agreement with a nonaffiliated third party to contribute
assets and certain liabilities of American Paging to a newly formed company. See
Note 5--Acquisitions, Exchanges and Divestitures.
26
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PRINCIPLES OF CONSOLIDATION
The accounting policies of TDS conform to generally accepted accounting
principles. The consolidated financial statements include the accounts of TDS,
its majority-owned subsidiaries since acquisition and the cellular partnerships
in which TDS has a majority general partnership interest. All material
intercompany items have been eliminated. Investments in entities in which the
Company does not have a controlling interest are generally accounted for using
the equity method.
TDS includes as investments in subsidiaries the value of the consideration
given and all direct and incremental costs relating to acquisitions accounted
for as purchases. All costs relating to unsuccessful negotiations for
acquisitions are expensed.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain amounts reported in prior years have been reclassified to conform to
current period presentation.
CASH AND CASH EQUIVALENTS AND TEMPORARY INVESTMENTS
Cash and cash equivalents include cash and those short-term, highly-liquid
investments with original maturities of three months or less. Those investments
with original maturities of more than three months to 12 months are classified
as temporary investments. Temporary investments are stated at cost. Those
investments with original maturities of more than 12 months are classified as
marketable securities and are stated at amortized cost.
The carrying amounts of Cash and Cash Equivalents and Temporary Investments
approximate fair value due to the short-term nature of these investments.
INVESTMENTS
Cellular license costs consist of costs incurred in acquiring Federal
Communications Commission ("FCC") licenses or minority interests which have been
awarded FCC licenses to provide cellular service. These costs include amounts
paid to license applicants and owners of interests in cellular entities awarded
licenses and all direct and incremental costs relating to acquiring the
licenses. These costs are capitalized and amortized through charges to expense
over 40 years upon commencement of operations. Amortization amounted to $29.8
million, $28.5 million and $27.8 million in 1997, 1996 and 1995, respectively.
Accumulated amortization of cellular license costs was $129.6 million and $112.2
million at December 31, 1997 and 1996, respectively. Included in cellular
license costs is approximately $281 million and $322 million at December 31,
1997 and 1996, respectively, of goodwill related to various acquisitions
structured to be tax-free.
Cellular minority interests consist of cellular entities in which TDS holds
a minority interest. The Company follows the equity method of accounting, which
recognizes TDS's proportionate share of the income and losses accruing to it
under the terms of its partnership or shareholder agreements where the Company's
ownership interest equals or exceeds 3% ($135.5 million and $196.0 million at
December 31, 1997 and 1996, respectively). Income and losses from these entities
are reflected in the consolidated income statements on a pretax basis. At
December 31, 1997, the cumulative share of income from minority cellular
investments accounted for under the equity method was $263.3 million, of which
$121.9 million was undistributed. The cost method of accounting is followed for
certain minority interests where the Company's ownership interest is less than
3% ($2.8 million and $10.4 million at December 31, 1997 and 1996, respectively).
Broadband PCS license costs consist of costs incurred in acquiring PCS
licenses ($284.9 million) and capitalized interest ($39.7 million). These costs
are amortized over 40 years upon commencement of operations. Amortization
amounted to $4.7 million in 1997. Accumulated amortization of Broadband PCS
license costs was $4.7 million at December 31, 1997.
27
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Franchise and other costs include the costs in excess of the underlying book
value of acquired telephone companies. Costs aggregating $209.1 million and
$205.1 million at December 31, 1997 and 1996, respectively, relating to
acquisitions since November 1, 1970, are being amortized on a straight-line
basis over a 40-year period. Amortization amounted to $5.2 million, $4.9 million
and $4.4 million in 1997, 1996 and 1995, respectively. Accumulated amortization
of excess cost was $34.9 million and $29.6 million at December 31, 1997 and
1996, respectively. Costs in excess of the underlying book value relating to
acquisitions initiated before November 1, 1970, aggregating $6.5 million, are
not being amortized. Included in franchise and other costs is approximately $135
million and $143 million at December 31, 1997 and 1996, respectively, of
goodwill related to various acquisitions structured to be tax-free.
Other investments consist of the following:
DECEMBER 31,
------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Narrowband PCS license costs........................................................................ $ 60,304 $ 60,304
Minority investments................................................................................ 25,073 23,633
Long-term notes receivable.......................................................................... 10,691 14,974
Rural Telephone Bank Stock, at cost................................................................. 7,175 6,639
Marketable equity securities........................................................................ 1,621 2,673
Marketable non-equity securities.................................................................... 31,024 29,735
Other............................................................................................... 6,825 6,882
----------- -----------
$ 142,713 $ 144,840
----------- -----------
----------- -----------
At December 31, 1997, the cumulative share of income from minority
investments accounted for under the equity method was $6.3 million, of which
$3.9 million was undistributed.
The Company's investment in debt securities with original maturities of more
than 12 months are classified as marketable non-equity securities and
held-to-maturity. They are stated at amortized cost.
Information regarding the Company's marketable non-equity securities is
summarized below.
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Held-to-Maturity
U.S. Treasury and other U.S. government corporations and agencies
Aggregate Fair Value
Current.......................................................................................... $ 10,025 $ 46,622
Noncurrent....................................................................................... 31,921 29,882
Amortized Cost Basis
Current.......................................................................................... 10,529 46,603
Noncurrent....................................................................................... 31,024 29,735
Gross Unrealized Holding Gains..................................................................... 393 174
Gross Unrealized Holding Losses.................................................................... $ -- $ 8
The noncurrent investments have contractual maturities of more than one to
five years at December 31, 1997 and 1996. No sales or transfers of securities
classified as held-to-maturity occurred during 1997 and 1996.
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 1996, the Company implemented the provisions of
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." Under SFAS No. 121, the Company is required to review long-lived assets and
certain identifiable
28
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
intangibles for impairment whenever events or changes in circumstances indicate
that the book value of a long-lived asset is not recoverable. An impairment loss
would be recognized whenever the review demonstrates that the book value of a
long-lived asset is not recoverable. The implementation of SFAS No. 121 did not
have an impact on the Company's financial position or results of operations.
REVENUE RECOGNITION
TDS's revenues are recognized when earned. TDS's telephone subsidiaries
participate in revenue pools with other telephone companies for interstate
revenue and for certain intrastate revenue. Such pools are funded by toll
revenue and/or access charges within state jurisdiction and by access charges in
the interstate market. Revenues earned through the various pooling processes are
initially recorded based on the Company's estimates.
ADVERTISING COSTS
The Company expenses advertising costs as incurred.
EARNINGS PER COMMON SHARE
The Company adopted SFAS No. 128, "Earnings per Share," effective December
31, 1997. Earnings per Common Share amounts for 1996 and 1995 have been restated
to conform to current period presentation. The effect of this accounting change
was to increase Earnings per Common Share--Basic by $.01 and $.03 in 1996 and
1995, respectively. The adoption of SFAS No. 128 had no effect on Earnings per
Common Share--Diluted.
The amounts used in computing Earnings per Common Share and the effect on
income and the weighted average number of Common and Series A Common Shares of
dilutive potential common stock are as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ----------- -----------
(DOLLARS AND SHARES IN THOUSANDS)
Net Income (Loss)...................................................................... $ (9,549) $ 128,139 $ 103,978
Less: Preferred Dividends.............................................................. (1,892) (1,957) (2,509)
---------- ----------- -----------
Net Income (Loss) Available to Common used in Earnings per Share-- Basic............... (11,441) 126,182 101,469
Reduction in preferred dividends if Preferred Shares converted into Common Shares...... -- 671 998
Minority Income Adjustment............................................................. (100) (152) (271)
---------- ----------- -----------
Net Income (Loss) Available to Common used in Earnings per Share-- Diluted............. $ (11,541) $ 126,701 $ 102,196
---------- ----------- -----------
---------- ----------- -----------
Weighted Average Number of Common Shares used in Earnings per Share--Basic............. 60,211 60,464 57,456
Effect of Dilutive Securities:
Common Shares outstanding if Preferred Shares converted.............................. -- 543 1,033
Stock Options and Stock Appreciation Rights.......................................... -- 165 159
Common Shares issuable............................................................... -- 28 33
---------- ----------- -----------
Weighted Average Number of Common Shares used in Earnings per Share--Diluted........... 60,211 61,200 58,681
---------- ----------- -----------
---------- ----------- -----------
For 1997, Preferred Shares convertible into 917,000 Common Shares, 130,000
stock options and stock appreciation rights and 15,000 Common Shares issuable in
the future were not included in computing diluted Earnings per Common Share
because their effects were antidilutive. For 1996 and 1995, Preferred Shares
convertible into 428,000 and 477,000 Common Shares, respectively, were not
included in computing diluted Earnings per Common Share because their effects
were antidilutive.
29
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The minority income adjustment reflects the additional minority share of
U.S. Cellular's income computed as if all of U.S. Cellular's issuable securities
were outstanding.
SUPPLEMENTAL CASH FLOW DISCLOSURES
Following are supplemental cash flow disclosures for interest and income
taxes paid, acquisitions and certain noncash transactions.
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- ----------- ---------
(DOLLARS IN THOUSANDS)
Interest paid............................................................................ $ 70,741 $ 52,835 $ 49,475
Income taxes paid........................................................................ 10,743 67,967 60,515
Common Shares issued for conversion of Preferred Shares.................................. 1,487 4,602 948
Increase in PCS network equipment and prepaid infrastructure costs through the issuance
of long-term debt and interim financing................................................ 84,335 100,000 --
Additions to property, plant and equipment financed through accounts payable and accrued
expenses............................................................................... $ 46,104 $ 87,109 $ 3,943
TDS has acquired operating telephone companies, certain cellular licenses
and operating companies and certain other assets since January 1, 1995. In
conjunction with these acquisitions, the following assets were acquired and
liabilities assumed, and Common Shares and Preferred Shares issued:
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Property, plant and equipment.......................................................... $ 120,365 $ 55,692 $ 56,132
Cellular licenses...................................................................... 137,409 95,447 129,510
(Decrease) increase in investment in cellular minority interests....................... (89,205) (3,641) 977
Franchise and other costs.............................................................. 2,452 17,679 25,657
Long-term debt......................................................................... (4,857) (22,979) (9,254)
Deferred credits....................................................................... 1,104 (6,205) (538)
Other assets and liabilities, excluding cash and cash equivalents...................... 7,396 8,188 (8,084)
Common Shares issued and issuable...................................................... (42,685) (113,128) (127,836)
Preferred Shares issued................................................................ (3,000) -- --
U.S. Cellular Common Shares issued and issuable........................................ -- (34) (12,794)
----------- ----------- -----------
Decrease in cash due to acquisitions................................................... $ 128,979 $ 31,019 $ 53,770
----------- ----------- -----------
----------- ----------- -----------
30
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--INCOME TAXES
TDS files a consolidated federal income tax return. Income tax provisions
charged to net income are summarized as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ------------ ------------
(DOLLARS IN THOUSANDS)
Current:
Federal............................................................................ $ 4,533 $ 31,356 $ 44,690
State.............................................................................. 6,790 17,275 16,736
Deferred:
Federal............................................................................ 13,302 67,040 19,253
State.............................................................................. 4,453 10,072 2,386
Amortization of deferred investment tax credits...................................... (519) (2,097) (2,036)
---------- ------------ ------------
Total income tax expense............................................................. $ 28,559 $ 123,646 $ 81,029
---------- ------------ ------------
---------- ------------ ------------
Investment tax credits resulting from investments in telephone plant and
equipment have been deferred and are being amortized over the service lives of
the related property.
A reconciliation of income tax expense and the amount computed by applying
the statutory federal income tax rate (35%) to income before income taxes is as
follows:
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ----------- ---------
(DOLLARS IN THOUSANDS)
Statutory federal income tax rate........................................................ $ 6,653 $ 88,125 $ 64,752
State income taxes, net of federal benefit............................................... 6,958 17,358 12,067
Amortization of license acquisition costs and costs in excess of book value.............. 5,276 4,280 4,440
Dividend exclusion and other permanent items............................................. 752 377 (250)
Amortization of deferred investment tax credits.......................................... (519) (2,014) (1,850)
Effects of corporations not included in consolidated federal tax return.................. 1,409 2,351 2,035
Sale of cellular interests............................................................... 5,549 12,337 --
Rate difference of federal net operating loss............................................ 1,246 -- --
Regulatory adjustment.................................................................... 101 624 595
Deferred investment tax credit........................................................... 399 365 197
Other differences, net................................................................... 735 (157) (957)
---------- ----------- ---------
Income tax expense....................................................................... $ 28,559 $ 123,646 $ 81,029
---------- ----------- ---------
---------- ----------- ---------
Deferred income taxes are provided for the temporary differences between the
amount of the Company's assets and liabilities for financial reporting purposes
and their tax bases.
The Company's current net deferred tax assets totaled $3.7 million and $2.7
million as of December 31, 1997 and 1996, respectively. The net current deferred
tax asset primarily represents the deferred tax effects of unearned revenues.
31
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--INCOME TAXES (CONTINUED)
The temporary differences that gave rise to the noncurrent deferred tax
assets and liabilities as of December 31, 1997 and 1996, are as follows:
DECEMBER 31,
------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Deferred Tax Asset:
Net operating loss carryforwards.................................................................. $ 55,363 $ 17,055
Taxes on acquisitions............................................................................. 54,134 --
Alternative minimum tax credit carryforward....................................................... 21,205 10,433
Postretirement benefits........................................................................... 4,819 4,819
Amortization of deferred charges.................................................................. 1,614 10,990
Other............................................................................................. 3,511 4,069
----------- -----------
140,646 47,366
Less valuation allowance............................................................................ (29,001) (16,891)
----------- -----------
Net Deferred Tax Asset............................................................................ 111,645 30,475
----------- -----------
Deferred Tax Liability:
Property, plant and equipment..................................................................... 134,672 86,056
Investment in equity securities................................................................... 64,603 40,540
Licenses.......................................................................................... 55,756 38,656
Partnership investments........................................................................... 25,687 26,965
Capitalized interest.............................................................................. 18,721 17,810
Other............................................................................................. 14,886 4,240
----------- -----------
Total Deferred Tax Liability........................................................................ 314,325 214,267
----------- -----------
Net Deferred Income Tax Liability................................................................. $ 202,680 $ 183,792
----------- -----------
----------- -----------
At December 31, 1997, TDS had $21.2 million of federal alternative minimum
tax credit carryforward available to offset regular income tax payable in future
years. TDS had $60.5 million of federal net operating loss carryforward
(generating a $19.9 million deferred tax asset) at December 31, 1997, expiring
in 2012 which is available to offset future consolidated taxable income. In
addition, TDS had $496.7 million of state net operating loss carryforward
(generating a $35.5 million deferred tax asset) at December 31, 1997, expiring
between 1997 and 2012 which is available to offset future taxable income
primarily of the individual subsidiaries which generated the loss. A valuation
allowance was established for the state operating loss carryforwards since it is
more likely than not that a portion will expire before such carryforwards can be
utilized.
NOTE 4--PROPERTY PLANT AND EQUIPMENT
CELLULAR
Cellular property, plant and equipment is stated at cost. Depreciation is
provided using the straight-line method over the estimated useful lives of the
assets. The provision for depreciation as a percentage of depreciable property,
plant and equipment was 10.3%, 10.4% and 10.0% in 1997, 1996 and 1995,
respectively.
32
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--PROPERTY PLANT AND EQUIPMENT (CONTINUED)
Cellular property, plant and equipment in service and under construction
consists of:
DECEMBER 31,
--------------------------
1997 1996
------------- -----------
(DOLLARS IN THOUSANDS)
Operating plant and equipment..................................................................... $ 923,480 $ 641,600
Buildings and leasehold improvements.............................................................. 136,023 86,533
Office furniture, equipment and vehicles.......................................................... 89,987 71,674
Land.............................................................................................. 63,085 46,198
------------- -----------
$ 1,212,575 $ 846,005
------------- -----------
------------- -----------
TELEPHONE
Telephone property, plant and equipment is stated at the original cost of
construction including the capitalized costs of certain taxes, payroll-related
expenses, and an allowance for funds used during construction ("AFUDC"). AFUDC,
a noncash item of nonoperating income, totaled $686,000, $825,000 and $682,000
in 1997, 1996 and 1995, respectively. The composite weighted average rates were
5.5%, 7.3% and 9.3% in 1997, 1996 and 1995, respectively. The amount of such
allowance has varied principally as a result of changes in the level of
construction work in process and in the cost of capital.
Renewals and betterments of units of property are added to telephone plant
in service. The original cost of depreciable property retired is removed from
plant in service and, together with removal cost less any salvage realized, is
charged to accumulated depreciation. Repairs and renewals of minor items of
property are included in plant operations expense. No gain or loss is recognized
on ordinary retirements of depreciable telephone property.
Depreciation is provided using the straight-line method over the estimated
useful lives of the assets. Composite depreciation rates, as applied to the
average cost of depreciable property were 7.4%, 7.2% and 7.1% in 1997, 1996 and
1995, respectively.
Telephone property, plant and equipment in service and under construction
consists of:
DECEMBER 31,
----------------------------
1997 1996
------------- -------------
(DOLLARS IN THOUSANDS)
Land and buildings.............................................................................. $ 67,203 $ 67,181
Central office equipment........................................................................ 399,016 372,008
Cable and wire.................................................................................. 719,945 639,537
Furniture and office equipment.................................................................. 112,921 77,046
Vehicles and other equipment.................................................................... 42,632 39,928
Plant under construction........................................................................ 52,677 59,213
Non-regulated investments and other............................................................. 26,496 38,866
------------- -------------
$ 1,420,890 $ 1,293,779
------------- -------------
------------- -------------
The Company's telephone operations follow accounting for regulated
enterprises prescribed by SFAS No. 71, "Accounting for the Effects of Certain
Types of Regulation." Management periodically reviews the criteria for applying
these provisions to determine whether continuing application of SFAS No. 71 is
appropriate. Management believes that such criteria are still being met and
therefore has no current plans to change its method of accounting.
In analyzing the effect of discontinuing the application of SFAS No. 71,
management has determined that the useful lives of plant assets used for
regulatory and financial reporting purposes are consistent with generally
accepted accounting principles and therefore, any adjustments to
telecommunications plant would be immaterial, as would be the write-off of
regulatory assets and liabilities.
33
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--PROPERTY PLANT AND EQUIPMENT (CONTINUED)
PCS
PCS property, plant and equipment is stated at original cost. Depreciation
is provided using the straight-line method over the estimated useful lives of
the assets. The provision for depreciation as a percentage of depreciable
property, plant and equipment was 10.9%, 20.2% and 2.2% in 1997, 1996 and 1995,
respectively.
PCS property, plant and equipment in service and under construction consists
of:
DECEMBER 31,
------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Network............................................................................................. $ 514,525 $ --
Information systems................................................................................. 83,950 15,951
Office equipment.................................................................................... 15,800 3,180
Leasehold improvements and other.................................................................... 8,466 1,442
Work in process..................................................................................... 19,381 233,830
Prepaid network infrastructure costs................................................................ -- 70,300
----------- -----------
$ 642,122 $ 324,703
----------- -----------
----------- -----------
Work in process includes expenditures for the design, construction and
testing of the Company's PCS networks as well as the cost to relocate dedicated
private microwave links currently operating in the Company's spectrum in its PCS
markets. Work in process also includes the costs associated with developing
information systems. The Company capitalized interest on certain of its work in
process expenditures totaling $6.0 million and $1.2 million in 1997 and 1996,
respectively. When assets are placed in service, the Company transfers the
assets to the appropriate property and equipment category.
Prepaid network infrastructure costs include the excess of the proceeds from
the sale of notes over the Company's current obligations (i.e. financed
purchases under a Credit Agreement with Nokia Telecomunications, Inc.) to Nokia.
The Company paid Nokia for a portion of 1997 equipment purchases by reducing the
amount of the prepaid balance by the cost of the equipment purchased. Nokia paid
the Company monthly interest on the unused portion of the note proceeds.
RADIO PAGING
Radio Paging property, plant and equipment is stated at original cost.
Depreciation is provided using the straight-line method over the estimated
useful lives of the assets. The provision for depreciation as a percentage of
depreciable property, plant and equipment was 24.6%, 27.9% and 22.1% in 1997,
1996 and 1995, respectively.
Radio Paging property, plant and equipment in service and under construction
consists of:
DECEMBER 31,
------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
Subscriber devices.................................................................................. $ 41,059 $ 39,714
Terminals and transmitters.......................................................................... 48,181 44,251
Computer equipment.................................................................................. 16,402 16,595
Furniture and fixtures.............................................................................. 10,515 10,314
Other............................................................................................... 2,118 2,126
----------- -----------
$ 118,275 $ 113,000
----------- -----------
----------- -----------
34
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--PROPERTY PLANT AND EQUIPMENT (CONTINUED)
OTHER
Other property, plant and equipment is stated at original cost. Depreciation
is provided using the straight-line method over the estimated useful lives of
assets. The provision for depreciation as a percentage of depreciable property,
plant and equipment was 12.3%, 15.9% and 10.0% in 1997, 1996 and 1995,
respectively.
Other property, plant and equipment in service and under construction
consists of:
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(DOLLARS IN
THOUSANDS)
Computer equipment..................................................................................... $ 54,062 $ 42,682
Furniture and fixtures................................................................................. 18,710 15,772
Cable, printing and other equipment.................................................................... 12,138 11,737
Work in progress....................................................................................... 11,899 5,055
Capital leases......................................................................................... -- 7,535
--------- ---------
$ 96,809 $ 82,781
--------- ---------
--------- ---------
Certain costs relating to the development of computer software for internal
use are capitalized and are amortized over the estimated five-year life of the
software.
NOTE 5--ACQUISITIONS, EXCHANGES AND DIVESTITURES
During 1997, 1996 and 1995, TDS and its subsidiaries completed the following
business combinations:
CONSIDERATION
-----------------------------
TDS AND USM
COMMON STOCK,
AND TDS
CASH PREFERRED SHARES
----------- ----------------
(DOLLARS IN THOUSANDS)
Acquisitions During 1997
Cellular interests........................................................................... $ 128,828 $ 32,486
Telephone interests.......................................................................... 151 13,200
Acquisitions During 1996
Cellular interests........................................................................... $ 13,596 $ 42,499
Telephone interests.......................................................................... 17,423 70,663
Acquisitions During 1995
Cellular interests........................................................................... $ 41,885 $ 94,542
Telephone interests.......................................................................... 250 46,087
Paging interests............................................................................. 5,656 --
----------- --------
Assuming that these acquisitions had taken place on January 1, 1996,
unaudited pro forma results of operations from continuing operations would have
been as follows:
YEAR ENDED DECEMBER 31,
----------------------------
1997 1996
------------- -------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
Operating Revenues.............................................................................. $ 1,576,361 $ 1,277,309
Net Income...................................................................................... 11,680 142,078
Earnings per Common Share--Basic................................................................ .19 2.29
Earnings per Common Share--Diluted.............................................................. $ .19 $ 2.27
------------- -------------
35
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--ACQUISITIONS, EXCHANGES AND DIVESTITURES (CONTINUED)
EXCHANGE OF MARKETS WITH BELLSOUTH
In October 1997, U.S. Cellular completed an exchange with BellSouth
Corporation. Pursuant to the exchange, U.S. Cellular received majority interests
representing approximately 4.0 million population equivalents in exchange for
majority interests representing 2.0 million population equivalents, minority
interests representing 1.2 million population equivalents and a net amount of
$86.7 million in cash. The majority interests U.S. Cellular received are in 12
markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana clusters.
SALES OF CELLULAR AND OTHER INVESTMENTS
The $41.4 million gain in 1997 reflects the sales of non-strategic cellular
and other investments. U.S. Cellular sold its majority interests in one market
and one market partition, minority interests in two other markets and received
cash from the settlement of a legal matter. These sales, along with the sales of
certain other investments by TDS, generated net cash proceeds of $84.2 million.
The $138.7 million gain in 1996 reflects the sales of non-strategic cellular
and other investments. U.S. Cellular sold its majority interests in eight
markets and minority interests in two other markets, received cash from the
settlement of two separate legal matters and received cash in an exchange of
markets with another cellular operator. Aerial sold its majority interests in
two markets. These transactions, along with the sales of certain other
investments by TDS, generated net cash proceeds of $221.5 million.
The $86.6 million gain in 1995 reflects the sales and exchanges of
non-strategic cellular and other investments. U.S. Cellular sold its majority
interests in six markets and its minority interests in six markets during 1995.
These sales, along with the sales of marketable equity securities and certain
other investments by TDS, generated net cash proceeds of $197.6 million.
PENDING SALES OF MINORITY INTERESTS
In December 1997, the Company announced that AirTouch Communications, Inc.
("AirTouch") will acquire interests owned by U.S. Cellular and TDS in cellular
systems in 11 markets. AirTouch will issue approximately 5,000,000 shares of its
common stock and pay approximately $54.2 million in cash to U.S. Cellular and
TDS in exchange for these interests, which represent approximately 900,000
population equivalents. U.S. Cellular has also entered into an agreement to sell
its minority interests in two other markets for $37.6 million in cash.
Management expects that it will record a significant pretax gain upon the
completion of the sales transaction. The sales are expected to be completed in
the first half of 1998.
AMERICAN PAGING MERGER
In December 1997, the Company announced an agreement with TSR Paging, Inc.
("TSR") to combine their respective paging businesses. On February 10, 1998, the
board of directors of American Paging approved a merger agreement providing for
the acquisition by TDS of all of the issued and outstanding shares of American
Paging not owned by TDS for cash in an amount equal to $2.50 per share,
approximately $9.1 million in total. Upon consummation of the merger, TDS will
contribute substantially all of the assets and certain, limited liabilities of
American Paging, and TSR will contribute all of its assets and liabilities to a
new limited liability company. The asset contribution agreement provides that,
subject to adjustment, TDS will have a 30% interest and TSR will have a 70%
interest in the new company. The formation of the new company, while subject to
a number of conditions, including consummation of the merger and regulatory
approvals, is expected to occur in the first half of 1998. TDS will adopt the
equity method of accounting for its investment in the new company. TDS will not
have any funding requirements once the combination is completed.
36
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--ACQUISITIONS, EXCHANGES AND DIVESTITURES (CONTINUED)
The following table summarizes the assets and liabilities which TDS would
contribute to the new company.
DECEMBER 31, 1997
--------------------
(DOLLARS IN
THOUSANDS)
Current assets
Cash.................................................................................................. $ 3,058
Temporary investments................................................................................. 61
Accounts receivable................................................................................... 9,051
Inventory............................................................................................. 6,851
Other................................................................................................. 1,076
Property, plant and equipment, net...................................................................... 41,762
Narrowband PCS license.................................................................................. 60,901
Other investments....................................................................................... 429
Deferred assets......................................................................................... 10,959
Current liabilities
Accounts payable...................................................................................... (942)
Advance billings and customer deposits................................................................ (6,827)
Accrued taxes......................................................................................... (42)
----------
$ 126,337
----------
----------
NOTE 6--NOTES PAYABLE
TDS has used short-term debt to finance its investments in PCS and radio
paging operations, for acquisitions and for general corporate purposes.
Long-term debt and equity financing from time to time, including sales of debt
and equity securities by subsidiaries, have reduced such short-term debt.
Proceeds from the issuance of long-term debt and equity securities retired
$241.4 million, $131.2 million and $131.4 million of short-term debt in 1997,
1996 and 1995, respectively. Proceeds from the sales of non-strategic cellular
and other investments from time to time in 1997, 1996 and 1995 have also been
used to retire short-term debt.
TDS had $644.2 million of bank lines of credit for general corporate
purposes at December 31, 1997, all of which were committed. Unused amounts of
such lines totaled $117.9 million, all of which were committed. These line of
credit agreements provide for borrowings at negotiated rates up to the prime
rate.
U.S. Cellular had $500.0 million of bank lines of credit for general
corporate purposes as of December 31, 1997, all of which were unused. These line
of credit agreements provide for borrowings at the London InterBank Offered Rate
("LIBOR") plus 26.5 basis points, due quarterly.
The carrying amount of short-term debt approximates fair value due to the
short-term nature of these instruments.
Information concerning notes payable is shown in the table below:
DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Balance at end of period......................................................... $ 527,587 $ 160,537 $ 184,320
Weighted average interest rate at end of period.................................. 6.3% 6.0% 6.3%
Maximum amount outstanding during the period..................................... $ 587,683 $ 204,140 $ 184,320
Average amount outstanding during the period (1)................................. $ 407,965 $ 112,341 $ 139,671
Weighted average interest rate during the period (1)............................. 6.1% 5.8% 6.4%
----------- ----------- -----------
- ---------
(1) The average was computed based on month-end balances.
37
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--LONG-TERM DEBT
Long-term debt is as follows:
DECEMBER 31,
----------------------------
1997 1996
------------- -------------
(DOLLARS IN THOUSANDS)
Telephone and Data Systems, Inc. (Parent)
Medium-term notes, 8% to 10%, due through 2025................................................ $ 239,200 $ 239,200
Purchase contracts and other long-term notes, 9% to 14%, due through 2003..................... 2,440 3,175
------------- -------------
Total Parent................................................................................ 241,640 242,375
------------- -------------
Subsidiaries
RUS, RTB and FFB Mortgage Notes, due through 2031, various rates averaging 5.5% in 1997, 5.4%
in 1996 and 5.4% in 1995.................................................................... 313,012 308,371
------------- -------------
6% zero coupon convertible redeemable debentures, maturing in 2015............................ 745,000 745,000
Unamortized discount.......................................................................... (479,670) (494,893)
------------- -------------
265,330 250,107
------------- -------------
7.25% notes, maturing in 2007................................................................. 250,000 --
------------- -------------
Vendor financing, approximating 90-day Commercial Paper Rate plus 1.4% due through 2002....... -- 103,654
------------- -------------
8.34% zero coupon notes, maturing in 2006..................................................... 226,245 226,245
Unamortized discount.......................................................................... (114,161) (122,502)
------------- -------------
112,084 103,743
------------- -------------
Interim vendor financing...................................................................... 84,355 --
------------- -------------
Other long-term notes, 0% to 12.6%, due through 2009.......................................... 12,613 10,601
------------- -------------
Total Subsidiaries.......................................................................... 1,037,394 776,476
------------- -------------
Total long-term debt............................................................................ 1,279,034 1,018,851
------------- -------------
Less current portion.......................................................................... 14,816 36,619
------------- -------------
Total long-term debt............................................................................ $ 1,264,218 $ 982,232
------------- -------------
------------- -------------
The Medium-Term Notes ("MTNs") carry original maturities of 12 to 30 years,
maturing at various times from 2003 to 2025. The MTNs may be redeemed by the
Company at par value beginning in 1999.
The RUS, RTB and FFB Mortgage Notes issued under certain loan agreements
with the Rural Utilities Service ("RUS"), Rural Telephone Bank ("RTB") and
Federal Financing Bank ("FFB"), agencies of the United States of America, are to
be repaid in equal monthly or quarterly installments covering principal and
interest beginning six months to three years after dates of issue and expiring
through 2031. Substantially all telephone plant is pledged under RUS and RTB
mortgage notes and various other obligations of the telephone subsidiaries.
U.S. Cellular sold $745 million principal amount at maturity of 20-year zero
coupon 6% yield to maturity convertible redeemable debt in June 1995 with
proceeds to the Company of $221.5 million. The unsecured notes are due in 2015
and there is no periodic payment of interest. The notes are convertible at any
time into 9.475 U.S. Cellular Common Shares per $1,000 of notes. Beginning in
2000, U.S. Cellular may redeem, or the holder may call, the notes at the issue
price plus accrued interest.
U.S. Cellular sold $250 million principal amount of 7.25% unsecured senior
notes in 1997 with proceeds to the Company of $247.0 million. The notes are due
2007 and interest is payable semi-annually. Beginning 2004, U.S. Cellular may
redeem the notes at principal amount plus accrued interest. U.S. Cellular used a
portion of the net proceeds to repay the outstanding vendor financing balance.
38
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--LONG-TERM DEBT (CONTINUED)
U.S. Cellular had financing arrangements with an equipment vendor for
cellular system equipment and construction costs. The borrowings were
collateralized by a secured interest in some or all of the assets of U.S.
Cellular's operating subsidiaries. Borrowings had terms of seven years at an
interest rate of 1.4% over the 90-day Commercial Paper Rate (for a rate of 7.03%
at December 31, 1996).
Aerial sold $226 million principal amount at maturity of 10-year zero coupon
8.34% yield to maturity debt in 1996 at an issue price of $100 million. The
unsecured notes are due in 2006 and there is no periodic payment of interest.
The proceeds were paid to Aerial's equipment vendor in satisfaction of all then
outstanding and future obligations up to $100 million. The notes are fully and
unconditionally guaranteed by TDS. The notes are subject to optional redemption
beginning in 2001 at redemption prices which reflect original issue discount
accrued since issuance.
The annual requirements for principal payments on long-term debt are
approximately $14.8 million, $15.8 million, $15.6 million, $15.3 million and
$15.2 million for the years 1998 through 2002, respectively.
The carrying value and estimated fair value of the Company's Long-term Debt
were approximately equal at December 31, 1997 and 1996, respectively. The fair
value of the Company's long-term debt was estimated using discounted cash flow
analysis based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements.
NOTE 8--MINORITY INTEREST IN SUBSIDIARIES
The following table summarizes the minority shareholders' and partners'
interests in the equity of consolidated subsidiaries.
DECEMBER 31,
------------------------
1997 1996
----------- -----------
(DOLLARS IN THOUSANDS)
U.S. Cellular
U.S. Cellular shareholders'....................................................................... $ 305,478 $ 285,835
U.S. Cellular subsidiaries' partners'............................................................. 53,908 48,715
----------- -----------
359,386 334,550
Aerial shareholders'................................................................................ 33,692 75,897
TDS Telecom telephone subsidiaries'................................................................. 23,293 21,810
Other............................................................................................... 195 86
----------- -----------
$ 416,566 $ 432,343
----------- -----------
----------- -----------
SALE OF STOCK BY SUBSIDIARIES
Aerial issued 12.3 million Common Shares in 1996 in an initial public
offering (at a price of $17 per share). The initial public offering reduced
TDS's ownership percentage from 100% to 82.8%. The Aerial Common Share offering
was recorded at a fair market value which was more than TDS's book value
investment in Aerial. TDS adjusted its book value investment as a result of this
issue and increased capital in excess of par value $114.1 million in 1996.
NOTE 9--COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES
In November 1997, TDS Capital I, a subsidiary trust (the "Trust") of TDS,
issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred
Securities (the "Preferred Securities") at $25 per Preferred Security. Net
proceeds from the issuance totaled $144.8 million and were used to retire
short-term debt.
The sole asset of TDS Capital I is $154.6 million principal amount of TDS's
8.5% Subordinated Debentures due December 31, 2037. There is a full and
unconditional guarantee by TDS of the Trust's obligations under the
39
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES
(CONTINUED)
Preferred Securities issued by the Trust. However, TDS's obligations are
subordinate and junior in right of payment to certain other indebtedness of TDS.
TDS has the right to defer payments of interest on the Subordinated Debentures
by extending the interest payment period, at any time, for up to 20 consecutive
quarters. If interest payments on the Subordinated Debentures are so deferred,
distributions on the Preferred Securities will also be deferred. During any
deferral, distributions will continue to accrue with interest thereon. In
addition, during any such deferral, TDS may not declare or pay any dividend or
other distribution on, or redeem or purchase, any of its common stock.
The Subordinated Debentures are redeemable by TDS, in whole or in part, from
time to time, on or after November 18, 2002, or, in whole but not in part, at
any time in the event of certain income tax circumstances. If the Subordinated
Debentures are redeemed, the Trust must redeem Preferred Securities on a pro
rata basis having an aggregate liquidation amount equal to the aggregate
principal amount of the Subordinated Debentures so redeemed. In the event of the
dissolution, winding up or termination of the Trust, the holders of Preferred
Securities will be entitled to receive, for each Preferred Security, a
liquidation amount of $25 plus accrued and unpaid distributions thereon to the
date of payment, unless, in connection with the dissolution, winding up or
termination, Subordinated Debentures are distributed to the holders of the
preferred securities.
NOTE 10--PREFERRED SHARES
TDS Cumulative Voting Preferred Shares have a stated value of $100 per
share. The 5,000,000 authorized Preferred Shares are issuable in series by the
Board of Directors who establish the terms of the issue. Those issues which
contain mandatory redemption features or which are redeemable at the option of
the holder are classified as Redeemable Preferred Shares. Those issues which are
not redeemable or which are redeemable at the option of TDS are classified as
Nonredeemable Preferred Shares.
REDEEMABLE PREFERRED SHARES
Redeemable Preferred Shares include outstanding series of TDS Cumulative
Voting Preferred Shares with mandatory redemption features or which are
redeemable at the option of the holder. At December 31, 1997, 14,794 shares of
Redeemable Preferred Shares were outstanding, redeemable at $100 per share.
The annual requirements for redemption of Redeemable Preferred Shares are
$1,299,100, $103,000 and $77,300 for the years 1998 through 2000, respectively.
40
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--PREFERRED SHARES (CONTINUED)
The following is a schedule of the Redeemable Preferred Shares' activity.
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Balance, beginning of period................................................................ $ 1,858 $ 15,093 $ 25,001
Add:
Stock dividends........................................................................... -- 113 546
Less:
Redemption of preferred................................................................... (359) (9,456) (9,608)
Conversion of preferred................................................................... -- (3,872) --
Expiration of redemption feature.......................................................... (20) (20) (839)
Change in redemption feature.............................................................. -- -- (7)
--------- --------- ---------
1,479 1,858 15,093
Less current portion........................................................................ 1,299 1,578 13,506
--------- --------- ---------
Balance, end of period...................................................................... $ 180 $ 280 $ 1,587
--------- --------- ---------
--------- --------- ---------
NONREDEEMABLE PREFERRED SHARES
Nonredeemable Preferred Shares include outstanding series of TDS Cumulative
Voting Preferred Shares which have no mandatory redemption features. At December
31, 1997, 309,873 shares of Nonredeemable Preferred Shares were outstanding.
Outstanding Nonredeemable Preferred Shares are generally redeemable at the
option of TDS at $100 per share, plus accrued and unpaid dividends. At December
31, 1997, certain series of Preferred Shares are convertible into TDS Common
Shares. (See Note 11--Convertible Preferred Shares)
The following is a schedule of the Nonredeemable Preferred Shares activity.
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Balance, beginning of period............................................................... $ 29,000 $ 29,710 $ 29,819
Add:
Acquisition.............................................................................. 3,000 -- --
Reclassification from Redeemable Preferred Shares........................................ 20 20 839
Less:
Conversion of preferred.................................................................. (1,031) (730) (948)
Redemption of preferred.................................................................. (2) -- --
--------- --------- ---------
Balance, end of period..................................................................... $ 30,987 $ 29,000 $ 29,710
--------- --------- ---------
--------- --------- ---------
NOTE 11--COMMON STOCK
COMMON STOCK ACQUISITIONS
During 1997, 1996 and 1995, TDS issued 998,783, 2,634,408 and 2,947,777
Common Shares, respectively, for the acquisition of cellular and telephone
interests. The 1997 Common Shares issued for acquisitions are reissued Treasury
Shares. (See Common Share Repurchase Program)
COMMON SHARES ISSUABLE
A certain acquisition agreement requires TDS to deliver 10,480 Common Shares
in 1998.
41
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--COMMON STOCK (CONTINUED)
DIVIDEND REINVESTMENT, INCENTIVE AND COMPENSATION PLANS
The following table summarizes Common and Series A Common Shares issued for
the employee stock ownership plans and dividend reinvestment plans described
below.
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Common Shares
Tax-deferred savings plan................................................................ 32,354 36,269 40,624
Dividend reinvestment plan............................................................... 25,273 28,827 105,001
Stock-based compensation plans........................................................... 64,367 35,273 40,025
--------- --------- ---------
121,994 100,369 185,650
--------- --------- ---------
--------- --------- ---------
Series A Common Shares
Dividend reinvestment plan............................................................... 19,731 26,445 17,855
--------- --------- ---------
--------- --------- ---------
TAX-DEFERRED SAVINGS PLAN. TDS had reserved 78,558 Common Shares for issue
under the TDS Tax-Deferred Savings Plan, a qualified profit-sharing plan
pursuant to Sections 401(a) and 401(k) of the Internal Revenue Code.
Participating employees have the option of investing their contributions in TDS
Common Shares, U.S.Cellular Common Shares, Aerial Common Shares, American Paging
Common Shares or five nonaffiliated funds.
DIVIDEND REINVESTMENT PLANS. TDS had reserved 460,742 Common Shares for
issue under the Automatic Dividend Reinvestment and Stock Purchase Plan and
172,523 Series A Common Shares for issue under the Series A Common Share
Automatic Dividend Reinvestment Plan. These plans enable holders of TDS's Common
Shares and Preferred Shares to reinvest cash dividends in newly issued Common
Shares and holders of Series A Common Shares to reinvest cash dividends in newly
issued Series A Common Shares. The purchase price of the shares is 95% of the
market value, based on the average of the daily high and low sales prices for
TDS's Common Shares on the American Stock Exchange for the ten trading days
preceding the date on which the purchase is made.
STOCK-BASED COMPENSATION PLANS
TDS had reserved 1,291,107 Common Shares for options granted and to be
granted to key employees. TDS has established certain plans that provide for the
grant of stock options to officers and employees. The options are exercisable
over a specified period not in excess of ten years. The options expire from 1998
to 2006 or the date of the employee's termination of employment, if earlier.
TDS accounts for stock options, stock appreciation rights ("SARs") and
employee stock purchase plans under Accounting Principles Board ("APB") Opinion
No. 25. No compensation costs have been recognized for the stock option and
employee stock purchase plans. Compensation expense for SARs, measured on the
difference between the year-end market price of the Common Shares and SAR
prices, was $91,000, $263,000 and $408,000 in 1997, 1996 and 1995, respectively.
Had compensation cost for all plans been determined consistent with SFAS
42
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--COMMON STOCK (CONTINUED)
No. 123, the Company's net income (loss) and earnings per share would have been
reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
------------ ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Net Income (Loss)
As Reported......................................................................... $ (9,549) $ 128,139 $ 103,978
Pro Forma........................................................................... (13,506) 126,495 103,316
Earnings per Common Share-Basic
As Reported......................................................................... (.19) 2.09 1.77
Pro Forma........................................................................... (.26) 2.06 1.75
Earnings per Common Share-Diluted
As Reported......................................................................... (.19) 2.07 1.74
Pro Forma........................................................................... $ (.26) $ 2.05 $ 1.73
------------ ----------- -----------
Because SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
A summary of the status of the Company's stock option plans at December 31,
1997, 1996 and 1995 and changes during the years ended is presented in the table
and narrative below:
WEIGHTED WEIGHTED
NUMBER OF AVERAGE AVERAGE
SHARES OPTION PRICES FAIR VALUES
--------- ------------- -----------
Stock Options:
Outstanding January 1, 1995
(172,689 exercisable)................................................................ 485,597 $ 30.25
Granted.............................................................................. 59,995 $ 38.67 $ 14.84
Exercised............................................................................ (26,101) $ 5.52
Cancelled............................................................................ (3,046) $ 43.32
---------
Outstanding December 31, 1995
(240,160 exercisable)................................................................ 516,445 $ 32.47
Granted.............................................................................. 89,228 $ 41.00 $ 13.30
Exercised............................................................................ (11,025) $ 13.10
Cancelled............................................................................ (3,210) $ 39.89
---------
Outstanding December 31, 1996
(405,996 exercisable)................................................................ 591,438 $ 34.08
Granted.............................................................................. 68,137 $ 43.90 $ 10.61
Exercised............................................................................ (43,824) $ 19.51
Cancelled............................................................................ (41,243) $ 40.78
---------
Outstanding December 31, 1997
(492,917 exercisable)................................................................ 574,508 $ 35.87
--------- -------------
--------- -------------
STOCK OPTIONS. The fair value of each option grant was estimated on the date
of the grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1997, 1996 and 1995,
respectively: risk-free interest rates of 6.1%, 5.6% and 6.6%; expected dividend
yields of 1.0%, 1.0% and 1.0%; expected lives of 5.0 years, 5.1 years and 6.9
years and expected volatility of 19.2%, 20.5% and 25.0%.
STOCK APPRECIATION RIGHTS allowed the grantee to receive an amount in cash
or Common Shares, or a combination thereof, equivalent to the difference between
the exercise price and the fair market value of the Common Shares on the
exercise date. The following table summarizes the SARs outstanding at $4.43 to
$36.60 per share. These rights expired March 1997. The fair value of each stock
appreciation right grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free
interest rates of 4.9%, 5.2% and 5.5%; expected dividend
43
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--COMMON STOCK (CONTINUED)
yields of 1.0%, 1.0% and 1.0%; expected lives of 0.1 year, 0.2 year and 0.7
year; and expected volatility of 20.5%, 18.4% and 20.2%.
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Outstanding beginning of period............................................................. 10,070 16,034 12,096
Granted................................................................................... 630 5,923 8,174
Exercised................................................................................. (10,700) (11,887) (4,236)
--------- --------- ---------
Outstanding end of period................................................................... -- 10,070 16,034
--------- --------- ---------
--------- --------- ---------
EMPLOYEE STOCK PURCHASE PLAN. TDS had reserved 159,816 Common Shares for
sale to the employees of TDS and its subsidiaries. The fair value of the
employees' purchase rights was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants rights in 1997 and 1996, respectively: risk-free
interest rate of 5.6% and 5.6%; expected dividend yield of 1.0% and 1.0%;
expected lives of 1.2 years and 0.5 year; and expected volatility of 16.9% and
15.3%.
CONVERTIBLE PREFERRED SHARES
TDS convertible Preferred Shares are convertible into 932,011 Common Shares.
(See Note 10--Nonredeemable Preferred Shares) TDS issued 56,365, 347,707 and
40,734 Common Shares in 1997, 1996 and 1995, respectively, for TDS preferred
shares converted and 11,345 and 3,781 Common Shares in 1997 and 1996,
respectively, for subsidiary preferred stock converted.
SERIES A COMMON SHARES
The holders of Common Shares and the outstanding Preferred Shares are
entitled to one vote per share. The holders of Series A Common Shares are
entitled to ten votes per share. Series A Common Shares are convertible, on a
share-for-share basis, into Common Shares. TDS has reserved 6,936,277 Common
Shares for possible issuance upon such conversion.
COMMON SHARE REPURCHASE PROGRAM
In December 1996, the Company authorized the repurchase of up to 3.0 million
TDS Common Shares over a period of three years. The Company plans to finance the
repurchase program using internally generated funds and borrowings under
short-term lines of credit. The Company may use repurchased shares to fund
acquisitions and for other corporate purposes. Subject to prevailing market
conditions, purchases may be made from time to time through open market
purchases or at negotiated prices in private transactions. The actual number of
Common Shares which may be repurchased will be subject to the trading price of
the Common Shares, the Company's financial position and other factors.
Through December 31, 1997, the Company purchased 1,798,100 Common Shares for
$69.9 million. The Company reissued 1,003,524 Common Shares primarily for
acquisitions.
NOTE 12--EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Company sponsors two qualified noncontributory defined contribution
pension plans. One plan (the "TDS Plan") provides benefits for the employees of
TDS, TDS Telecom and substantially all of the telephone company subsidiaries.
(Employees of certain telephone subsidiaries are covered under other pension
plans or receive direct pension payments.) The other plan provides pension
benefits for U.S. Cellular and Aerial employees. Under these plans, pension
costs are calculated separately for each participant and are funded currently.
TDS also sponsors an unfunded non-qualified deferred compensation plan to
supplement the benefits under these plans to offset the reduction of benefits
caused by the limitation on annual employee compensation under the tax laws.
44
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--EMPLOYEE BENEFIT PLANS (CONTINUED)
Total pension costs were $5.3 million, $4.6 million and $4.6 million in
1997, 1996 and 1995, respectively.
OTHER POSTRETIREMENT BENEFITS
The Company sponsors two defined benefit postretirement plans that cover
most of the employees of TDS, TDS Telecom and its telephone subsidiaries. One
plan provides medical benefits and the other plan provides life insurance
benefits. Both plans are contributory, with retiree contributions adjusted
annually. The medical plan anticipates future cost sharing changes that are
consistent with the Company's intent to increase retiree contributions by the
health care cost trend rate. An amount not to exceed 25% of the total
contribution to the TDS Plan will be contributed to fund the cost of the medical
benefits annually. An additional contribution equal to a reasonable amortization
of the past service cost may be made without regard to the 25% limitation
described above. The Company will limit overall contributions to the aggregate
accruals recorded by its subsidiaries. The Company's postretirement medical and
life insurance plans are currently underfunded. Total contributions to fund
postretirement medical and life insurance plans were $1.9 million, $2.2 million
and $3.1 million in 1997, 1996 and 1995, respectively.
The following table sets forth the plans' funded status reconciled with the
amount shown in the Company's consolidated balance sheet at December 31, 1997:
LIFE
INSURANCE HEALTH CARE
PLAN PLAN TOTAL
------------- ----------- ---------
(DOLLARS IN THOUSANDS)
Accumulated postretirement benefit obligation:
Retirees........................................................................... $ 2,002 $ 5,196 $ 7,198
Fully eligible active plan participants............................................ 588 2,427 3,015
Other active plan participants..................................................... 1,111 10,015 11,126
------------- ----------- ---------
3,701 17,638 21,339
Plan assets at fair value............................................................ 1,635 12,969 14,604
------------- ----------- ---------
Accumulated postretirement benefit obligation in excess of plan assets............... 2,066 4,669 6,735
Unrecognized prior service cost...................................................... (290) (1,801) (2,091)
Unrecognized net gain from past experience different from that assumed and from
changes in assumptions............................................................. (34) 6,754 6,720
------------- ----------- ---------
Accrued postretirement benefit cost at December 31, 1997............................. $ 1,742 $ 9,622 $ 11,364
------------- ----------- ---------
------------- ----------- ---------
Net postretirement cost for 1997, 1996 and 1995 includes the following
components:
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Service cost................................................................................... $ 875 $ 796 $ 588
Interest cost on accumulated postretirement benefit obligation................................. 1,346 1,125 1,082
Actual return on plan assets................................................................... (632) (753) (656)
Net amortization and deferral.................................................................. (344) 99 204
--------- --------- ---------
Net postretirement cost........................................................................ $ 1,245 $ 1,267 $ 1,218
--------- --------- ---------
--------- --------- ---------
For measurement purposes, a 9.6% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1997; the rate was assumed
to decrease over six years to 6.1% and to remain at 6.1% thereafter. The assumed
rate of return on plan assets was 8.0%. The health care cost trend rate
assumption has a significant effect on the amounts reported. Increasing the
assumed health care cost trend rates by one percentage point in each year would
increase the accumulated postretirement benefit obligation as of December 31,
1997, by $3.5 million and the aggregate of the service and interest cost
components of postretirement expense for the year then ended by $506,000.
45
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--EMPLOYEE BENEFIT PLANS (CONTINUED)
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0%.
NOTE 13--COMMITMENTS AND CONTINGENCIES
CONSTRUCTION AND EXPANSION
The primary purpose of TDS's construction and expansion program is to
provide for normal growth, to upgrade communications service, to expand into new
communication areas, and to take advantage of service-enhancing and cost-
reducing technological developments. The cellular capital additions budget
totals approximately $330 million for 1998, including about $240 million for new
cell sites and about $90 million for various information systems initiatives.
The telephone capital additions budget totals approximately $140 million for
1998, including about $50 million for new digital switches and other switching
facilities and $35 million for improvements to outside plant facilities. The PCS
capital additions budget totals approximately $75 million for 1998, including
$20 million for cell sites, $25 million for switching equipment and $15 million
for systems development.
PENDING ACQUISITIONS
At December 31, 1997, TDS and U.S. Cellular have entered into definitive
agreements to acquire a majority interest in one cellular market, the remaining
minority interest in one cellular market already controlled by U.S. Cellular and
one telephone company for an aggregate consideration of approximately $62.0
million, primarily cash and TDS Common Shares.
LEASE COMMITMENTS
TDS and its subsidiaries have leases for certain cellular plant facilities,
office space and data processing equipment, most of which are classified as
operating leases. For the years 1997, 1996 and 1995, rent expense for
noncancelable, long-term leases was $36.9 million, $20.9 million and $13.6
million, respectively, and rent expense under cancelable, short-term leases was
$8.7 million, $7.6 million and $7.5 million, respectively. At December 31, 1997,
the aggregate minimum rental commitments under noncancelable, long-term
operating leases were as follows:
MINIMUM FUTURE
RENTAL PAYMENTS
--------------------
(DOLLARS IN
THOUSANDS)
1998................................................................................ $ 38,594
1999................................................................................ 34,476
2000................................................................................ 30,490
2001................................................................................ 28,367
2002................................................................................ 18,960
Thereafter.......................................................................... $ 96,578
--------
LEGAL PROCEEDINGS
The Company is involved in legal proceedings before the FCC and various
state and federal courts from time to time. Management does not believe that any
of such proceedings should have a material adverse impact on the financial
position or results of operations of the Company.
On December 29, 1997, a party which claims to be a holder of U.S. Cellular
Common Shares, filed a putative class action complaint on behalf of common
stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware
in New Castle County. The complaint names as defendants TDS, U.S. Cellular and
the directors of U.S. Cellular. The complaint alleges a breach of fiduciary
duties by the defendents and seeks to have the U.S. Cellular Merger enjoined or,
if it is consummated, to have it rescinded and to recover unspecified damages,
fees and expenses. A virtually identical complaint has been filed by an
individual. None of the defendants have been served with this complaint.
46
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--COMMITMENTS AND CONTINGENCIES (CONTINUED)
On January 5, 1998, an individual, who claims to be a holder of Aerial
Common Shares, filed a putative class action complaint on behalf of common
stockholders of Aerial in the Court of Chancery of the State of Delaware in New
Castle County. The complaint names as defendants, TDS, Aerial and the directors
of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the
defendants and seeks to have the Aerial Merger enjoined or, if it is
consummated, to have it rescinded and to recover unspecified damages, fees and
expenses. A virtually identical complaint has been filed by a second individual.
None of the defendants have been served with this complaint.
The Company intends to vigorously defend against these lawsuits.
47
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--BUSINESS SEGMENT INFORMATION
TDS's businesses are classified into four principal segments: Cellular,
Telephone, PCS and Radio Paging operations.
YEAR ENDED OR AT DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN MILIONS)
Revenues
Cellular..................................................................................... $ 877 $ 680 $ 480
Telephone.................................................................................... 444 396 355
PCS.......................................................................................... 56 -- --
Paging....................................................................................... 95 104 107
--------- --------- ---------
Total...................................................................................... $ 1,472 $ 1,180 $ 942
--------- --------- ---------
--------- --------- ---------
Operating Income (Loss)
Cellular..................................................................................... $ 130 $ 87 $ 43
Telephone.................................................................................... 99 103 98
PCS.......................................................................................... (197) -- --
Paging....................................................................................... (36) (37) (9)
--------- --------- ---------
Total...................................................................................... $ (4) $ 153 $ 132
--------- --------- ---------
--------- --------- ---------
Depreciation and Amortization Expense
Cellular..................................................................................... $ 132 $ 109 $ 90
Telephone.................................................................................... 98 88 77
PCS.......................................................................................... 39 -- --
Paging....................................................................................... 33 34 25
--------- --------- ---------
Total...................................................................................... $ 302 $ 231 $ 192
--------- --------- ---------
--------- --------- ---------
Identifiable Assets
Cellular..................................................................................... $ 2,549 $ 2,117 $ 1,891
Telephone.................................................................................... 1,221 1,181 1,058
PCS.......................................................................................... 961 638 318
Paging....................................................................................... 136 153 159
Parent and Other............................................................................. 105 112 43
--------- --------- ---------
Total...................................................................................... $ 4,972 $ 4,201 $ 3,469
--------- --------- ---------
--------- --------- ---------
Capital Expenditures
Cellular..................................................................................... $ 319 $ 248 $ 211
Telephone.................................................................................... 151 144 104
PCS.......................................................................................... 275 113 9
Paging....................................................................................... 19 33 27
Parent and Other............................................................................. 22 12 9
--------- --------- ---------
Total...................................................................................... $ 786 $ 550 $ 360
--------- --------- ---------
--------- --------- ---------
48
TELEPHONE AND DATA SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--INVESTMENTS IN UNCONSOLIDATED ENTITIES
The following summarizes the unaudited combined assets, liabilities and
equity, and the unaudited results of operations of the cellular and telephone
companies in which TDS's investments are accounted for by the equity method.
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(DOLLARS IN
MILLIONS)
Assets
Current assets......................................................................................... $ 425 $ 325
Due from affiliates.................................................................................... 3 6
Property and other..................................................................................... 1,159 1,122
--------- ---------
$ 1,587 $ 1,453
--------- ---------
--------- ---------
Liabilities and Equity
Current liabilities.................................................................................... $ 287 $ 278
Due to affiliates...................................................................................... 38 21
Deferred credits....................................................................................... 9 3
Long-term debt......................................................................................... 70 42
Partners' capital and stockholders' equity............................................................. 1,183 1,109
--------- ---------
$ 1,587 $ 1,453
--------- ---------
--------- ---------
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(DOLLARS IN MILIONS)
Results of Operations
Revenues.................................................................................... $ 1,740 $ 1,395 $ 1,174
Costs and expenses.......................................................................... (1,256) (958) (808)
Other income................................................................................ 5 7 8
Interest expense............................................................................ (10) (6) (6)
Income taxes................................................................................ (6) (3) (5)
Extraordinary item.......................................................................... -- (2) --
--------- --------- ---------
Net income.................................................................................. $ 473 $ 433 $ 363
--------- --------- ---------
--------- --------- ---------
NOTE 16--SUBSEQUENT EVENTS
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES
In February 1998, TDS Capital II, a subsidiary trust of TDS, issued
6,000,000 of its 8.04% Company-Obligated Manditorily Redeemable Preferred
Securities at $25 per Preferred Security. Net proceeds from the issuance totaled
$145 million and were used to retire short-term debt. The sole asset of TDS
Capital II is $154.6 million principal amount of TDS's 8.04% Subordinated
Debentures due March 31, 2038 or such date to which the maturity is extended by
TDS, but in no event later than March 31, 2047. The Subordinated Debentures are
redeemable by TDS, in whole or in part, from time to time, on or after March 31,
2003, or, in whole but not in part, at any time in the event of certain income
tax circumstances. All other terms and conditions are identical to those of TDS
Capital I. (See Note 9--Company-Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trust Holding Solely Company Subordinated Debentures)
AERIAL 8.05% ZERO COUPON NOTES
Aerial sold $100 million principal amount at maturity of 10-year zero coupon
8.05% yield to maturity debt in February 1998 at an issue price of $100 million.
The unsecured notes are due in 2008 and there is no periodic payment of
interest. The proceeds were paid to Aerial's equipment vendor in satisfaction of
all then outstanding obligations and future obligations up to $100 million. The
notes are fully and unconditionally guaranteed by TDS. The notes are subject to
optional redemption beginning in 2003 at redemption prices which reflect
original issue discount accrued since issuance. These notes will replace the
$84.4 million of Interim vendor financing. (See Note 7--Long-Term Debt)
49
CONSOLIDATED QUARTERLY INCOME INFORMATION (UNAUDITED)
QUARTER ENDED
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997
Operating Revenues....................................................... $ 314,735 $ 356,344 $ 388,122 $ 412,332
Operating Income (Loss).................................................. 41,941 7,354 (3,990) (49,007)
Gain on Sale of Cellular and Other Investments........................... -- 10,598 13,767 17,073
Net Income (Loss)........................................................ 9,617 6,821 9,019 (35,006)
Net Income (Loss) Available to Common.................................... 9,136 6,351 8,549 (35,476)
From Operations........................................................ 9,136 2,344 106 (38,940)
From Gains............................................................. $ -- $ 4,007 $ 8,443 $ 3,464
Weighted Average Common Shares (000s).................................... 61,184 60,051 59,511 60,099
Earnings per Common Share-Basic.......................................... $ .15 $ .11 $ .14 $ (.59)
Earnings per Common Share-Diluted........................................ .15 .11 .14 (.59)
From Operations........................................................ .15 .04 -- (.65)
From Gains............................................................. $ -- $ .07 $ .14 $ .06
1996
Operating Revenues....................................................... $ 259,063 $ 293,701 $ 308,548 $ 318,545
Operating Income......................................................... 30,957 49,081 41,263 32,147
Gain on Sale of Cellular and Other Investments........................... 41,758 86,494 7,797 2,686
Net Income............................................................... 33,689 59,692 22,669 12,089
Net Income Available to Common........................................... 33,190 59,201 22,185 11,606
From Operations........................................................ 12,882 18,720 19,256 10,852
From Gains............................................................. $ 20,308 $ 40,481 $ 2,929 $ 754
Weighted Average Common Shares (000s).................................... 59,035 60,610 61,084 61,127
Earnings per Common Share-Basic.......................................... $ .56 $ .98 $ .36 $ .19
Earnings per Common Share-Diluted........................................ .56 .97 .36 .19
From Operations........................................................ .22 .31 .32 .18
From Gains............................................................. $ .34 $ .66 $ .04 $ .01
Note: Certain 1996 amounts were reclassified for current period presentation.
Net Income Available to Common for 1997 and 1996 included significant gains from
the sales of cellular and other investments. The table above summarizes the
effect of the gains on Net Income (Loss) Available to Common and Earnings per
Common Share--Diluted.
Management believes there exists a seasonality at U.S. Cellular in both service
revenues, which tend to increase more slowly in the first and fourth quarters,
and operating expenses, which tend to be higher in the fourth quarter due to
increased marketing activities and customer growth. This seasonality may cause
operating income to vary from quarter to quarter.
Aerial began commercial service in 1997 which resulted in Aerial's revenue and
expenses being included in operating income. The significant decrease in
Operating Income (Loss) and Net Income (Loss) beginning in the second quarter of
1997 is primarily a result of the commencement of PCS operations.
50
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
Telephone and Data Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Telephone
and Data Systems, Inc. (an Iowa corporation) and Subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations, common
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Telephone and Data Systems,
Inc. and Subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Chicago, Illinois
January 28, 1998 (except with respect to the matters discussed in Note 5,
"American Paging Merger"; and in Note 16, as to which the date is February 18,
1998)
51
TELEPHONE AND DATA SYSTEMS, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED OR AT DECEMBER 31,
-------------------------------------------------------------------------
1997 1996 1995 1994 1993
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Operating Revenues $ 1,471,533 $ 1,179,857 $ 942,307 $ 726,036 $ 553,829
Operating Income (Loss) (3,702) 153,448 131,998 108,822 69,733
Net Income (Loss) Before
Cumulative Effect of
Accounting Change (9,549) 128,139 103,978 60,544 33,896
Cumulative Effect of
Accounting Change -- -- -- (723) --
Net Income (Loss) (9,549) 128,139 103,978 59,821 33,896
Net Income (Loss) Available
to Common $ (11,441) $ 126,182 $ 101,469 $ 57,362 $ 31,510
Weighted Average
Common Shares (000s) 60,211 60,464 57,456 53,295 46,995
Earnings per Common Share-Basic:
Before Cumulative Effect of
Accounting Change $ (.19) $ 2.09 $ 1.77 $ 1.09 $ .67
Cumulative Effect of
Accounting Change -- -- -- (.01) --
Net Income (Loss) (.19) 2.09 1.77 1.08 .67
Earnings per Common
Share-Diluted:
Before Cumulative Effect of
Accounting Change (.19) 2.07 1.74 1.08 .67
Cumulative Effect of
Accounting Change -- -- -- (.02) --
Net Income (Loss) $ (.19) $ 2.07 $ 1.74 $ 1.06 $ .67
Pretax Profit on Revenues 1.3% 21.3% 19.6% 13.9% 10.9%
Effective Income Tax Rate
(Before Cumulative Effect
of Accounting Change) N/M 49.1% 43.8% 40.2% 43.9%
Dividends per Common
and Series A Common Share $ .42 $ .40 $ .38 $ .36 $ .34
Cash and Cash Equivalents
and Temporary Investments $ 75,567 $ 119,297 $ 80,851 $ 44,566 $ 73,385
Working Capital (497,601) (163,197) (166,514) (160,266) 16,025
Property, Plant and
Equipment (Net) 2,465,653 1,828,889 1,293,410 1,063,656 846,089
Total Assets 4,971,601 4,200,969 3,469,082 2,790,127 2,259,182
Notes Payable 527,587 160,537 184,320 98,608 6,309
Long-term Debt
(including current portion) 1,279,034 1,018,851 894,584 562,165 537,566
Redeemable Preferred Shares
(including current portion) 1,479 1,858 15,093 25,001 27,367
Common Stockholders' Equity 1,968,119 2,032,941 1,684,365 1,473,038 1,224,285
Capital Expenditures $ 786,317 $ 550,204 $ 359,996 $ 319,701 $ 200,984
Current Ratio .5 .7 .6 .5 1.1
Common Equity per Share $ 32.06 $ 33.23 $ 29.01 $ 26.85 $ 24.15
Return on Equity (.6%) 6.8% 6.4% 4.3% 3.0%
-------------------------------------------------------------------------
N/M - NOT MEANINGFUL
52
TELEPHONE AND DATA SYSTEMS, INC.
TDS STOCK AND DIVIDEND INFORMATION
TDS's Common Shares are listed on the American Stock Exchange ("AMEX") under the
symbol "TDS" and in the newspapers as "TeleData." As of February 27, 1998, TDS
Common Shares were held by 3,744 record owners and the Series A Common Shares
were held by 57 record owners. TDS has paid cash dividends on Common Shares
since 1974, and paid dividends of $.42 and $.40 per Common and Series A Common
Share during 1997 and 1996, respectively.
The Common Shares of United States Cellular Corporation, an 81.1%-owned
subsidiary of TDS, are listed on the AMEX under the symbol "USM" and in the
newspapers as "US Cellu." The Common Shares of American Paging, Inc., an 81.9%-
owned subsidiary of TDS, are also listed on the AMEX under the symbol "APP" and
in the newspapers as "AmPaging." The Common Shares of Aerial Communications,
Inc., an 82.5%-owned subsidiary of TDS are listed on the NASDAQ National Market
under the symbol "AERL" and in the newspapers as "AerialComm."
MARKET PRICE PER COMMON SHARE BY QUARTER
TDS's Series A Common Shares and Preferred Shares are not actively traded and
therefore, quotations are not reported for such securities. Dividends on TDS's
Preferred Shares have been paid quarterly since the dates of issue. The high and
low sales prices of the Common Shares on the AMEX as reported by the Dow Jones
News Service are as follows:
1997 1st 2nd 3rd 4th
------------------------------------------------
High $ 42.00 40.50 45.31 49.94
Low $ 34.50 36.25 36.56 39.50
Dividends Paid $ .105 .105 .105 .105
------------------------------------------------
1996 1st 2nd 3rd 4th
------------------------------------------------
High $ 48.75 48.88 45.63 40.50
Low $ 39.00 43.38 37.75 34.75
Dividends Paid $ .10 .10 .10 .10
------------------------------------------------
53