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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
---------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 001-14157
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TELEPHONE AND DATA SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
Delaware 36-2669023
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
30 North LaSalle Street, Chicago, Illinois 60602
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (312) 630-1900
Not Applicable
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(Former address of principal executive offices) (Zip Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 30, 1998
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Common Shares, $.01 par value 54,214,899 Shares
Series A Common Shares, $.01 par value 6,947,513 Shares
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TELEPHONE AND DATA SYSTEMS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page No.
--------
Part I. Financial Information
Management's Discussion and Analysis of
Results of Operations and Financial Condition 2-16
Consolidated Statements of Income -
Three Months and Nine Months Ended
September 30, 1998 and 1997 17
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and 1997 18
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 19-20
Notes to Consolidated Financial Statements 21-29
Part II. Other Information 30-31
Signatures 32
PART I. FINANCIAL INFORMATION
-----------------------------
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
Telephone and Data Systems, Inc. ("TDS" or the "Company") is a diversified
telecommunications company which provides high-quality telecommunications
services to approximately 2.8 million cellular telephone, local telephone and
personal communications service ("PCS") customer units. 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.
TDS reported a 34% increase in revenues for the first nine months of 1998 on a
45% growth in customers since September 30, 1997. United States Cellular
Corporation ("U.S. Cellular") revenues increased 34% primarily due to a 49%
increase in customer units. TDS Telecommunications Corporation ("TDS Telecom")
reported a 12% increase in revenues on a 7% increase in access lines and
increased activity in its new business ventures. Aerial Communications, Inc.
("Aerial") reported revenues of $105.9 million in the first nine months of 1998
and 231,000 customer units at September 30, 1998. Aerial launched service in its
markets between late March and late June of 1997.
Consolidated operating cash flow increased 17% reflecting strong increases at
U.S. Cellular offset somewhat by increased operating expenses at Aerial as it
continues to develop its markets and attract new customers. Operating income,
however, decreased to $1.1 million reflecting an increase in depreciation
expense from U.S. Cellular's change in useful lives and a full nine months of
depreciation at Aerial, which offset the increase in operating cash flow. U.S.
Cellular's cash flow and operating income increased 43% and 32%, respectively,
reflecting the increase in customers. Aerial's cash outflow and operating loss
increased 42% and 70%, respectively, as its markets were in operation for all
nine months in 1998 compared to only the second and third quarters of 1997. TDS
Telecom's cash flow and operating income declined by 1% and 15%, respectively,
reflecting start-up costs in the new business ventures and increased operating
expenses in the telephone operations.
Investment and other income totaled $254.6 million, consisting primarily of
$235.4 million of gains from the sale of cellular interests and other
investments recorded in the first nine months of 1998. Interest expense
increased 58% as a result of the increase in short- and long-term debt balances
primarily to finance Aerial's activities. Net income available to common
increased $41.5 million over the first nine months of 1997 due primarily to
significant gains recorded on the sale of cellular interests and other
investments offset somewhat by the increased Aerial losses.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
TDS reported net income available to common of $65.5 million, or $1.07 per
diluted share, in the first nine months of 1998, compared to $24.0 million, or
$.40 per diluted share, in the first nine
2
months of 1997. Net income included significant gains from the sale of cellular
interests and other investments totaling $119.5 million, or $1.96 per share, in
1998, compared to $12.5 million, or $.21 per share, in 1997.
Net income from U.S. Cellular, excluding gains, increased to $66.4 million, or
$1.09 per share, in 1998, from $64.1 million, or $1.06 per share, in 1997. Net
income from TDS Telecom, excluding gains, decreased to $16.9 million, or $.28
per share, in 1998 from $23.1 million, or $.38 per share, in 1997, primarily due
to an $11.7 million decrease in operating income. Aerial's activities reduced
net income by $217.8 million, or $3.58 per share, in 1998 compared to $127.6
million, or $2.12 per share in 1997. Net income from Parent and Other increased
to $80.5 million, or $1.32 per share, in 1998 from $51.9 million, or $.87 per
share, in 1997 due primarily to the increase in the tax benefit associated with
Aerial's losses. The business units compute their federal income taxes as if
they filed a separate return. Any income tax benefits used on a consolidated
basis not used by the business units are recorded by TDS, the parent company.
TDS and the business units have tax allocation agreements and policies under
which the business units are able to carry forward any losses and credits and
use them to offset any future income tax liability to TDS.
The table below summarizes the results of operations of the business units and
gains (along with the related impact of income taxes and minority interest) on
net income available to common and diluted earnings per share.
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
(Dollars in thousands, except per share amounts)
Net Income (Loss) Available to Common
U.S. Cellular $ 66,417 $ 64,145
TDS Telecom 16,862 23,126
Aerial (217,752) (127,573)
Parent and Other 80,509 51,887
Gains 119,509 12,450
------------- -------------
$ 65,545 $ 24,035
============= =============
Diluted Earnings (Loss) Per Share
U.S. Cellular $ 1.09 $ 1.06
TDS Telecom .28 .38
Aerial (3.58) (2.12)
Parent and Other 1.32 .87
Gains 1.96 .21
------------- -------------
$ 1.07 $ .40
============= =============
Operating Revenues increased 34% ($335.2 million) during the first nine months
of 1998 primarily as a result of a 45% increase in customer units served from
September 30, 1997. U.S. Cellular generated 64% ($215.1 million) of the increase
in revenues as customer units increased by 661,000 units, or 49%, to 2,018,000
units. Aerial generated 24% ($80.1 million) of the increase as customer units
increased 165,700 units to 231,000 units. TDS Telecom generated 12% ($40.1
million) of the increase in revenues. Access lines increased 7% to 543,200
access lines.
3
U.S. Cellular revenues increased 34% ($215.1 million) in 1998. Local retail
revenue increased 40% ($161.6 million) in the first nine months of 1998 due
primarily to the 49% customer growth. Average local minutes of use per retail
customer decreased by 1% to 104 in 1998 from 105 in 1997, while average local
retail revenue per minute totaled $.33 in 1998 compared to $.36 in 1997. U.S.
Cellular's use of pricing and other incentive programs that encourage
lower-priced weekend and off-peak usage, in order to stimulate overall usage,
resulted in a lower average revenue per minute of use in 1998. Inbound roaming
revenue (charges to customers of other systems who use U.S. Cellular's cellular
systems when roaming) increased 7% ($11.2 million) in the first nine months of
1998. The growth in inbound roaming revenue is affected by the exchange with
BellSouth Corporation ("BellSouth"). Prior to the BellSouth exchange, revenue
from BellSouth customers, who were in markets included in the exchange,
traveling into the Company's service areas was recorded as inbound roaming
revenue. For periods after the exchange, this revenue is recorded as outbound
roaming revenue, which is reported as an offset to systems operations expense.
In addition, increased roaming minutes used was offset by negotiated reductions
in roaming rates. While minutes of use increased by 41%, average inbound roaming
revenue per minute declined by 22% to $.67 in 1998 from $.86 in 1997.
Total average monthly service revenue per customer decreased 14% ($7.71) to
$48.87 in the first nine months of 1998 from $56.58 in 1997. Average monthly
local retail revenue per customer declined 9% ($3.43) to $33.87 in 1998 from
$37.30 in 1997 due primarily to competitive pressures, incentive programs being
offered, consumer market penetration and the effects of acquisitions. The
recently acquired markets produced a lower amount of revenue per customer,
thereby reducing the average retail revenue per customer. Average monthly
inbound roaming revenue per customer declined 31% ($4.57) to $10.40 in 1998
compared to $14.97 in 1997. This decrease is related to the decrease in roaming
revenue per minute, the faster growth of U.S. Cellular's customer base as
compared to the growth of inbound roaming revenues and the elimination of
certain inbound roaming revenues between U.S. Cellular's existing markets and
the acquired markets.
TDS Telecom revenues increased 12% ($40.1 million) in 1998 due to growth in
telephone operations ($27.2 million) and growth in other services ($13.7
million). Telephone operations revenues increased primarily as a result of the
effects of acquisitions ($5.8 million), recovery of increased costs of providing
long-distance services ($5.3 million), increased network usage ($4.1 million),
increased sale of customer premise equipment ($4.0 million), internal access
line growth of 5% since September 30, 1997 ($3.9 million) and increased sales of
custom calling and advanced feature sales ($3.2 million). The number of
telephone access lines increased by 7% (5% from internal growth and 2% from
acquisitions) to 543,200 at September 30, 1998 from 506,600 at September 30,
1997. Average monthly revenue per access line increased to $69.46 for the first
nine months of 1998 from $68.33 in 1997. The other services increase was
primarily driven by increases in revenues in the LAN wiring business of $8.3
million and from the Internet access provider of $2.8 million. TDS Telecom's
competitive local exchange carrier ("CLEC") began operations in 1998, generating
revenues of $1.9 million.
Aerial revenues increased $80.1 million to $105.9 million in 1998, consisting of
service revenue of $85.5 million and equipment sales revenues of $20.3 million.
Average monthly service revenue per customer was $51.87 in the first nine months
of 1998. Aerial added 165,700 customer units in the first nine months of 1998
and had 231,000 customers in service at September 30, 1998.
4
Operating Expenses rose 43% ($392.8 million) in the first nine months of 1998
due primarily to added expenses at Aerial for the development of its markets and
added expenses to serve the growing customer base at U.S. Cellular and Aerial.
U.S. Cellular generated 46% ($179.8 million) of the total increase in operating
expenses, while Aerial generated 41% ($161.3 million) and TDS Telecom generated
13% ($51.8 million) of the total increase.
U.S. Cellular expenses increased 34% ($179.8 million) during 1998. System
operations expenses increased 31% ($33.6 million) in 1998 as a result of
increases in customer usage expenses and costs associated with the growing
number of cell sites within U.S. Cellular's systems. Customer usage expenses
grew 38% ($26.8 million) primarily due to the increase in net outbound roaming
expense and the increase in minutes used on U.S. Cellular's systems. Net
outbound roaming usage expense increased primarily as a result of U.S. Cellular
offering its customers increasingly larger service footprints in which their
calls are billed at local rates. In certain cases these service areas include
other operators' service areas. U.S. Cellular pays roaming rates to the other
carriers for calls U.S. Cellular's customers make in these areas, while charging
those customers a local rate which is usually lower than the roaming rate.
Maintenance, utility and cell site expenses increased 17% ($6.8 million)
reflecting primarily the increase in the number of cell sites to 1,958 in 1998
from 1,556 in 1997.
Marketing and selling expenses increased 24% ($42.7 million), reflecting
increased advertising and costs incurred to add new customers, including an $8.4
million increase in cost of equipment sold. Cost per gross customer addition
declined to $314 in 1998 from $328 in 1997 while gross customer activations
increased to 614,000 in 1998 from 494,000 in 1997. General and administrative
expenses increased 36% ($50.4 million) due to the growing customer base and an
expansion of local office and corporate staff necessitated by U.S. Cellular's
growth. General and administrative expenses were 23% of revenues in 1998
compared to 22% in 1997. Depreciation and amortization increased 56% ($53.1
million) primarily due to the 34% increase in average fixed assets since
September 30, 1997 as well as a reduction in useful lives of certain assets
beginning in 1998 which increased depreciation expense by $13.6 million.
TDS Telecom expenses increased 21% ($51.8 million) during 1998 due to growth in
telephone operations ($27.9 million) and in other services ($24.7 million).
Telephone operations expenses increased primarily due to increased depreciation
and amortization ($7.9 million), the effects of acquisitions ($4.9 million),
increased costs to support and maintain information systems ($4.7 million),
increased sales of customer premise equipment ($3.8 million) and increased costs
of maintaining the centralized network management center and other network
administration ($3.1 million). The remaining increase is primarily due to growth
in internal operations, including wage and salary increases, staffing and
inflation. Other services expenses increased primarily due to the growth in the
LAN wiring business of $11.8 million, development activities at a start-up CLEC
of $7.6 million and growth at the Internet access provider of $3.1 million.
Aerial's expenses increased $161.3 million to $303.3 million in 1998 reflecting
a full nine months of operation in 1998 and the significant efforts to build its
customer base. Expenses incurred in the first quarter of 1997 prior to the
launch of service totaled $21.6 million and were reported as PCS Development
Costs as part of Investment and Other Income (Expense). For the first nine
months of 1998, system operations expenses increased $32.5 million to $48.1
million reflecting the costs of operating Aerial's network, primarily cell site
expenses, landline interconnection charges and wages. The number of cell sites
increased to 1,152 in 1998 from 850 in 1997.
5
Marketing and selling expenses incurred to add new customers increased $23.0
million to $52.0 million while cost of equipment sold increased $18.8 million to
$59.6 million. General and administrative expenses increased $15.7 million to
$43.9 million reflecting the expenses associated with the management and
operating teams as well as overhead expenses. Customer service expenses
increased $30.0 million to $38.5 million, primarily due to staffing to support
the PCS markets, bad debt expenses and additional consulting and temporary
services expenses directed at reducing customer churn and bad debts.
Depreciation and amortization increased $41.2 million to $61.1 million.
Operating Income totaled $1.1 million in the first nine months of 1998 compared
to $45.3 million in 1997 reflecting the increase in Aerial's losses as its
markets were in operation nine months of 1998 compared to only the second and
third quarters of 1997. Aerial incurred an operating loss of $197.4 million in
the first nine months of 1998 compared to $116.2 million in 1997. U.S.
Cellular's operating income increased 32% to $145.8 million in the first nine
months of 1998; however, U.S. Cellular's operating income margin decreased to
17.2% in 1998 from 17.4% in 1997 due to increased depreciation expense in 1998.
TDS Telecom's operating income declined $11.7 million to $64.1 million
reflecting $11.0 million of additional operating losses from new business
ventures as anticipated, primarily the CLEC business and the LAN wiring
business, and a $700,000 decrease in telephone operating income. TDS Telecom's
operating margin decreased to 17.4% in 1998 from 23.1% in 1997 due to the impact
of new business ventures and higher operating costs, including depreciation on
improvements to the telephone network and costs to develop programs which will
improve customer satisfaction and provide long-term benefits in future cost
avoidance.
Nine Months Ended September 30,
----------------------------------
1998 1997 Change
---- ---- ------
(Dollars in thousands)
Operating Income (Loss) from Ongoing Operations
U.S. Cellular $ 145,807 $ 110,511 $ 35,296
TDS Telecom 64,116 75,809 (11,693)
Aerial (197,382) (116,170) (81,212)
--------- --------- ----------
12,541 70,150 (57,609)
American Paging Operating (Loss) (11,406) (24,845) 13,439
--------- --------- ---------
Operating Income $ 1,135 $ 45,305 $ (44,170)
========= ========= ==========
TDS completed the transfer of substantially all of the assets and certain,
limited liabilities of American Paging, Inc. to TSR Wireless Holdings, LLC
effective March 31, 1998. American Paging's revenues are netted against its
expenses with the resulting operating loss reported as American Paging Operating
(Loss). American Paging's revenues totaled $17.8 million and expenses totaled
$29.2 million for the three month period ended March 31, 1998. Effective in the
second quarter of 1998, TDS followed the equity method of accounting for its 30%
interest in TSR Wireless Holdings, LLC and reported these results as a component
of Investment and Other Income (Expense). American Paging's revenues totaled
$22.9 million and $71.8 million for the three and nine months ended September
30, 1997, respectively, and operating expenses totaled $32.2 million and $96.6
million, respectively, for the same periods.
Investment and Other Income (Expense) totaled $254.6 million in 1998 and $68.0
million in 1997
6
Gain on Sale of Cellular Interests and Other Investments totaled $235.4 million
in the first nine months of 1998 and $24.4 million in 1997, as the Company has
sold or traded certain non- strategic minority cellular interests.
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, decreased 43% ($25.8 million) in the first nine months of 1998
primarily due to the transfer of minority interests to BellSouth in 1997 and the
sale of minority interests to AirTouch Communications, Inc. ("AirTouch") in
1998. Cellular investment income is net of amortization of license costs
relating to these minority interests.
Minority Share of Income includes the minority shareholders' share of U.S.
Cellular's and Aerial's net income or loss, the minority partners' share of U.S.
Cellular's operating markets and other minority shareholders' and partners'
share of subsidiaries' net income or loss. U.S. Cellular's minority share of
income in the first nine months of 1998 reflects gains from the sale of cellular
interests, which contributed $(22.0) million of the $(37.5) million of U.S.
Cellular's minority shareholders' share of income.
Nine Months Ended September 30,
------------------------------------
1998 1997 Change
---- ---- ------
(Dollars in thousands)
Minority Share of (Income) Loss
U.S. Cellular
Minority Shareholders' Share $(37,476) $(16,478) $(20,998)
Minority Partners' Share (4,401) (10,271) 5,870
--------- --------- ---------
(41,877) (26,749) (15,128)
Aerial Communications 41,546 26,840 14,706
Telephone Subsidiaries and Other (3,601) (1,526) (2,075)
--------- -------- --------
$ (3,932) $ (1,435) $ (2,497)
========= ========= =========\
Other (expense), net increased $16.6 million to $19.0 million in 1998 due
primarily to expenses incurred as a result of the merger of American Paging with
TSR Wireless Holdings, LLC and the Tracking Stock Proposal.
PCS Development Costs totaled $21.6 million in 1997 reflecting the costs prior
to the launch of PCS service in Aerial's markets in the second quarter of 1997.
Interest Expense increased 58% ($34.9 million) to $95.4 million in the first
nine months of 1998 primarily due to a reduced amount of capitalized interest
($10.7 million), the increase in short-term debt ($5.4 million), the increase in
U.S. Cellular's long-term debt ($11.1 million) and the increase in Aerial's
long-term debt ($7.1 million). The Company capitalized $132,000 of interest in
the first nine months of 1998 and $10.9 million in 1997 related to qualifying
license and construction costs.
Minority Interest in Income of Subsidiary Trust totaled $17.3 million in the
first nine months of 1998. This preferred dividend requirement is the result of
the issuance of Company-
7
Obligated Mandatorily Redeemable Preferred Securities ("Trust Originated
Preferred Securities") in November 1997 and February 1998.
Income Tax Expense increased $48.9 million in 1998 to $76.2 million primarily
due to the significant gains on the sale of cellular interests and other
investments.
Net Income Available to Common increased $41.5 million to $65.5 million in the
first nine months of 1998 from $24.0 million in 1997. The gains from the sale of
cellular interests and other investments totaled $119.5 million in 1998 and
$12.5 million in 1997. Earnings Per Common Share - Diluted was $1.07 in the
first nine months of 1998 and $.40 in the first nine months of 1997. Gains from
the sale of cellular interests and other investments contributed $1.96 per share
in 1998 and $.21 per share in 1997.
Management believes operating expenses tend to be higher in the fourth quarter,
particularly at U.S. Cellular, due to increased marketing activities and
customer growth. This seasonality may cause operating income to be lower in the
fourth quarter. PCS competitors have initiated service in many of U.S.
Cellular's markets over the past two years. U.S. Cellular expects PCS
competitors to complete initial deployment of PCS in portions of all of its
market clusters by the end of 1998. U.S. Cellular has increased its advertising
to promote the United States Cellular brand and to distinguish its service from
other wireless communications providers. U.S. Cellular's management continues to
monitor other wireless communications providers' strategies to determine what
effects additional competition will have on U.S. Cellular's future strategies
and results. TDS anticipates that Aerial will continue to incur operating losses
and generate negative cash flow as it continues to build its customer base
reducing TDS's cash flow, operating and net income during the next few years.
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
TDS reported net income available to common of $5.9 million, or $.10 per diluted
share, in the third quarter ended September 30, 1998, compared to $8.5 million,
or $.14 per diluted share in 1997. Net income included gains from the sale of
cellular interests and other investments totaling $1.9 million, or $.03 per
share, in 1998, compared to $8.4 million, or $.14 per share, in 1997.
Net income from U.S. Cellular, excluding gains, increased to $28.7 million, or
$.47 per share, in 1998, from $25.9 million, or $.43 per share, in 1997. Net
income from TDS Telecom, excluding gains, decreased to $5.5 million, or $.09 per
share, in 1998 from $7.4 million, or $.12 per share, in 1997. Aerial's
activities reduced net income by $72.4 million, or $1.19 per share, in 1998
compared to $63.2 million, or $1.07 per share in 1997. Net income from Parent
and Other increased to $42.2 million, or $.70 per share, in 1998 from $30.1
million, or $.52 per share, in 1997 due primarily to increase in the tax benefit
associated with Aerial's losses.
8
The table below summarizes the results of operations of the business units and
gains (along with the related impact of income taxes and minority interest) on
net income available to common and diluted earnings per share.
Three Months Ended September 30,
--------------------------------
1998 1997
---- ----
(Dollars in thousands, except per share amounts)
Net Income (Loss) Available to Common
U.S. Cellular $ 28,690 $ 25,904
TDS Telecom 5,521 7,384
Aerial (72,371) (63,246)
Parent and Other 42,168 30,064
Gains 1,902 8,443
------------- -------------
$ 5,910 $ 8,549
============= =============
Diluted Earnings (Loss) Per Share
U.S. Cellular $ .47 $ .43
TDS Telecom .09 .12
Aerial (1.19) (1.07)
Parent and Other .70 .52
Gains .03 .14
------------- -------------
$ .10 $ .14
============= =============
Operating Revenues increased 31% ($113.5 million) during the third quarter of
1998 for reasons generally the same as the first nine months. U.S. Cellular
revenues increased 35% ($82.0 million) in 1998. Local retail revenue increased
36% ($53.6 million) in the third quarter of 1998, while inbound roaming revenue
increased 18% ($10.9 million). Average monthly service revenue per customer was
$51.40 in the third quarter of 1998 and $57.56 in 1997. TDS Telecom revenues
increased 10% ($11.7 million) in the third quarter of 1998 due to the growth in
telephone operations ($6.4 million) and growth in other services ($5.4 million).
Average monthly revenue per access line decreased slightly to $69.48 in the
third quarter of 1998 from $70.34 in 1997. Aerial revenues totaled $38.4 million
in the third quarter of 1998 consisting of service revenues of $32.6 million and
revenue from units sold to customers of $5.8 million. Average monthly service
revenue per customer was $50.24 in the third quarter of 1998.
Operating Expenses rose 26% ($95.1 million) during the third quarter of 1998 for
reasons generally the same as the first nine months. U.S. Cellular expenses
increased 34% ($64.4 million) for reasons generally the same as the first nine
months. Cost per gross customer addition decreased to $324 in the third quarter
of 1998 from $334 in 1997. TDS Telecom expenses increased 17% ($14.9 million)
due to growth in telephone operations ($5.5 million) and in other services ($9.4
million) for reasons generally the same as the first nine months. Aerial's
operating expenses increased 19% ($15.9 million) due to growth in the customer
base. Cost of equipment sold declined $9.6 million due primarily to handset
price declines.
Operating Income increased $27.7 million to $23.7 million in the third quarter
of 1998. U.S. Cellular's operating income increased $17.6 million reflecting
continued growth in customers and revenues. TDS Telecom's operating income
decreased $3.1 million reflecting the impact of new business ventures. Aerial's
operating loss decreased by $3.9 million. The results of American Paging were
not included in operating income in the third quarter of 1998 reflecting the
transfer to TSR Wireless Holdings, LLC at the end of the first quarter of 1998.
TDS's investment in TSR Wireless Holdings, LLC is reported under the equity
method as a component of Investment and Other Income (Expense).
9
Three Months Ended September 30,
---------------------------------
1998 1997 Change
---- ---- ------
(Dollars in thousands)
Operating Income (Loss) from Ongoing Operations
U.S. Cellular $ 62,515 $ 44,912 $ 17,603
TDS Telecom 21,803 24,940 (3,137)
Aerial (60,607) (64,537) 3,930
-------- -------- --------
23,711 5,315 18,396
American Paging Operating (Loss) -- (9,305) 9,305
-------- -------- --------
Operating Income (Loss) $ 23,711 $ (3,990) $ 27,701
======== ======== ========
Investment and Other Income totaled $11.8 million in 1998 and $43.3 million in
1997. Gain on Sale of Cellular Interests and Other Investments totaled $3.4
million in the third quarter of 1998 compared to $13.8 million in 1997 as the
Company has sold or traded certain non-strategic cellular interests and sold
other investments. Cellular Investment Income decreased 50% ($11.8 million) to
$11.6 million, reflecting the transfer of minority interests to BellSouth in the
fourth quarter of 1997 and the sale of minority interests to AirTouch in 1998.
Minority Share of Income decreased $1.7 million to $1.0 million in the third
quarter of 1998 compared with 1997.
Three Months Ended September 30,
------------------------------------
1998 1997 Change
-------- -------- --------
(Dollars in thousands)
Minority Share of (Income) Loss
U.S. Cellular
Minority Shareholders' Share $ (6,722) $ (6,915) $ 193
Minority Partners' Share (1,707) (3,023) 1,316
-------- -------- --------
(8,429) (9,938) 1,509
Aerial 10,532 13,352 (2,820)
Telephone Subsidiaries and Other (1,066) (657) (409)
-------- -------- --------
$ 1,037 $ 2,757 $ (1,720)
======== ======== ========
Interest Expense increased $5.7 million to $32.6 million in the third quarter of
1998 for reasons generally the same as the first nine months.
Minority Interest in Income of Subsidiary Trust totaled $6.2 million in the
third quarter of 1998. This preferred dividend requirement is the result of the
issuance of Trust Originated Preferred Securities in November 1997 and February
1998.
Income Tax Expense (Benefit) decreased $13.0 million to $(9.6 million) in the
third quarter of 1998 compared with 1997.
Net Income Available to Common decreased $2.6 million to $5.9 million in the
third quarter of 1998 from $8.5 million in 1997. Earnings Per Common
Share-Diluted was $.10 in 1998 and $.14 in 1997.
10
FINANCIAL RESOURCES AND LIQUIDITY
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, TDS has obtained
substantial funds from external sources to finance its PCS operations, to fund
acquisitions and for general corporate purposes. Although increasing internal
cash flow from U.S. Cellular and steady internal cash flow from TDS Telecom have
reduced the need for external financing, Aerial's working capital, operating
expenses and construction activities will require substantial additional funds
from external sources.
Cash Flows From Operating Activities. Cash flows from operating activities
totaled $214.6 million in the first nine months of 1998 compared to $149.7
million in 1997. U.S. Cellular and TDS Telecom generated substantial internal
funds in 1998 and 1997. Aerial's operations, however, required substantial funds
reducing cash flows from operating activities in 1998 and 1997. U.S. Cellular's
operating cash flow (operating income plus depreciation and amortization)
totaled $293.5 million in the first nine months of 1998 (up 43%) while TDS
Telecom's operating cash flow totaled $147.6 million (down 1%). Aerial's post
launch activities resulted in an operating cash outflow of $136.3 million for
the first nine months of 1998. Cash flows for other operating activities
(investment and other income, interest and income tax expense, and changes in
working capital and other assets and liabilities) required $86.7 million in the
first nine months of 1998 and $106.9 million in 1997.
Nine Months Ended September 30,
---------------------------------------
1998 1997 Change
--------- --------- ---------
(Dollars in thousands)
Operating cash flow
U.S. Cellular $ 293,544 $ 205,152 $ 88,392
TDS Telecom 147,555 148,955 (1,400)
Aerial (136,300) (96,313) (39,987)
American Paging (3,511) (1,187) (2,324)
--------- --------- ---------
301,288 256,607 44,681
Other operating activities (86,683) (106,878) 20,195
--------- --------- ---------
$ 214,605 $ 149,729 $ 64,876
========= ========= =========
Cash Flows from Financing Activities. TDS has used short-term debt to finance
its PCS operations, for acquisitions and for general corporate purposes. TDS has
taken advantage of attractive opportunities from time-to-time to reduce
short-term debt with proceeds from long-term debt and equity sales, and sales of
non-strategic assets.
Cash flows from financing activities totaled $170.7 million in the first nine
months of 1998 compared to $339.2 million in 1997. TDS received $198.2 million
on the sale of eight year 7% Notes and $144.9 million on the sale of 8.04% Trust
Originated Preferred Securities during the first nine months of 1998. In
addition, in September 1998, Aerial received $200 million from the sale of a
19.4% equity interest in its subsidiary, Aerial Operating Co. Inc., to Sonera
Ltd. The proceeds from the debt and equity financings were used to reduce notes
payable balances. Increases in short-term debt of $292.7 million during the
first nine months of 1997 were used primarily to fund expenditures for PCS
construction and development activities and for stock repurchases. U.S. Cellular
received net proceeds of $247 million on the sale of 7.25% notes in
11
August 1997. The proceeds were used to repay notes payable and long-term debt.
In the first nine months of 1998, TDS expended $9.1 million for the purchase of
American Paging common shares pursuant to a tender offer. In the first nine
months of 1997, TDS purchased 1,798,100 TDS Common Shares for $69.9 million and
350,000 U.S. Cellular Common Shares for $9.8 million.
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. Cash flows from investing activities required $354.8 million in
the first nine months of 1998 compared to $499.3 million in 1997. Capital
expenditures required $409.2 million in 1998 and $579.1 million in 1997.
Acquisitions, net of cash acquired, required $85.9 million in 1998 and $39.2
million in 1997. The sales of non-strategic cellular interests and other
investments provided $100.6 million in 1998 and $53.9 million in 1997, reducing
total cash flows required for investing activities.
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. Capital expenditures totaled $409.2
million in the first nine months of 1998 consisting primarily of $231.0 million
for cellular plant and equipment, $104.7 million for telephone plant and
equipment and $64.5 million for PCS property and equipment. Capital expenditures
totaled $579.1 million in 1997 consisting primarily of $248.0 million for
cellular plant and equipment, $96.7 million for telephone plant and equipment
and $203.4 million for PCS property and equipment. Aerial's capital expenditures
have decreased in 1998 because it has completed its initial build out program.
LIQUIDITY
TDS anticipates that the aggregate resources required for 1998 will include
approximately $540 million for capital spending, consisting of $310 million for
cellular capital additions, $140 million for telephone capital additions and $90
million for PCS capital additions. At September 30, 1998, the remaining amount
of capital spending approximates $140 million, consisting of $79 million for
cellular additions, $35 million for telephone additions and $26 million for PCS
additions. In addition, Aerial's working capital and operating expenses will
require an estimated $45 million in the fourth quarter of 1998.
U.S. Cellular plans to finance its cellular construction program using primarily
internally generated cash supplemented by short-term financing. U.S. Cellular
had $500 million of bank lines of credit for general corporate purposes at
September 30, 1998, all of which was unused. These line of credit agreements
provide for borrowings at the London InterBank Offered Rate ("LIBOR") plus 26.5
basis points.
TDS Telecom plans to finance its construction program using primarily internally
generated cash supplemented by long-term financing from federal government
programs and short-term financing. At September 30, 1998, TDS Telecom telephone
subsidiaries had $116.6 million in unadvanced loan funds from federal government
programs to finance the telephone construction program.
12
Aerial plans to finance its construction expenditures and working capital
requirements with short-term financing and vendor financing. In June, Nokia
Telecommunications, Inc. ("Nokia") agreed to provide up to an aggregate of $150
million in financing to Aerial for the purchase of network infrastructure
equipment and services from Nokia. Aerial may borrow up to $75 million prior to
June 30, 1999 and an additional $75 million between June 30, 1999 and June 30,
2000. At September 30, 1998, Aerial had $35 million outstanding under the Nokia
Credit Agreement.
TDS and its subsidiaries had cash and temporary investments totaling $93.1
million and longer-term cash investments totaling $14.2 million at September 30,
1998. 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.
TDS and its subsidiaries also have access to a variety of external capital
sources. TDS had $625 million of bank lines of credit for general corporate
purposes at September 30, 1998. Unused amounts of such lines totaled $432
million. These line of credit agreements provide for borrowings at negotiated
rates up to the prime rate.
Management believes that TDS's internal cash flows and funds available from cash
and cash equivalents, lines of credit, and longer-term financing availability
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 when capital requirements,
financial market conditions and other factors warrant.
Tracking Stock Proposal.
At a Special Meeting on April 27, 1998, Shareholders of the Company approved the
"Tracking Stock Proposal" and two related proposals which, among other things,
changed the state of incorporation of TDS from Iowa to Delaware and permits TDS
to issue shares of tracking stock which are intended to reflect the performance
of the Company's interest in its three principal business units: TDS Telecom,
U.S. Cellular and Aerial. The reincorporation of TDS in Delaware occurred on May
22, 1998.
In connection with the Tracking Stock Proposal, TDS had made offers to each of
U.S. Cellular and Aerial to acquire the common stock of such corporations which
TDS does not own, in exchange for tracking stock of TDS which would be intended
to reflect the separate performance of U.S. Cellular and Aerial, respectively.
U.S. Cellular's special committee expressed significant reservations relating to
the TDS offer. Aerial's special committee has recommended the Aerial Board of
Directors reject the TDS offer. TDS has stated that it is actively engaged in
ascertaining whether the Tracking Stock Proposal or another alternative is the
best vehicle to unlock and build shareholder value, and that it is working
toward a resolution.
13
Year 2000 Issue
The Year 2000 Issue exists because many computer systems and applications
abbreviate dates using only two digits rather than four digits, e.g., "98"
rather than "1998". Unless corrected, this shortcut may cause problems when the
century date "2000" occurs. On that date, some computer operating systems and
applications and embedded technology may recognize the date as January 1, 1900
instead of January 1, 2000. If the Company fails to correct any critical Year
2000 processing problems prior to January 1, 2000, the affected systems may
either cease to function or produce erroneous data, which could have material
adverse operational and financial consequences. Currently, the Company believes
that a disruption in the operation of its networks, and financial and accounting
systems and/or an inability to access interconnections with other
telecommunications carriers, are the major risks associated with the inability
of systems and software to process Year 2000 data correctly. The Company's
results of operations, financial position and cash flows could be materially and
adversely affected by such failures.
The Company's management has established a project team to address Year 2000
issues. The Company's plan to address the Year 2000 Issue consists of five
general phases: (i) Awareness, (ii) Assessment, (iii) Renovation, (iv)
Validation and (v) Implementation.
The awareness phase consisted of establishing a Year 2000 project team and
developing an overall strategy. A Year 2000 Program Office has been established
at the TDS corporate level to coordinate activities of the Year 2000 project
team, to monitor the current status of individual projects, to report
periodically to the Audit Committee, and to promote the exchange of information
between all business units to share knowledge and solution techniques. The Year
2000 effort covers the network and supporting infrastructure for the provision
of cellular, local switched and data telecommunications and PCS services; the
operational and financial information technology ("IT") systems and
applications, such as computer systems that support key business functions such
as billing, finance, customer service, procurement and supply; and a review of
the Year 2000 compliance efforts of the Company's key suppliers.
The assessment phase includes the identification of core business areas and
processes, analysis of systems and hardware supporting the core business areas
and the prioritization of renovation or replacement of systems and hardware that
are not Year 2000 compliant. Included in the assessment phase is an analysis of
risk management factors such as contingency plans and legal matters. The
assessment phase is scheduled to be completed in the first quarter of 1999.
Certain critical systems and hardware components have been identified and are in
the renovation phase. The renovation phase consists of the conversion or
replacement of selected platforms, applications, databases and utilities. The
renovation of critical hardware, systems and applications is scheduled to be
substantially completed by the third quarter of 1999.
The validation phase includes testing, verifying and validating the renovated or
replaced platforms, applications, databases and utilities. A goal of the
validation phase is to conduct independent verification testing of key hardware,
systems and applications as well as network and system component upgrades
received from suppliers. In addition, selected Year 2000 upgrades are slated to
undergo testing in a controlled environment that replicates the current
environment and is equipped to simulate the turn of the century and leap year
dates. Validation
14
is scheduled to be completed in the third quarter of 1999.
The implementation phase involves switching over to the converted and renovated
systems and applications. This phase is expected to be completed by the end of
1999.
The Company's current schedule is subject to change depending on developments
that may arise through unforeseen circumstances, and through finalization of the
assessment phase and the renovation and validation phases of the Company's
compliance efforts. The Company, like most other telecommunications operators,
is highly dependent on the telecommunications network vendors to provide
compliant hardware, systems and applications and on other third parties,
including vendors, other telecommunications service providers, government
agencies and financial institutions, to deliver reliable services. The Company
is dependent on the development of compliant hardware, systems and applications
and upgrades by experts, both internal and external, and the availability of
critical resources with the requisite skill sets. The Company's ability to meet
its target dates is dependent upon the timely provision of necessary upgrades
and modifications by its suppliers and internal resources. In addition, the
Company cannot guarantee that third parties on whom it depends for essential
services (such as electric utilities, other interconnected telecommunications
operators, etc.) will convert their critical systems and processes in a timely
manner. Failure or delay by any of these parties could significantly disrupt the
Company's business, including the provision of cellular, local switched and PCS
services, billing and collection processes and other areas of the business.
The Company has begun implementing additional initiatives to assess the degree
to which third parties with whom it has business relationships are addressing
Year 2000 Issues. These initiatives include analysis of the Year 2000 compliance
programs of the Company's critical vendors. In the near future, the initiative
will be extended to other telecommunications service providers with which the
Company interconnects. The Company's contingency plans will address mechanisms
for preventing or mitigating interruption caused by such third parties.
The Company is currently in the assessment phase, analyzing all systems and
hardware to determine which systems and hardware are not Year 2000 compliant.
The Company has not yet completed the cost estimate of this project. The Company
expects to complete this phase and develop total cost estimates in early 1999.
Through the third quarter of 1998, the total incremental costs associated with
the Year 2000 Issue were less than $2 million. The timing of expenditures may
vary and is not necessarily indicative of readiness efforts or progress to date.
Though Year 2000 project costs will directly impact the reported level of future
net income, the Company intends to manage its total cost structure, including
deferral of non-critical projects, in an effort to mitigate the impact of Year
2000 project costs.
Based on the Company's current schedule for completion of Year 2000 tasks, the
Company believes that its planning is adequate to secure Year 2000 readiness of
its critical systems. Nevertheless, management cannot provide assurance that its
plan to achieve Year 2000 compliance will be successful as it is subject to
various risks and uncertainties, many of which are described above. Accordingly,
the Company's goal is to develop business continuity and contingency plans in
1999 to address high risk areas as they are identified. These plans are expected
to assess the potential for business disruption in various scenarios, and to
provide for key operational back-up, recovery and restoration alternatives.
However, if the Company, or third parties with whom it has significant business
relationships, fails to achieve Year 2000 readiness with respect to critical
systems, there could be a material adverse affect on the
15
Company's results of operations, financial position and cash flows.
The above information, which contains statements that are "forward-looking"
within the meaning of the Private Securities Litigation Reform Act of 1995, is
based on the Company's current best estimates, which were derived using numerous
assumptions of future events, including the availability and future costs of
certain technological and other resources, third party modification actions and
other factors. Given the complexity of these issues and the possibility of
unidentified risks, actual results may vary materially from those anticipated
and discussed above. Specific factors that might cause such differences include,
among others, the availability and cost of personnel trained in this area, the
ability to locate and correct all affected computer code, the timing and success
of remedial efforts of third party suppliers and similar uncertainties.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY
STATEMENT
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains "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;
unanticipated changes in growth in cellular customers, penetration rates, churn
rates and the mix of products and services offered in our markets; and
unanticipated problems with the Year 2000 Issue. Readers should evaluate any
statements in light of these important factors.
16
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Unaudited
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ---------------------------
1998 1997 1998 1997
---------- --------- --------- ---------
(Dollars in thousands, except per share amounts)
OPERATING REVENUES
U.S. Cellular $ 313,947 $ 231,959 $ 849,212 $ 634,122
TDS Telecom 126,328 114,585 367,597 327,530
Aerial 38,438 18,648 105,872 25,791
--------- --------- --------- ---------
478,713 365,192 1,322,681 987,443
--------- --------- --------- ---------
OPERATING EXPENSES
U.S. Cellular 251,432 187,047 703,405 523,611
TDS Telecom 104,525 89,645 303,481 251,721
Aerial 99,045 83,185 303,254 141,961
--------- --------- --------- ---------
455,002 359,877 1,310,140 917,293
--------- --------- --------- ---------
Operating Income from Ongoing Operations 23,711 5,315 12,541 70,150
American Paging Operating (Loss) -- (9,305) (11,406) (24,845)
--------- --------- --------- ---------
OPERATING INCOME 23,711 (3,990) 1,135 45,305
--------- ---------- --------- ---------
INVESTMENT AND OTHER INCOME
Interest and dividend income 2,304 3,026 8,766 9,922
Cellular investment income, net of
license cost amortization 11,649 23,431 33,495 59,271
Gain on sale of cellular interests
and other investments 3,399 13,767 235,357 24,365
PCS development costs -- -- -- (21,614)
Other (expense), net (6,636) 305 (19,039) (2,461)
Minority share of (income) loss 1,037 2,757 (3,932) (1,435)
--------- --------- --------- ---------
11,753 43,286 254,647 68,048
--------- --------- --------- ---------
INCOME BEFORE INTEREST AND INCOME TAXES 35,464 39,296 255,782 113,353
Interest expense 32,556 26,885 95,441 60,579
Minority interest in income of subsidiary trust 6,202 -- 17,301 --
--------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES (3,294) 12,411 143,040 52,774
Income tax expense (benefit) (9,622) 3,392 76,219 27,317
--------- --------- --------- ---------
NET INCOME 6,328 9,019 66,821 25,457
Preferred Dividend Requirement (418) (470) (1,276) (1,422)
--------- --------- --------- ---------
NET INCOME AVAILABLE TO
COMMON $ 5,910 $ 8,549 $ 65,545 $ 24,035
========= ========= ========= ========
WEIGHTED AVERAGE COMMON
SHARES (000s) 61,036 59,511 60,923 60,249
EARNINGS PER COMMON SHARE-Basic $ .10 $ .14 $ 1.08 $ .40
========= ========= ========= ========
EARNINGS PER COMMON SHARE-Diluted $ .10 $ .14 $ 1.07 $ .40
========= ========= ========= ========
DIVIDENDS PER COMMON AND
SERIES A COMMON SHARE $ .11 $ .105 $ .33 $ .315
========= ========= ========= ========
<FN>
The accompanying notes to financial statements are an integral part of these statements.
</FN>
17
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
Nine Months Ended
September 30,
1998 1997
--------- ---------
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 66,821 $ 25,457
Add (Deduct) adjustments to reconcile net income
to net cash provided by operating activities
Depreciation and amortization 300,153 212,397
Deferred taxes 66,457 2,593
Investment income (34,205) (62,754)
Minority share of income 3,932 1,435
Gain on sale of cellular interests and other investments (235,357) (24,365)
Noncash interest expense 26,890 17,676
Other noncash expense 17,909 16,618
Change in accounts receivable (42,420) (46,389)
Change in materials and supplies 10,043 (29,300)
Change in accounts payable 13,034 16,617
Change in accrued taxes 17,832 22,088
Change in other assets and liabilities 3,516 (2,344)
-------- -------
214,605 149,729
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of long-term debt 200,655 260,236
Repayments of long-term debt (13,243) (115,853)
Change in notes payable (333,894) 292,727
Trust preferred securities 144,881 --
Dividends paid (21,162) (20,363)
Repurchase of Common Shares -- (69,942)
Purchase of subsidiary common stock (9,107) (9,801)
Proceeds from issuance of subsidiary's stock 200,000 --
Other financing activities 2,538 2,149
-------- -------
170,668 339,153
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (409,242) (579,138)
Investments in and advances to cellular
minority partnerships (6,356) (499)
Distributions from partnerships 19,748 42,695
Investments in PCS licenses -- (5,034)
Proceeds from investment sales 100,571 53,865
Other investing activities (3,032) 1,475
Acquisitions, net of cash acquired (85,942) (39,169)
Change in temporary investments and marketable securities 29,470 26,510
-------- -------
(354,783) (499,295)
-------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 30,490 (10,413)
CASH AND CASH EQUIVALENTS -
Beginning of period 51,008 57,633
-------- -------
End of period $ 81,498 $47,220
======== =======
<FN>
The accompanying notes to financial statements are an integral part of these statements.
</FN>
18
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
(Unaudited)
September 30, 1998 December 31, 1997
------------------ -----------------
(Dollars in thousands)
CURRENT ASSETS
Cash and cash equivalents $ 81,498 $ 51,008
Temporary investments 11,582 24,559
Accounts receivable from customers and others 282,046 247,298
Materials and supplies, at average cost,
and other current assets 65,472 85,419
---------- ----------
440,598 408,284
---------- ----------
INVESTMENTS
Cellular license acquisition costs, net 1,268,662 1,190,917
Cellular minority interests 99,554 138,367
PCS license acquisition costs, net 313,916 319,918
Franchise costs and other costs in excess of
the underlying book value of subsidiaries, net 182,861 180,669
Marketable equity securities 299,161 1,621
Other investments 173,972 141,092
---------- ----------
2,338,126 1,972,584
---------- ----------
PROPERTY, PLANT AND EQUIPMENT
Cellular telephone, net 961,007 940,253
Telephone, net 862,239 830,767
PCS, net 625,766 604,104
Radio paging, net -- 43,230
Other, net 43,956 47,299
---------- ----------
2,492,968 2,465,653
---------- ----------
OTHER ASSETS AND DEFERRED CHARGES 157,273 125,080
---------- ----------
TOTAL ASSETS $5,428,965 $4,971,601
========== ==========
<FN>
The accompanying notes to financial statements are an integral
part of these statements.
</FN>
19
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
(Unaudited)
September 30, 1998 December 31, 1997
------------------ -----------------
(Dollars in thousands)
CURRENT LIABILITIES
Current portion of long-term debt
and preferred shares $ 15,541 $ 16,115
Notes payable 193,693 527,587
Accounts payable 222,018 239,783
Advance billings and customer deposits 33,835 33,640
Accrued interest 10,703 18,284
Accrued taxes 25,077 6,961
Accrued compensation 25,707 23,386
Other current liabilities 39,688 40,129
----------- -----------
566,262 905,885
----------- -----------
DEFERRED LIABILITIES AND CREDITS 328,755 235,646
----------- -----------
LONG-TERM DEBT, excluding current portion 1,537,132 1,264,218
----------- -----------
REDEEMABLE PREFERRED SHARES, excluding
current portion 175 180
----------- -----------
MINORITY INTEREST in subsidiaries 457,914 416,566
----------- -----------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE
PREFERRED SECURITIES of Subsidiary Trust
Holding Solely Company Subordinated Debentures (a) 300,000 150,000
----------- -----------
NONREDEEMABLE PREFERRED SHARES 25,825 30,987
----------- -----------
COMMON STOCKHOLDERS' EQUITY (Note 3)
Common Shares - par value $.01 and $1.00, respectively 549 54,443
Series A Common Shares - par value $.01 and
$1.00, respectively 69 6,936
Common Shares issuable (12,584 and 10,480
shares, respectively) 549 499
Capital in excess of par value 1,879,408 1,663,749
Unrealized gains on securities 43,769 683
Treasury Shares, at cost (766,234 and 794,576
shares, respectively) (29,622) (30,682)
Retained earnings 318,180 272,491
----------- -----------
2,212,902 1,968,119
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,428,965 $ 4,971,601
=========== ===========
<FN>
(a) As described in Note 6, the sole asset of TDS Capital I is $154.6 million
principal amount of 8.5% subordinated debentures due 2037 from TDS. The sole
asset of TDS Capital II is $154.6 million principal amount of 8.04% subordinated
debentures due 2038 from TDS.
The accompanying notes to financial statements are an integral
part of these statements.
</FN>
20
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
1. Basis of Presentation
The consolidated financial statements included herein have been prepared
by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the disclosures are adequate to make the information
presented not misleading. It is suggested that these consolidated
financial statements be read in conjunction with the consolidated
financial statements and the notes thereto included in the Company's
latest annual report on Form 10-K.
The accompanying unaudited consolidated financial statements contain all
adjustments (consisting of only normal recurring items) necessary to
present fairly the financial position as of September 30, 1998 and
December 31, 1997, and the results of operations and cash flows for the
periods presented. The results of operations and cash flows for the nine
months ended September 30, 1998 and 1997, are not necessarily indicative
of the results to be expected for the full year.
2. Tracking Stock Proposal
At a Special Meeting on April 27, 1998, Shareholders of the Company
approved the "Tracking Stock Proposal" and two related proposals which,
among other things, changed the state of incorporation of TDS from Iowa to
Delaware and permits TDS to issue shares of tracking stock which are
intended to reflect the performance of the Company's interest in its three
principal business units: TDS Telecom, U.S. Cellular and Aerial. The
reincorporation of TDS in Delaware occurred on May 22, 1998.
In connection with the Tracking Stock Proposal, TDS had made offers to
each of U.S. Cellular and Aerial to acquire the common stock of such
corporations which TDS does not own, in exchange for tracking stock of TDS
which would be intended to reflect the separate performance of U.S.
Cellular and Aerial, respectively. U.S. Cellular's special committee has
expressed significant reservations relating to the TDS offer. Aerial's
special committee has recommended the Aerial Board of Directors reject the
TDS offer. TDS has stated that it is actively engaged in ascertaining
whether the Tracking Stock Proposal or another alternative is the best
vehicle to unlock and build shareholder value, and that it is working
toward a resolution.
3. Common Stockholders' Equity
In connection with the reincorporation of TDS in Delaware on May 22, 1998,
each issued Iowa Preferred Share no par value and each issued Iowa Common
Share and Series A Common Share, $1 par value was converted into a
Delaware Preferred Share, $.01 par value and Delaware Common Share and
Series A Common Share, $.01 par value. The September 30, 1998 amounts for
Common Shares, Series A Common Shares, and Capital in excess of par value
have been adjusted to reflect the change in par value.
21
4. American Paging Merger
TDS completed the transfer of substantially all of the assets and certain,
limited liabilities of American Paging, Inc. to TSR Wireless Holdings, LLC
pursuant to a previously announced asset contribution agreement on April
7, 1998. American Paging's revenues totaled $17.8 million and expenses
totaled $29.2 million for the three month period ended March 31, 1998.
Effective in the second quarter of 1998, TDS applied the equity method of
accounting for its 30% interest in TSR Wireless Holdings, LLC and reported
these results as a component of Investment and Other Income (Expense).
American Paging's revenues totaled $22.9 million and $71.8 million for the
three and nine month periods ended September 30, 1997, respectively, and
expenses totaled $32.2 million and $96.6 million, respectively, for the
same periods of 1997.
5. Marketable Equity Securities
The following table lists the Company's marketable equity securities at
September 30, 1998.
Fair Cumulative Net
Market Original Unrealized Tax Unrealized
Value Cost Gain Effect Gain
--------- -------- ---------- --------- ---------
(Dollars in thousands
Investment in AirTouch $ 295,167 $ 229,562 $ 65,605 $ 23,728 $ 41,877
Other 3,994 782 3,212 1,320 1,892
--------- --------- --------- --------- ---------
$ 299,161 $ 230,344 $ 68,817 $ 25,048 $ 43,769
========= ========= ========= ========= =========
The cumulative unrealized gain, net of taxes, is included in Common
Stockholders' Equity.
6. Company-Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust Holding Solely Company Subordinated Debentures
In February 1998, TDS Capital II, a subsidiary trust (the "Trust") of TDS,
issued 6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable
Preferred Securities (the "Preferred Securities") at $25 per Preferred
Security. Net proceeds from the issuance totaled $144.9 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. There is a full and unconditional guarantee by TDS of the
Trust's obligations under the 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 payment
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,
22
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 March 31, 2003, 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.
7. Long-term Debt
Aerial sold $220 million principal amount at maturity of 8.05% 10-year
zero coupon notes 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. 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.
On June 30, 1998, Aerial and Nokia Telecommunications Inc. ("Nokia")
entered into an agreement (the "1998 Credit Agreement") in which Nokia
will provide up to an aggregate $150 million in financing to Aerial for
the purchase of network infrastructure equipment and services from Nokia.
Loans under the 1998 Credit Agreement are to be made available in two $75
million tranches. With respect to Tranche A, Aerial may borrow up to $75
million until June 30, 1999. Tranche A loans mature on June 30, 1999,
however, the maturity date of Tranche A loans may be extended to June 30,
2000, upon written notice and payment of an extension fee by Aerial to
Nokia. A second $75 million ("Tranche B") becomes available commencing on
June 30, 1999, and ending on June 30, 2000, the maturity date of Tranche B
loans. Interest under the 1998 Credit Agreement is payable monthly at a
per annum rate equal to the 30 day London Interbank Offered Rate ("LIBOR")
plus 0.25% (the "Eurodollar margin"). The Eurodollar margin on any Tranche
A loans with an extended maturity date is subject to adjustment based on
ratings for TDS long-term senior unsecured debt. The obligations of Aerial
under the 1998 Credit Agreement are fully and unconditionally guaranteed
by TDS.
8. Minority Investor
On September 8, 1998, pursuant to the terms of a Purchase Agreement dated
June 1, 1998, Sonera Ltd. ("Sonera"), formerly Telecom Finland Ltd., made
a $200 million investment in Aerial Operating Co., Inc. ("AOC"), a
wholly-owned subsidiary of Aerial. Sonera purchased approximately 19.4%
equity interest in AOC. Sonera's equity ownership amount in AOC is subject
to adjustment based on Aerial's 20-day average stock price during the
three years commencing September 8, 1998. Depending on the level of
increase in the stock price, Sonera's ownership amount in AOC could
decline to approximately 15%. In addition, after five years Sonera's
equity in AOC becomes incrementally exchangeable for equity in Aerial
23
Communications, Inc. or, in certain circumstances, incrementally
exchangeable for equity in Telephone and Data Systems, Inc. or cash.
9. Gains from Sale of Cellular Interests and Other Investments
Gains from the sale of cellular interest and other investments in 1998
primarily reflects gains recorded on the sale of the Company's minority
interests in certain non-strategic markets to AirTouch Communications Inc.
("AirTouch") for AirTouch common shares and cash.
10. Other Comprehensive Income
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income," ("SFAS No. 130"), which
requires companies to report all of the changes in stockholders' equity,
except those resulting from investment by owners or distribution to owners
("Comprehensive Income").
The Company's Comprehensive Income includes Net Income and Unrealized
Gains from Marketable Equity Securities that are classified as
"available-for-sale". The following table summarizes the Company's
Comprehensive Income.
Nine Months Ended
September 30,
--------------------
1998 1997
---- ----
(Dollars in thousands)
Net Income $ 66,821 $ 25,457
Other Comprehensive Income -
Unrealized gains on securities,
net of tax of $24,584 43,086 --
-------- --------
$109,907 $ 25,457
======== ========
24
11. Earnings Per Share
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:
Nine Months Ended
September 30,
-----------------
1998 1997
---- ----
(Dollars and shares in thousands)
Net Income $ 66,821 $ 25,457
Less: Preferred Dividends (1,276) (1,422)
-------- --------
Net Income Available to Common used in Earnings
per Share-Basic 65,545 24,035
Reduction in preferred dividends if Preferred Shares
converted into Common Shares 292 --
Minority income adjustment (80) (86)
-------- --------
Net Income Available to Common used in Earnings
per Share-Diluted $ 65,757 $ 23,949
======== ========
Weighted Average Number of Common Shares
used in Earnings per Share-Basic 60,923 60,249
Effect of Dilutive Securities:
Common Shares outstanding if Preferred
Shares converted 456 --
Stock options and stock appreciation rights 124 129
Common Shares issuable 14 16
-------- ---------
Weighted Average Number of Common Shares
used in Earnings per Share-Diluted 61,517 60,394
======== =========
For 1998 and 1997, respectively, Preferred Shares convertible into 418,000
and 943,000 Common Shares were not included in computed diluted Earnings
per Common Share because their effects were antidilutive.
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.
25
12. Acquisition Effects
Assuming that acquisitions accounted for as purchases during the period
January 1, 1997, to September 30, 1998, had taken place on January 1,
1997, unaudited pro forma results of operations from continuing operations
would have been as follows:
Nine Months Ended
September 30,
--------------------------
1998 1997
----------- -----------
(Dollars in thousands, except
per share amounts)
Operating revenues $ 1,323,639 $ 1,048,058
Net income 66,781 31,243
Earnings per share - Basic 1.07 .49
Earnings per share - Diluted $ 1.07 $ .48
13. Supplemental Cash Flow Information
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 twelve
months are classified as temporary investments. Temporary investments are
stated at cost, which approximates market. Those investments with original
maturities of more than 12 months are classified as marketable securities
and are stated at amortized cost.
TDS acquired certain cellular licenses, operating companies and telephone
companies in 1998. In conjunction with these acquisitions, the following
assets were acquired and liabilities assumed and Common Shares issued.
Nine Months Ended
September 30,
----------------------
1998 1997
---- ----
(Dollars in thousands)
Property, plant and equipment $ 13,271 $ --
Cellular licenses 68,695 37,258
Equity method investment in cellular interests (2,317) --
Franchise costs 5,477 --
Long-term debt (4,634) --
Deferred credits (991) --
Other assets and liabilities,
excluding cash and cash equivalents 3,301 --
Decrease in Minority interest 13,168 1,911
Common Shares issued (10,028) --
-------- --------
Decrease in cash due to acquisitions $ 85,942 $ 39,169
======== ========
26
The following table summarizes interest and income taxes paid, and other noncash
transactions.
Nine Months Ended
September 30,
1998 1997
------- -------
(Dollars in thousands)
Interest Paid $73,242 $56,526
Income Taxes Paid (net of income tax refund
received of $10,000 in 1998) 6,754 9,286
Common Shares issued by TDS for
conversion of TDS Preferred Stock $ 5,162 $ 762
14. Business Segment Information
The following tables summarize business segment information for the three
and nine months ended or at September 30, 1998, and 1997.
CELLULAR OPERATIONS
Three Months Ended or at Nine Months Ended or at
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Dollars in thousands)
Operating Revenues
Local service $ 200,885 $ 147,279 $ 569,192 $ 407,591
Inbound roaming 71,880 60,992 174,761 163,576
Long-distance and other 41,182 23,688 105,259 62,955
----------- ----------- ----------- -----------
313,947 231,959 849,212 634,122
----------- ----------- ----------- -----------
Operating Expenses
System operations 53,817 40,268 143,127 109,545
Marketing and selling 55,546 43,712 156,875 122,602
Cost of equipment sold 22,776 19,716 63,881 55,473
General and administrative 67,265 50,303 191,785 141,350
Depreciation 40,795 24,504 117,593 68,735
Amortization 11,233 8,544 30,144 25,906
----------- ----------- ----------- -----------
251,432 187,047 703,405 523,611
----------- ----------- ----------- -----------
Operating Income $ 62,515 44,912 145,807 110,511
=========== =========== =========== ===========
Additions to property, plant
and equipment $ 93,976 $ 86,899 $ 230,968 $ 247,957
Identifiable assets $ 2,876,555 $ 2,340,079 $ 2,876,555 $ 2,340,079
27
AERIAL OPERATIONS
Three Months Ended or at Nine Months Ended or at
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Dollars in thousands)
Operating Revenues $ 38,438 $ 18,648 $ 105,872 $ 25,791
----------- ----------- ----------- -----------
Operating Expenses
Systems operations 15,498 10,776 48,107 15,652
Marketing and selling 16,603 13,013 52,009 28,971
Cost of equipment sold 16,223 25,798 59,616 40,770
General and administrative 15,689 13,444 43,899 28,167
Customer service 14,890 6,180 38,541 8,544
Depreciation 18,253 12,121 55,416 17,282
Amortization 1,889 1,853 5,666 2,575
----------- ----------- ----------- -----------
99,045 83,185 303,254 141,961
----------- ----------- ----------- -----------
Operating (Loss) $ (60,607) $ (64,537) $ (197,382) $ (116,170)
=========== =========== =========== ===========
Additions to property, plant
and equipment $ 16,480 $ 45,672 $ 64,541 $ 203,374
Identifiable assets $ 971,495 $ 899,580 $ 971,495 $ 899,580
TDS TELECOM OPERATIONS
Three Months Ended or at Nine Months Ended or at
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Dollars in thousands)
Telephone Operations
Operating Revenues
Local Service $ 34,828 $ 31,031 $ 100,949 $ 91,383
Network access and long distance 62,406 61,512 187,423 174,821
Miscellaneous 15,444 13,714 43,986 38,997
----------- ----------- ----------- -----------
112,678 106,257 332,358 305,201
----------- ----------- ----------- -----------
Operating Expenses
Network operations 22,469 22,227 65,602 58,027
Depreciation and amortization 27,504 23,939 80,117 71,043
Customer operations 17,205 17,732 52,073 48,919
Corporate and other 18,708 16,454 57,600 49,517
----------- ----------- ----------- -----------
85,886 80,352 255,392 227,506
----------- ----------- ----------- -----------
Telephone Operating Income 26,792 25,905 76,966 77,695
----------- ----------- ----------- -----------
Other Operations
Revenues 14,489 9,117 37,278 23,578
Expenses 19,478 10,082 50,128 25,464
----------- ----------- ----------- -----------
Other Operating Income (4,989) (965) (12,850) (1,886)
----------- ----------- ----------- -----------
Intercompany Eliminations
Revenues (839) (789) (2,039) (1,249)
Expenses (839) (789) (2,039) (1,249)
----------- ----------- ----------- -----------
Operating Income $ 21,803 $ 24,940 $ 64,116 $ 75,809
=========== =========== =========== ===========
Additions to property, plant
and equipment $ 42,218 $ 41,879 $ 104,650 $ 96,717
Identifiable assets $ 1,326,064 $ 1,192,035 $ 1,326,064 $ 1,192,035
28
OTHER OPERATIONS
Three Months Ended or at Nine Months Ended or at
September 30, September 30,
------------------------- -----------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Dollars in thousands)
Additions to property, plant
and equipment $ 6,067 $ 11,456 $ 9,083 $ 31,090
Identifiable Assets $ 220,235 $ 86,809 $ 220,235 $ 86,809
29
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
At the Annual Meeting of Shareholders of TDS held on July 10, 1998, the
following numbers of votes were cast for the matters indicated:
1. For the election of two Class II Directors of the Company
a. by the Public Holders
Nominee For Withhold Broker Non-vote
- ------------------ ---------- --------- ---------------
Kevin A. Mundt 44,865,422 1,687,579 0
Murray L. Swanson 45,488,466 1,064,536 0
b. by the Series A Holders:
Nominee For Withhold Broker Non-vote
- ---------------------- ----------- -------- ---------------
LeRoy T. Carlson, Jr. 67,691,690 0 0
Donald C. Nebergall 67,691,690 0 0
2. Proposal to approve the Amendment to the Restated Certificate of
Incorporation of the Company:
For Against Abstain Broker Non-vote
- -------------- ---------- ------- ---------------
102,218,060 1,407,586 145,406 10,471,443
3. Proposal to Ratify the Selection of Arthur Andersen LLP as Independent Public
Accountants for 1998:
For Against Abstain Broker Non-vote
- ------------- ------- ------- ---------------
113,953,571 266,085 25,035 0
Item 6. Exhibits and Reports on Form 8-K.
- ------------------------------------------
(a) Exhibit 11 - Computation of earnings per common share is included
herein as footnote 11 to the financial statements.
(b) Exhibit 12 - Statement regarding computation of ratios.
(c) Exhibit 27 - Financial Data Schedule
30
(d) Reports on Form 8-K filed during the quarter ended September 30, 1998:
TDS filed a Current Report on Form 8-K on July 16, 1998, dated July 15,
1998, which included a news release that announced the Company's second
quarter 1998 financial results.
TDS filed a Current Report on Form 8-K on September 17, 1998, dated
September 8, 1998, which announced that Sonera Ltd. (formerly Telecom
Finland Ltd.), completed its $200 million investment in Aerial Operating
Co., Inc., a wholly-owned subsidiary of Aerial.
31
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TELEPHONE AND DATA SYSTEMS, INC.
--------------------------------
(Registrant)
Date November 13, 1998 SANDRA L. HELTON
------------------------- ---------------------------------
Sandra L. Helton
Executive Vice President-Finance
(Chief Financial Officer)
Date November 13, 1998 GREGORY J. WILKINSON
------------------------- ---------------------------------
Gregory J. Wilkinson
Vice President and Controller
(Principal Accounting Officer)
32