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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-14157
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TELEPHONE AND DATA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 36-2669023
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
30 NORTH LASALLE STREET, CHICAGO, 60602
ILLINOIS (Zip code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER: (312) 630-1900
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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<S> <C>
Common Shares, $.01 par value American Stock Exchange
8.5% TDS-Obligated Mandatorily
Redeemable Preferred Securities
of Subsidiary Trust American Stock Exchange
8.04% TDS-Obligated
Mandatorily Redeemable Preferred
Securities of Subsidiary Trust American Stock Exchange
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
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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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _X_
As of February 26, 1999, the aggregate market values of the registrant's
Common Shares, Series A Common Shares and Preferred Shares held by
non-affiliates were approximately $2.7 billion, $26.1 million and $33.3 million,
respectively. The closing price of the Common Shares on February 26, 1999, was
$50.25, as reported by the American Stock Exchange. Because no market exists for
the Series A Common Shares and Preferred Shares, the registrant has assumed for
purposes hereof that (i) each Series A Common Share has a market value equal to
one Common Share because the Series A Common Shares were initially issued by the
registrant in exchange for Common Shares on a one-for-one basis and are
convertible on a share-for-share basis into Common Shares, (ii) each
nonconvertible Preferred Share has a market value of $100 because each of such
shares had a stated value of $100 when issued, and (iii) each convertible
Preferred Share has a value of $50.25 times the number of Common Shares into
which it was convertible on February 26, 1999.
The number of shares outstanding of each of the registrant's classes of
common stock, as of February 26, 1999, is 54,391,873 Common Shares, $.01 par
value, and 6,949,904 Series A Common Shares, $.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Those sections or portions of the registrant's 1998 Annual Report to
Shareholders and of the registrant's Notice of Annual Meeting of Shareholders
and Proxy Statement for its Annual Meeting of Shareholders to be held May 14,
1999, described in the cross reference sheet and table of contents attached
hereto are incorporated by reference into Part II and III of this report.
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<PAGE>
CROSS REFERENCE SHEET
AND
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NUMBER
OR REFERENCE(1)
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<S> <C> <C>
Item 1. Business........................................................................... 3
Item 2. Properties......................................................................... 42
Item 3. Legal Proceedings.................................................................. 42
Item 4. Submission of Matters to a Vote of Security Holders................................ 42
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............. 43(2)
Item 6. Selected Financial Data............................................................ 43(3)
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... 43(4)
Item 7A. Quantitative and Qualitative Disclosures About Market Risk......................... 43(4)
Item 8. Financial Statements and Supplementary Data........................................ 43(5)
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure....................................................................... 43
Item 10. Directors and Executive Officers of the Registrant................................. 44(6)
Item 11. Executive Compensation............................................................. 44(7)
Item 12. Security Ownership of Certain Beneficial Owners and Management..................... 44(8)
Item 13. Certain Relationships and Related Transactions..................................... 44(9)
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................... 45
</TABLE>
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(1) Parenthetical references are to information incorporated by reference from
the registrant's Exhibit 13, which includes portions of its Annual Report to
Shareholders for the year ended December 31, 1998 ("Annual Report") and from
the registrant's Notice of Annual Meeting of Shareholders and Proxy
Statement for its Annual Meeting of Shareholders to be held on May 14, 1999
("Proxy Statement").
(2) Annual Report sections entitled "TDS Stock and Dividend Information" and
"Market Price per Common Share by Quarter."
(3) Annual Report section entitled "Selected Consolidated Financial Data."
(4) Annual Report section entitled "Management's Discussion and Analysis of
Results of Operations and Financial Condition."
(5) Annual Report sections entitled "Consolidated Statements of Operations,"
"Consolidated Statements of Cash Flows," "Consolidated Balance Sheets,"
"Consolidated Statements of Common Stockholders' Equity," "Notes to
Consolidated Financial Statements," "Consolidated Quarterly Income
Information (Unaudited)" and "Report of Independent Public Accountants."
(6) Proxy Statement sections entitled "Election of Directors" and "Executive
Officers."
(7) Proxy Statement section entitled "Executive Compensation," except for the
information specified in Item 402(a)(8) of Regulation S-K under the
Securities Exchange Act of 1934, as amended.
(8) Proxy Statement section entitled "Security Ownership of Certain Beneficial
Owners and Management."
(9) Proxy Statement section entitled "Certain Relationships and Related
Transactions."
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TELEPHONE AND DATA SYSTEMS, INC.
30 NORTH LASALLE STREET, CHICAGO, ILLINOIS 60602
TELEPHONE (312) 630-1900
[LOGO]
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PART I
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ITEM 1. BUSINESS
Telephone and Data Systems, Inc. (the "Company" or "TDS"), is a diversified
telecommunications service company with cellular telephone, telephone and
personal communications services ("PCS") operations. At December 31, 1998, the
Company served approximately 3.0 million customer units in 35 states, including
2,183,000 cellular telephones, 547,500 telephone access lines and 311,900 PCS
telephones. For the year ended December 31, 1998, cellular operations provided
64% of the Company's consolidated revenues; telephone operations provided 27%;
and PCS operations provided 9%. The Company's long-term business development
strategy is to expand its existing operations through internal growth and
acquisitions and to explore and develop other telecommunications businesses that
management believes will utilize the Company's expertise in customer-based
telecommunications.
The Company conducts substantially all of its cellular operations through
its 81.0%-owned subsidiary, United States Cellular Corporation [AMEX: USM]. At
December 31, 1998, U.S. Cellular provided cellular telephone service to
2,183,000 customers through 138 majority-owned and managed ("consolidated")
cellular systems serving approximately 17% of the geography and approximately 9%
of the population of the United States. Since 1985, when U.S. Cellular began
providing cellular service in Knoxville, Tennessee, U.S. Cellular has expanded
its cellular networks and customer service operations to cover 145 managed
markets in 26 states as of December 31, 1998. In total, the Company operated
eight market clusters, of which four had a total population of more than two
million, and each of which had a total population of more than one million.
Overall, 90% of the Company's 26.2 million population equivalents were in
markets which were consolidated, 2% were in managed but not consolidated markets
and 8% were in markets in which the Company holds an investment interest.
The Company conducts substantially all of its telephone operations through
its wholly-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom").
At December 31, 1998, TDS Telecom operated 105 telephone companies serving
547,500 access lines in 28 states. TDS Telecom is expanding by offering
additional lines of telecommunications products and services to existing
customers and through the selective acquisition of local exchange telephone
companies serving rural and suburban areas. TDS Telecom has acquired 16
telephone companies and divested one telephone company since the beginning of
1994. These net acquisitions added 76,000 access lines during this five-year
period, while internal growth added 115,300 lines. TDS Telecom also began
offering services as a Competitive Local Exchange Carrier ("CLEC") in 1998 in
certain markets in Wisconsin and Minnesota. At December 31, 1998, TDS Telecom's
CLECs served 38,800 access lines.
The Company conducts substantially all of its broadband PCS operations
through its 82.3%-owned subsidiary, Aerial Communications, Inc. [NASDAQ: AERL].
Aerial provides PCS service in the Minneapolis, Tampa-St. Petersburg-Orlando,
Houston, Pittsburgh, Kansas City and Columbus Major
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Trading Areas ("MTAs") (collectively, the "PCS Markets"). The PCS Markets
include approximately 27.7 million population equivalents. Aerial has commenced
service in all its markets and provided service to 311,900 PCS telephones as of
December 31, 1998.
The Company was incorporated in 1968 and changed its corporate domicile from
Iowa to Delaware in 1998. The Company's executive offices are located at 30
North LaSalle Street, Chicago, Illinois 60602. Its telephone number is
312-630-1900.
Unless the context indicates otherwise: (i) references to "TDS" or the
"Company" refer to Telephone and Data Systems, Inc., and its subsidiaries; (ii)
references to "USM" or "U.S. Cellular" refer to United States Cellular
Corporation and its subsidiaries; (iii) references to "TDS Telecom" refer to TDS
Telecommunications Corporation and its subsidiaries; (iv) references to "AERL"
or "Aerial" refer to Aerial Communications, Inc. and its subsidiaries; (v)
references to "MSA" or to a particular city refer to the Metropolitan
Statistical Area, as designated by the U.S. Office of Management and Budget and
used by the Federal Communications Commission ("FCC") in designating
metropolitan cellular market areas; (vi) references to "RSA" refer to the Rural
Service Area, as used by the FCC in designating non-MSA cellular market areas;
(vii) references to cellular "markets" or "systems" refer to MSAs, RSAs or both;
(viii) references to "MTA" refer to Major Trading Areas, as used by the FCC in
designating PCS markets; (ix) references to "population equivalents" mean the
population of a market, based on 1998 Claritas estimates, multiplied by the
percentage interests that the Company owns or has the right to acquire in an
entity licensed, designated to receive a license or expected to receive a
construction permit ("licensee") by the FCC to construct or operate a cellular
or a PCS system in such market.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY
STATEMENT
This Annual Report on Form 10-K, including exhibits, 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; unanticipated changes in growth in
cellular and PCS customers, penetration rates, churn rates; the mix of products
and services offered in the Company's markets; and unanticipated problems with
the Year 2000 Issue. Readers should evaluate any statements in light of these
important factors.
PROPOSED CORPORATE RESTRUCTURING
In December 1997, the Board of Directors of Telephone and Data Systems, Inc.
adopted a proposal, which was approved by the shareholders in April 1998, to
authorize three new classes of common stock and to change the state of
incorporation of TDS from Iowa to Delaware. The three new classes of stock were
intended to separately reflect the performance of the Company's cellular
telephone, telephone and personal communications services businesses ("Tracking
Stocks"). The reincorporation was completed May 1998.
The Company intended to: a) offer and sell Telecom Group Shares in a public
offering for cash, b) issue Cellular Group Shares in exchange for all of the
Common Shares of U.S. Cellular not owned by the Company, c) issue Aerial Group
Shares in exchange for all of the Common Shares of Aerial not owned by the
Company, and d) 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.
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In December 1998, TDS announced the withdrawal of its offers to exchange
tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial
which it did not own. An integral part of the tracking stock plan was the
offering of shares in the Telecom Group, which TDS was not able to complete at a
reasonable offering price. In addition, TDS was unable to reach mutually
acceptable agreements with the special committees representing the minority
shareholders of U.S. Cellular and Aerial.
At the same time TDS announced that it was pursuing a tax-free spin-off of
its 82.3% interest in Aerial, as well as reviewing other alternatives. There are
a number of conditions that must be met for a spin-off to occur, including the
receipt of a favorable Internal Revenue Service ruling on the tax free status of
such a spin-off, final approval by the TDS Board of Directors, certain
government and third party approvals and review by the Securities and Exchange
Commission ("SEC") of appropriate SEC filings.
Prior to any spin-off, it is expected that Aerial will seek additional
financing so that Aerial would have the appropriate capitalization to operate as
a stand-alone entity. In connection with such financing, it is anticipated that
a substantial amount of Aerial's debt to TDS may be converted into equity. TDS
intends to seek shareholder approval of a proposal to distribute Aerial Series A
Common Shares, on a pro-rata basis, to holders of TDS Series A Common Shares and
Aerial Common Shares, on a pro-rata basis, to holders of TDS Common Shares.
There can be no assurance that a spin-off will be consummated or that other
alternatives will not be pursued.
In September 1998, pursuant to a purchase agreement between TDS, Aerial,
Aerial Operating Company, Inc. ("AOC"), and Sonera Ltd., a limited liability
company organized under the laws of Finland ("Sonera"), Sonera purchased 2.4
million shares of common stock of AOC representing a 19.423% equity interest in
AOC, subject to adjustment under certain circumstances, for an aggregate
purchase price of $200 million. Sonera has the right, subject to adjustment
under certain circumstances, to exchange each share of AOC, common stock which
it owns for 6.72919 Common Shares of Aerial. Upon the exchange of all of the AOC
shares, Sonera would own an 18.452% equity interest in Aerial, reflecting a
purchase price equivalent to $12.33 per Common Share of Aerial (the "Equivalent
Purchase Price").
Following the announcement by TDS in December 1998, that it intended to
distribute to its shareholders all of the capital stock of Aerial that it owns,
and that Aerial would seek additional financing from sources other than TDS in
connection therewith, Sonera contacted TDS to express certain concerns about the
announcement. Sonera has asserted that the TDS announcement reflects a change in
circumstances that warrant the renegotiation of certain matters related to its
investment in AOC, including an adjustment in the Equivalent Purchase Price, and
has raised the possibility of litigation in connection therewith. TDS and Aerial
intend to attempt to reach a mutually acceptable resolution of the concerns
raised by Sonera. There can be no assurance that this matter will not lead to
litigation, or that it will not have a material adverse effect on TDS or Aerial
or on the plans relating to the refinancing and spin-off of Aerial.
CELLULAR TELEPHONE OPERATIONS
The Company's cellular operations are conducted through U.S. Cellular and
its subsidiaries. U.S. Cellular is the eleventh largest wireless company in the
United States, based on the aggregate number of customers in its consolidated
markets. U.S. Cellular's corporate development strategy is to operate
controlling interests in cellular market licensees in areas adjacent to or in
proximity to its other markets, thereby building clusters of operating markets.
Customers benefit from larger service areas such as these, which provide longer
uninterrupted service and the ability to make outgoing calls and receive
incoming calls within the designated area without special roaming arrangements.
In addition, U.S. Cellular anticipates that clustering will continue to provide
it certain economies in its capital and operating costs. As the number of
opportunities for outright acquisitions has decreased in recent years, and as
U.S. Cellular's clusters have grown, U.S. Cellular's focus has shifted toward
exchanges and divestitures of managed and investment interests which are
considered less essential to U.S. Cellular's clustering strategy.
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The following table summarizes the status of U.S. Cellular's interests in
cellular markets at December 31, 1998.
<TABLE>
<S> <C>
Owns Majority Interest and Manages.................................. 138
Owns Minority Interest and Manages.................................. 7
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Total Markets Managed by the Company................................ 145
Markets Managed by Others (1)....................................... 38
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Total Markets....................................................... 183
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(1) Represents markets in which U.S. Cellular owns a minority or other
noncontrolling interest and which are managed by third parties; as of
December 31, 1998, U.S. Cellular accounted for its interests in 31 of these
markets using the equity method and accounted for the remaining seven
markets using the cost method.
Cellular systems in U.S. Cellular's 138 majority-owned and managed markets
served 2,183,000 customers at December 31, 1998, and contained 2,065 cell sites.
The average penetration rate in U.S. Cellular's consolidated markets was 8.84%
at December 31, 1998, and the churn rate in all consolidated markets averaged
1.9% per month for the twelve months ended December 31, 1998.
THE CELLULAR TELEPHONE INDUSTRY
Cellular telephone technology provides high-quality, high-capacity
communications services to in-vehicle and hand-held portable cellular
telephones. Cellular technology is a major improvement over earlier mobile
telephone technologies. Cellular telephone systems are designed for maximum
mobility of the customer. Access is provided through system interconnections to
local, regional, national and world-wide telecommunications networks. Cellular
telephone systems also offer a full range of ancillary services such as
conference calling, call-waiting, call-forwarding, voice mail, facsimile and
data transmission.
Cellular telephone systems divide each service area into smaller geographic
areas or "cells." Each cell is served by radio transmitters and receivers
operating on discrete radio frequencies licensed by the FCC. All of the cells in
a system are connected to a computer-controlled Mobile Telephone Switching
Office ("MTSO"). The MTSO is connected to the conventional ("landline")
telephone network and potentially other MTSOs. Each conversation on a cellular
phone involves a transmission over a specific set of radio frequencies from the
cellular phone to a transmitter/receiver at a cell site. The transmission is
forwarded from the cell site to the MTSO and from there may be forwarded to the
landline telephone network to complete the call. As the cellular telephone moves
from one cell to another, the MTSO determines radio signal strength and
transfers ("hands off") the call from one cell to the next. This hand-off is not
noticeable to either party on the phone call.
The FCC currently grants only two licenses to provide cellular telephone
service in each market. However, competition for customers includes competing
communications technologies such as conventional landline and mobile telephone,
Specialized Mobile Radio ("SMR") systems, radio paging and PCS. PCS has become
available in many areas of the United States, including U.S. Cellular's markets,
and U.S. Cellular expects PCS operators to continue deployment of PCS in
portions of all of U.S. Cellular's clusters through 1999. Additionally,
technologies such as Enhanced Specialized Mobile Radio ("ESMR") and mobile
satellite communication systems may prove to be competitive with cellular
service in the future in some or all of U.S. Cellular's markets.
The services available to cellular customers and the sources of revenue
available to cellular system operators are similar to those provided by
conventional landline telephone companies. Customers may be charged a separate
fee for system access, airtime, long-distance calls and ancillary services.
Cellular system operators often provide service to customers of other operators'
cellular systems while the customers are temporarily located within the
operators' service areas. Customers using service away from their home system
are called "roamers." Roaming is not limited to cellular customers and systems;
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PCS customers and systems have this roaming capability as well. In all cases,
the system that provides the service to roamers will generate usage revenue.
Many operators, including U.S. Cellular, charge premium rates for this roaming
service.
There have been a number of technical developments in the cellular industry
since its inception. Currently, while most companies' MTSOs process information
digitally, on certain cellular systems the radio transmission is done on an
analog basis. During 1992, a new transmission technique was approved for
implementation by the cellular industry. Time Division Multiple Access ("TDMA")
technology was selected as one industry standard by the cellular industry and
has been deployed in several markets, including U.S. Cellular's operations in
portions of several clusters. Another digital technology, Code Division Multiple
Access ("CDMA"), is also being deployed by U.S. Cellular in portions of several
clusters. Digital radio technology offers several advantages, including greater
privacy, less transmission noise, greater system capacity and potentially lower
incremental costs to accommodate additional system usage. The conversion from
analog to digital radio technology is continuing on an industry-wide basis;
however, this process is expected to take a number of years. PCS operators have
deployed TDMA, CDMA and a third digital technology, Global System for Mobile
Communication ("GSM"), in the markets where they have begun operations.
The cellular telephone industry is characterized by high initial fixed
costs. Accordingly, if and when revenues less variable costs exceed fixed costs,
incremental revenues should yield an operating profit. The amount of profit, if
any, under such circumstances is dependent on, among other things, prices and
variable marketing costs which in turn are affected by the amount and extent of
competition. Until technological limitations on total capacity are approached,
additional cellular system capacity can normally be added in increments that
closely match demand and at less than the proportionate cost of the initial
capacity.
CELLULAR OPERATIONS
From its inception in 1983 until 1993, U.S. Cellular was principally in a
start-up phase. Until 1993, U.S. Cellular's activities had been concentrated
significantly on the acquisition of interests in cellular licensees and on the
construction and initial operation of cellular systems. The development of a
cellular system is capital-intensive and requires substantial investment prior
to and subsequent to initial operation. U.S. Cellular experienced operating
losses and net losses from its inception until 1993. During the past five years,
U.S. Cellular generated operations-driven net income and has significantly
increased its operating cash flows during that time. Management anticipates
further growth in cellular units in service and revenues as U.S. Cellular
continues to expand through internal growth. Marketing and system operations
expenses associated with this expansion may reduce the rate of growth in
operating cash flows and operating income during the period of additional
growth. In addition, U.S. Cellular anticipates that the seasonality of revenue
streams and operating expenses may cause U.S. Cellular's operating income to
vary from quarter to quarter.
While U.S. Cellular produced operating income and net income during the last
five years, changes in any of several factors may reduce U.S. Cellular's growth
in operating income and net income over the next few years. These factors
include: (i) the growth rate in U.S. Cellular's customer base; (ii) the usage
and pricing of cellular services; (iii) the churn rate; (iv) the cost of
providing cellular services, including the cost of attracting new customers; (v)
continued competition from PCS and other technologies; and (vi) continuing
technological advances which may provide additional competitive alternatives to
cellular service.
U.S. Cellular is building a substantial presence in selected geographic
areas throughout the United States where it can efficiently integrate and manage
cellular telephone systems. Its cellular interests include regional market
clusters in the following areas: Wisconsin/Illinois,
Iowa/Missouri/Illinois/Indiana, Eastern North Carolina/South Carolina, West
Virginia/Maryland/Pennsylvania/Ohio, Virginia/North Carolina,
Washington/Oregon/Idaho, Oregon/California, Maine/New Hampshire/Vermont,
Florida/Georgia,
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Oklahoma/Missouri/Kansas, Texas/Oklahoma, Eastern Tennessee/Western North
Carolina and Southern Texas. See "U.S. Cellular's Cellular Interests." U.S.
Cellular has acquired its cellular interests through the wireline application
process (16%), including settlements and exchanges with other applicants, and
through acquisitions (84%), including acquisitions from TDS and third parties.
CELLULAR SYSTEMS DEVELOPMENT
ACQUISITIONS, DIVESTITURES AND EXCHANGES. U.S. Cellular assesses its
cellular holdings on an ongoing basis in order to maximize the benefits derived
from clustering its markets. As U.S. Cellular's clusters have grown, its focus
has shifted toward exchanges and divestitures of managed and investment
interests, with outright acquisitions becoming a decreasing portion of U.S.
Cellular's overall acquisition strategy. As a result, U.S. Cellular has not
substantially increased its population equivalents during the past five years,
but has shifted the balance of its holdings between investment and operating
interests so that currently over 90% of U.S. Cellular's interests are in markets
where it is the operator. This shift has resulted primarily because of U.S.
Cellular's recent focus on exchanges and divestitures of investment interests
and the acquisitions of interests in markets where it will become the operator.
U.S. Cellular has only increased its population equivalents by 5% in the
last five years, from approximately 24.8 million at December 31, 1993, to
approximately 26.1 million at December 31, 1998. However, during that period
U.S. Cellular has increased the percentage of those population equivalents which
are in markets U.S. Cellular operates. As of December 31, 1998, 92% of U.S.
Cellular's population equivalents represented interests in markets U.S. Cellular
operates compared to 81% at December 31, 1993. Also, the number of markets
operated by U.S. Cellular have increased to 145 markets at December 31, 1998
from 136 markets at December 31, 1993.
Recently, the pace of acquisitions, exchanges and divestitures has slowed as
industry-wide consolidation has reduced the number of markets available for
acquisition. U.S. Cellular may continue to make opportunistic acquisitions or
exchanges in markets that further strengthen its market clusters and in other
attractive markets. U.S. Cellular also seeks to acquire minority interests in
markets where it already owns the majority interest and/or operates the market.
There can be no assurance that U.S. Cellular, or TDS for the benefit of U.S.
Cellular, will be able to negotiate additional acquisitions or exchanges on
terms acceptable to it or that regulatory approvals, where required, will be
received. U.S. Cellular plans to retain minority interests in certain cellular
markets which it believes will earn a favorable return on investment. Other
minority interests may be exchanged for interests in markets which enhance U.S.
Cellular's market clusters or may be sold for cash or other consideration. U.S.
Cellular also continues to evaluate the disposition of certain managed interests
which are not essential to its corporate development strategy.
COMPLETED ACQUISITIONS. During 1998, U.S. Cellular, or TDS for the benefit
of U.S. Cellular, purchased majority interests in six markets and several
additional minority interests, representing approximately 1.3 million population
equivalents. The total consideration paid for these purchases, primarily in the
form of cash and U.S. Cellular Common Shares issued to TDS to reimburse TDS for
the value of TDS Common Shares issued to third parties, totaled $168.3 million.
COMPLETED DIVESTITURES. During 1998, U.S. Cellular and TDS sold a majority
interest in one market and several minority interests, representing
approximately 1.2 million population equivalents. In exchange, U.S. Cellular and
TDS received approximately 5.2 million AirTouch Communications, Inc.
("AirTouch") common shares and cash totaling $119.7 million.
PENDING ACQUISITIONS AND DIVESTITURE. At December 31, 1998, U.S. Cellular
had agreements pending to acquire minority interests in two markets in which
U.S. Cellular currently owns majority interests, representing 74,000 population
equivalents, for $8.1 million in cash. Also at December 31, 1998 U.S. Cellular
had an agreement pending to divest a majority interest in one market,
representing 264,000 population equivalents, for a total consideration of $35.2
million. U.S. Cellular expects all of the pending transactions to be completed
during the first half of 1999.
TDS and U.S. Cellular maintain shelf registrations of Common Shares and
Preferred Stock under the Securities Act of 1933 for issuance specifically in
connection with acquisitions.
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U.S. Cellular is a majority-owned subsidiary of TDS. At December 31, 1998,
TDS owned 81.0% of the combined total of the outstanding Common Shares and
Series A Common Shares of U.S. Cellular and controlled 95.7% of the combined
voting power of both classes of common stock.
CELLULAR INTERESTS AND CLUSTERS
U.S. Cellular operates clusters of adjacent cellular systems in nearly all
of its markets, enabling its customers to benefit from larger service areas than
otherwise possible. Where U.S. Cellular offers wide-area coverage, its customers
enjoy uninterrupted service within the designated area. Customers may also make
outgoing calls and receive incoming calls within this area without special
roaming arrangements. In addition to benefits to customers, clustering also has
provided to U.S. Cellular certain economies in its capital and operating costs.
These economies are made possible through increased sharing of facilities,
personnel and other costs and have resulted in a reduction of U.S. Cellular's
per customer cost of service. The extent to which U.S. Cellular benefits from
these revenue enhancements and economies of operation is dependent on market
conditions, population size of each cluster and engineering considerations.
U.S. Cellular may continue to make opportunistic acquisitions and exchanges
which will complement its established market clusters. From time to time, U.S.
Cellular may also consider exchanging or selling its interests in markets which
do not fit well with its long-term strategies.
U.S. Cellular owned interests in cellular telephone systems in 183 markets
at December 31, 1998, representing 26.4 million population equivalents.
Including the minority interests to be purchased and the majority interest to be
sold during 1999, U.S. Cellular owned or had the right to acquire 182 markets,
representing 26.2 million population equivalents, at December 31, 1998. The
following table summarizes the growth in U.S. Cellular's population equivalents
in recent years and the development status of these population equivalents.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(THOUSANDS OF POPULATION EQUIVALENTS)(1)
Operational Markets:
Majority-Owned and Managed.................................. 23,661 22,929 20,539 20,230 18,812
Minority-Owned and Managed (2).............................. 354 401 401 512 1,213
Majority-Owned Markets to be Managed, Net of Markets to be
Divested: (2)(3)............................................ -- -- 218 274 2,228
--------- --------- --------- --------- ---------
Total Markets Managed and to be Managed................... 24,015 23,330 21,158 21,016 22,253
Minority Interests in Markets Managed by Others............... 2,150 2,143 4,569 4,070 3,821
--------- --------- --------- --------- ---------
Total..................................................... 26,165 25,473 25,727 25,086 26,074
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) Based on 1998 Claritas estimates for all years.
(2) Includes markets where the Company has the right to acquire an interest but
does not currently own an interest.
(3) Includes markets which are operational but which are currently managed by
third parties.
The following section details U.S. Cellular's cellular interests, including
those it owned or had the right to acquire as of December 31, 1998. The table
presented therein lists clusters of markets that U.S. Cellular manages. U.S.
Cellular's market clusters show the areas in which U.S. Cellular is currently
focusing its development efforts. These clusters have been devised with a
long-term goal of allowing delivery of cellular service to areas of economic
interest and along corridors of economic activity. The number of population
equivalents represented by U.S. Cellular's cellular interests may have no direct
relationship to the number of potential cellular customers or the revenues that
may be realized from the operation of the related cellular systems.
9
<PAGE>
U.S. CELLULAR'S CELLULAR INTERESTS
The table below sets forth certain information with respect to the interests
in cellular markets which U.S. Cellular owned or had the right to acquire
pursuant to definitive agreements as of December 31, 1998.
<TABLE>
<CAPTION>
TOTAL CURRENT
AND
ACQUIRABLE
1998 POPULATION
CLUSTER/MAJOR SERVICE AREA POPULATION EQUIVALENTS
- ------------------------------------------------------------------------------------ ------------- -------------
<S> <C> <C>
MIDWEST REGIONAL MARKET CLUSTER:
Wisconsin/Illinois................................................................ 4,874,000 4,792,000
Iowa/Missouri/Illinois/Indiana.................................................... 4,666,000 4,240,000
------------- -------------
Total Midwest Regional Market Cluster........................................... 9,540,000 9,032,000
------------- -------------
MID-ATLANTIC REGIONAL MARKET CLUSTER:
Eastern North Carolina/South Carolina............................................. 2,602,000 2,557,000
West Virginia/Maryland/Pennsylvania/Ohio.......................................... 1,379,000 1,251,000
Virginia/North Carolina........................................................... 1,320,000 1,313,000
------------- -------------
Total Mid-Atlantic Regional Market Cluster...................................... 5,301,000 5,121,000
------------- -------------
NORTHWEST REGIONAL MARKET CLUSTER:
Washington/Oregon/Idaho........................................................... 1,506,000 1,406,000
Oregon/California................................................................. 1,046,000 1,046,000
------------- -------------
Total Northwest Regional Market Cluster......................................... 2,552,000 2,452,000
------------- -------------
MAINE/NEW HAMPSHIRE/VERMONT MARKET CLUSTER:......................................... 1,690,000 1,636,000
------------- -------------
FLORIDA/GEORGIA MARKET CLUSTER:..................................................... 1,562,000 1,562,000
------------- -------------
TEXAS/OKLAHOMA/MISSOURI/KANSAS REGIONAL MARKET CLUSTER:
Oklahoma/Missouri/Kansas.......................................................... 1,428,000 882,000
Texas/Oklahoma.................................................................... 694,000 575,000
------------- -------------
Total Texas/Oklahoma/Missouri/Kansas Regional Market Cluster:................... 2,122,000 1,457,000
------------- -------------
EASTERN TENNESSEE/WESTERN NORTH CAROLINA MARKET CLUSTER:............................ 1,636,000 1,319,000
------------- -------------
SOUTHERN TEXAS MARKET CLUSTER:...................................................... 1,306,000 1,295,000
------------- -------------
Other Operations:................................................................... 141,000 141,000
------------- -------------
Total Managed Markets............................................................... 25,850,000 24,015,000
Markets Managed by Others........................................................... 2,150,000
-------------
Total Population Equivalents........................................................ 26,165,000
-------------
-------------
</TABLE>
SYSTEM DESIGN AND CONSTRUCTION. U.S. Cellular designs and constructs its
systems in a manner it believes will permit it to provide high-quality service
to mobile, transportable and portable cellular telephones, based on market and
engineering studies which relate to specific markets. Engineering studies are
performed by U.S. Cellular personnel or independent engineering firms. U.S.
Cellular's switching equipment is digital, which reduces noise and crosstalk and
is capable of interconnecting in a manner which reduces costs of operation.
While digital microwave interconnections are typically made between the MTSO and
cell sites, both analog and digital radio transmissions are made between cell
sites and the cellular telephones themselves. Network reliability is given
careful consideration and extensive redundancy is employed in virtually all
aspects of U.S. Cellular's network design. Route diversity, ring topology and
extensive use of emergency standby power are also utilized to enhance network
reliability and minimize service disruption from any particular network failure.
10
<PAGE>
In accordance with its strategy of building and strengthening market
clusters, U.S. Cellular has selected high capacity digital cellular switching
systems that are capable of serving multiple markets through a single MTSO. U.S.
Cellular's cellular systems are designed to facilitate the installation of
equipment which will permit microwave interconnection between the MTSO and the
cell site. U.S. Cellular has implemented such microwave interconnection in most
of the cellular systems it manages. In other systems in which U.S. Cellular owns
a majority interest and where it is believed to be cost-efficient, such
microwave technology will also be implemented. Otherwise, such systems will rely
upon landline telephone connections to link cell sites with the MTSO. Although
the installation of microwave network interconnection equipment requires a
greater initial capital investment, a microwave network enables a system
operator to avoid the current and future charges associated with leasing
telephone lines from the landline telephone company, while generally improving
system reliability. In addition, microwave facilities can be used to connect
separate cellular systems to allow shared switching, which reduces the aggregate
cost of the equipment necessary to operate multiple systems. Microwave
facilities can also be used to carry long-distance calls, which reduces the
costs of interconnecting to the landline network.
U.S. Cellular has continued to expand its Wide Area Network to accommodate
various business functions, including: automatic call delivery, intersystem
handoff, credit validation, fraud prevention, network management, long-distance
traffic, SS7 signaling and virtually all internal data communications between
various U.S. Cellular office locations and a significant number of U.S.
Cellular's retail locations.
Management believes that currently available technologies will allow
sufficient capacity on U.S. Cellular's networks to meet anticipated demand over
the next few years.
COSTS OF SYSTEM CONSTRUCTION AND FINANCING
Construction of cellular systems is capital-intensive, requiring substantial
investment for land and improvements, buildings, towers, MTSOs, cell site
equipment, microwave equipment, engineering and installation. U.S. Cellular,
consistent with FCC control requirements, uses primarily its own personnel to
engineer and oversee construction of each cellular system it owns and operates.
In so doing, U.S. Cellular expects to improve the overall quality of its systems
and to reduce the expense and time required to make them operational.
The costs (exclusive of license costs) of the systems in which U.S. Cellular
owns an interest have historically been financed through capital contributions
or intercompany loans from U.S. Cellular to the entities owning the systems, and
through certain vendor financing. In recent years, these funding requirements
have been met with cash generated from operations, proceeds from debt and equity
offerings and proceeds from the sales of cellular interests.
MARKETING
U.S. Cellular's marketing plan is centered around rapid penetration of its
market clusters, increasing customer awareness of cellular service and reducing
churn through both the building of brand awareness and the implementation of
marketing programs. The marketing plan stresses the value of U.S. Cellular's
service offerings and incorporates combinations of rate plans and cellular
telephone equipment which are designed to meet the needs of a variety of
customer segments and their usage patterns. U.S. Cellular's distribution
channels include direct sales personnel, agents and retail service centers in
the vast majority of its markets.
U.S. Cellular-owned and managed locations are designed to market cellular
service to the consumer segment in a familiar setting. In late 1997, U.S.
Cellular expanded its e-commerce site to offer three rate plans across the
country aimed at each of U.S. Cellular's three major segments. Sales are
relatively light at this time, but U.S. Cellular anticipates that as customers
become more comfortable with on-line purchasing the Internet will become more of
a robust marketing channel.
U.S. Cellular manages each cluster of markets with a local staff, including
sales, customer service, engineering and in some cases installation personnel.
Direct sales consultants market cellular service to business customers
throughout each cluster. Retail associates work out of the retail locations and
market cellular service primarily to the consumer and small business segment.
U.S. Cellular maintains
11
<PAGE>
an ongoing training program to improve the effectiveness of sales consultants
and retail associates by focusing their efforts on obtaining customers and
maximizing the sale of high-user packages. These packages provide for customers
to obtain a minimum amount of usage at discounted rates per minute, at fixed
prices which are charged even if usage falls below a defined monthly minimum
amount.
U.S. Cellular continues to expand its relationships with agents, dealers and
non-U.S. Cellular retailers to obtain customers. Agents and dealers are
independent business people who obtain customers for U.S. Cellular on a
commission basis. U.S. Cellular's agents are generally in the business of
selling cellular telephones, cellular service packages and other related
products. U.S. Cellular's dealers include car stereo companies and other
companies whose customers are also potential cellular customers. The non-U.S.
Cellular retailers include car dealers, major appliance dealers, office supply
dealers and mass merchants.
U.S. Cellular opened its first retail locations in late 1993, expanding to
over 280 stand-alone retail stores by the end of 1998. These U.S. Cellular-owned
and operated businesses utilize rental facilities in high-traffic areas,
primarily in strip malls. U.S. Cellular has implemented a uniform appearance in
these stores, with all having similar displays and layouts. The retail centers'
hours of business match those of the retail trade in the local marketplace,
often staying open on weekends and later in the evening than a typical business
supplier. To fully serve customer needs, these stores sell accessories to
complement the phones and services U.S. Cellular has traditionally provided.
During 1998, U.S. Cellular further expanded its retail presence by opening
smaller retail kiosks within other larger merchandisers, called "stores within a
store," and had several of these locations in place at year-end. Additionally,
U.S. Cellular operates small kiosks within stores such as Wal-Mart and staffs
those kiosks with U.S. Cellular personnel. At December 31, 1998, U.S. Cellular
managed nearly 170 of these kiosks.
U.S. Cellular actively pursues national retail accounts, as agents of U.S.
Cellular, which yield new customer additions in multiple markets. Agreements
have been entered into with such national distributors as Ford Motor Company,
General Motors, Radio Shack, Best Buy, Circuit City, Staples, Office Depot,
Sears, TDS Telecom, TSR Wireless and Onstar in certain of U.S. Cellular's
markets. Upon the sale of a cellular telephone by one of these national
distributors, U.S. Cellular receives, often exclusively within the territories
served, the resulting cellular customer. U.S. Cellular created a new class of
agent during 1998, the Value Added Distributor agent channel. This channel's
initial focus was on the sale of U.S. Cellular's prepaid service product,
TalkTracker, to selected market segments, and complements U.S. Cellular's own
distribution channels.
U.S. Cellular uses a variety of direct mail, billboard, radio, television
and newspaper advertising to stimulate interest by prospective customers in
purchasing U.S. Cellular's cellular service and to establish familiarity with
U.S. Cellular's name. In 1998, U.S. Cellular increased its focus on brand
advertising, including the addition of several new television commercials, using
the tag line "The Way People Talk Around Here"-SM- to promote the United States
Cellular-Registered Trademark- brand. Additionally, U.S. Cellular began actively
advertising its digital service offerings through both television and radio
advertising during the year. Advertising is directed at gaining customers,
improving customers' awareness of the United States
Cellular-Registered Trademark- brand, increasing existing customers' usage and
increasing the public awareness and understanding of the cellular services
offered by U.S. Cellular. U.S. Cellular attempts to select the advertising and
promotion media that are most appealing to the targeted groups of potential
customers in each local market. U.S. Cellular utilizes local advertising media
and public relations activities and establishes programs such as its
CommunityCare programs to enhance public awareness of U.S. Cellular. These
programs are aimed at supporting the communities in which U.S. Cellular serves.
The programs range from loaning phones to support public service operations in
emergencies to assisting victims of domestic abuse.
12
<PAGE>
The following table summarizes, by operating cluster, the total population,
U.S. Cellular's customer units and penetration for U.S. Cellular's
majority-owned and managed markets that were operational as of December 31,
1998.
<TABLE>
<CAPTION>
OPERATING CLUSTERS POPULATION CUSTOMERS PENETRATION
- --------------------------------------------- ------------ ------------ ---------------
<S> <C> <C> <C>
Wisconsin/Illinois........................... 4,874,000 498,000 10.22 %
Iowa/Missouri/Illinois/Indiana............... 4,096,000 426,000 10.40
Eastern North Carolina/South Carolina........ 2,602,000 168,000 6.46
West Virginia/Maryland/Pennsylvania/Ohio..... 1,129,000 90,000 7.97
Virginia/North Carolina...................... 1,320,000 107,000 8.11
Washington/Oregon/Idaho...................... 1,506,000 124,000 8.23
Oregon/California............................ 1,046,000 86,000 8.22
Maine/New Hampshire/Vermont.................. 1,690,000 129,000 7.63
Florida/Georgia.............................. 1,562,000 136,000 8.71
Oklahoma/Missouri/Kansas..................... 1,428,000 133,000 9.31
Texas/Oklahoma............................... 694,000 59,000 8.50
Eastern Tennessee/Western North Carolina..... 1,289,000 137,000 10.63
Southern Texas............................... 1,306,000 70,000 5.36
Other Operations............................. 141,000 20,000 14.18
------------ ------------ -----
24,683,000 2,183,000 8.84 %
------------ ------------ -----
------------ ------------ -----
</TABLE>
CUSTOMERS AND SYSTEM USAGE
Cellular customers come from a wide range of demographic segments. Business
users typically include a large proportion of individuals who work outside of
their offices such as people in the construction, real estate, wholesale and
retail distribution businesses and professionals. Increasingly, U.S. Cellular is
providing cellular service to consumers and to customers who use their cellular
telephones for mixed business and personal use as well as for security purposes.
A major portion of U.S. Cellular's recent customer growth is from these lower
revenue segments. Although some of U.S. Cellular's customers still use
in-vehicle cellular telephones, most new customers are selecting portable
cellular telephones. These units have become more compact and fully featured as
well as more attractively priced, and they appeal to newer segments of the
customer population.
U.S. Cellular's cellular systems are used most extensively during normal
business hours between 7:00 AM and 6:00 PM. On average, the local retail
customers in U.S. Cellular's consolidated markets used their cellular systems
approximately 105 minutes per unit each month and generated retail revenue of
approximately $33 per month during 1998, compared to 103 minutes and $36 per
month in 1997. Revenue generated by roamers using U.S. Cellular's systems
("inbound roaming"), together with local retail, toll and other revenues,
brought U.S. Cellular's total average monthly service revenue per customer unit
in consolidated markets to $49 during 1998. Average monthly service revenue per
customer unit decreased approximately 10% during 1998. This decrease resulted
from decreases in average revenue per minute of use from both local retail
customers and inbound roamers. Competitive pressures and U.S. Cellular's
increasing use of pricing and other incentive programs that encourage weekend
and off-peak usage at reduced rates, in order to stimulate overall usage,
resulted in a decrease in average local retail revenue per minute of use in
1998. Although the introduction of "one rate" pricing plans by other wireless
companies has helped increase inbound roaming minutes of use on U.S. Cellular's
systems during 1998, the inbound roaming revenue per minute has decreased during
the year. The decrease is partially a result of the ongoing trend toward reduced
per minute prices for roaming negotiated between U.S. Cellular and other
cellular operators and also due to the additional minutes generated by customers
with "one rate" pricing plans, which are at lower than average rates. U.S.
Cellular anticipates that average monthly service revenue per customer unit will
continue to decline in the future. However, this effect is more than offset by
U.S. Cellular's increasing number of customers; therefore, U.S. Cellular expects
total revenues to continue to grow for the next few years.
13
<PAGE>
U.S. Cellular's main sources of revenue are from its own customers and from
inbound roaming customers. U.S. Cellular's roaming service allows a customer to
place or receive a call in a cellular service area away from the customer's home
service area. U.S. Cellular has entered into "roaming agreements" with operators
of other cellular systems covering virtually all systems in the United States,
Canada and Mexico. U.S. Cellular also has roaming agreements with several PCS
operators. The charge for this service is typically at premium rates and is
billed by U.S. Cellular to the customer's home system, which then bills the
customer. U.S. Cellular has entered into agreements with other cellular carriers
to transfer roaming usage at agreed-upon rates. In some instances, based on
competitive factors, U.S. Cellular may charge a lower amount to its customers
than the amount actually charged to U.S. Cellular by another cellular carrier
for roaming.
The following table summarizes certain information about customers and
market penetration in U.S. Cellular's consolidated operations.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Majority-owned and managed markets:
Cellular markets in operation (1)............... 138 134 131 137 130
Total population of markets in service (000s)... 24,683 24,034 21,712 22,309 21,314
Customer Units: (2)
at beginning of period........................ 1,710,000 1,073,000 710,000 421,000 261,000
additions during period....................... 915,000 941,000 561,000 426,000 250,000
disconnects during period..................... 442,000 304,000 198,000 137,000 90,000
at end of period.............................. 2,183,000 1,710,000 1,073,000 710,000 421,000
Market penetration at end of period (3)......... 8.84% 7.11% 4.94% 3.18% 1.98%
Consolidated revenues............................. $1,162,467 $ 876,965 $ 680,068 $ 480,316 $ 327,630
Depreciation expense.............................. 167,150 97,591 74,631 57,302 39,520
Amortization expense.............................. 39,629 34,788 34,208 32,156 25,934
Operating Income.................................. 176,075 129,543 87,366 42,755 17,385
Capital expenditures.............................. 320,417 318,748 248,123 210,878 167,164
Identifiable Assets............................... $3,010,651 $2,548,909 $2,116,592 $1,890,621 $1,584,142
</TABLE>
- ------------------------------
(1) Represents the number of markets in which U.S. Cellular owned at least a 50%
interest and which it managed. The revenues and expenses of these cellular
markets are included in U.S. Cellular's consolidated revenues and expenses.
(2) Represents the approximate number of revenue-generating cellular telephones
served by the cellular markets referred to in footnote (1). The revenue
generated by such cellular telephones is included in consolidated revenues.
(3) Computed by dividing the number of customer units at the end of the period
by the total population of markets in service as estimated by Claritas
(1997-1998) or Donnelley Marketing Service (1994-1996) for the respective
years.
PRODUCTS AND SERVICES
CELLULAR TELEPHONES AND INSTALLATION. There are a number of different types
of cellular telephones, all of which are currently compatible with cellular
systems nationwide. U.S. Cellular offers a full range of vehicle-mounted,
transportable and portable cellular telephones. Features offered in some of the
cellular telephones include hands-free calling, repeat dialing, horn alert and
others. In the systems where U.S. Cellular offers digital service, additional
features such as caller ID and short messaging services are available on those
cellular telephones.
U.S. Cellular negotiates volume discounts from its cellular telephone
suppliers. U.S. Cellular discounts cellular telephones to meet competition or to
stimulate sales by reducing the cost of becoming a cellular customer. In these
instances, where permitted by law, customers are generally required to sign a
service contract with U.S. Cellular. U.S. Cellular also cooperates with cellular
equipment manufacturers in local advertising and promotion of cellular
equipment.
U.S. Cellular has established service and/or installation facilities in many
of its local markets to ensure quality installation and service of the cellular
telephones it sells. These facilities allow U.S. Cellular to improve its service
by promptly assisting customers who experience equipment problems. Additionally,
U.S. Cellular maintains a repair facility in Tulsa, Oklahoma, which handles more
complex service and repair issues.
14
<PAGE>
CELLULAR SERVICES. U.S. Cellular's customers are able to choose from a
variety of packaged pricing plans which are designed to fit different calling
patterns. The ability to help a customer find the right technology and the right
pricing plan is central to U.S. Cellular's brand positioning. During 1998, U.S.
Cellular focused its efforts on new products with the continued introduction of
its digital service offering, called Digital PCS, and its prepaid offering,
TalkTracker-Registered Trademark-. Both offerings were very successful, as many
higher revenue customers purchased U.S. Cellular's digital offering and new
market segments such as individuals with credit difficulties, were able to
purchase cellular service through U.S. Cellular's prepaid offering. U.S.
Cellular's customer bills typically show separate charges for custom-calling
features, airtime in excess of the packaged amount, and toll calls.
Custom-calling features provided by U.S. Cellular include wide-area call
delivery, call forwarding, call waiting, three-way calling and no-answer
transfer. U.S. Cellular also offers a voice message service in many of its
markets. This service, which functions like a sophisticated answering machine,
allows customers to receive messages from callers when they are not available to
take calls. Additional services, such as short messaging services, are available
in U.S. Cellular's markets where digital service is offered.
REGULATION
REGULATORY ENVIRONMENT. The operations of U.S. Cellular are subject to FCC
and state regulation. The cellular telephone licenses held by U.S. Cellular are
granted by the FCC for the use of radio frequencies and are an important
component of the overall value of the assets of U.S. Cellular. The construction,
operation and transfer of cellular systems in the United States are regulated to
varying degrees by the FCC pursuant to the Communications Act of 1934 (the
"Communications Act"). In 1996, Congress enacted the Telecommunications Act of
1996 (the "1996 Act"), which amended the Communications Act. The 1996 Act
mandates significant changes in existing telecommunications rules and policies
to promote competition, ensure the availability of telecommunications services
to all parts of the nation and to streamline regulation of the
telecommunications industry to remove regulatory burdens, as competition
develops. The FCC has promulgated regulations governing construction and
operation of cellular systems, licensing (including renewal of licenses) and
technical standards for the provision of cellular telephone service under the
Communications Act, and is implementing the legislative objectives of the 1996
Act, as discussed below.
LICENSING. For cellular telephone licensing purposes, the FCC has divided
the United States into separate geographic markets (MSAs and RSAs). In each
market, the allocated cellular frequencies are divided into two equal blocks.
During the application process, the FCC reserved one block of frequencies for
non-wireline applicants and another block for wireline applicants. Subject to
FCC approval, a cellular system may be sold to either a wireline or non-wireline
entity, but no entity which controls a cellular system may own an interest in
another cellular system in the same MSA or RSA.
The completion of acquisitions involving the transfer of control of a
cellular system requires prior FCC approval. Acquisitions of minority interests
generally do not require FCC approval. Whenever FCC approval is required, any
interested party may file a petition to dismiss or deny the application for
approval of the proposed transfer.
The FCC must be notified each time an additional cell is constructed which
enlarges the service area of a given market. The FCC's rules also generally
require persons or entities holding cellular construction permits or licenses to
coordinate their proposed frequency usage with neighboring cellular licensees in
order to avoid electrical interference between adjacent systems. The height and
power of base stations in the cellular system are regulated by FCC rules, as are
the types of signals emitted by these stations. In addition to regulation by the
FCC, cellular systems are subject to certain Federal Aviation Administration
("FAA") regulations with respect to the siting and construction of cellular
transmitter towers and antennas as well as local zoning requirements.
Beginning in 1996, the FCC has also imposed a requirement that all licensees
register and obtain FCC registration numbers for all of their antenna towers
which require prior FAA clearance. All new towers must be registered at the time
of construction and existing towers were required to be registered on a
staggered state-by-state basis, by May 1998. U.S. Cellular has completed the
registration of its existing towers.
15
<PAGE>
Beginning in October 1997, cellular systems, which previously were
"categorically excluded" from having to evaluate their facilities to ensure
their compliance with federal "radio frequency" (RF) radiation requirements,
were made subject to those requirements (all cellular towers of less than 10
meters in height, building mounted antennas and cellular telephones must comply
with RF radiation guidelines). After October 1997, all new cellular facilities
must be in compliance when they are brought into service. Existing facilities
must be brought into compliance with the requirements when their licenses are
renewed. U.S. Cellular believes that the great majority of its existing
facilities already comply with the requirements, the remainder will be brought
into compliance as required and that the cellular telephones it sells comply
with the standards.
Initial cellular telephone licenses were granted for ten-year periods. The
FCC has established standards for conducting comparative renewal proceedings
between a cellular licensee seeking renewal of its license and challengers
filing competing applications. The FCC has: (i) established criteria for
comparing the renewal applicant to challengers, including the standards under
which a renewal expectancy will be granted to the applicant seeking license
renewal; (ii) established basic qualifications standards for challengers; and
(iii) provided procedures for preventing possible abuses in the comparative
renewal process. The FCC has concluded that it will award a renewal expectancy
if the licensee has (i) provided "substantial" performance, which is defined as
"sound, favorable and substantially above a level of mediocre service just
minimally justifying renewal," and (ii) complied with FCC rules, policies and
the Communications Act. If a renewal expectancy is awarded to an existing
licensee, its license is renewed and competing applications are not considered.
All of U.S. Cellular's licenses which it applied to have renewed in 1995, 1996,
1997, and 1998 were renewed.
U.S. Cellular conducts and plans to conduct its operations in accordance
with all relevant FCC rules and regulations and anticipates being able to
qualify for a renewal expectancy in its upcoming renewal filings. Accordingly,
U.S. Cellular believes that current regulations will have no significant effect
on its operations and financial condition. However, changes in the regulation of
cellular operators or their activities and of other mobile service providers
could have a material adverse effect on U.S. Cellular's operations.
The FCC has also provided that five years after the initial licenses are
granted, unserved areas within markets previously granted to licensees may be
applied for by both wireline and non-wireline entities and by third parties.
Accordingly, many unserved area applications have been filed by U.S. Cellular
and others and have generally been routinely granted. U.S. Cellular's strategy
with respect to system construction in its markets has been to build cells
covering areas within such markets that U.S. Cellular considers economically
feasible to serve or might conceivably wish to serve and to do so within the
five-year period following issuance of the license. In cases where applications
for unserved areas are filed which are mutually exclusive and would result in
overlapping service areas, the FCC decides between the competing applicants by
an auction process.
Pursuant to 1993 amendments to the Communications Act, cellular service is
classified as a Commercial Mobile Radio Service ("CMRS"), in that it is service
offered to the public, for a fee, which is interconnected to the public switched
telephone network. The FCC has determined that it will forebear from requiring
CMRS carriers to comply with a number of statutory provisions otherwise
applicable to common carriers, such as the filing of tariffs.
RECENT EVENTS. There are certain regulatory proceedings currently pending
before the FCC which are of particular importance to the cellular industry. In
one proceeding, the FCC has imposed new "enhanced 911" regulations on cellular
carriers. Enhanced 911 capabilities will enable cellular systems to determine
the precise location of persons making emergency calls. The new rules will
require cellular carriers to work with local public safety officials to process
911 calls, including those made from mobile telephones not registered with the
cellular system. Since April 1998, cellular carriers have had to be able to
identify the cell from which the call has been made. The rules will require
cellular systems to improve their ability to locate wireless 911 callers by
2001.
The FCC has adopted a limited expansion of the obligation of cellular
carriers to serve the roaming subscribers of broadband PCS providers, among
others, even though the subscribers involved have no pre-existing service
relationship with that carrier. Under these new policies, broadband PCS
providers
16
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may offer their subscribers handsets which are capable of operating over
broadband PCS and cellular networks so that when their subscribers are out of
range of broadband PCS networks, they will be able to obtain non-automatic
access to cellular networks. The FCC expects that implementation of these
roaming capabilities will promote competition between broadband PCS and cellular
service providers.
The FCC has adopted requirements which will make it possible for subscribers
to retain, subject to certain geographic and other limitations, their existing
telephone numbers when they switch from one service provider to another. This
numbering portability will include switching between Local Exchange Carriers
("LECs") and other wireline providers, between wireless service providers and
between LEC/ wireline and wireless providers. LECs, in the 100 largest MSAs, had
implementation deadlines by the end of 1998 at those switches which received
specific requests for numbering portability. The FCC recently extended the
compliance date for cellular, broadband PCS, and certain other wireless
providers to November 2002.
In another proceeding, the FCC in 1996 adopted rules regarding the method by
which cellular carriers and LECs shall compensate each other for interconnecting
cellular and local exchange facilities. The FCC rules provided for symmetrical
and reciprocal compensation between LECs and cellular carriers, and also
prescribed interim interconnection proxy rates, which are much lower than the
rates formerly paid by cellular carriers to LECs. Symmetrical and reciprocal
compensation means they must pay each other at the same rate. Interconnection
rate issues will be decided by the states. Cellular carriers are now paying and
in the future can be expected to pay lower rates to LECs than they previously
paid. This result is expected to be favorable to the wireless industry and
somewhat unfavorable to LECs.
The FCC is also proceeding to implement other parts of the 1996 Act. The
1996 Act provides that implementing its legislative objectives will be the task
of the FCC, the state public utilities commissions and a Federal-state Joint
Board. Much of this implementation is proceeding in numerous, concurrent
proceedings with aggressive deadlines. The Company cannot predict the full
extent of, nature of and interrelationships among state and federal
implementation and other responses to the 1996 Act.
The primary purpose and effect of the new law is to open all
telecommunications markets to competition. The 1996 Act makes most direct or
indirect state and local barriers to competition unlawful. It directs the FCC to
preempt all inconsistent state and local laws and regulations, after notice and
comment proceedings. It also enables electric and other utilities to engage in
telecommunications service through qualifying subsidiaries.
Only narrow powers over competitive entry are left to state and local
authorities. Each state retains the power to impose competitively neutral
requirements that are consistent with the 1996 Act's universal service
provisions and necessary for universal services, public safety and welfare,
continued service quality and consumer rights.
The 1996 Act establishes principles and a process for implementing a
modified "universal service" policy. This policy seeks nationwide, affordable
service and access to advanced telecommunications and information services. It
calls for reasonably comparable urban and rural rates and services. The 1996 Act
also requires universal service to schools, libraries and rural health
facilities at discounted rates. Cellular carriers must provide such discounted
rates in accordance with federal regulations. The FCC has implemented the
mandate of the 1996 Act to create a new universal service support mechanism "to
ensure that all Americans have access to telecommunications services." The 1996
Act requires all interstate telecommunications providers, including wireless
service providers, to "make an equitable and non-discriminatory contribution" to
support the cost of providing universal service, unless their contribution would
be de minimis. At present, the provision of landline telephone service in high
cost areas is subsidized by access charges and other payments by interexchange
carriers to LECs. The obligation to make payments to support universal service
has been expanded to include other telecommunications service providers,
including cellular carriers. Such payments, based on a percentage of the total
"billed revenue" of carriers for a given previous half year and began in the
first quarter of 1998. Carriers are free to pass such charges on to their
customers. Cellular carriers are also eligible to receive universal service
support payments in certain circumstances under the new systems if they provide
specified services in "high cost" areas. U.S. Cellular has sought designation as
an "eligible telecommunications carrier" qualified to receive universal service
support in certain states.
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Under a 1994 federal law, the Communications Assistance to Law Enforcement
Act, all telecommunications carriers, including U.S. Cellular and other wireless
licensees, were to have implemented, by October 1998, certain equipment changes
necessary to assist law enforcement authorities in achieving an enhanced ability
to conduct electronic surveillance of those suspected of criminal activity.
However, owing to disputes between the Federal Bureau of Investigation and the
relevant industry groups about the law's requirements, the FCC has not yet
adopted the necessary technical standards to enable carriers to meet those
requirements. Questions also exist regarding reimbursement by a federal fund of
certain of the costs involved. U.S. Cellular supported the efforts of industry
groups to obtain from the FCC a postponement of the October 1998 deadline on the
grounds that compliance with the originally proposed schedule was impossible. In
September 1998, the FCC postponed the compliance deadline until June 2000.
The FCC also has pending proceedings: (1) to ensure that the customers of
wireless providers, among others, receive complete, accurate, and understandable
bills; (2) to establish safeguards to protect against authorized access to
customer information; (3) to retain, relax or repeal its 45 megahertz ("MHz")
cap on the amount of spectrum which entities under common ownership and control
may hold in a single market and its related cellular cross-interest
restrictions; and (4) to implement requirements for wireless providers to set
interstate interexchange rates in each state at levels no higher than the rates
charged to subscribers in any other state.
The FCC has also allocated a total of 140 MHz to broadband PCS, 20 MHz to
unlicensed operations and 120 MHz to licensed operations, consisting of two 30
MHz blocks in each of the 51 Major Trading Areas ("MTAs") and one 30 MHz block
and three 10 MHz blocks in each of 493 Basic Trading Areas ("BTAs"). Cellular
operators and those entities under common ownership with them are permitted to
participate in the ownership of PCS licenses, except for those PCS licenses
reserved for small businesses, and licenses for PCS service areas in which the
cellular operator owns a 20% or greater interest in a cellular licensee, the
service area of which covers 10% or more of the population of the PCS service
area. In the latter case, the cellular license is limited to two 10 MHz PCS
channel blocks. As noted previously, the FCC is now reconsidering these
ownership limits.
PCS technology is similar in some respects to cellular technology. Where it
has become commercially available, this technology is capable of offering
increased capacity for wireless two-way and one-way voice, data and multimedia
communications services and has resulted in increased competition with U.S.
Cellular's operations in the markets where PCS systems have begun operations.
The ability of these PCS licensees to complement or compete with existing
cellular licensees will be affected by future FCC rule-makings. These and other
future technological and regulatory developments in the wireless
telecommunications industry and the enhancement of current technologies will
likely create new products and services that are competitive with the services
currently offered by U.S. Cellular. There can be no assurance that U.S. Cellular
will not be adversely affected by such technological and regulatory
developments.
STATE AND LOCAL REGULATION. U.S. Cellular is also subject to state and
local regulation in some instances. In 1981, the FCC preempted the states from
exercising jurisdiction in the areas of licensing, technical standards and
market structure. In 1993, Congress preempted states from regulating the entry
of cellular systems into service and the rates charged by cellular systems to
customers. The siting and construction of the cellular facilities, including
transmitter towers, antennas and equipment shelters are still subject to state
or local zoning and land use regulations. However, in 1996, Congress amended the
Communications Act to provide that states could not discriminate against
wireless carriers in tower zoning proceedings and had to decide on zoning
requests with reasonable speed. In addition, states may still regulate other
terms and conditions of cellular service.
The FCC is required to forbear from applying any statutory or regulatory
provision that is not necessary to keep telecommunications rates and terms
reasonable or to protect consumers. A state may not apply a statutory or
regulatory provision that the FCC decides to forbear from applying. In addition,
the FCC must review its telecommunications regulations every two years and
change any that are no longer necessary. Further, the FCC is empowered under
certain circumstances to preempt state regulatory authorities if a state is
obstructing the Communications Act's basic purposes.
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U.S. Cellular and its subsidiaries have been and intend to remain active
participants in proceedings before the FCC and state regulatory authorities.
Proceedings with respect to the foregoing policy issues before the FCC and state
regulatory authorities could have a significant impact on the competitive market
structure among wireless providers and the relationships between wireless
providers and other carriers. U.S. Cellular is unable to predict the scope, pace
or financial impact of policy changes which could be adopted in these
proceedings.
COMPETITION
U.S. Cellular's principal competitor for cellular telephone service in each
market is the licensee of the second cellular system in that market. Since each
competitor operates its cellular system on a 25 MHz frequency block licensed by
the FCC using comparable technology and facilities, competition for customers
between the two systems in each market is principally on the basis of quality of
service, price, size of area covered, services offered, and responsiveness of
customer service. The competing entities in many of the markets in which U.S.
Cellular has an interest have financial resources which are substantially
greater than those of U.S. Cellular and its partners in such markets.
The FCC's rules require all operational cellular systems to provide, on a
nondiscriminatory basis, cellular service to resellers which purchase blocks of
mobile telephone numbers from an operational system and then resell them to the
public.
In addition to competition from the other cellular licensee in each market,
there is also competition from PCS providers and ESMR system providers, both of
which are able to connect with the landline telephone network. PCS providers
have initiated service in many markets across the United States, including
markets where U.S. Cellular has operations. PCS providers offer digital,
wireless communications services to their customers. U.S. Cellular expects PCS
operators to continue deployment of PCS in portions of all of U.S. Cellular's
clusters throughout 1999. ESMR, an enhanced SMR system, has cells and frequency
reuse like other wireless services, thereby eliminating any technological
limitation. In recent years, ESMR providers have initiated service in several of
U.S. Cellular's markets. Although less directly a substitute for cellular
service, wireless data services and paging services may be adequate for those
who do not need full two-way voice service. Similar technological advances or
regulatory changes in the future may make available other alternatives to
cellular service, thereby creating additional sources of competition.
Continuing technological advances in the communications field make it
difficult to predict the extent of additional future competition for cellular
systems. For example, the FCC has allocated radio channels to a mobile satellite
system in which transmissions from mobile units to satellites would augment or
replace transmissions to cell sites, and several consortia to provide such
service have been formed. Such a system is designed primarily to serve the
communications needs of remote locations and a mobile satellite system could
provide viable competition for land-based cellular systems in such areas. It is
also possible that the FCC may in the future assign additional frequencies to
cellular telephone service to provide for more than two cellular telephone
systems per market.
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TELEPHONE OPERATIONS
OVERVIEW
The Company's telephone operations are conducted through TDS Telecom and its
subsidiaries. TDS Telecom is a full-service local exchange carrier providing
high-quality telecommunication services, including local and long-distance
telephone service and Internet access, to rural and suburban communities through
TDS Telecom's 105 telephone company subsidiaries. Each of these telephone
companies, ranging in size from less than 500 to more than 60,000 access lines,
is an Incumbent Local Exchange Carrier ("ILEC"). TDS Telecom served
approximately 547,500 access lines through its ILEC subsidiaries at December 31,
1998, in 28 states.
The table below sets forth, as of December 31, 1998, (i) the nine largest
states of operations of TDS Telecom based on the number of access lines and (ii)
the total number of access lines operated by all of the telephone subsidiaries
of TDS Telecom.
<TABLE>
<CAPTION>
NUMBER OF ACCESS LINES
STATE AT DECEMBER 31, 1998 % OF TOTAL
- ---------------------------------------------------------------------------- ------------------------ -----------
<S> <C> <C>
Tennessee................................................................... 94,102 17.2%
Wisconsin................................................................... 90,099 16.5
Georgia..................................................................... 41,224 7.5
Minnesota................................................................... 31,463 5.7
Indiana..................................................................... 28,575 5.2
Alabama..................................................................... 26,735 4.9
Michigan.................................................................... 24,721 4.5
Maine....................................................................... 24,037 4.4
New York.................................................................... 23,959 4.4
-------- -----
Total for 9 Largest States.............................................. 384,915 70.3
Other States................................................................ 162,585 29.7
-------- -----
Total................................................................. 547,500 100.0%
-------- -----
-------- -----
</TABLE>
TDS Telecom provides consumers and businesses with landline local telephone
service through its switching and intra-city network. Long-distance or toll
service is provided through connections with long-distance carriers, primarily
AT&T and the Regional Bell Operating Companies ("RBOCs"), which purchase network
access from TDS Telecom. In 1998, TDS Telecom began providing telecommunications
services as a Competitive Local Exchange Carrier ("CLEC") in Madison, Appleton,
Green Bay, Menasha and Neenah, Wisconsin under the TDS METROCOM brand name and
in Minnesota markets including Brainerd, Duluth and St. Cloud under the USLink
brand name. TDS Telecom served approximately 38,800 customers through its CLEC
subsidiaries at December 31, 1998.
Future growth in telephone operations is expected to be derived from
providing service to new or presently unserved establishments, from business
expansion in the areas served by TDS Telecom and others, from upgrading existing
customers to higher grades of service, from increased usage of the network
through both local and long-distance calling, from providing additional services
made possible by advances in technology and from the acquisition of additional
telephone companies.
TDS Telecom is committed to offering its customers a full complement of
telecommunications services, and is bundling those services in customer friendly
packages in order to become a single source for their telecommunications needs.
TDS Telecom intends to provide its customers with an ever-growing range of
communications products and services covering their local, long distance, data,
video and wireless needs. In 1998, TDS Telecom grew its competitive market
offerings with products and services such as cellular telephone service (in
partnership with U.S. Cellular), Personal Number Services, Prepaid Calling
Cards, and a Commercial DISH Network (digital broadcast satellite) product.
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The following table summarizes certain information regarding TDS Telecom's
telephone operations:
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
------------- ------------- ------------- ------------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
ILEC Access lines(1).................... 547,500 515,500 484,500 425,900 392,500
% Residential......................... 78.1% 78.3% 79.9% 80.6% 81.3%
% Business (nonresidential)........... 21.9% 21.7% 20.1% 19.4% 18.7%
CLEC Access lines....................... 38,800 -- -- -- --
Total Revenues.......................... $ 488,104 $ 437,624 $ 395,059 $ 354,841 $ 306,341
% Local service....................... 28.0% 28.1% 28.0% 26.8% 26.8%
% Network access and long-distance.... 52.5% 53.9% 53.9% 55.1% 56.9%
% Miscellaneous and other............. 19.5% 18.0% 18.1% 18.1% 16.3%
Depreciation and amortization expense... $ 111,402 $ 98,021 $ 88,459 $ 77,354 $ 68,878
Operating income........................ 94,412 100,143 102,649 98,240 91,606
Construction expenditures............... 143,125 151,460 144,440 104,372 115,483
Total identifiable assets............... $ 1,341,856 $ 1,221,463 $ 1,181,084 $ 1,058,241 $ 984,563
</TABLE>
- ------------------------
(1) An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
TDS Telecom is a wholly-owned business unit of TDS, founded in 1968. TDS
Telecom's corporate headquarters are located in Madison, Wisconsin.
BUSINESS STRATEGY
TDS Telecom has historically produced revenue growth in its ILEC markets by
providing its customers with state-of-the-art telecommunications solutions,
maintaining a high quality of on-going service and selectively acquiring local
telephone companies. Management believes that TDS Telecom has a number of
advantages as an ILEC, including (i) a modern network substantially upgraded to
provide a variety of Advanced Calling Services ("ACS"), (ii) a strong local
presence and established brand name, (iii) economies of scale not available to
smaller independent operators and (iv) attractive, growing markets. However, the
competitive environment in the telecommunications industry has changed
significantly as a result of technological advances, increasing customer
requirements and regulatory changes, including the Telecommunications Act of
1996 ("the 1996 Act"). In response to this changing competitive environment, TDS
Telecom's business plan is designed to leverage TDS Telecom's strength as an
ILEC into a full-service telecommunications company. The business plan provides
for TDS Telecom to meet these challenges in three areas: (i) by growing and
protecting TDS Telecom's core ILEC business, (ii) by leveraging its strengths
into attractive new markets, and (iii) by creating a robust line of data
products and services, and selling them in existing and new markets.
GROW AND PROTECT CORE ILEC BUSINESS
Management of TDS Telecom believes that the key to growing and protecting
its existing ILEC markets is to continue to build customer loyalty by providing
superior customer service, offering a suite of standardized products and
services, including bundled service offerings, and rapidly developing new
products and services. Management of TDS Telecom believes that its
community-based business offices offering full face-to-face customer service are
a fundamental competitive advantage. That advantage was further enhanced in 1998
when TDS Telecom rolled out its Virtual Business Office ("VBO") initiative,
which links multiple business offices electronically, permitting TDS Telecom to
maintain its local presence while expanding hours and achieving certain
efficiencies of a consolidated call center. With respect to products and
services, TDS Telecom markets itself to consumers as a single telecommunications
provider offering bundled packages of advanced telecommunications services
including local, long distance, Internet and data services. These service
packages are all offered under the TDS Telecom
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<PAGE>
brand name in order to benefit from the brand equity in this name. In addition,
management of TDS Telecom believes it can achieve cost economies by refining its
acquisition strategy to focus on certain acquisitions which will increase the
geographic clustering of TDS Telecom's ILEC markets. See "--ILEC Telephone
Markets".
LEVERAGE STRENGTHS INTO CLEC MARKETS
TDS Telecom has begun its controlled entry into certain targeted midsized
communities, geographically proximate to existing TDS Telecom facilities and
service areas, for facilities-based entry as a CLEC (a term which depicts
companies that enter the operating areas of traditional telephone companies).
Management of TDS Telecom believes that the smaller size of these markets
reduces the likelihood of facing significant competition and it can offer a
significantly improved service level over that of the ILEC. Because it can
utilize the infrastructure (e.g. billing systems, network control center,
operating systems, financial and control accounting, technology planners, etc.)
built for the ILEC business, management believes that TDS Telecom can become
profitable in markets too small for start-ups and become profitable faster than
start-ups at the high end of its targeted range (about 200,000 population). As
in its ILEC markets, TDS Telecom intends to be the single source for customers'
telecommunications needs in its CLEC markets.
The geographic focus of TDS Telecom's CLEC strategy is designed to leverage
TDS Telecom's existing infrastructure to facilitate early entry into new CLEC
markets and to complement TDS Telecom's ILEC clustering strategy. Consistent
with this strategy, TDS Telecom initiated service as a CLEC in Madison,
Wisconsin, and in Brainerd, Duluth and St. Cloud, Minnesota, in January 1998 and
initiated service as a CLEC in Appleton, Green Bay, Menasha and Neenah,
Wisconsin, in June 1998. In Minnesota, TDS Telecom has adopted a slightly
different strategy by entering as a CLEC through its long-distance subsidiary,
USLink. USLink is able to build on its relationship developed as a long distance
reseller and now offers local and Internet access services to its long distance
customers in a number of locations in Minnesota. During 1999, USLink will be
converting customers in Brainerd, Duluth and St. Cloud to its facilities as part
of its long-term strategy. TDS Telecom plans to expand its CLEC operations to
additional markets if the results of operations in the aforementioned markets
prove successful. See "--CLEC Telephone Markets".
PURSUE EMERGING DATA MARKETS
Data communications is one of the fastest growing segments of the
telecommunications services industry. In light of the growth of Internet use and
rapid introduction of new telecommunications technology, TDS Telecom intends to
offer a suite of data products in all of its markets, thereby positioning itself
as a full-service data networking service provider. TDS Telecom currently
provides Internet access service to its ILEC and CLEC customers. Most of TDS
Telecom's data products are in the early stages of development. See "--Data
Initiatives".
ILEC TELEPHONE MARKETS
TDS Telecom's goal is to be a leading provider of electronically deliverable
products in its ILEC markets. According to published sources, at December 31,
1998 TDS Telecom was the 9th largest non-Bell local exchange telephone company
in the United States, based on the number of telephone access lines served. At
December 31, 1998, the telephone subsidiaries of TDS Telecom served
approximately 547,500 access lines in 28 states. TDS Telecom currently operates
over 435 central office and remote switching centers in its telephone operating
areas. Substantially all of TDS Telecom's access lines are served by digital
switching technology, which, in conjunction with other technologies, allows TDS
Telecom to offer additional premium services to its customers, including call
forwarding, conference calling, caller identification, selective call ringing
and call waiting. At December 31, 1998, TDS Telecom's telephone subsidiaries
also provided Internet services to approximately 4,000 customers.
As one of the major independent telephone companies in the United States,
TDS Telecom's ILECs provide both local telephone service and access to the long
distance network for customers in their respective service areas. The ILECs also
provide directory advertising through a contract with another
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<PAGE>
company and billing and collection services to interexchange carriers ("IXCs").
TDS Telecom provides centralized administrative and support services to field
operations from its corporate offices in Madison, Wisconsin.
RETAIL MARKETS
TDS Telecom's ILEC presence includes a Retail Markets Group and Wholesale
Markets Group. The Retail Markets Group is the customer-facing organization for
all retail sales with residential and commercial customers. The Retail Markets
Group includes 119 sales and service offices located in 28 states. The retail
customer base is a mix of rural and suburban customers, with significant
concentrations in the Upper Midwest and in the Southeast. Approximately 78% of
TDS Telecom's retail access lines serve residential customers and approximately
22% serve business customers. Most business customers could be described as
small business or small office/home office type customers.
The Retail Markets Group has three primary goals to support its grow and
protect strategy: (i) build customer loyalty, (ii) grow revenues, and (iii)
control costs. Management of TDS Telecom believes it can achieve these goals by
offering a continually updated flow of new products and services through value-
added packages and bundles, by building brand equity in the TDS Telecom brand
name, and by providing superior customer service to its retail customers.
VALUE ADDED PRODUCT BUNDLES AND PACKAGES. Management of TDS Telecom
believes that its consumer and business customers have a strong preference to
purchase all of their telecommunications services from a single provider. TDS
Telecom believes that by offering a full complement of telecommunication
services and bundling those services in customer-friendly packages it can build
customer loyalty and reduce customer churn. TDS Telecom added several new
services in 1998 by combining the services of its network with the services of
carefully selected strategic partners. These products include: cellular
telephone service (in partnership with U.S. Cellular), Personal Number Services,
Prepaid Calling Cards, and a Commercial DISH Network (digital broadcast
satellite) product. These products were sold both as stand-alone items and as
part of value-added product bundles and packages. TDS Telecom will continue to
pursue relationships with strategic partners to further develop the long
distance, video and wireless components of its product mix.
BRAND EQUITY. TDS Telecom continued the branding process started in 1996.
This process adopted the TDS Telecom name as a unified brand name across its
ILEC markets to build its brand image. TDS Telecom has continued its customer
awareness campaign to build awareness of the TDS Telecom name. TDS Telecom
continues to build name awareness through existing customer-facing vehicles such
as bill statements, and vehicle and company signage. Centralized media
purchasing has enabled higher reach and frequency at a lower cost. In 1998, TDS
Telecom focused on building a positive share of mind with current and
prospective customers. This was done by increasing the volume of public
relations messages and through linkage of company image with sales and marketing
messages. The strategy will continue through 1999. Management of TDS Telecom
believes that branding will increase the loyalty of its customers and also
reduce expenses through more cost-effective marketing.
CUSTOMER SERVICE. TDS Telecom makes a unique customer service offer to its
retail customers. TDS Telecom is a large national company with a local sales and
service office in each of its ILEC markets. This combination provides TDS
Telecom's retail customers with the economies of scale and product offers
generally associated with large companies. It also provides the high levels of
personal customer service generally associated with small companies, through
community-based professional service representatives and field representatives
who both live and work in the communities served. TDS Telecom's strength in two
key areas--product/price and customer service-- provides a fundamental
competitive advantage for TDS Telecom.
TDS Telecom began deploying a Virtual Business Office ("VBO") initiative in
1998. This initiative enables multiple local sales and service offices to
function as a single office. Management of TDS Telecom believes that VBO will
facilitate enhanced customer service at a lower cost. Cost savings are expected
to come through standardization of training and procedures and improved voice
and customer service application technology. Enhanced customer service will come
through expanded hours of
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<PAGE>
operation, improved product, service and sales training for all customer sales
and service representatives, and through improved customer access to company
personnel on the first call. Initial customer surveys show that customer
satisfaction with transactions in the VBO environment is equal to or better than
satisfaction with transactions in the prior environment. TDS Telecom plans to
complete deployment of VBO in 1999.
WHOLESALE MARKETS
The Wholesale Markets Group focuses on TDS Telecom's wholesale customers and
has traditionally provided a majority of TDS Telecom's revenues. TDS Telecom
receives much of its ILEC revenue from the sale of traditional wholesale
services, such as access service charges and billing and collections services to
the IXCs. As a result, TDS Telecom continues to provide a high level of service
to traditional IXC wholesale customers such as AT&T, MCI, Sprint and the RBOCs.
ACCESS REVENUES. TDS Telecom's operating telephone subsidiaries receive
access revenue as compensation for carrying interstate and intrastate
long-distance traffic on its network. The interstate and intrastate access rates
charged include the cost of providing service plus a fair rate of return. Access
revenues account for approximately 56% of the revenue generated by TDS Telecom's
ILEC subsidiaries.
TDS Telecom participates in the National Exchange Carrier Association
("NECA") interstate common line and traffic sensitive tariffs for all but one of
its ILEC subsidiaries. These operating companies participate in the access
revenue pools administered by NECA, which collect and distribute revenue from
interstate access services. The FCC created NECA and it is subject to FCC rules
and oversight.
The FCC regulates interstate toll rates and other matters relating to
interstate telephone service. On June 4, 1998, the FCC released a Notice of
Proposed Rulemaking (NPRM) on access reform for local exchange carriers subject
to rate of return regulation. In the NPRM, the FCC proposed changes similar to
those which were ordered for price cap local exchange carriers ("LECs") in 1997.
The proposed changes could negatively affect rural LECs' ability to recover
costs from the interstate jurisdiction. The FCC also released an NPRM on
jurisdictional separations reform on October 7, 1997. In the NPRM, the FCC
reviewed the current procedures for separating LECs' service costs between state
and federal jurisdictions. Many of the proposals in the NPRM seek to limit costs
assigned to the interstate jurisdiction and seek to assign greater costs to the
intrastate jurisdiction. To the extent that the costs are not made up in the
federal and state universal service mechanisms, TDS Telecom may seek rate
increases to offset any reductions in interstate revenues. The FCC has not yet
issued a final order on either of these two NPRMs.
TDS Telecom is also monitoring the effects of increasing volumes of Internet
traffic on the operating telephone subsidiaries' ability to appropriately
recover the network-related costs associated with this traffic. Unless changes
to the access charge methodology and/or to the separations process are made,
increasing costs will continue to be shifted to the intrastate jurisdiction for
recovery and TDS Telecom may need to seek rate increases to recover these costs.
Where applicable and subject to state regulatory approval, TDS Telecom's
ILEC subsidiaries utilize intrastate access tariffs and participate in
intrastate revenue pools. However, many intrastate toll revenue pooling
arrangements, a source of substantial revenues to TDS Telecom's ILECs, have been
replaced with access-charge-based arrangements. In these cases, access charges
are typically set to generate revenue flows similar to those realized in the
pooling process. To the extent that state-ordered access charge revisions reduce
revenues, TDS Telecom may seek adjustments in other rates. Some states are
utilizing a state high cost fund to offset access charge reductions.
FEDERAL FINANCING
TDS Telecom's primary sources of long-term financing for additions to
telephone plant and equipment have been the Rural Utilities Service ("RUS"), the
Rural Telephone Bank ("RTB") and the Federal Financing Bank ("FFB"), agencies of
the United States of America. The RUS has made primarily 35-year loans to
telephone companies since 1949, at interest rates of 2% and 5%, for the purpose
of improving telephone service in rural areas. Currently, the RUS is authorized
to issue hardship loans at a 5% interest
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<PAGE>
rate and other loans at an interest rate approximating the government's rate for
instruments of comparable maturity. The RTB, established in 1971, makes loans at
interest rates based on its average cost of money (5.71% for its fiscal year
ended September 30, 1998), and in some cases makes loans concurrently with RUS
loans. In addition, the RUS guarantees loans made to telephone companies by the
FFB at the federal cost of money. All such loans have a maturity date based on
the life of the assets being financed.
Substantially all of TDS Telecom's telephone plant is pledged under, or is
otherwise subject to, mortgages securing obligations of the operating telephone
companies to the RUS, RTB and FFB. The amount of dividends on common stock that
may be paid by the operating telephone companies is limited by certain financial
requirements set forth in the mortgages. In any calendar year, companies with
greater than 40% net worth to total assets can distribute the entire amount
above 40%. The majority of TDS Telecom's telephone subsidiaries exceed this
percentage. Approximately $400.9 million may be paid as dividends from the
operating subsidiaries to TDS Telecom and TDS.
At December 31, 1998, TDS Telecom's operating telephone companies had
unadvanced loan commitments under the RUS, RTB and FFB loan programs aggregating
approximately $116.4 million, at a weighted average annual interest rate of
5.10%, to finance specific construction activities in 1999 and future years.
These loan commitments are generally issued for five-year periods and may be
extended under certain circumstances. TDS Telecom's operating telephone
companies intend to make further applications for additional loans from the RUS,
RTB and FFB as their needs arise. There is no assurance that these applications
will be accepted or what the terms or interest rates of any future loan
commitments will be.
FEDERAL SUPPORT REVENUES
To promote universal service, the FCC developed a number of federal support
mechanisms to keep telephone rates affordable for both high-cost rural areas and
low-income customers. Many of TDS Telecom's ILEC subsidiaries provide telephone
service in rural areas and all of them offer service to low-income customers.
The 1996 Act codified universal service; set forth principles for ensuring
affordable access to modern telephone service nationwide; established discounts
for schools, libraries and rural health care facilities; and established a
federal-state joint board to make recommendations to the FCC regarding
implementation of the universal service provisions of the 1996 Act. On May 8,
1997, the FCC released its Order on universal service, adopting many of the
joint board's recommendations. The FCC adopted the use of forward-looking proxy
cost models to determine costs rather than relying on actual costs. However,
rural LECs will continue to receive support based on their actual costs through
at least December 31, 2000. Rural LECs will then transition to another method of
receiving support if it can be shown that the method will be sufficient to meet
the universal service needs of customers in the areas they serve. Proceedings to
resolve additional universal service issues, including what ILEC or CLEC lines
can receive support, petitions for reconsideration and judicial appeals of
portions of the FCC's universal service rules and policies remain pending.
The FCC's Order also mandated that all telecommunications providers
contribute to the universal service fund beginning January 1, 1998. However, the
Order allows LECs to recover these contributions through their interstate access
rates.
The final rules to implement the universal service provisions of the 1996
Act will involve development of new support mechanisms and changes in the
eligibility criteria. In addition, some of TDS Telecom's LEC subsidiaries
operate in states where support and rate structures are either being
re-evaluated or have already been changed. Full recovery of universal service
costs in the future through interstate and intrastate mechanisms is uncertain.
If interstate or intrastate support decreases, TDS Telecom's LEC subsidiaries
may pursue local service rate increases to recover the difference.
Historically, telephone company acquisition and investment decisions assumed
the ability to recover the cost and a reasonable rate of return through local
service, access and support revenues. Significant changes in the universal
service funding system could affect TDS's and TDS Telecom's acquisition and
investment strategy.
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TELEPHONE ACQUISITIONS
TDS and TDS Telecom continually review attractive opportunities to acquire
operating telephone companies. Since January 1, 1994, TDS has acquired 16
telephone companies serving a total of 77,100 net access lines for an aggregate
consideration totaling $238.1 million, all of which were transferred to TDS
Telecom. The consideration paid by TDS consisted of $27.3 million in cash and
notes, 155,000 TDS Preferred Shares and 4.4 million TDS Common Shares. TDS sold
one telephone company serving 1,100 access lines in 1995.
Telephone holding companies and others actively compete for the acquisition
of telephone companies and such acquisitions are subject to the consent or
approval of regulatory agencies in most states and, in some cases, to federal
waivers that may affect the form of regulation or amount of interstate cost
recovery of acquired telephone exchanges. The Company has modified its
acquisition strategy to focus on geographic clustering of telephone companies to
achieve cost economies and to complement TDS Telecom's growth strategy. While
management believes that it will be successful in making additional
acquisitions, there can be no assurance that TDS or TDS Telecom will be able to
negotiate additional acquisitions on terms acceptable to it or that regulatory
approvals, where required, will be received.
It is TDS Telecom's policy to preserve, in so far as possible, the local
management of each telephone company it acquires. TDS Telecom provides the
telephone subsidiaries with centralized purchasing and general management and
other services, at cost plus a reasonable rate of return on invested capital.
These services afford the subsidiaries expertise in finance, accounting and
treasury services; marketing; customer service; traffic; network management;
engineering and construction; customer billing; rate administration; credit and
collection; and the development of administrative and procedural practices.
CLEC TELEPHONE MARKETS
The 1996 Act facilitates entry of TDS Telecom into new markets by requiring
non-exempted ILECs (e.g., RBOCs and GTE) to provide reasonable and
non-discriminatory interconnection services and access to unbundled network
elements to any CLEC that seeks to enter the markets in which the ILEC already
offers services. TDS Telecom, through TDS METROCOM and USLink, wholly owned
subsidiaries of TDS Telecom, has targeted certain midsized communities,
geographically proximate to existing TDS Telecom facilities and service areas
for facilities-based entry as a CLEC. Management of TDS Telecom believes that
the size of the target markets will sustain one or two facilities-based
competitors in addition to the ILEC. While additional competitors may enter such
markets as resellers, TDS Telecom believes only facility-based CLECs will be
profitable over the long term because facilities will provide a long-run cost
advantage, discourage further competitors from entry and enable an alternative
wholesale strategy for growth. To this end, TDS Telecom plans to build switching
and other network facilities in its targeted CLEC markets. TDS Telecom plans to
follow a "clustering" approach to building its CLECs which will allow it to seek
regional long distance traffic, share service and repair resources, and realize
marketing efficiencies. As in its ILEC markets, TDS Telecom intends to become an
Integrated Communications Provider ("ICP") in its chosen CLEC markets. It will
provide local, long distance, Internet access and other services through its own
facilities and via resale. TDS Telecom intends to resell mobile services in many
markets. TDS Telecom's CLEC strategy is currently focused on third-tier cities
in Wisconsin and Minnesota.
TDS Telecom's first CLEC in Madison, Wisconsin, became operational in
January 1998. The Madison CLEC is a facilities-based, full-service alternative
to Ameritech and Mid-Plains Telephone Companies, providing both voice and data
services to commercial and consumer accounts, as well as wholesale services to
IXCs and other carriers. TDS Telecom also began CLEC operations in Appleton,
Green Bay, Menasha and Neenah, Wisconsin. USLink began offering local service
(in addition to its long distance and Internet products) on a resale basis in
1998 in Minnesota, with a focus on the Brainerd, St. Cloud and Duluth markets.
USLink plans to deploy local facilities in these markets during 1999 to enhance
the operating margins. TDS Telecom will consider expanding into other markets if
the results of operations in the aforementioned markets prove successful.
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<PAGE>
The CLEC strategy will place primary emphasis on the small and medium-sized
commercial and wholesale customers such as Internet Service Providers ("ISP's"),
cellular, paging and PCS companies. Consumer markets will be pursued
approximately six months after the CLEC enters the commercial market. Wholesale
customers purchase transmission capacity and access services from CLECs. These
services will be available to wholesale customers shortly after network
completion. TDS Telecom believes that these customers are generally more
sophisticated and are more likely to switch providers to obtain network
reliability, redundancy and more flexible pricing. Medium-sized commercial
prospects are characterized by above-average access line to employee ratios,
heavier utilization of data services, and a focus on using telecommunications
for business improvement rather than on cost reduction concerns. The companies
are generally growth-oriented and may be underserved by the ILEC or major IXCs.
TDS Telecom will pursue a personal selling approach for its primary target
markets. This approach builds on customer preference for integrated
communication services and the customer's perception that the quality of the
product is in the personalized service.
While the CLEC is positioning itself as a high-quality provider, it expects
price competition from the ILECs as they attempt to retain and regain their
customers. The CLEC will seek to maintain an efficient cost structure to ensure
it can match price-based initiatives from competitors. The ILEC is likely to be
constrained in the short term by the existing regulatory environment; as a
result, TDS Telecom expects to be more flexible in responding to customer needs.
To effectively compete in this new environment, TDS Telecom will enhance its
efforts at product development to provide high-quality, cutting-edge services to
its customers.
TDS Telecom believes the targeted third-tier markets present a significant
opportunity to market data services, as the major carriers serving these
locations have typically underinvested in these markets despite the growing
demand. Switched data communications represents one of the fastest growing
segments of the telecommunications services market. Computer proliferation,
connectivity via local and wide area networks, the Internet and the emergence of
multimedia applications are all driving demand. As a result, the domestic
network infrastructure is strained at both the local and national levels. TDS
Telecom's CLEC initiative will add local capacity in its selected cities
designed to accommodate this growth.
DATA INITIATIVES
TDS Telecom is also seeking to recognize additional revenue opportunities in
adjacent areas of the telecommunications industry. In 1998, TDS Telecom
continued to expand its investments into data communications to offer a suite of
data products in its CLEC and in many of its ILEC markets. TDSNET, TDS Telecom's
Internet service provider, expanded its operation in 1998 to serve approximately
43,000 customers at December 31, 1998. As of December 31, 1998, TDS Telecom
integrated its Internet and developing data services into existing products and
services offered by its ILEC and CLEC business units. Alignment of the company's
growing Internet product line into its core business units, coupled with sales
and marketing strategies focused on in-territory and nearby markets, will allow
TDS Telecom to continue its Internet sales growth while benefiting from
operational and financial synergies. The FCC has proposed to reduce the dominant
carrier regulation on an ILEC's advanced network capabilities, but only if the
ILEC's basic telephone services and advanced operations follow strict standards
for structural and operational separation. During 1998, management determined
that the TDS Datacom structured wiring business did not fit well with the
Company's other lines of business and subsequently TDS Datacom was disposed of
through a combination of sales and market closings.
In furtherance of TDS Telecom's strategy to position itself as a
full-service, networking service provider, it plans to make high-speed Digital
Subscriber Loop ("DSL") based services available to customers in several of its
ILEC markets. TDS Telecom believes DSL technology will form the foundation for
new, high-speed data services and applications and has conducted trials of DSL
modems manufactured by several vendors. The first commercial offering of DSL
began in Wisconsin in 1998. This technology will be employed to offer high-speed
Internet access as well as high-speed LAN connectivity to remote users. In
addition, TDS Telecom plans to offer Frame Relay and asynchronous transfer mode
("ATM") services in select markets. TDS Telecom is expanding its business
offerings to include web hosting services and customized web content development
for various sized market segments. TDS
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Telecom also plans to attract new Internet customers by offering Internet access
appliances. TDS Telecom is a provider of enterprise network management center
("ENMC") services to large businesses and government through expanded use of its
own network management facilities, and its knowledgeable personnel. Such
services would consist of centralized network monitoring as well as network
management. In 1997, the State of Wisconsin awarded TDS Telecom the "BadgerNet"
ENMC multi-year contract. The BadgerNet ENMC has been designed to provide a
focal point for the operational management of over 72 state agency and
university networks, services and equipment and began operations in 1998. TDS
Telecom believes it has developed substantial expertise in developing its ENMC
and has the capacity through existing facilities (and personnel) to provide ENMC
services to additional third parties.
Although TDS Telecom currently operates these businesses, they are in an
early stage of development. There can be no assurance that TDS Telecom will
expand these businesses.
SALES AND MARKETING
TDS Telecom seeks to leverage its networks through sales and marketing
activities targeted at two separate customer groups: retail and wholesale.
Retail customers are composed primarily of residential customers, businesses,
government and institutional telecommunications users. Wholesale customers
consist of IXCs and information service providers such as commercial data
processing service providers and ISPs.
RETAIL MARKETS
COMMERCIAL MARKETS. Businesses account for approximately 22% of TDS
Telecom's access lines. TDS Telecom focuses its marketing on
information-intensive industries such as financial services, health services,
realty, hotels and motels, education and government. TDS Telecom uses its direct
sales force, targeted mailings, and telemarketing to sell products and services
to the commercial markets, which are segmented into tiers based on size and
strategic importance. Different sales and distribution channels are employed for
each segment. Account executives focus on the most profitable customers by
staying in contact with them on a regular basis. TDS Telecom employs an
aggressive compensation plan for its account executives targeted at revenue and
customer satisfaction results.
CONSUMER MARKETS. TDS Telecom's promotional and sales strategy consists of
two major initiatives: building brand equity by creating awareness of the TDS
Telecom brand name; and using direct marketing to sell specific products and
product groupings. Approximately 78% of TDS Telecom's total access lines are
residential. Approximately 25% of TDS Telecom's residential customers live in
rural areas, while the other 75% are located in suburban settings. The nature of
TDS Telecom's markets has historically made direct marketing more effective than
mass media such as radio and television. In addressing its consumer markets, TDS
Telecom has made extensive and aggressive use of direct mail. It has been more
selective, though still active, in the use of telemarketing as a means of
generating awareness, qualified leads, and actual sales. Newspaper is used as
well. Uniform branding has made the use of mass media more attractive, and TDS
Telecom has increasingly incorporated these elements into its media mix.
In nearly all of its markets, TDS Telecom offers the complete family of
custom calling services including call waiting, call forwarding, three-way
calling, and speed dialing. In 1998, TDS Telecom sold 10,200 residential second
lines, an increase of 37% over 1997. TDS Telecom's advanced calling services
("ACS") family of products is centered around Caller ID service. In 1998, the
ACS family of services were available to 89% of the lines in service compared to
78% in 1997. Penetration of Caller ID increased from 16% to 19% of lines
equipped, and aggregate penetration of ACS increased from 30% to 35% of lines
equipped.
WHOLESALE MARKETS
Access charges, billing and collection services and other primarily
traditional wholesale offerings generated $275 million, or approximately 60%, of
TDS Telecom's revenue for the year ended December 31, 1998. Wholesale customers
are currently serviced by account teams in Madison, Wisconsin, and
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<PAGE>
Knoxville, Tennessee. These teams manage and coordinate the purchasing of access
services by the major IXC's and RBOCs on a national basis.
TDS Telecom also provides new wholesale offerings to non-traditional
customers. TDS Telecom has targeted wireline and wireless telecommunications
service providers and select vertical markets.
COMPETITION
ILEC MARKETS
The 1996 Act has helped to introduce a new wave of competition in the
telecommunications industry. The 1996 Act embraced competition in
telecommunications as a national policy and also started the process of
deregulation. The 1996 Act requires ILECs to provide reasonable and non-
discriminatory interconnection services and access to unbundled network elements
to any CLEC that seeks to enter the markets in which the ILEC already offers
services. The 1996 Act also allows CLECs to co-locate network equipment on the
ILEC's premises and prevents ILECs and CLECs from unduly restricting each other
from use of facilities or information that would allow other organizations to
effectively compete with them. The FCC has proposed adding further
interconnection requirements to spur competitive broadband development.
All 105 TDS Telecom ILEC companies are exempt from many of the provisions of
the 1996 Act. Specifically, they are exempt from the requirements imposed on the
ILECs until they receive a bona fide request for interconnection and the state
commission lifts the exemption. This, coupled with the economics of competing in
lower population density markets, may delay certain forms of competition
occurring in TDS Telecom ILEC service areas while additional regulatory issues
are resolved. However, some TDS Telecom ILECs already face interconnection
requests, filed by potential competitors, and TDS Telecom believes there will
eventually be open entry into nearly every aspect of the telephone industry,
including local service, interstate and intrastate toll, switched and special
access services and customer premises equipment.
TDS Telecom expects competition in the telephone business to be dynamic and
intense as a result of the entrance of new competitors and the development of
new technologies, products and services. Increased competition is expected from
competitive access providers, IXCs, out-of-territory RBOCs and independent
telephone companies, niche entrepreneurs, cable and utility companies, and
wireless and satellite providers. To face this increasing competition, TDS
Telecom's strategy is to build customer loyalty by providing superior customer
service, offering a suite of standardized products and services bundled in
response to customer preferences, and rapidly developing new data products and
services.
In the long-run, TDS Telecom believes that the wireless companies pose the
most significant threat to the local exchange industry. Wireless providers are
also seeking universal service support in various rural markets. Although
traditional analog cellular radio service currently cannot match the features or
the clarity of communications provided via wireline networks, and as a result of
high error rates and speed limitations is not suitable for data transmission,
advances in digital cellular and PCS technology may permit wireless companies to
match the functionality and clarity of wireline communication and still allow
customers the mobility of traditional wireless service. As the emerging PCS
companies compete directly with established cellular radio companies, flat-rate
pricing alternatives may drive wireless rates towards or below wireline rates.
In order to minimize the impact of wireless competition, TDS Telecom is pursuing
wholesale service agreements with wireless companies to provide services to them
and expects to provide wireless services through resale in many of its markets.
CLEC MARKETS
In Wisconsin and Minnesota and in each location in which TDS Telecom expands
as a CLEC, TDS Telecom faces, and expects to continue to face, significant
competition from the ILECs which currently dominate their local
telecommunications markets. TDS Telecom will compete with the ILECs on the basis
of price, reliability, state-of-the-art technology, product offerings, route
diversity, ease of ordering and customer service. However, the ILECs have
long-standing relationships with their customers, may have the potential to
subsidize competitive services from monopoly service revenues, and benefit from
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some favorable state and federal regulations. TDS Telecom will seek to achieve
parity with the ILECs to be able to provide a full range of local
telecommunications services.
Although the ILECs generally are subject to greater pricing and regulatory
constraints than CLECs, ILECs are achieving increased pricing flexibility for
their services as a result of, among other things, the 1996 Act. Existing
competition for private line, special access and local exchange services is
based primarily on quality, capacity and reliability of network facilities,
customer service, response to customer needs, service features and price, and is
not based on any proprietary technology. As a result of the technology used in
its networks, TDS Telecom may have cost and service quality advantages over some
currently available ILEC networks. In addition, TDS Telecom believes that, in
general, it will provide more attention and responsiveness to its customers than
will its ILEC competitors.
TDS Telecom may face competition from other CLECs and other potential
competitors in certain of the cities in which TDS Telecom plans to offers its
services. Many of TDS Telecom's existing and potential competitors have
financial, personnel and other resources significantly greater than those of TDS
Telecom. However, TDS Telecom believes that its strategy of targeting third-tier
cities (midsized communities), and its capital, technical and management
resources will enable it to achieve its strategic objectives.
In addition to the ILECs and other CLECs, potential competitors capable of
offering private line, special access and local exchange services include long
distance carriers, cable television companies, electric utilities, microwave
carriers, wireless telephone system operators, and private networks built by
large end users. Previous impediments to certain utility companies entering
telecommunications markets under the Public Utility Holding Company Act of 1935
were removed by the 1996 Act.
CONSTRUCTION AND DEVELOPMENT PROGRAM
In 1998, TDS Telecom continued its program of enhancing and expanding its
service providing network. TDS Telecom intends to meet competition by providing
its customers with high-quality telecommunications services and building its
network to take full advantage of advanced telecommunications technologies such
as Signaling System 7 ("SS7"), fiber optic fed Digital Serving Areas ("DSAs"),
Integrated Services Digital Network ("ISDN"), and ACS. The following table shows
that TDS Telecom continues to make these advanced features available to a large
majority of its customers:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
---------------------------------------------
# OF EQUIPPED LINES % OF EQUIPPED LINES
-------------------- -----------------------
<S> <C> <C>
Signaling System 7................................................... 509,331 96%
Advanced Calling Services............................................ 509,331 96%
Integrated Services Digital Network.................................. 400,715 76%
</TABLE>
As TDS Telecom upgrades and expands its network, it is also standardizing
equipment and processes to increase efficiency and has centralized the
monitoring and management of its network to reduce costs and improve service
reliability. TDS Telecom formed strategic alliances with Lucent Technologies and
Siemens Telecom Networks to modernize and standardize TDS Telecom's switching
platform with the Lucent 5ESS-2000 and Siemens EWSD switches. This standardized
switching platform assisted TDS Telecom in implementing its
24-hour-a-day/7-day-per-week Network Management Center. The Network Management
Center continuously monitors the network in an effort to proactively identify
and correct network faults prior to any customer impact. The Network Management
Center is proactively monitoring 100% of TDS Telecom's network.
TDS Telecom's total 1999 capital budget is $120 million compared to actual
capital expenditures of $143.1 million in 1998 and $151.5 million in 1997. The
telephone capital additions budget for 1999 includes approximately $12 million
for current CLEC markets, $45 million for outside plant facilities and $35
million for switching facilities in the ILEC markets. Financing for the 1999
capital additions will be primarily provided by internally generated funds and
supplemented by federal long-term financing.
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REGULATION
TDS Telecom's ILEC subsidiaries are regulated by state regulatory agencies
and TDS Telecom seeks to maintain positive relationships with these regulators.
Rate setting, including local rates, intrastate toll rates and intrastate access
charges, are subject to state commission approval in most states. The state
regulators also establish and oversee any state universal service funds. TDS
Telecom will continue to pursue necessary changes in rate structures to ensure
affordable rates and reasonable earnings.
State regulators can approve service areas, service standards, and
accounting methods. In some states, construction plans, borrowing, depreciation
rates, affiliated charge transactions and certain other financial transactions
are also subject to regulatory approval. States have traditionally regulated
entry into local markets by designating a single carrier to be the universal
service provider. However, the 1996 Act has almost completely pre-empted state
authority over market entry. Each state retains the power to impose
competitively neutral requirements that are consistent with the 1996 Act's
universal service provision and necessary for universal services, public safety,
and welfare, continued service quality and consumer rights. While a state may
not impose requirements that effectively function as barriers to entry, and the
FCC must pre-empt challenged state requirements if they impose such barriers to
entry, a state retains limited authority to regulate certain competitive
practices in rural telephone company service areas. Proceedings to pre-empt laws
and policies in several states are pending before the FCC.
The 1996 Act establishes a general duty for all telecommunications carriers,
including wireless providers, to interconnect with other carriers. Congress
prescribed a more specific list of interconnection requirements for all LECs
including resale, number portability, dialing parity, access to rights-of-way
and reciprocal compensation. The FCC recently ruled that Internet access traffic
is primarily interstate, but left in place negotiated contracts and state
arbitrated arrangements for local reciprocal compensation between ILECs and
CLECs that provide interconnecting links between ISPs and their customers, as
well as the existing exemption from interstate access charges applicable to
ISPs. Challenges to these non-interstate arrangements for interstate traffic
will now continue at the federal appellate court level.
Unless exempted, or granted suspension or modification, ILECs have
additional obligations: (a) to negotiate in good faith terms of interconnection;
(b) to comply with more detailed interconnection terms, including
non-discrimination and unbundling their network and service components so
competitors may use only those elements they choose for providing their
services; (c) to offer their retail services at wholesale rates to facilitate
resale by their competitors; and (d) to allow other carriers to place equipment
necessary for interconnection or access on their premises.
The FCC has adopted or is considering rules and policies implementing the
provisions of the 1996 Act. Many of the FCC determinations made to implement the
1996 Act and to facilitate competition in local service and other telephone
services involve investment and upgrades to TDS Telecom LEC networks, and impose
greater costs and obligations on ILECs than on their competitors. These
investments and upgrades include requirements to implement local number
portability so subscribers may change to competitors' services without changing
their telephone numbers, network signaling information that must be provided to
certain other carriers and pay phone providers, requirements for preventing
unauthorized use of customer information gained from providing telephone service
for other purposes, and other changes that require additional investments and
expenses. TDS Telecom is seeking to comply with these requirements or to obtain
the necessary suspensions or modifications where appropriate, while at the same
time also pursuing policies that provide a fair opportunity to recover its
costs. A new law also requires LECs to provide certain communications for law
enforcement purposes. The full cost and the adequacy of the government
compensation are not yet known, but the LEC industry is pursuing regulatory
policies that cover any shortfall in available government compensation. The FCC
is also exploring how to comply with the requirement in the 1996 Act for federal
and state authorities to encourage nationwide advanced broadband infrastructure
development that could require extensive additional investment.
As defined in the 1996 Act, all of TDS Telecom's ILEC subsidiaries qualify
as rural telephone companies. Therefore, they are exempted from the ILEC
interconnection requirements until they receive a bona fide request for
interconnection and the state commission lifts the exemption. The FCC has also
adopted extensive rules for state commissions to follow in mediating and
arbitrating interconnection negotiations between incumbent LECs and carriers
requesting interconnection, services or network
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elements. The 1996 Act establishes deadlines, standards for state commission
approval of interconnection agreements and recourse to the FCC if a state
commission fails to act. A federal appellate decision striking down FCC pricing
regulations for interconnection and several rules that limited TDS Telecom
telephone companies' ability to obtain regulatory relief from stricter
interconnection requirements for incumbent telephone companies was taken to the
U.S. Supreme Court in petitions for certiorari. On January 25, 1999, the Supreme
Court overturned most of the Eighth Circuit Court of Appeals decision that the
FCC's interconnection rules unlawfully infringed upon state regulatory
jurisdiction. Among the rulings the Supreme Court struck down were decisions
that the FCC had unlawfully increased the showings and changed the burden of
proof for retaining a rural ILEC's interconnection exemption and had misread the
1996 Act to allow an ILEC's competitors to demand piece parts of interconnection
agreements negotiated by other competitors with ILECs without agreeing to the
overall terms of the agreement.
TDS Telecom seeks to maintain and enhance existing revenue streams despite
heightened earnings review activity by state regulators and the advent of local
exchange competition sparked by the 1996 Act. TDS Telecom is preparing for
competition even though its operating subsidiaries remain governed by state
regulators. For example, TDS Telecom is seeking the necessary pricing
flexibility to adjust its rate structures to a more competitive model. TDS
Telecom is also participating in state regulatory and legislative processes to
urge that any telecommunications reform measures treat rural areas fairly and
continue to provide sufficient contributions to high cost rural service areas to
keep TDS Telecom ILECs' rates affordable and allow for the continued development
of rural infrastructure. The ongoing changes in public policy due to numerous
court proceedings and the introduction of competition may affect the earnings of
the operating subsidiaries, and TDS Telecom is not able to predict the impact of
these changes.
While the majority of TDS Telecom's ILEC subsidiaries continue to operate in
a rate-of-return environment, a number of state commissions are negotiating, or
have agreed to, alternative regulation plans with LECs. Price regulation, the
most common form of alternative regulation, focuses on the price of
telecommunication services. TDS Telecom's ILEC subsidiaries in Alabama,
Arkansas, Michigan and Pennsylvania are currently operating in a price-regulated
environment, whereby the commissions in those states no longer review earnings.
For several years, the RBOCs and some of the nation's larger LECs have operated
under an FCC "price cap" plan, modified in 1997, where earnings can be increased
only through productivity improvements.
For 1998, TDS Telecom's telephone subsidiaries did not elect either price
caps or an alternative FCC plan, which was designed for smaller LECs. Instead,
the operating subsidiaries plan to continue to abide by traditional
rate-of-return regulation for interstate purposes, unless those regulatory
requirements are changed. Since approximately one-third of TDS Telecom's
telephone subsidiaries serve high-cost areas, important averaging mechanisms
associated with the NECA pooling process would be lost if TDS Telecom elected
either of the alternatives to traditional rate-of-return regulation. However,
the FCC periodically considers whether to initiate a proceeding to lower the
allowed rate-of-return for rate-of-return LECs. On October 5, 1998, the FCC
released a Public Notice initiating a proceeding to represcribe the authorized
rate of return for interstate services provided by ILECs. Currently, this rate
is set at 11.25%. Reduction of the interstate rate of return would have
detrimental effects on ILECs and may impact the ability of ILECs to continue to
invest in infrastructure and economic development. TDS Telecom, along with the
rural industry associations, believes that it is inappropriate for the FCC to
represcribe the rate of return at this time, and that represcription should not
occur until after the FCC resolves other pending issues including universal
service, access reform, and separations reform. If the FCC proceeds with the
represcription, TDS Telecom may potentially be faced with a lower allowed
interstate rate of return, a reduction in universal service funds, and
potentially higher local rates.
Access to affordable long-distance service in rural areas was achieved
because the FCC ordered AT&T to provide nationwide average rates. As a result of
increasing competition, the FCC lifted all regulations relating to AT&T's
interstate services in 1996. However, the 1996 Act preserves interstate toll
rate averaging and endorses a nationwide policy that interstate and intrastate
long-distance rates of all long-distance carriers should not be higher in rural
areas than in urban areas they serve. TDS Telecom will continue to monitor
regulatory activities at both the federal and state levels to ensure continued
affordable long-distance and local rates for even its most remote exchanges.
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BROADBAND PCS OPERATIONS
The Company's broadband PCS operations are conducted through Aerial and its
subsidiaries. Aerial is a provider of Personal Communications Services in the
Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and
Columbus Major Trading Areas (collectively, the "PCS Markets"). The PCS Markets
include approximately 27.7 million population equivalents. Aerial has
constructed networks for its PCS Markets using Global System for Mobile
Communication ("GSM") technology. Aerial served 311,900 PCS telephones at
December 31, 1998. At December 31, 1998, Aerial had expanded its system coverage
to total more than 80% of the six MTAs' total population.
PCS is the term used to describe the wireless telecommunications services
that are offered by those companies that acquired licenses for radio spectrum
(frequency range 1850-1990 MHz) in the Federal Communications Commission ("FCC")
auctions and are the newest entrants in the wireless telecommunications market.
PCS competes directly with existing cellular telephone, paging and specialized
mobile radio services. PCS providers were the first in most markets to offer
mass market all-digital mobile networks. In addition, Aerial believes PCS
providers may be among the first to be able to offer mass market wireless local
loop applications, in competition with switched and direct access local
telecommunications services.
Aerial's strategic goal is to take full advantage of the potential of
wireless telecommunications. Aerial sees an opportunity for significant growth
in the wireless telecommunications market through the shift of existing wireless
usage patterns from applications focused on business use, special occasions and
emergencies to much broader applications for everyday use. Aerial is structured
to meet the increasingly competitive challenges of the wireless
telecommunications marketplace, and has a marketing-oriented approach focused on
serving its customers and their needs. Since 1983, the demand for wireless
telecommunications services has grown dramatically as cellular, paging and other
emerging wireless personal communications services have become widely available
and increasingly affordable.
During 1996 and early 1997, Aerial contracted for network equipment, billing
systems, support software and the equipment and services necessary to launch
service. Additionally during this period, Aerial completed the design for its
PCS networks, acquired and built out the switching centers serving each market,
leased and built out a National Operations Center, leased or purchased the cell
sites required to launch service and commenced zoning and building the sites.
The Columbus MTA launched service on March 27, 1997. Aerial's five remaining
MTAs launched service during the second quarter of 1997. Across all six markets,
Aerial launched with approximately 600 cell sites in service. Aerial had 1,180
cell sites in service by the end of 1998. The coverage of Aerial's PCS networks
includes the major metropolitan areas within the PCS Markets, as well as
portions of the major highway corridors extending out from those areas.
In November 1996, the Company entered into a Member Control Agreement
("Agreement") forming a joint venture with Rural Cellular Corporation ("RCC"),
called the Wireless Alliance, LLC ("WALLC"), to build out certain rural areas
covering approximately 925,000 population equivalents in the Minneapolis MTA.
Aerial has contributed 20 MHz of its Minneapolis MTA license covering certain
territories as defined in the Agreement in return for a 49% equity interest in
the joint venture. RCC built the network and is responsible for the ongoing
operations. The WALLC launched service on in 1998. The joint venture purchases
services such as network switching from Aerial. The network uses GSM technology.
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 Company, Inc. ("AOC"), a then
wholly-owned subsidiary of Aerial. Sonera purchased approximately 2.4 million
shares of common stock of AOC at a price of approximately $83 per share
representing a 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
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exchangeable for equity in Aerial Communications, Inc. or, in certain
circumstances, incrementally exchangeable for equity in TDS or cash. See
"--Proposed Corporate Restructuring".
The following table summarizes certain information regarding Aerial's
initial years of operations:
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER
31,
----------------------------
1998 1997
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
MTAs in operation........................................................... 6 6
Total MTA population (in millions).......................................... 27.7 27.6
Customers................................................................... 311,900 125,000
Market penetration.......................................................... 1.13% .45%
Consolidated revenues....................................................... $ 155,154 $ 55,952
Depreciation expense........................................................ 75,846 36,045
Amortization expense........................................................ 7,555 4,509
Operating (loss)............................................................ (279,985) (218,165)
Capital expenditures........................................................ 74,580 274,709
Identifiable assets......................................................... $ 961,347 $ 960,648
</TABLE>
WIRELESS TELECOMMUNICATIONS INDUSTRY
OVERVIEW. Wireless service is currently available using analog or digital
technology. Traditionally wireless services transmitted voice and data signals
over analog-based networks by varying the amplitude or frequency of one
continuous electronic signal transmitted over a single radio channel. Analog
technology currently has several limitations, including inconsistent service
quality, lack of privacy, limited capacity and less reliability in transferring
data without errors. Aerial has chosen GSM, which utilizes a digital technology,
for use in the PCS Markets. Digital systems convert voice or data signals into a
stream of digits that is compressed before transmission, enabling a single radio
channel to carry multiple simultaneous signal transmissions. This additional
capacity, along with improvements in digital protocols, allows digital-based
wireless technologies to offer new and enhanced services, such as greater call
privacy and more robust data transmission features, such as "mobile office"
applications (including facsimile, electronic mail and wireless connections to
computer/data networks, including the Internet).
PCS spectrum differs from existing cellular and specialized mobile radio
("SMR") spectrum in three basic ways: frequency, spectrum and geographic
division. PCS networks will operate in a higher frequency range (1850-1990 MHz)
compared to the cellular and SMR frequency (800-900 MHz). PCS is comprised of 30
or 10 MHz spectrum versus 25 MHz spectrum for cellular networks. As a result of
the improved capacity of the infrastructure and large allocation of spectrum in
the A, B and C PCS frequency Blocks, PCS will have more capacity for new
wireless services such as data and video transmission. Finally, the geographic
areas for PCS licenses are divided differently than for cellular licenses. PCS
is segmented among 51 MTAs and 493 Basic Trading Areas ("BTAs") as opposed to
cellular's 306 MSAs and 428 RSAs. An MTA license generally covers a much larger
geographic area than a BTA, MSA or RSA license.
OPERATION OF WIRELESS NETWORKS. Wireless service areas are divided into
smaller geographic areas called "cells", each of which contains an antenna and a
base transceiver station ("BTS") consisting of a low-power transmitter, a
receiver and signaling equipment. The cells are typically configured on a grid
in a honeycomb-like pattern, although terrain factors (including natural and
man-made obstructions) and signal coverage patterns may result in irregularly
shaped cells and overlaps or gaps in coverage. The BTS in each cell is connected
by microwave, fiber optic cable or telephone wires to a switching office
("mobile switching center" or "MSC"). The MSC controls the operation of the
wireless telephone network for its entire service area, performing inter-BTS
hand-offs, managing call delivery to handsets, allocating calls among the cells
within the network and connecting calls to local landline telephone systems or
to long-distance telephone carriers. Wireless service providers have
interconnection agreements with various local exchange carriers and
interexchange carriers, thereby integrating the wireless telephone network with
landline telecommunications systems. Because two-way wireless networks are
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fully interconnected with landline telephone networks and long-distance
networks, customers can receive and originate both local and long-distance calls
from their wireless telephones.
The signal strength of a transmission between a handset and a BTS antenna
declines as the handset moves away from the BTS antenna. The MSC and the BTSs
monitor the signal strength of calls in process. When the signal strength of a
call declines to a predetermined level, the MSC may "hand off" the call to
another BTS that can establish a stronger signal with the handset. If a handset
leaves the service area of the wireless service provider, the call is
disconnected unless an appropriate technical interface is established to hand
off the call to an adjacent service provider's system.
Operators of wireless networks frequently agree to provide service to
customers from other compatible networks who are temporarily located or
traveling through the operator's service area. Such customers are called
"roamers." Agreements among network operators allocate revenues received from
roamers. With automatic roaming, wireless customers are preregistered in certain
networks outside their home service area and receive service automatically while
they are roaming. Other roaming features permit calls to a customer to follow
the customer into different networks, so that the customer will continue to
receive calls in a different network just as if the customer were within his or
her service area.
Wireless customers generally are charged separately for monthly access, air
time, long-distance calls and custom-calling features (although custom-calling
features may be included in monthly access charges in certain pricing plans).
Wireless network operators pay fees to local exchange and long-distance
telephone companies for access to their networks and toll charges based on
standard or negotiated rates. When wireless operators provide service to roamers
from other networks, they generally charge roamer air-time usage rates, which
usually are higher than standard air-time usage rates for their own customers,
and additionally may charge daily access fees. Special, discounted rate roaming
arrangements, often between neighboring operators who wish to stimulate usage in
their respective territories, provide for reduced roaming fees and no daily
access fees.
TECHNOLOGY
With GSM technology, Aerial offers easy-to-use, interactive menu-driven
phones, and advanced features such as caller identification and a smart card, as
well as more complex features such as text messaging, which allows the GSM
handset to function as a two-way messaging device. In the future, Aerial intends
to increasingly emphasize services which are expected to increase the size and
scope of the wireless market, such as wireless data and information services as
well as wireless local loop services. Aerial anticipates that PCS will
ultimately offer a competitive alternative to wireline telephone service as PCS
networks are constructed and PCS operators form strategic alliances.
GSM is not compatible with other PCS or cellular technologies. However,
compatibility can be achieved through the use of handsets that support multiple
technologies. Aerial expects that compatibility between GSM and the existing
analog cellular systems will be achieved with the use of dual-mode handsets.
Aerial expects to launch its dual-mode service in 1999.
To date, seventeen North American PCS companies are providing commercial GSM
service. GSM systems are currently in commercial operation in over 2,400 North
American cities with more than 3 million customers. Aerial anticipates that its
customers will be able to roam substantially throughout the United States,
either on other GSM-based PCS networks or by using dual-mode handsets that can
also be used on existing cellular networks.
Aerial is a member of the North American GSM Alliance LLC ("GSM Alliance"),
an all-digital wireless PCS network of U.S. and Canadian carriers. The GSM
Alliance was established to create a national network and develop seamless
wireless communications for customers, whether at home, away or abroad. The GSM
Alliance's collaborative efforts focus on serving the wireless customer
efficiently by addressing the areas of roaming, customer care, national
distribution and data communications. Aerial is also a member of the GSM Capital
Limited Partnership. The partnership was formed to make investments in companies
mainly engaged in the wireless communications industry using the GSM platform,
that are in a development or expansion stage, or whose securities trade in an
organized market. Aerial is also a part of the GSM North America consortium,
which is the North American interest
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<PAGE>
group for the GSM Association. Formed in 1995, GSM North America brings together
service providers and equipment manufacturers to identify and resolve issues
related to making GSM the premier PCS digital technology.
SOURCES OF EQUIPMENT
Aerial does not manufacture any of the GSM network equipment, handsets or
accessories ("equipment") used or anticipated to be used in its operations. The
equipment Aerial uses or anticipates to use is available from multiple sources,
and Aerial anticipates such equipment will continue to be available to Aerial in
the foreseeable future, consistent with normal manufacturing and delivery lead
times. As GSM uses an open system architecture, and due to the fact that GSM has
well-developed features, software systems and equipment that are available "off
the shelf", Aerial is able to design its GSM networks and systems without being
dependent upon any single manufacturing source. Nokia Telecommunications Inc.
has been Aerial's sole supplier of digital radio channel and switching
infrastructure equipment during the initial build-out of its PCS networks.
Aerial's current handset vendors are Nokia Mobile Phones, Inc., Motorola Inc.,
and Mitsubishi Wireless Communications, Inc.
PRODUCTS AND SERVICES
Aerial offers coverage in those areas of the PCS Markets where most of the
population lives and works. Subsequent construction of its PCS networks will
provide coverage which, in combination with roaming services as described above,
is competitive with that of current cellular operators. Aerial provides roaming
capabilities through agreements with other GSM and cellular operators.
Aerial's two primary sources of revenues are similar to those available to
other cellular system providers. Service revenue primarily consists of charges
for access, airtime and value-added services provided to Aerial's retail
customers who use the network operated by Aerial, and charges for long-distance
calls made on Aerial's systems. Service revenue also consists of charges to
customers of other wireless carriers who use Aerial's PCS network when roaming
(outcollect roaming revenue). Equipment sales revenue consists of the sale of
handsets and related accessories to retailers, independent agents and end user
customers. At December 31, 1998, Aerial had 311,900 customers. Service revenues
and equipment sales revenues totaled $123.6 million and $31.5 million,
respectively, for the year ended December 31, 1998.
Aerial provides the following services and features:
THE SMART CARD. GSM technology employs a Smart Card which contains a
microchip containing detailed information about a customer's service profile.
The Smart Card allows Aerial to initiate services or change a customer's service
package from a remote location. The Smart Card also allows customers to roam
onto other participating GSM-based networks by using their cards in handsets
compatible with the local network.
FEATURE-RICH HANDSETS. As part of its basic service package, Aerial
provides easy-to-use, interactive menu-driven phones that enable customers to
utilize the features available in a GSM network. These handsets primarily use
words and easy-to-use menus rather than numeric codes to operate handset
functions such as call-forwarding, call-waiting and text messaging.
SHORT TEXT MESSAGING. GSM technology allows for the capability to send and
receive short text messages, similar to two-way radio paging services. This
service allows Aerial to offer a quicker and less expensive form of wireless
communication when a full conversation is not necessary.
ENHANCED SECURITY. Aerial's service provides greater security from
eavesdropping and cloning than analog wireless service. Greater conversation
security is provided by the encryption code of the digital GSM signal. Greater
fraud protection is provided because GSM handsets require the use of a Smart
Card with a sophisticated authentication scheme, the replication of which is
virtually impossible.
As the market for wireless telecommunications services continues to develop,
Aerial expects to offer advanced wireless applications such as mobile data
services, wireless private branch exchange applications, wireless local loop
services and other individually customized wireless products and services.
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MARKETING AND DISTRIBUTION
Aerial's marketing objective is to create demand for its PCS service by
clearly differentiating its service offerings. Aerial believes the strength of
its marketing efforts is a key contributor to its success. Aerial has developed
overall marketing strategies as well as certain, specific local marketing
strategies for each PCS Market.
Aerial's mass marketing efforts emphasize the value of Aerial's services and
its "fairness" to customers and are supported by heavily promoting the Aerial
brand name. This is supported by a substantial advertising program.
Aerial offers its services and products through traditional cellular sales
channels as well as through new, lower cost channels which increase the quality
of the typical sale. Aerial utilizes traditional sales channels which include
mass merchandisers and retail outlets, company retail stores, sales agents and a
direct sales force. National distributors include Best Buy, Office Depot,
Staples and Ritz Camera. Aerial currently also distributes its services and
products through over 90 company retail locations (mall stores, strip mall
stores and kiosks). Based in part upon the remote activation feature of the GSM
Smart Card, Aerial also intends to develop distribution innovations such as
simplified retail sales processes and lower-cost channels which include inbound
telesales, affinity marketing programs, and via the Internet.
COMPETITION
The wireless telecommunications industry is experiencing significant
technological change, as evidenced by the increasing pace of digital upgrades to
existing analog cellular networks, evolving industry standards, ongoing
improvements in the capacity and quality of digital technology, shorter
development cycles for new products and enhancements, and changes in end-user
requirements and preferences. Accordingly, Aerial expects competition in the
wireless telecommunications business to be dynamic and intense as a result of
the entrance of new competitors and the development of new technologies,
products and services.
Aerial competes directly with up to five other PCS providers in each of its
PCS Markets. The other successful bidders in the FCC's broadband Block A and
Block B PCS auction in each of the six PCS Markets were PCS PrimeCo (Houston and
Tampa-St. Petersburg-Orlando), Sprint Spectrum (Minneapolis, Pittsburgh and
Kansas City) and AT&T Wireless Services, Inc. (Columbus). The existing cellular
providers in the PCS Markets, most of which have an infrastructure in place and
have been operational for a number of years, have, in most cases, upgraded their
networks to provide comparable services in competition with Aerial. Principal
cellular providers in the PCS Markets are AT&T Wireless Services, Inc.,
BellSouth Mobility, Inc., GTE Mobile Communications Corporation, AirTouch
Communications, Inc., Southwestern Bell, Bell Atlantic-NYNEX Mobile and
Ameritech Cellular. Additionally, the Company competes with SMR provider Nextel
Communications, Inc. in each of its six PCS Markets.
Aerial also competes with other communications technologies that now exist,
such as paging, enhanced specialized mobile radio ("ESMR") and global satellite
networks. In the future, cellular service and PCS will also compete more
directly with traditional landline telephone service providers and with cable
operators who expand into the offering of traditional communications services
over their cable systems.
All of such competition is intense. There can be no assurance that Aerial
will be able to compete successfully in this environment or that new
technologies and products that are more commercially effective than Aerial's
technologies and products will not be developed. In addition, many of Aerial's
competitors have substantially greater financial, technical, marketing, sales
and distribution resources than those of Aerial and have significantly greater
experience than Aerial in testing new or improved telecommunications products
and services and obtaining regulatory approvals. Some competitors are expected
to market other services, such as cable television access, with their wireless
telecommunications service offerings. Several of Aerial's competitors are
operating, or planning to operate, through joint ventures and affiliation
arrangements, wireless telecommunications networks that cover most of the United
States.
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Aerial anticipates that market prices for two-way wireless services
generally will continue to decline in the future based on increased competition.
Aerial will compete to attract and retain customers principally on the basis of
services and enhancements, its customer service, the size and location of its
service areas and pricing. Aerial's ability to compete successfully will also
depend, in part, on its ability to anticipate and respond to various competitive
factors affecting the industry, including new services that may be introduced,
changes in consumer preferences, demographic trends, economic conditions and
discount pricing strategies by competitors, which could adversely affect
Aerial's operating margins.
REGULATION
REGULATORY ENVIRONMENT. The FCC regulates the licensing, construction,
operation and acquisition of wireless telecommunications systems in the United
States pursuant to the Communications Act of 1934, as amended, and the rules,
regulations and policies promulgated by the FCC thereunder. Under the
Communications Act, the FCC is authorized to allocate, grant and deny licenses
for PCS frequencies, establish regulations governing the interconnection of PCS
networks with wireline and other wireless carriers, grant or deny license
renewals and applications for transfer of control or assignment of PCS licenses,
and impose fines and forfeitures for any violations of FCC regulations.
In addition, the 1996 Act, which amended the Communications Act, mandates
significant changes in existing telecommunications rules and policies to promote
competition, ensure the availability of telecommunications services to all parts
of the nation and to streamline regulation of the telecommunications industry to
remove regulatory burdens, as competition develops, and makes regulation less
necessary. The FCC promulgated and continues to promulgate regulations governing
construction and operation of wireless carriers, licensing (including renewal of
licenses) and technical standards for the provision of PCS services under the
Communications Act, and is implementing the legislative objectives of the 1996
Act, as discussed below.
PCS LICENSING. The FCC established PCS service areas in the United States
and its possessions and territories based upon Rand McNally's market definition
of 51 MTAs comprised of 493 smaller BTAs. Each MTA consists of at least two
BTAs.
The FCC has allocated 120 MHz of radio spectrum in the 2 GHz band for
licensed broadband PCS services. The FCC divided the 120 MHz of spectrum into
six individual blocks, each of which is allocated to serve either MTAs or BTAs.
The spectrum allocation includes two 30 MHz blocks ("A" and "B" Blocks) licensed
for each of the 51 MTAs, one 30 MHz block ("C" Block) licensed for each of the
493 BTAs, and three 10 MHz blocks ("D," "E" and "F" Blocks) licensed for each of
the 493 BTAs. A PCS license has been awarded for each MTA and substantially all
of the BTAs in every block, for a total of more than 1,500 licenses. This means
that in any PCS service area as many as six licensees could be operating
separate PCS networks. Under the FCC's rules, a broadband PCS licensee may own
combinations of licenses with total aggregate spectrum coverage of up to 45 MHz
in a single geographic area. The FCC adopted comprehensive rules that outlined
the bidding process, described the bidding application and payment process,
established penalties for certain bid withdrawals, default or disqualification
and established regulatory safeguards.
Several auction winners have filed for bankruptcy. Other winners tendered
approximately 450 licenses acquired in auctions to the FCC for cancellation in
1998. These licenses are scheduled to be reauctioned starting in March of 1999.
On November 9, 1995, in CINCINNATI BELL TELEPHONE CO. V. FCC (Case No.
94-3701/4113), the United States Court of Appeals for the Sixth Circuit granted
two petitions for review of an FCC order that had barred certain common
ownership of cellular and PCS interests in the same market, and remanded the
case to the FCC for further proceedings. Neither of the two petitioners had been
barred by cross interests from applying for any of the authorizations the FCC
later granted to Aerial. Aerial is watching the FCC proceedings closely.
The grants of licenses to Aerial are conditioned upon timely compliance with
the FCC's build-out requirements, I.E., coverage of one-third of the population
of a PCS market within five years of initial
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license grant and coverage of two-thirds of that population within ten years.
Aerial has exceeded the buildout requirements for both the five year and ten
year stages for each of its MTAs.
The FCC also imposes a requirement that all licensees register and obtain
FCC registration numbers for all of their antenna towers which require prior FAA
clearance. All broadband PCS transmitting facilities of Aerial also must comply
with federal "radio frequency" (RF) radiation requirements. Aerial has complied
with and continues to comply with the antenna registration and RF radiation
requirements.
The FCC enhanced 911 ("E911") regulations require broadband PCS operators to
"be capable of transmitting 911 calls from individuals with speech or hearing
disabilities through the use of Text Telephone Devices ("TTY")." TTY equipment
currently, however, is not compatible with digital wireless systems such as
Aerial's. Consequently, on December 4, 1998, Aerial filed a petition with the
FCC requesting a waiver of the applicability of the TTY connectivity requirement
to Aerial's digital system. On December 30, 1998, the FFC granted Aerial, along
with over 100 other wireless operators, a temporary waiver of the regulation.
Equipment manufacturers are developing hardware and software that will make TTY
devices compatible with the digital wireless technologies used by Aerial and
other wireless service providers. Aerial is working with manufacturers and other
members of the wireless industry in developing solutions for users of TTY
devices.
The E911 regulations also require broadband PCS operators to determine the
approximate location of persons making the emergency calls. On February 5, 1999,
Aerial filed a petition requesting a waiver to clarify that handset based
location technology will meet the FCC's E911 location requirements. A waiver
will enable Aerial to be compliant with the location requirements by introducing
new handsets that have the capability of being located rather than installing
very expensive upgraded equipment throughout Aerial's entire network. Aerial's
waiver and dozens of other wireless operators' waiver requests are pending
before the FCC.
The FCC licenses granted to Aerial are issued for a ten-year period expiring
June 23, 2005 and may be renewed. In the event challengers file competing
applications in response to any of Aerial's renewal filings, the FCC has rules
and policies providing that the application of the licensee seeking renewal will
be granted and the application of the challenger will not be considered in the
event that the broadband PCS licensee involved has (i) provided "substantial"
service, which is defined as "sound, favorable and substantially above a level
of mediocre service just minimally justifying renewal" and (ii) substantially
complied with FCC rules, policies and the Communications Act. Although Aerial is
unaware of any circumstances which would prevent the approval of any future
renewal applications, there can be no assurance that Aerial's licenses will be
renewed by the FCC in the future. Moreover, although revocation and involuntary
modification of licenses are extraordinary regulatory measures, the FCC has the
authority to restrict the operation of licensed facilities or revoke or modify
licenses.
The FCC has proceedings in process which could open up other frequency bands
for wireless telecommunications and PCS-like services. There can be no assurance
that such proceedings will not result in additional wireless competition.
In addition, there are citizenship requirements, assignment requirements and
other federal regulations and requirements which may affect the business of
Aerial.
RECENT EVENTS. There are certain regulatory proceedings currently pending
before the FCC which are of particular importance to the broadband PCS industry.
The FCC is expected to give the telecommunications industry guidance as to
the implementation of the Communications Assistance for Law Enforcement Act
("CALEA"). Due to a conflict between manufacturing standards and law enforcement
requirements, the FCC extended the compliance date to June 30, 2000.
The FCC has adopted a limited expansion of the obligation of cellular
carriers to serve the subscribers of broadband PCS providers, among others, even
though neither the subscribers or the PCS providers involved have a pre-existing
service relationship with such cellular carrier. Under these new policies,
broadband PCS providers may offer their subscribers handsets which are capable
of operating over broadband PCS and cellular networks so that when their
subscribers are out of range of broadband
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PCS networks, they will be able to obtain non-automatic access to cellular
networks. The FCC expects that implementation of these roaming capabilities will
promote competition between broadband PCS and cellular service providers. The
FCC is considering whether cellular, broadband PCS and certain SMR providers
instead should be required to provide "automatic" roaming service to other
providers (i.e., carrier-to-carrier roaming service) during a five year period
commencing after the last group of initial broadband PCS licenses are awarded,
which is expected to occur in 1999.
The FCC has adopted requirements which will make it possible for subscribers
to retain, subject to certain geographic and other limitations, their existing
telephone numbers when they switch from one service provider to another. This
numbering portability will include switching between LEC and other wireline
providers, between wireless service providers and between LEC/wireline and
wireless providers. LECs, in the 100 largest MSAs, had implementation deadlines
by the end of 1998 at those switches which received specific requests for
numbering portability. The FCC recently extended the compliance date for
cellular, broadband PCS, and certain other wireless providers to November 2002.
The FCC also has pending proceedings (1) to ensure that the customers of
wireless providers, among others, receive complete, accurate and understandable
bills, (2) to establish effective safeguards to protect against unauthorized
access to customer information, (3) to retain, relax or repeal its 45MHz
spectrum cap on the amount of broadband PCS and cellular spectrum which entities
under common ownership or control may hold in any single market and its related
cellular cross-interest restrictions, (4) to devise guidelines for the operation
and administration of universal service support mechanisms as applied to
wireless providers and (5) to implement requirements for wireless providers to
set rates for interstate interexchange services in each state at levels no
higher than the rates charged to subscribers in any other state.
The FCC is also continuing to implement the 1996 Act. The 1996 Act provides
that implementing its legislative objectives will be the task of the FCC, the
state public utilities commissions and a Federal-State Joint Board. Much of this
implementation has and continues to be proceeding in numerous, concurrent
proceedings with aggressive deadlines. Aerial cannot predict the full extent and
nature of developments of the 1996 Act, which will depend, in part, upon
interrelationships among state and federal regulators.
The primary purpose and effect of the 1996 Act is to open all
telecommunications markets to competition -- including local telephone service.
The 1996 Act makes most direct or indirect state and local barriers to
competition unlawful. It directs the FCC to preempt all inconsistent state and
local laws and regulations, after notice and comment proceedings. It also
enables electric and other utilities to engage in telecommunications service
through qualifying subsidiaries.
Only narrow powers over competitive entry are left to state and local
authorities. Each state retains the power to impose competitively neutral
requirements that are consistent with the 1996 Act's universal service provision
and necessary for universal services, public safety and welfare, continued
service quality and consumer rights.
The 1996 Act establishes principles and a process for implementing a
modified "universal service" policy. This policy seeks nationwide, affordable
service and access to advanced telecommunications and information services. It
calls for reasonably comparable urban and rural rates and services. The 1996 Act
also requires universal service to schools, libraries and rural health
facilities at discounted rates. In a series of orders adopted in 1997, the FCC
established universal service support mechanisms which require
telecommunications providers, including all wireless carriers, to contribute.
Aerial has made the required Universal Service Worksheet filings and makes the
required periodic payments.
Since enactment, the FCC has adopted orders implementing the local
competition provisions of the 1996 Act. The FCC found that broadband PCS and
certain other wireless providers that are entitled to reciprocal compensation,
may not be charged for LEC-originated traffic or for code opening/per-number
fees, and may obtain LEC interconnection subject to the terms of the 1996 Act.
Appeals were taken to the United States Supreme Court from these FCC orders by
numerous parties alleging that the FCC has exceeded its statutory mandate, among
other matters. On January 25, 1999, the U.S. Supreme Court upheld the FCC's
general jurisdiction to implement the local competition provisions of the 1996
Act.
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STATE AND LOCAL REGULATION The scope of state and local regulatory
authority covers such matters as the terms and conditions of interconnection
between LECs and wireless carriers with respect to intrastate services, customer
billing information and practices, billing disputes, other consumer protection
matters, facilities construction issues and transfers of control, among other
matters. In these areas, particularly the terms and conditions of
interconnection between LECs and wireless providers, the FCC and state
regulatory authorities share regulatory responsibilities with respect to
interstate and intrastate issues, respectively.
The FCC has pending numerous petitions for preemption of state and local
regulations which allege such regulations prohibit or impair the provision of
interstate or intrastate telecommunications services. It has also requested
public comment on a petition requesting preemption of moratoria imposed by state
and local governments on siting of telecommunications facilities, the imposition
of state taxes on the gross receipts of CMRS providers and other proposed state
taxes based on the asset value of CMRS licenses awarded by the FCC. The FCC has
been actively involved in educating state and local regulatory and zoning
authorities as to the prohibitions in the 1996 Act against the creation of
unreasonable and discriminatory zoning, taxation or other barriers to new
wireless providers.
The FCC is required to forbear from applying any statutory or regulatory
provision that is not necessary to keep telecommunications rates and terms
reasonable or to protect consumers. A state may not apply a statutory or
regulatory provision that the FCC decides to forbear from applying. In addition,
the FCC must review its telecommunications regulations every two years and
change any that are no longer necessary.
Aerial and its subsidiaries have been and intend to remain active
participants in proceedings before the FCC and before state regulatory and
zoning authorities. Proceedings with respect to the foregoing policy issues
before the FCC and state regulatory authorities could have significant impacts
on the competitive market structure among wireless providers and the
relationships between wireless providers and other carriers. Aerial is unable to
predict the scope, pace, or financial impact of policy changes which could be
adopted in these proceedings.
EMPLOYEES
The Company enjoys satisfactory employee relations. As of December 31, 1998,
9,907 persons were employed by the Company, 144 of whom are represented by
unions.
41
<PAGE>
- --------------------------------------------------------------------------------
ITEM 2. PROPERTIES
The property of TDS consists principally of switching and cell site
equipment related to cellular telephone and broadband PCS operations; telephone
lines, central office equipment, telephone instruments and related equipment,
and land and buildings related to telephone operations. As of December 31, 1998,
TDS's property, plant and equipment, net of accumulated depreciation, totaled
approximately $2.7 billion and consisted of the following:
<TABLE>
<S> <C>
Cellular telephone................................................. 42.6%
Telephone.......................................................... 33.0
PCS................................................................ 23.2
Other.............................................................. 1.2
-----
100.0%
-----
-----
</TABLE>
The plant and equipment of TDS is maintained in good operating condition and
is suitable and adequate for the Company's business operations. The properties
of the operating telephone subsidiaries are subject to the lien of the mortgages
securing the funded debt of such companies. The Company leases most of its
offices and transmitter sites used in its cellular and PCS businesses and owns
substantially all of its central office buildings, local administrative
buildings, warehouses, and storage facilities used in its telephone operations.
All of the Company's cell and transmitter sites and telephone lines are located
either on private or public property. Locations on private land are by virtue of
easements or other arrangements.
- --------------------------------------------------------------------------------
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in a number of legal proceedings before the FCC and
various state and federal courts. Management does not believe that any such
proceeding should have a material adverse impact on the financial position or
results of operations of the Company. See Item 1. Business-- "Proposed Corporate
Restructuring".
- --------------------------------------------------------------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of 1998.
42
<PAGE>
- --------------------------------------------------------------------------------
PART II
- --------------------------------------------------------------------------------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Incorporated by reference from Exhibit 13, Annual Report sections entitled
"TDS Stock and Dividend Information" and "Market Price per Common Share by
Quarter."
- --------------------------------------------------------------------------------
ITEM 6. SELECTED FINANCIAL DATA
Incorporated by reference from Exhibit 13, Annual Report section entitled
"Selected Consolidated Financial Data," except for ratios of earnings to fixed
charges, which are incorporated herein by reference from Exhibit 12 to this
Annual Report on Form 10-K.
- --------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Incorporated by reference from Exhibit 13, Annual Report section entitled
"Management's Discussion and Analysis of Results of Operations and Financial
Condition."
- --------------------------------------------------------------------------------
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Incorporated by reference from Exhibit 13, Annual Report section entitled
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" under the caption "Market Risk."
- --------------------------------------------------------------------------------
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated by reference from Exhibit 13, Annual Report sections entitled
"Consolidated Statements of Operations," "Consolidated Statements of Cash
Flows," "Consolidated Balance Sheets," "Consolidated Statements of Common
Stockholders' Equity," "Notes to Consolidated Financial Statements,"
"Consolidated Quarterly Income Information (Unaudited)," and "Report of
Independent Public Accountants."
- --------------------------------------------------------------------------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
43
<PAGE>
- --------------------------------------------------------------------------------
PART III
- --------------------------------------------------------------------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from Proxy Statement sections entitled "Election
of Directors" and "Executive Officers."
- --------------------------------------------------------------------------------
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from Proxy Statement section entitled "Executive
Compensation" except for the information specified in Item 402(a)(8) of
Regulation S-K under the Securities Exchange Act of 1934, as amended.
- --------------------------------------------------------------------------------
ITEM 12. BENEFICIAL OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from Proxy Statement sections entitled "Security
Ownership of Management" and "Principal Shareholders."
- --------------------------------------------------------------------------------
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from Proxy Statement section entitled "Certain
Relationships and Related Transactions."
44
<PAGE>
- --------------------------------------------------------------------------------
PART IV
- --------------------------------------------------------------------------------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The following documents are filed as a part of this report:
(a) (1) Financial Statements
<TABLE>
<S> <C>
Consolidated Statements of Operations.............................. Annual Report*
Consolidated Statements of Cash Flows.............................. Annual Report*
Consolidated Balance Sheets........................................ Annual Report*
Consolidated Statements of Common Stockholders' Equity............. Annual Report*
Notes to Consolidated Financial Statements......................... Annual Report*
Consolidated Quarterly Income Information (Unaudited).............. Annual Report*
Report of Independent Public Accountants........................... Annual Report*
</TABLE>
- ------------------------
* Incorporated by reference from Exhibit 13.
(2) Schedules
<TABLE>
<CAPTION>
LOCATION
----------
<S> <C> <C>
Report of Independent Public Accountants on Financial Statement Schedules................................... page 48
I. Condensed Financial Information of Registrant-Balance Sheets as of December 31, 1998 and 1997 and
Statements of Operations and Statements of Cash Flows for each of the Three Years in the Period
Ended December 31, 1998.......................................................................... page 49
II. Valuation and Qualifying Accounts for each of the Three Years in the Period Ended December 31,
1998............................................................................................. page 54
</TABLE>
All other schedules have been omitted because they are not applicable or not
required because the required information is shown in the financial statements
or notes thereto.
(3) Exhibits
The exhibits set forth in the accompanying Index to Exhibits are filed as a
part of this Report. The following is a list of each management contract or
compensatory plan or arrangement required to be filed as an exhibit to this form
pursuant to Item 14(c) of this Report.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------------------------------------------------
<S> <C>
10.1 Salary Continuation Agreement for LeRoy T. Carlson dated May 20, 1977, as amended May 22, 1981 and May
25, 1984 is hereby incorporated by reference to the Company's Registration Statement on Form S-2, No.
2-92307.
10.2(a) Supplemental Benefit Agreement for LeRoy T. Carlson dated March 21, 1980, as amended March 20, 1981 is
hereby incorporated by reference to an exhibit to the Company's Registration Statement on Form S-7, No.
2-74615.
10.2(b) Memorandum of Amendment to Supplemental Benefit Agreement dated May 28, 1991 is hereby incorporated by
reference to Exhibit 10.2(b) to the Company's Annual Report Form 10-K for the year ended December 31,
1991.
10.3 Description of Terms of Letter Agreement with Sandra L. Helton dated August 7, 1998.
10.4(a) 1988 Stock Option and Stock Appreciation Rights Plan of the Company is hereby incorporated by reference
to Exhibit A to the Company's definitive Notice of Annual Meeting and Proxy Statement dated March 31,
1988.
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------------------------------------------------
<S> <C>
10.4(b) Amendment #1 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company is hereby
incorporated by reference to Exhibit 10.7(b) to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993.
10.4(c) Amendment #2 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company is hereby
incorporated by reference to Exhibit 10.7(c) to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993.
10.5 Telephone and Data Systems, Inc. 1994 Long-Term Incentive Plan is hereby incorporated by reference to
Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257).
10.6 Telephone and Data Systems, Inc. 1998 Long-Term Incentive Plan is hereby incorporated by reference to
Exhibit D to the Company's Proxy Statement/Prospectus dated March 24, 1998 which was part of the
Company's Registration Statement on Form S-4 (Registration No. 333-42535).
10.7 Amended and Restated Supplemental Executive Retirement Plan of the Company.
10.11 Supplemental Benefit Agreement between United States Cellular Corporation and H. Donald Nelson is
hereby incorporated by reference to an exhibit to United States Cellular Corporation's Registration
Statement on Form S-1 (Registration No. 33-16975).
10.12 Deferred Compensation Agreement for H. Donald Nelson dated July 15, 1996, is hereby incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report in Form 10-Q for the quarterly period ended
September 30, 1996.
10.13 Stock Option and Stock Appreciation Rights Plan, is hereby incorporated by reference to Exhibit B to
United States Cellular Corporation's definitive Notice of Annual Meeting and Proxy Statement dated
April 15, 1991, as filed with the Commission on April 16, 1991.
10.14 Summary of 1998 Bonus Program for the Senior Corporate Staff on United States Cellular Corporation is
hereby incorporated by reference to Exhibit 10.11 to United States Cellular Corporation's Annual Report
on Form 10-K for the year ended December 31, 1998.
10.15 United States Cellular Corporation 1994 Long-Term Incentive Plan is hereby incorporated by reference to
Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration
No. 33-57255).
10.16 United States Cellular Corporation 1996 Senior Executive Stock Bonus and Restricted Stock Award Plan is
hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration
Statement on Form S-8 (Registration No. 333-19405).
10.17 United States Cellular Corporation Special Retention Restricted Stock Award Plan is hereby incorporated
by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8
(Registration No. 333-23861).
10.18 United States Cellular Corporation 1998 Long-Term Incentive Plan is hereby incorporated by reference to
Exhibit 99.4 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration
No. 333-57063).
10.19 Form of 1997 Special Retention Restricted Stock Awards is hereby incorporated by reference to Exhibit
99.2 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No.
333-57063).
10.20 Description of Terms of Signing Letter with Donald W. Warkentin dated June 7, 1995, is hereby
incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996.
10.21 Aerial Communications, Inc. 1996 Long-Term Incentive Plan, as amended, is hereby incorporated by
reference to Exhibit 99.1 to Aerial Communications, Inc.'s Registration Statement on Form S-8
(Registration No. 333-06471)
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------------------------------------------------
<S> <C>
10.22 Amendment to the Aerial Communications, Inc. 1996 Long-Term Incentive Plan is hereby incorporated by
reference to Aerial Communications, Inc.'s Form S-8 dated April 30, 1998 (Registration No. 333-51561).
10.23 Description of Supplemental Benefit Agreement with Donald W. Warkentin dated August 2, 1996, is hereby
incorporated by reference to Exhibit 10.17 to Aerial Communications, Inc.'s Annual Report on Form 10-K
for the year ended December 31, 1997.
10.24 TDS Compensation Plan for Non-Employee Directors is hereby incorporated by reference to Exhibit 99.1 of
the Company's Registration Statement on Form S-8 (Registration No. 333-23947).
10.25 Executive Deferred Compensation Agreement for James Barr III dated January 1, 1998 is hereby
incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
10.26 Form of TDS Telecommunications Corporation Phantom Stock Option Incentive Agreement between TDS
Telecommunications Corporation and James Barr III is hereby incorporated by reference to Exhibit 10.16
to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
10.28 Employment Agreement with Murray L. Swanson dated October 15, 1998.
</TABLE>
(b) Reports on Form 8-K filed during the quarter ended December 31, 1998.
TDS filed a Current Report on Form 8-K on December 23, 1998 dated December
18, 1998, which included a news release relating to the announcement that TDS
had withdrawn its offers to exchange tracking stocks for the outstanding common
shares of United States Cellular Corporation and Aerial Communications, Inc.
which it did not own. In addition, the Company announced that it is pursuing a
tax-free spin-off of its 82.3% interest in Aerial Communications, Inc., as well
as other alternatives.
47
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Stockholders and Board of Directors of Telephone and Data Systems, Inc.:
We have audited in accordance with generally accepted auditing standards,
the consolidated financial statements included in Telephone and Data Systems,
Inc. and Subsidiaries Annual Report incorporated by reference in this Form 10-K,
and have issued our report thereon dated January 27, 1999. Our audits were made
for the purpose of forming an opinion on the basic consolidated financial
statements taken as a whole. The financial statement schedules listed in Item
14(a)(2) are the responsibility of the Company's management and are presented
for purposes of complying with the Securities and Exchange Commission's rules
and are not part of the basic consolidated financial statements. These financial
statement schedules have been subjected to the auditing procedures applied in
the audits of the basic consolidated financial statements and, in our opinion,
fairly state in all material respects the financial data required to be set
forth therein in relation to the basic consolidated financial statements taken
as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 27, 1999
48
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TELEPHONE AND DATA SYSTEMS, INC. (PARENT)
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents......................................................... $ 264 $ 271
Temporary investments............................................................. -- 132
Notes receivable from affiliates.................................................. 91,354 42,586
Accounts receivable
Due from subsidiaries--Income taxes............................................. -- 17,673
Due from subsidiaries--Other.................................................... 32,552 21,060
Other........................................................................... 3,838 6,407
Prepaid income taxes.............................................................. 5,064 16,975
Other current assets.............................................................. 2,621 4,287
------------- -------------
135,693 109,391
------------- -------------
INVESTMENT IN SUBSIDIARIES.......................................................... 2,629,812 2,396,557
------------- -------------
OTHER INVESTMENTS
Notes receivable from affiliates.................................................. 510,274 376,809
Minority interests and other investments.......................................... 50,151 50,846
------------- -------------
560,425 427,655
------------- -------------
PROPERTY AND EQUIPMENT
Property and Equipment, net of accumulated depreciation........................... 19,778 34,216
------------- -------------
OTHER ASSETS AND DEFERRED CHARGES
Net deferred income taxes......................................................... 58,999 --
Debt issuance expenses............................................................ 13,350 6,829
Development and acquisition expenses.............................................. 426 267
Other............................................................................. 483 (28)
------------- -------------
73,258 7,068
------------- -------------
$ 3,418,966 $ 2,974,887
------------- -------------
------------- -------------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
49
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TELEPHONE AND DATA SYSTEMS, INC. (PARENT)
BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
CURRENT LIABILITIES
Current portion of long-term debt................................................. $ 248 $ 239
Notes payable..................................................................... 170,889 525,885
Notes payable to affiliates....................................................... 179,606 --
Accounts payable
Due to subsidiaries--Income Taxes............................................... 12,854 --
Due to subsidiaries--Other...................................................... 3,037 763
Other........................................................................... 7,637 5,032
Accrued interest.................................................................. 16,527 10,892
Other............................................................................. 5,346 4,854
------------- -------------
396,144 547,665
------------- -------------
DEFERRED LIABILITIES AND CREDITS
Net deferred income taxes......................................................... -- 22,659
Postretirement benefits obligation other than pensions............................ 779 696
Other............................................................................. 7,717 7,241
------------- -------------
8,496 30,596
------------- -------------
LONG-TERM DEBT, excluding current portion (Note A).................................. 441,153 241,401
LONG-TERM DEBT--due to affiliates (Note B).......................................... 309,280 154,640
------------- -------------
750,433 396,041
------------- -------------
PREFERRED SHARES.................................................................... 25,985 32,466
------------- -------------
COMMON STOCKHOLDERS' EQUITY
Common Shares, par value $.01 and $1 per share, respectively; authorized
100,000,000 shares; issued and outstanding 54,988,498 and 54,443,260 shares,
respectively.................................................................... 550 54,443
Series A Common Shares, par value $.01 and $1 per share, respectively; authorized
25,000,000 shares; issued and outstanding 6,949,904 and 6,936,277 shares,
respectively.................................................................... 69 6,936
Capital in excess of par value.................................................... 1,882,710 1,664,248
Accumulated other comprehensive income from subsidiaries.......................... 75,609 683
Treasury Shares, at cost, 761,220 and 794,576 shares, respectively................ (29,439) (30,682)
Retained earnings................................................................. 308,409 272,491
------------- -------------
2,237,908 1,968,119
------------- -------------
$ 3,418,966 $ 2,974,887
------------- -------------
------------- -------------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
50
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TELEPHONE AND DATA SYSTEMS, INC. (PARENT)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
------------ ------------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating service revenues............................................... $ 78,269 $ 72,372 $ 61,239
Cost of sales and operating expenses..................................... 76,238 72,249 57,538
------------ ------------ -----------
Net operations......................................................... 2,031 123 3,701
------------ ------------ -----------
Other income
Interest income received from affiliates............................... 72,455 32,945 7,385
Gain on sale of investments............................................ 7,164 10,307 3,434
Other, net............................................................. (10,631) (4,798) (2,139)
------------ ------------ -----------
68,988 38,454 8,680
------------ ------------ -----------
Income before interest and income taxes.................................. 71,019 38,577 12,381
Interest expense......................................................... 78,002 44,482 15,790
Income tax expense (credit).............................................. (157,735) (100,074) (28,522)
------------ ------------ -----------
Corporate operations..................................................... 150,752 94,169 25,113
Equity in net income (loss) of subsidiaries and other investments........ (86,344) (103,718) 103,026
------------ ------------ -----------
Net income (loss)........................................................ $ 64,408 $ (9,549) $ 128,139
------------ ------------ -----------
------------ ------------ -----------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
Note A: The annual requirements for principal payments on long-term debt are
$248,000, $258,000, $270,000, $283,000 and $32.1 million for the years
1999 through 2003, respectively.
Note B: In 1998, TDS Capital II, a subsidiary trust ("Capital II") of TDS,
issued 6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable
Preferred Securities (the "1998 Preferred Securities") at $25 per
Preferred Security. Net proceeds totaled $144.9 million and were used to
reduce 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.
In 1997, TDS Capital I, a subsidiary trust ("Capital I") of TDS, issued
6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred
Securities (the "1997 Preferred Securities") at $25 per Preferred
Security. Net proceeds totaled $144.8 million and were used to reduce
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.
The obligations of TDS Capital I and II under the 1998 Preferred
Securities and 1997 Preferred Securities (the "Preferred Securities")
issued by TDS Capital I and II are fully and unconditionally guaranteed
by TDS. 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 8.04% and 8.5% Subordinated Debentures are redeemable by TDS, in
whole or in part, from time to time, on or after March 31, 2003, and
November 18, 2002, respectively, or, in whole
51
<PAGE>
but not in part, at any time in the event of certain income tax
circumstances. If the Subordinated Debentures are redeemed, TDS Capital
I and II 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 TDS Capital I and II, 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.
52
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TELEPHONE AND DATA SYSTEMS, INC. (PARENT)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)....................................................... $ 64,408 $ (9,549) $ 128,139
Add (Deduct) adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization......................................... 10,813 9,508 11,047
Gain on sale of investments........................................... (7,164) (10,307) (3,434)
Deferred taxes........................................................ (82,300) (8,918) 5,432
Equity in net loss (income) of subsidiaries and other investments..... 86,344 103,718 (103,026)
Other noncash expense................................................. (394) (211) 677
Change in accounts receivable......................................... 19,705 (19,063) 20,795
Change in accounts payable............................................ 6,810 3,598 (39,897)
Change in accrued taxes............................................... 9,324 2,151 (12,289)
Change in other assets and liabilities................................ 8,340 435 2,849
----------- ----------- -----------
115,886 71,362 10,293
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Long-term debt borrowings............................................... 343,127 144,788 --
Repayment of long-term debt............................................. (239) (735) (2,815)
Change in notes payable................................................. (354,996) 368,658 (23,533)
Change in notes payable to affiliates................................... 183,216 (47,990) 104,843
Change in advances from affiliates...................................... -- -- (2,464)
Change in notes receivable from affiliates.............................. (270,349) (451,048) (35,165)
Change in advances to affiliates........................................ -- 1,616 200
Common stock issued..................................................... 3,391 5,225 5,114
Redemption of preferred shares.......................................... (367) (359) (605)
Dividends from subsidiaries............................................. 38,391 22,022 17,953
Dividends paid.......................................................... (28,488) (27,191) (26,232)
Repurchase of Common Shares............................................. -- (69,942) --
Purchase of subsidiary common stock..................................... (9,107) (9,801) --
----------- ----------- -----------
(95,421) (64,757) 37,296
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions
Value of assets acquired.............................................. (14,425) (8,767) (121,053)
Common Shares issued.................................................. 10,028 3,601 113,128
Preferred Shares issued............................................... -- 3,000 --
----------- ----------- -----------
Net cash paid for acquisitions...................................... (4,397) (2,166) (7,925)
Capital expenditures.................................................... 6,662 (20,957) (13,362)
Payment to subsidiary under contract agreement.......................... (28,696) -- --
Proceeds from sale of investments....................................... 5,382 20,886 500
Investments in subsidiaries............................................. 262 (7,111) (19,533)
Other investments....................................................... 183 2,851 (8,941)
Change in temporary investments......................................... 132 22 (54)
----------- ----------- -----------
(20,472) (6,475) (49,315)
----------- ----------- -----------
NET DECREASE (INCREASE) IN CASH AND CASH EQUIVALENTS...................... (7) 130 (1,726)
CASH AND CASH EQUIVALENTS
Beginning of period..................................................... 271 141 1,867
----------- ----------- -----------
End of period........................................................... $ 264 $ 271 $ 141
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
53
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ---------------------------------------------- ------------- ------------ ------------ ----------- -----------
COLUMN A COLUMN B COLUMN C-1 COLUMN C-2 COLUMN D COLUMN E
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 31, 1998
Deducted from deferred state tax asset:
For unrealized net operating losses......... $ (29,001) $ (1,023) $ (24,661) $ -- $ (54,685)
Deducted from accounts receivable:
For doubtful accounts..................... (15,102) (40,629) -- 43,123 (12,608)
FOR THE YEAR ENDED DECEMBER 31, 1997
Deducted from deferred state tax asset:
For unrealized net operating losses......... (16,891) 877 (12,987) -- (29,001)
Deducted from accounts receivable:
For doubtful accounts..................... (6,090) (39,107) -- 30,095 (15,102)
FOR THE YEAR ENDED DECEMBER 31, 1996
Deducted from deferred state tax asset:
For unrealized net operating losses......... (10,061) 239 (7,069) -- (16,891)
Deducted from accounts receivable:
For doubtful accounts..................... $ (5,104) $ (22,432) $ -- $ 21,446 $ (6,090)
</TABLE>
54
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ LEROY T. CARLSON
-----------------------------------------
LeRoy T. Carlson
CHAIRMAN
By: /s/ LEROY T. CARLSON, JR.
-----------------------------------------
LeRoy T. Carlson, Jr.
PRESIDENT, (CHIEF EXECUTIVE OFFICER)
By: /s/ SANDRA L. HELTON
-----------------------------------------
Sandra L. Helton
EXECUTIVE VICE PRESIDENT--FINANCE
(CHIEF FINANCIAL OFFICER)
By: /s/ GREGORY J. WILKINSON
-----------------------------------------
Gregory J. Wilkinson
VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
Dated March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ LEROY T. CARLSON
- ------------------------------ Director March 30, 1999
LeRoy T. Carlson
/s/ LEROY T. CARLSON, JR.
- ------------------------------ Director March 30, 1999
LeRoy T. Carlson, Jr.
/s/ SANDRA L. HELTON
- ------------------------------ Director March 30, 1999
Sandra L. Helton
/s/ JAMES BARR III
- ------------------------------ Director March 30, 1999
James Barr III
/s/ WALTER C.D. CARLSON
- ------------------------------ Director March 30, 1999
Walter C.D. Carlson
</TABLE>
55
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ LETITIA G.C. CARLSON
- ------------------------------ Director March 30, 1999
Letitia G.C. Carlson
/s/ HERBERT S. WANDER
- ------------------------------ Director March 30, 1999
Herbert S. Wander
/s/ DONALD C. NEBERGALL
- ------------------------------ Director March 30, 1999
Donald C. Nebergall
/s/ GEORGE W. OFF
- ------------------------------ Director March 30, 1999
George W. Off
/s/ MARTIN L. SOLOMON
- ------------------------------ Director March 30, 1999
Martin L. Solomon
/s/ KEVIN A. MUNDT
- ------------------------------ Director March 30, 1999
Kevin A. Mundt
/s/ MURRAY L. SWANSON
- ------------------------------ Director March 30, 1999
Murray L. Swanson
</TABLE>
56
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- ---------- -----------------------------------------------------------------------------------------------------
<C> <S>
3.1 Restated Certificate of Incorporation, as amended, are hereby incorporated by reference to Exhibit
3.1 to the Company's Report on Form 8-A/A filed on July 10, 1998.
3.2 Restated By-laws, as amended, are hereby incorporated by reference to Exhibit 3.2 to the Company's
Current Report on Form 8-K dated May 22, 1998.
4.1 Restated Certificate of Incorporation, as amended, are hereby incorporated by reference to Exhibit
3.1 to the Company's Report on Form 8-A/A filed on July 10, 1998.
4.2 Restated By-laws, as amended, are hereby incorporated by reference to Exhibit 3.2 to the Company's
Current Report on Form 8-K dated May 22, 1998.
4.3(a) The Indenture between the Company and Harris Trust and Savings Bank, Trustee, dated February 1, 1991,
under which the Company's Medium-Term Notes are issuable, is hereby incorporated by reference to the
Company's Current Report on Form 8-K filed on February 19, 1991.
4.3(b) Form of First Supplemental Indenture with Harris Trust and Savings Bank is hereby incorporated by
reference to Exhibit 4.1(b) of Post Effective Amendment No. 1 to Form S-3 (Registration No.
33-68456).
4.4 Revolving Credit Agreement, dated as of May 19, 1995, among TDS and the First National Bank of
Boston, as agent, is hereby incorporated by reference to the registrant's Form 8-K dated May 19,
1995.
4.5 The Trust Indenture dated as of November 4, 1996 between Aerial Communications, Inc. as issuer, the
Company as guarantor, and The First National Bank of Chicago, as trustee for Aerial's Series A Zero
Coupon Notes, is hereby incorporated by reference to Exhibit 4.1 to Aerial's Current Report on Form
8-K filed on November 29, 1996.
4.6 The Trust Indenture, dated as of February 5, 1998, between Aerial Communications, Inc. as issuer, the
Company as guarantor, and The First National Bank of Chicago, as trustee for Aerial's Series B Zero
Coupon Notes, is hereby incorporated by reference to Exhibit 4.1 to Aerial's Current Report on Form
8-K filed on April 29, 1998.
4.7(a) The Amended and Restated Declaration of Trust, dated November 18, 1997, by and among the Company, as
Sponsor, the Trust, The First National Bank of Chicago, as Property Trustee, First Chicago Delaware,
Inc., as Delaware Trustee and the Regular Trustees named therein, is hereby incorporated by reference
to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on December 2, 1997, dated November
18, 1997.
4.7(b) The Amended and Restated Declaration of Trust, dated February 10, 1998, by and among the Company, as
Sponsor, the Trust, The First National Bank of Chicago, as Property Trustee, First Chicago Delaware,
Inc., as Delaware Trustee and the Regular Trustees named therein, is hereby incorporated by reference
to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on April 28, 1998, dated February
10, 1998.
4.7(c) Form of First Supplemental Indenture to Amended and Restated Declaration of Trust relating to
assumption of TDS Delaware is hereby incorporated by reference to Exhibit 4.7 of Post Effective
Amendment No. 1 to Form S-3 (Registration No. 333-38355).
4.8(a) The Subordinated Indenture, dated October 15, 1997, by and between the Company and the First National
Bank of Chicago, as Trustee under which the Trust Originated Preferred Securities are issuable, is
hereby incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K filed on
December 2, 1997, dated November 18, 1997.
</TABLE>
57
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- ---------- -----------------------------------------------------------------------------------------------------
<C> <S>
4.8(b) The Supplemental Indenture dated November 18, 1997, by and between the Company and the First National
Bank of Chicago, as Trustee under which the Trust Originated Preferred Securities are issuable, is
hereby incorporated by reference to Exhibit 4.4 to the Company's Current Report on Form 8-K filed on
December 2, 1997, dated November 18, 1997.
4.8(c) The Second Supplemental Indenture, dated as of February 10, 1998, by and among the Company and The
First National Bank of Chicago, as Debt Trustees, is hereby incorporated by reference to Exhibit 4.3
to the Company's Current Report on Form 8-K filed on April 28, 1998, dated February 10, 1998.
4.8(d) Form of Third Supplemental Indenture to Subordinated Indenture relating to assumption by TDS Delaware
is hereby incorporated by reference to Exhibit 4.9 of Post Effective Amendment No. 1 to Form S-3
(Registration No. 333-38355).
4.9(a) The Preferred Securities Guarantee Agreement, dated as of November 18, 1997, by and among the Company
and The First National Bank of Chicago, as Guarantee Trustee for the benefit of the holders of Trust
Preferred Securities of the Trust, is hereby incorporated by reference to Exhibit 4.2 to the
Company's Current Report on Form 8-K filed on December 2, 1997, dated November 18, 1997.
4.9(b) The Preferred Securities Guarantee Agreement, dated as of February 10, 1998, by and among the Company
and The First National Bank of Chicago, as Guarantee Trustee for the benefit of the holders of Trust
Preferred Securities of the Trust, is hereby incorporated by reference to Exhibit 4.2 to the
Company's Current Report on Form 8-K filed on April 28, 1998, dated February 10, 1998.
4.9(c) Form of First Supplemental Indenture to Preferred Securities Guarantee Agreement relating to
assumption by TDS Delaware is hereby incorporated by reference to Exhibit 4.8 of Post Effective
Amendment No. 1 to Form S-3 (Registration No. 333-38355).
9.1(a) Voting Trust Agreement, dated as of June 30, 1989, is hereby incorporated by reference to an exhibit
to Post-Effective Amendment No. 3 to the Company's Registration Statement on Form S-1, No. 33-12943.
9.1(b) Amendment dated as of May 9, 1991 to the Voting Trust Agreement dated as of June 30, 1989, is hereby
incorporated by reference to Exhibit 9.2 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1991.
9.1(c) Amendment dated as of November 20, 1992, to the Voting Trust Agreement dated as of June 30, 1989, as
amended, is hereby incorporated by reference to Exhibit 9.1(c) to the Company's Annual Report on Form
10-K for the year ended December 31, 1992.
9.1(d) Amendment dated as of May 22, 1998, to the Voting Trust Agreement dated as of June 30, 1989, as
amended, is hereby incorporated by reference to Exhibit 99.3 to the Company's Current Report on Form
8-K filed on June 5, 1998.
10.1 Salary Continuation Agreement for LeRoy T. Carlson dated May 20, 1977, as amended May 22, 1981 and
May 25, 1984 is hereby incorporated by reference to the Company's Registration Statement on Form S-2,
No. 2-92307.
10.2(a) Supplemental Benefit Agreement for LeRoy T. Carlson dated March 21, 1980, as amended March 20, 1981,
is hereby incorporated by reference to an exhibit to the Company's Registration Statement on Form
S-7, No. 2-74615.
10.2(b) Memorandum of Amendment to Supplemental Benefit Agreement dated as of May 28, 1991, is hereby
incorporated by reference to Exhibit 10.2(b) to the Company's Annual Report on Form 10-K for the year
ended December 31, 1991.
10.3 Description of Terms of Letter Agreement with Sandra L. Helton dated August 7, 1998.
10.4(a) 1988 Stock Option and Stock Appreciation Rights Plan of the Company, is hereby incorporated by
reference to Exhibit A to the Company's definitive Notice of Annual Meeting and Proxy Statement dated
March 31, 1988.
</TABLE>
58
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- ---------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.4(b) Amendment #1 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company, is hereby
incorporated by reference to Exhibit 10.7(b) to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993.
10.4(c) Amendment #2 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company, is hereby
incorporated by reference to Exhibit 10.7(c) to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993.
10.5 Telephone and Data Systems, Inc. 1994 Long-Term Incentive Plan is hereby incorporated by reference to
Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257).
10.6 Telephone and Data Systems, Inc. 1998 Long-Term Incentive Plan is hereby incorporated by reference to
Exhibit D to the Company's Proxy Statement/Prospectus dated March 24, 1998 which was part of the
Company's Registration Statement on Form S-4 (Registration No. 333-42535).
10.7 Amended and Restated Supplemental Executive Retirement Plan.
10.8 Securities Loan Agreement, dated June 13, 1995, between TDS and Merrill Lynch & Co. is hereby
incorporated by reference to Exhibit 99.1 to the Form 8-K dated June 16, 1995 of United States
Cellular Corporation.
10.9 Registration Rights Agreement among TDS, Merrill Lynch & Co. and United States Cellular Corporation
is hereby incorporated by reference to Exhibit 99.2 to the Form 8-K dated June 16, 1995 of United
States Cellular Corporation.
10.10 Common Share Delivery Arrangement Agreement among TDS, Merrill Lynch & Co. and United States Cellular
Corporation is hereby incorporated by reference to Exhibit 99.3 to the Form 8-K dated June 16, 1995
of United States Cellular Corporation.
10.11 Supplemental Benefit Agreement between United States Cellular Corporation and H. Donald Nelson is
hereby incorporated by reference to an exhibit to United States Cellular Corporation's Registration
Statement on Form S-1 (Registration No. 33-16975).
10.12 Deferred Compensation Agreement for H. Donald Nelson dated July 15, 1996, is hereby incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996.
10.13 Stock Option and Stock Appreciation Rights Plan, is hereby incorporated by reference to Exhibit B to
United States Cellular Corporation's definitive Notice of Annual Meeting and Proxy Statement dated
April 15, 1991, as filed with the Commission on April 16, 1991.
10.14 Summary of 1998 Bonus Program for the Senior Corporate Staff on United States Cellular Corporation is
hereby incorporated by reference to Exhibit 10.11 to United States Cellular Corporation's Annual
Report on Form 10-K for the year ended December 31, 1998.
10.15 United States Cellular Corporation 1994 Long-Term Incentive Plan is hereby incorporated by reference
to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8
(Registration No. 33-57255).
10.16 United States Cellular Corporation 1996 Senior Executive Stock Bonus and Restricted Stock Award Plan
is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's
Registration Statement on Form S-8 (Registration No. 333-19405).
10.17 United States Cellular Corporation Special Retention Restricted Stock Award Plan is hereby
incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration
Statement on Form S-8 (Registration No. 333-23861).
10.18 United States Cellular Corporation 1998 Long-Term Incentive Plan is hereby incorporated by reference
to Exhibit 99.4 to United States Cellular Corporation's Registration Statement on Form S-8
(Registration No. 333-57063).
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- ---------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.19 Form of 1997 Special Retention Restricted Stock Awards is hereby incorporated by reference to Exhibit
99.2 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No.
333-57063).
10.20 Description of Terms of Signing Letter with Donald W. Warkentin dated June 7, 1995, is hereby
incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996.
10.21 Aerial Communications, Inc. 1996 Long-Term Incentive Plan, as amended, is hereby incorporated by
reference to Exhibit 99.1 to Aerial Communications, Inc.'s registration statement on Form S-8
(Registration No. 333-06471).
10.22 Amendment to the Aerial Communications, Inc. 1996 Long-Term Incentive Plan is hereby incorporated by
reference to Aerial Communications, Inc.'s Form S-8 dated April 30, 1998 (Registration No.
333-51561).
10.23 Description of Supplemental Benefit Agreement with Donald W. Warkentin dated August 2, 1996, is
hereby incorporated by reference to Exhibit 10.17 to Aerial Communications, Inc.'s Annual Report on
Form 10-K for the year ended December 31, 1997.
10.24 TDS Compensation Plan for Non-Employee Directors is hereby incorporated by reference to Exhibit 99.1
of the Company's Registration Statement on Form S-8 (Registration No. 333-23947).
10.25 Executive Deferred Compensation Agreement for James Barr III dated January 1, 1998 is hereby
incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997.
10.26 Form of TDS Telecommunications Corporation Phantom Stock Option Incentive Agreement between TDS
Telecommunications Corporation and James Barr III is hereby incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
10.27 Credit Agreement dated June 30, 1998, by and between Nokia Telecommunications Inc. and Aerial
Communications, Inc., is hereby incorporated by reference to Exhibit 99.1 of Aerial Communications,
Inc.'s Form 8-K dated June 30, 1998 and filed on November 9, 1998.
10.28 Employment Agreement with Murray L. Swanson dated October 15, 1998.
11 Statement regarding computation of per share earnings (included in Footnote 4 to financial statements
in Exhibit 13).
12 Statements regarding computation of ratios.
13 Incorporated portions of 1998 Annual Report to Security Holders.
21 List of Subsidiaries of the Company.
23 Consent of independent public accountants.
27 Financial Data Schedules for the year ended December 31, 1998.
</TABLE>
60
<PAGE>
[LOGO]
TELEPHONE AND DATA SYSTEMS, INC.
30 North LaSalle Street
Chicago, Illinois 60602
312/630-1900
<PAGE>
EXHIBIT 10.3
SANDRA L. HELTON -- LETTER AGREEMENT
Ms. Helton was hired as Executive Vice President-Finance and Chief
Financial Officer on August 10, 1998. The following describes the material
terms of Ms. Helton's employment arrangements pursuant to a letter agreement
between TDS and Sandra L. Helton, dated August 7, 1998:
- A base salary at the annual rate of $365,000 per year through
December 31, 1998, with a partial year performance review
following year-end 1998. Annual reviews will then follow on
January 1st of each subsequent year.
- Assuming a start date of September 1, a guaranteed bonus of
$60,000 for 1998, with the possibility of obtaining up to $90,000
if certain key fourth quarter objectives are met. Starting in
1999, a target bonus opportunity of 50% of base salary for the
year with bonuses above this level for superior performance.
- A signing bonus of 3,000 shares of TDS restricted stock. One
third of the shares will vest on each of the first three
anniversary dates with TDS.
- Participation in the TDS three year 1997-1999 Long-Term Incentive
Program. Non-qualified stock options consisting of two parts:
(i) an automatic grant of 36,000 stock option shares
which will vest in three equal annual installments
of 12,000 shares, and
(ii) an opportunity to receive performance based non-
qualified stock options for 1999. If target level
individual performance levels are achieved in 1999,
an option to purchase 12,000 shares of TDS stock
will be granted.
Attached is a schedule which provides more detail about these
stock option grants.
- Participation in the then current Long-Term Incentive Program.
- A seat on the TDS Board of Directors.
- A moving expense reimbursement program providing reimbursement
for:
(i) actual moving expenses (i.e., all reasonable costs
of packing, insuring, transporting, storing and
unpacking furniture, other household furnishings and
personal effects),
(ii) legal fees and other reasonable expenses incurred in
connection with purchasing a new home (if within the
first two years of employment),
(iii) reasonable travel expenses to look for housing,
61
<PAGE>
(iv) normal living expenses for up to sixty days while
waiting to move into a new residence,
(v) travel expenses incurred during the actual move to
Chicago, and
(vi) miscellaneous relocation expenses, up to a maximum
of one month's salary.
- The same medical insurance and life insurance programs currently
offered to other TDS managerial employees.
- The same pension program currently offered to other TDS managerial
employees.
- A company car under the company car policy for senior executives
pursuant to which executives may purchase a company car of their
choice with TDS paying up to $33,200 of the cost of the vehicle.
- A luncheon club membership.
- Three weeks vacation per year.
62
<PAGE>
Attachment
SANDRA L. HELTON
STOCK OPTION PROGRAM AWARDS
AUTOMATIC STOCK OPTION GRANT OF 36,000 SHARES.
- The first one third, or 12,000 shares, will vest on December 15,
1998.
- On December 15, 1999, and 2000, an additional 12,000 stock option
shares will vest.
- The strike price for this 36,000 stock option grant will be the
fair market price of a share of TDS stock on August 10, 1998.
PERFORMANCE-BASED STOCK OPTION AWARD.
- The performance year for this award (i.e. the measurement period)
will be 1999.
- This award will be made in 2000 and will vest on December 15th of
that year.
- The strike price of performance-based awards is the fair market
value of a share of TDS stock on the date the award is approved.
- Our performance-based stock option awards are based on individual
performance. At target individual performance, an option to
purchase 12,000 shares of TDS stock will be granted.
- Performance-based stock option award will be determined by the
President's assessment of the extent to which the key performance
measures/targets were accomplished or exceeded.
- The amount of the annual performance stock option award could vary
to a maximum of 24,000 stock option shares for truly exceptional
performance.
63
<PAGE>
EXHIBIT 10.7
TELEPHONE AND DATA SYSTEMS, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
(As Amended and Restated, Effective January 1, 1998)
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
(AS AMENDED AND RESTATED, EFFECTIVE JANUARY 1, 1998)
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
SECTION 1 INTRODUCTION....................................................................................1
1.1 Title and Purpose...............................................................................1
1.2 Definitions.....................................................................................2
1.3 Gender and Number...............................................................................5
SECTION 2 ELIGIBILITY AND BENEFITS........................................................................6
2.1 Eligibility.....................................................................................6
2.2 Benefits........................................................................................6
2.3 Earnings and Other Adjustments..................................................................8
SECTION 3 PAYMENT OF BENEFITS.............................................................................8
3.1 Vesting.........................................................................................8
3.2 Commencement of Payments.......................................................................10
3.3 Schedule of Payments...........................................................................10
3.4 Survivor Benefits..............................................................................11
3.5 Distributions to Minor and Disabled Persons....................................................12
3.6 Small Benefits Paid in Lump Sum................................................................13
SECTION 4 GENERAL PROVISIONS.............................................................................13
4.1 Employment Rights..............................................................................13
4.2 Rights Not Secured.............................................................................13
4.3 Administration.................................................................................14
4.4 Effect on Other Plans..........................................................................14
4.5 Interests Not Transferable.....................................................................14
4.6 Adoption by Employers..........................................................................15
4.7 Tax Liability..................................................................................15
4.8 Controlling Law................................................................................15
SECTION 5 CLAIMS PROCEDURE...............................................................................16
SECTION 6 AMENDMENT AND TERMINATION......................................................................17
6.1 Amendment......................................................................................17
6.2 Termination....................................................................................18
</TABLE>
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
(AS AMENDED AND RESTATED, EFFECTIVE JANUARY 1, 1998)
SECTION 1
INTRODUCTION
1.1 TITLE AND PURPOSE. The title of this Plan is the
"Telephone and Data Systems, Inc. Supplemental Executive Retirement Plan".
This Plan was established by Telephone and Data Systems, Inc. (the
"Company"), effective January 1, 1994. This Plan was amended by an Amendment
Number 1, effective January 1, 1996. Pursuant to the power reserved by the
Company in Section 6.1, this Plan is hereby amended and restated, effective
January 1, 1998. The purpose of this Plan has been to supplement the benefits
under the Telephone and Data Systems, Inc. Employees' Pension Trust I (the
"TDS Target Plan") and the Telephone and Data Systems, Inc. Wireless
Companies' Pension Plan (the "TDS Wireless Plan") (both Plans being referred
to herein as "TDS Pension Plans"), each of which is intended to operate as a
"qualified" plan as defined under Section 401(a) of the Internal Revenue Code
of 1986, as amended (the "Code"). Qualified plans must comply with
Section 401(a)(17) of the Code, which limits the annual compensation of each
employee which can be taken into account under a qualified plan. This Plan was
established to offset the Code mandated reduction of benefits caused by the
limitation on annual employee compensation to be considered under
Section 401(a)(17)
<PAGE>
of the Code for eligible employees participating in either TDS Pension Plan.
Additionally, neither of the TDS Pension Plans includes in its definition of
compensation for determining benefits any participant's compensation earned in
the Plan Year but deferred under a Nonqualified Deferred Compensation Plan.
Effective January 1, 1998, this Plan provides a benefit for Qualifying Employer
Officers to replace the reduction in benefits which occurs under the TDS Pension
Plans because compensation earned in the Plan Year but deferred under a
Nonqualified Deferred Compensation Plan is not included in the definition of
compensation under the TDS Pension Plans. This Plan is intended to be unfunded
and maintained primarily for the purpose of providing deferred compensation for
a select group of management or highly compensated employees.
1.2 DEFINITIONS. All capitalized terms used herein shall have
the meanings set forth below, except as otherwise provided in the preamble to or
text of this Plan:
(a) "AERIAL" means Aerial Communications, Inc., a Delaware
corporation, and any corporation which shall succeed to the business of such
corporation and adopts this Plan pursuant to Section 4.6.
(b) "BENEFICIARY" means the beneficiary designated by the
Participant or otherwise entitled to payment of benefits hereunder. If no
separate designation is made by a Participant
-2-
<PAGE>
under this Plan, the Beneficiary shall be his beneficiary under the TDS Pension
Plan in which the Participant was most recently participating.
(c) "BENEFITS DEPARTMENT" means the employee benefits
department of the Company, located at 8401 Greenway Boulevard, Post Office Box
628010, Middleton, Wisconsin 53562-8010.
(d) "CAUSE" means (i) the continued failure by a Participant
to substantially perform the Participant's duties with the Company or an
Employer, or (ii) the willful engaging by the Participant in conduct which is
clearly injurious to the Company or any of its respective affiliates, monetarily
or otherwise. For purposes of clause (ii) of this definition, no act, or failure
to act, on the Participant's part shall be deemed "willful" unless done, or
omitted to be done, by the Participant not in good faith or without reasonable
belief that such act, or failure to act, was in the best interest of the Company
or an Employer.
(e) "COMMITTEE" means, unless otherwise appointed by the Board
of Directors of the Company, the Investment Management Committee of the TDS
Target Plan, which shall administer the Plan.
(f) "EMPLOYER" means the Company, Telecom, USCC, Aerial and
any other entity that participates in the TDS Target
-3-
<PAGE>
Plan or the TDS Wireless Plan and adopts this Plan pursuant to Section 4.6.
(g) "NONQUALIFIED DEFERRED COMPENSATION PLAN" means any plan
or agreement, other than the Telephone and Data Systems, Inc. Tax-Deferred
Savings Plan, which is sponsored, maintained or entered into by the Company,
Telecom, USCC or Aerial and which allows employees of any such Employer to defer
compensation.
(h) "PARTICIPANT" means any employee who meets the eligibility
for participation requirements set forth in Section 2.1.
(i) "PLAN" means this Telephone and Data Systems, Inc.
Supplemental Executive Retirement Plan, as from time to time amended.
(j) "PLAN YEAR" means the calendar year.
(k) "QUALIFYING EMPLOYER OFFICER" means the Chief
Executive Officer, President and any Vice President of the
Company, Telecom, USCC or Aerial.
(l) "TDS PENSION PLAN" means the TDS Target Plan with respect
to a Participant who participates in the TDS Target Plan and the TDS Wireless
Plan with respect to a Participant who participates in the TDS Wireless Plan.
-4-
<PAGE>
(m) "TELECOM" means TDS Telecommunications Corporation, a
Delaware corporation, and any corporation which shall succeed to the business of
such corporation and adopts this Plan pursuant to Section 4.6.
(n) "USCC" means United States Cellular Corporation, a
Delaware corporation, and any corporation which shall succeed to the business of
such corporation and adopts this Plan pursuant to Section 4.6.
(o) "YEAR OF SERVICE" means, with respect to a Participant who
participates in the TDS Target Plan, a Year of Vesting Service as defined in
Article 2 of the TDS Target Plan, and with respect to a Participant who
participates in the TDS Wireless Plan, a Year of Service as defined in Article 2
of the TDS Wireless Plan, including all such Years of Vesting Service and Years
of Service completed prior to and after January 1, 1996.
1.3 GENDER AND NUMBER. Where the context permits, words in the
masculine shall include the feminine and neutral; words in the plural shall
include the singular and the singular shall include the plural.
-5-
<PAGE>
SECTION 2
ELIGIBILITY AND BENEFITS
2.1 ELIGIBILITY. An employee who is a participant in the
TDS Target Plan or the TDS Wireless Plan shall commence participation in this
Plan as a Participant (i) if his compensation (as defined in the TDS Pension
Plan) for the Plan Year exceeds the limit set forth in Section 401(a)(17) of
the Code for such Plan Year (adjusted for changes in the cost of living
pursuant to Section 401(a)(17)) or (ii) if he is a Qualifying Employer Officer
and part of his compensation earned in the Plan Year from an Employer is
being deferred under a Nonqualified Deferred Compensation Plan.
2.2 BENEFITS. If Employer contributions that would
otherwise have been made on behalf of the Participant under the provisions of
the TDS Pension Plan are limited in a Plan Year (A) because of
Section 401(a)(17) of the Code or (B) in the case of a Qualifying Employer
Officer, because the Participant's compensation considered under the TDS
Pension Plan does not include part or all of the Participant's compensation
earned in the Plan Year because it is being deferred under a Nonqualified
Deferred Compensation Plan, such Employer shall credit to an account for the
Participant as of the last day of such Plan Year, for bookkeeping purposes
only, an amount equal to the difference between (i) the amount of Employer
contributions that would have been allocated to the Participant's account
under the TDS Pension
-6-
<PAGE>
Plan without regard to Section 401(a)(17) of the Code for such Plan Year, and
in the case of a Qualifying Employer Officer, including as compensation for
purposes of the TDS Pension Plan all of the Participant's compensation earned
in the Plan Year which was deferred under any Nonqualified Deferred
Compensation Plan, and (ii) the amount of Employer contributions actually
allocated to the Participant's account under the TDS Pension Plan for that
Plan Year. When calculating the amount described in part (i) of the previous
sentence with respect to TDS Target Plan benefits based on a Participant's
compensation in excess of the limitation under Section 401(a)(17) of the
Code, amounts credited to the account for such Participant for prior plan
years must be considered. Effective January 1, 1996, when calculating the
amount described in part (i) of the first sentence of this Section 2.2 with
respect to TDS Target Plan benefits, a Participant's compensation shall mean
all wages within the meaning of Section 3401(a) of the Code (for purposes of
income tax withholding at the source) paid to such Participant by an Employer
while a participant in a TDS Pension Plan during such Plan Year, but
determined without regard to any rules that limit the remuneration included
in wages based on the nature or location of the employment or the services
performed, reduced by all reimbursements or other expense allowances, fringe
benefits (cash and noncash), moving expenses, deferred compensation, and
welfare benefits and increased by all elective contributions that are made by
an Employer on behalf of such Participant that are not includible in gross
income under Sections 125, 402(e)(3), 402(h) and 403(b) of the Code; provided,
-7-
<PAGE>
however, effective January 1, 1998, with respect to any Qualifying Employer
Officer who is a Participant all of such Participant's compensation earned in
the Plan Year which was deferred under any Nonqualified Deferred Compensation
Plan shall be included in compensation for purposes of part (i) of the first
sentence of this Section 2.2. For calculating benefits under this Section 2.2
with respect to TDS Target Plan benefits for a plan year, the actuarial
assumptions and methods in effect during that plan year from the TDS Target Plan
will be applied.
2.3 EARNINGS AND OTHER ADJUSTMENTS. For bookkeeping purposes
only, the account established for each Participant pursuant to Section 2.2 shall
be adjusted at the end of each Plan Year to reflect (i) an assumed rate of
earnings on all items other than the contributions for the current Plan Year
equal to the yield on ten year BBB rated industrial bonds for the last trading
date of the prior Plan Year as quoted by Standard & Poors and (ii) any payments
made pursuant to Section 3.
SECTION 3
PAYMENT OF BENEFITS
3.1 VESTING. (a) TERMINATION OF EMPLOYMENT UNDER CIRCUMSTANCES
ENTITLING THE PARTICIPANT TO DISTRIBUTION OF HIS FULL ACCOUNT. A Participant
shall be entitled to distribution of his entire account balance under the Plan
if the Participant's
-8-
<PAGE>
employment is terminated, without Cause, after either of the following events:
(i) his attainment of age 65; or
(ii) his completion of at least ten Years of Service.
(b) TERMINATION OF EMPLOYMENT UNDER CIRCUMSTANCES RESULTING IN
COMPLETE OR PARTIAL FORFEITURE OF THE PARTICIPANT'S ACCOUNT. If a Participant
terminates employment under circumstances other than those set forth in
paragraph (a) above, without Cause, the Participant shall be entitled to
distribution of the following percentage of his account balance:
<TABLE>
<CAPTION>
Nonforfeitable
Years of Service Percentage
- ---------------- --------------
<S> <C>
Less than 1 0%
At least 1, but less than 2 10%
At least 2, but less than 3 20%
At least 3, but less than 4 30%
At least 4, but less than 5 40%
At least 5, but less than 6 50%
At least 6, but less than 7 60%
At least 7, but less than 8 70%
At least 8, but less than 9 80%
At least 9, but less than 10 90%
10 years or more 100%
</TABLE>
If a Participant's employment is terminated for Cause, such
Participant shall be entitled to no portion of his account balance under this
Plan.
-9-
<PAGE>
3.2 COMMENCEMENT OF PAYMENTS. The nonforfeitable portion of
the Participant's account determined under Section 3.1, adjusted for the assumed
rate of earnings in the manner described in Section 2.3 (including periods after
the Participant's termination of employment), shall be payable to the
Participant, beginning on the first day of the month next following the later of
his termination of employment and his completion of all forms and applications
requested by the Committee.
3.3 SCHEDULE OF PAYMENTS. The nonforfeitable portion of the
Participant's account determined under Section 3.1, adjusted each Plan Year
(including periods after any annual installment payments begin) for the assumed
rate of earnings in the manner described in Section 2.3 and reduced for annual
installments previously paid under the Plan, shall be payable in one of the
forms described in the following sentence selected by the Participant on the
date he first becomes a Participant and shall commence being paid on the date
determined pursuant to Section 3.2. The forms available for payment hereunder
are the following: (a) a single lump sum payment; or (b) annual installments
over a period of 5, 10, 15, 20 or 25 years. Notwithstanding the Participant's
selection of the payment method on the date he becomes a Participant, the
Participant may make a one-time request that payments be made in accordance with
a different form provided under this Section, provided that such form results in
payments over a shorter period than the period
-10-
<PAGE>
formerly selected by him. This request shall be irrevocable, must be made to the
Committee prior to the date of the first payment under Section 3.2 and shall be
subject to the approval of the Committee. The approval of the request shall be
at the sole discretion of the Committee. If a Participant fails to designate a
payment schedule in accordance with this Section, the nonforfeitable portion of
his account shall be paid in annual installments for a period of ten years.
Notwithstanding anything contained herein to the contrary, in
the event that the Participant owes any amount to an Employer (an "Obligation"),
the payments due hereunder shall be used to offset any Obligation in accordance
with the payment schedule selected by the Participant. Any amounts not used to
offset an Obligation shall be paid to the Participant or his Beneficiary.
3.4 SURVIVOR BENEFITS. If a Participant dies before payment of
his account balance commences, his Beneficiary shall receive the nonforfeitable
portion of his account balance determined under Section 3.1 (after offset of any
Obligation as provided in Section 3.3) in the form selected by the Participant
for payment of his account. If a Participant dies after payment of his account
balance commences, his Beneficiary shall receive the remaining portion of the
Participant's account balance to which the Participant would have been entitled
had he survived, payable in the same form as payments would have been made to
the
-11-
<PAGE>
Participant had he survived. Notwithstanding the preceding two sentences, a
Beneficiary entitled to payment under this Section may make a one-time request
that payments be made in accordance with a different form provided under Section
3.3, provided that such form results in payments over a shorter period than the
period formerly selected by the Participant. This request shall be irrevocable,
must be made to the Committee prior to the date of the first payment to the
Beneficiary and shall be subject to the approval of the Committee in the same
manner as provided in Section 3.3.
3.5 DISTRIBUTIONS TO MINOR AND DISABLED PERSONS. If a
distribution is to be made to a minor or to a person who, in the opinion of the
Committee, is unable to manage his affairs by reason of illness or mental
incompetency, such distribution may be made to or for the benefit of any such
person in such of the following ways as the Committee shall direct: (a) directly
to any such minor person if, in the opinion of the Committee, he is able to
manage his affairs, (b) to the legal representative of any such person, (c) to a
custodian under a Uniform Gifts to Minors Act for any such minor person, or (d)
to some near relative of any such person to be used for the latter's benefit.
Neither the Committee nor the Employer shall be required to see to the
application by any third party of any distribution made to or for the benefit of
a Participant or Beneficiary pursuant to this Section.
-12-
<PAGE>
3.6 SMALL BENEFITS PAID IN LUMP SUM. Notwithstanding any
provision in the Plan to the contrary, if the amount of a Participant's account
balance to be distributed under Article 3 is not more than $10,000, such amount
shall be distributed, as soon as administratively feasible on or after the date
on which such Participant's termination of service occurs, by payment in a lump
sum.
SECTION 4
GENERAL PROVISIONS
4.1 EMPLOYMENT RIGHTS. This Plan shall not be construed to
give any Participant the right to be retained in the employ of any Employer nor
any right to benefits not specifically provided for in this Plan.
4.2 RIGHTS NOT SECURED. All payments to be made pursuant to
this Plan shall be an obligation of the general assets of the Employers, and no
Employer shall be required to segregate any of its assets in order to provide
for the satisfaction of the obligations hereunder or to make any investment of
assets. Although the amounts credited to each Participant's account shall be
reflected in the Employers' accounting records, this Plan shall not be construed
to create a trust, custodial, or escrow account nor shall the Participant have
any right, title, or interest in any specific investment reserves, accounts,
funds or a trust that any Employer may
-13-
<PAGE>
accumulate or establish to aid it in providing benefits under this Plan. Nothing
contained in this Plan shall create a trust or fiduciary relationship between
any Employer and any Participant or Beneficiary. Neither a Participant nor his
Beneficiary shall acquire any interest greater than that of an unsecured
creditor.
4.3 ADMINISTRATION. This Plan shall be administered by the
Committee. The Committee shall have the same rights and duties with respect to
this Plan as the plan administrator of the TDS Plan has with respect to the TDS
Plan. The Committee will apply uniform rules to all Participants similarly
situated. The determination of the Committee as to any question arising under
this Plan shall be final and binding upon all persons. The expenses of
administering the Plan shall be borne by the Employers.
4.4 EFFECT ON OTHER PLANS. Amounts credited or paid under this
Plan shall not be considered to be compensation for the purposes of any
qualified plan maintained by any Employer.
4.5 INTERESTS NOT TRANSFERABLE. Except as provided in Section
3.3 with respect to an Obligation, the interests of the Participants and their
Beneficiaries under the Plan are not subject to the claims of their creditors
and may not be voluntarily or involuntarily assigned or encumbered in any way,
-14-
<PAGE>
including any assignment, division or awarding of property under state domestic
relations law (including community property law).
4.6 ADOPTION BY EMPLOYERS. Any corporation which is or becomes
an "Employer" under the Company Pension Plan may, with the consent of the
Company, become an Employer in this Plan by delivery to the Company of a
resolution of its board of directors or duly authorized committee to such
effect, which resolution shall specify the first Plan Year for which this Plan
shall be effective in respect of the employees of such corporation.
4.7 TAX LIABILITY. An Employer may withhold from any payment
under this Plan any taxes required to be withheld plus such sums as such
Employer may reasonably estimate to be necessary to cover any taxes for which
the Employer may be liable and which may be assessed with regard to such
payment.
4.8 CONTROLLING LAW. The law of Illinois and, where
applicable, the provisions of the Employee Retirement Income Security Act of
1974, as amended, shall be controlling in all matters relating to the Plan.
-15-
<PAGE>
SECTION 5
CLAIMS PROCEDURE
If any Participant or Beneficiary believes he is entitled to
benefits in an amount greater than those which he is receiving or has received,
he may file a claim with the Benefits Department. Such a claim shall be in
writing and state the nature of the claim, the facts supporting the claim, the
amount claimed and the address of the claimant. The Benefits Department shall
review the claim and, unless special circumstances require an extension of time,
within 90 days after receipt of the claim, give written notice by registered or
certified mail to the claimant of its decision with respect to the claim. If
special circumstances require an extension of time, the claimant shall be so
advised in writing within the initial 90-day period and in no event shall such
an extension exceed 90 days. The notice sent by the Benefits Department shall be
written in a manner calculated to be understood by the claimant and, if the
claim is wholly or partially denied, set forth the specific reasons for the
denial, specific references to the pertinent Plan provisions on which the denial
is based, a description of any additional material or information necessary for
the claimant to perfect the claim and an explanation of why such material or
information is necessary, and an explanation of the claim review procedure under
this Plan. The Benefits Department shall also advise the claimant that he or his
duly authorized representative may request a review by the Committee of the
denial by filing with the Committee within 60
-16-
<PAGE>
days after notice of the denial has been received by the claimant, a written
request for such review. The claimant shall be informed that he may have
reasonable access to pertinent documents and submit comments in writing to the
Committee within the same 60-day period. If a request is so filed, review of the
denial shall be made by the Committee and the claimant shall be given written
notice of the Committee's final decision within sixty days after receipt of such
request, unless special circumstances require an extension of time. If special
circumstances require an extension of time, the claimant shall be so advised in
writing within the initial 60-day period and in no event shall such an extension
exceed 60 days. The notice of the Committee's final decision shall include
specific reasons for the decision and specific references to the pertinent Plan
provisions on which the decision is based and shall be written in a manner
calculated to be understood by the claimant.
SECTION 6
AMENDMENT AND TERMINATION
6.1 AMENDMENT. The Company may amend this Plan at any time by
resolution duly adopted by its board of directors. No such amendment shall
reduce or otherwise adversely affect the rights of Participants or Beneficiaries
with respect to amounts accrued hereunder as of the date of such amendment.
-17-
<PAGE>
6.2 TERMINATION. Although the Company expects to continue this
Plan indefinitely, it must necessarily reserve the right to terminate this Plan
at any time by a resolution duly adopted by its board of directors.
-18-
<PAGE>
IN WITNESS WHEREOF, the Company has caused this instrument to
be executed on March 1, 1999, by its duly authorized officer to be effective as
of January 1, 1998.
TELEPHONE AND DATA SYSTEMS, INC.
By: /s/ Leroy T. Carlson, Jr.
-------------------------
LeRoy T. Carlson, Jr.
ATTEST:
By: /s/ Michael G. Hron
-------------------
Secretary
<PAGE>
[TDS LETTERHEAD]
CONFIDENTIAL EMPLOYMENT AGREEMENT
This Confidential Employment Agreement ("Agreement") is entered into by
and between Telephone and Data Systems, Inc., a Delaware corporation with its
principal place of business located in Chicago, Illinois ("TDS"), and Murray L.
Swanson, an individual currently residing at 1118 Sheridan Rd., Evanston,
Illinois 60202 ("Swanson").
WHEREAS, TDS and its subsidiaries are in the business of providing
local telephone, personal communication, and wireless communication services to
their customers;
WHEREAS, TDS has employed Swanson since 1981 and Swanson formerly held
the position of Executive Vice President - Finance and Chief Financial Officer
of TDS;
WHEREAS, Swanson is a member of TDS's Board of Directors;
WHEREAS, Swanson has acquired extensive knowledge of and experience
in TDS's business during his employment at TDS;
WHEREAS, Swanson and TDS desire to continue their employment
relationship until December 15, 1998, when Swanson will retire from TDS;
NOW, THEREFORE, in consideration of the mutual promises contained in
this Agreement and for other good and valuable consideration, the adequacy and
receipt of which the parties expressly acknowledge, Swanson and TDS agree as
follows:
1. EMPLOYMENT PERIOD. TDS will continue to employ Swanson at his
current annual salary until December 15, 1998, on which date Swanson will retire
from employment with TDS. Swanson will complete all necessary paperwork to
establish December 15, 1998 as his official TDS retirement date. Until December
15, 1998, Swanson will make himself available to TDS personnel at reasonable
times to respond to questions regarding TDS's financial matters. Nothing in this
Agreement shall preclude Swanson from seeking, accepting, or commencing
employment with an employer other than TDS prior to December 15, 1998, provided
that such employment does not violate Paragraph 11 of this Agreement.
2. EMPLOYMENT BENEFITS. TDS will maintain all of Swanson's current TDS
employment benefits until December 15, 1998 when they will cease in accordance
with the terms of the respective benefit plans. Thereafter, Swanson may continue
his medical and life insurance coverages on the same terms and conditions as any
other retiree under TDS's Retiree Insurance Plan. TDS will offer Swanson
continued dental and vision insurance coverage in accordance with TDS's Retiree
Insurance Plan for 18 months after his December 15, 1998 retirement date.
<PAGE>
3. COMPANY CAR. Swanson may keep his current company car after December
15, 1998, provided that he bears the entire cost of all expenditures for the car
after that date.
4. COMPUTER EQUIPMENT. Swanson may keep the TDS computer equipment that
he now has in his home. Swanson agrees that he will not request, and TDS will
not purchase, any additional computer equipment for Swanson's use in his home,
or elsewhere.
5. STOCK OPTIONS. On December 15, 1998, Swanson will vest in an
automatic award of 3700 stock options pursuant to the 1994 TDS Long Term
Incentive Plan. On December 15, 1998, Swanson also will vest in the 1997
performance based award of 12,950 stock options and in an automatic award of
9700 stock options pursuant to the 1998 TDS Long Term Incentive Plan. TDS shall
request its Board of Directors to grant Swanson until March 15, 1999, 90 days
after his December 15, 1998 retirement date, to exercise his stock options in
accordance with terms of those respective Plans.
6. SEPARATION PAYMENT. On Swanson's December 15, 1998 retirement date,
TDS will pay Swanson the gross amount of $365,000 less (i) any amounts earned
and paid as salary for Swanson's employment at TDS after August 31, 1998, (ii)
the $3541.67 cash advance that Swanson received when he joined TDS, and (iii)
all authorized and legally required withholding and deductions. TDS will make
such payment by check payable to Swanson and will send it to Swanson at his
address set forth in Paragraph 19 or to such other address as Swanson
subsequently notifies TDS in writing.
7. PENSION, 401(k), AND SERP PAYMENTS. As soon after Swanson's
retirement date as feasible and provided that Swanson completes the necessary
paperwork, TDS will pay Swanson his Telephone and Data Systems, Inc. Employees'
Pension Trust I Plan, 401(k), and SERP balances in accordance with the terms of
those Plans.
8. MEMBERSHIP IN TDS, UNITED STATES CELLULAR CORPORATION, AND AERIAL
COMMUNICATIONS, INC. BOARDS OF DIRECTORS. On or before the date that Swanson
executes this Agreement, Swanson will resign his positions as a member of the
Boards of Directors of United States Cellular Corporation and Aerial
Communications, Inc. by signing the resignation forms attached to this Agreement
and returning them with the signed Agreement to TDS. Nothing in this Agreement
is intended to limit or interfere with Swanson's ability to fully discharge his
continued responsibilities as a TDS Director.
9. EMPLOYMENT INQUIRIES. TDS will direct to TDS's President and Chief
Executive Officer all inquiries regarding Swanson's employment with TDS.
10. NON-DISCLOSURE AND USE OF CONFIDENTIAL AND PROPRIETARY INFORMATION.
TDS's employment of Swanson has and will result in his exposure and access to
confidential and proprietary information including, but not limited to, TDS and
its subsidiaries' customer lists, price lists, manufacturing and supply costs,
customer information, business plans, financial information, and business
strategies which Swanson did not have access to prior to his employment with TDS
and which information is of great value to TDS. Swanson shall not, at any
- 2 -
<PAGE>
time, make available to any competitor or potential competitor of TDS or of
its subsidiaries, or divulge, disclose, or communicate to any person, firm,
corporation, or other business entity other than TDS authorized personnel, in
any manner whatsoever, any such confidential or proprietary information,
unless authorized to do so in writing by TDS's President and Chief Executive
Officer. Under no circumstance shall Swanson remove any confidential or
proprietary information from TDS's premises without the express written
consent of TDS's President and Chief Executive Officer. Swanson shall not at
any time utilize any of TDS's confidential or proprietary information on
behalf of himself or any entity other than TDS or its subsidiaries.
11. RESTRICTIVE COVENANT AND EMPLOYEE NON-SOLICITATION. Until June 15,
1999, Swanson shall not directly, or through any other individual or entity,
other than on TDS's behalf:
(a) provide services similar to those provided by TDS or its
subsidiaries including, but not limited to, local telephone, personal
communication, or wireless communication services, to any customer of
TDS or of any of its subsidiaries. The term "customer" is defined as
any individual or entity for whom TDS or any of its subsidiaries
provided services during the one year period from June 15, 1998 to June
15, 1999;
(b) solicit for employment any employee of TDS or of its
subsidiaries whom TDS or any of its subsidiaries employed at any time
during the one year period from June 15, 1998 to June 15, 1999.
Nothing in this Paragraph precludes Swanson from seeking, accepting, or
commencing employment with Sonera.
12. INJUNCTIVE RELIEF. Swanson acknowledges that the covenants
contained in Paragraphs 10 and 11 above are reasonable in scope and duration, do
not unduly restrict Swanson's ability to engage in his livelihood, and are
necessary to protect TDS's legitimate business interests. Without limiting the
rights of TDS to pursue and obtain any other legal and/or equitable remedy
available to it for any breach by Swanson of the covenants contained in
Paragraphs 10 and 11 above, Swanson further acknowledges that a breach of those
covenants would cause a loss to TDS and its subsidiaries which could not
reasonably or adequately be compensated in damages in an action at law, that
remedies other than injunctive relief could not fully compensate TDS for a
breach of those covenants and that, accordingly, TDS shall be entitled to
injunctive relief to prevent any breach or continuing breaches of Swanson's
covenants set forth in Paragraphs 10 and 11 above. Swanson and TDS intend that
if, in any action before any Court empowered to enforce those covenants, the
Court finds any term, restriction, covenant or promise to be unenforceable, then
such term, restriction, covenant or promise shall be deemed modified to the
extent necessary to make it enforceable by such Court.
13. GENERAL RELEASE. Swanson, and anyone claiming through Swanson,
agree not to sue and release TDS and any and all parents, divisions,
subsidiaries, partnerships, affiliates and/or other related entities of TDS
(whether or not such entities are wholly owned) and each of those entities'
past, present, and future owners, trustees, fiduciaries, shareholders,
directors, officers, administrators, agents, partners, employees, attorneys, and
the predecessors, successors, and
- 3 -
<PAGE>
assigns of each of them (collectively, the "Released Parties"), from any and
all claims, whether known or unknown, which Swanson now has, has ever had, or
may ever have against any of the Released Parties arising from or related to any
act, omission, or thing occurring at any time prior to his signing this
Agreement including, but not limited to, any and all claims that in any way
result from, or relate to, Swanson's employment or cessation of employment with
any of the Released Parties. These released claims further include, but are not
limited to, any and all claims that Swanson could assert or could have asserted
in any federal, state, or local court, commission, department, or agency under
any common law theory, or under any fair employment, employment, contract, tort,
federal, state, or local law, regulation, ordinance, or executive order
including under the following laws as amended from time to time: the Age
Discrimination in Employment Act, Title VII of the Civil Rights Act of 1964, the
Americans With Disabilities Act, the Employee Retirement Income Security Act,
the Family and Medical Leave Act, the Illinois Human Rights Act, and the Chicago
and Cook County Human Rights Ordinances.
TDS agrees not to sue and further releases Swanson from all claims that
it now has, has ever had, or may ever have against Swanson arising from or
related to any act, omission, or thing occurring at any time prior to his
signing this Agreement.
14. ACKNOWLEDGMENT OF SUFFICIENT TIME TO CONSIDER THIS AGREEMENT AND TO
CONSULT WITH A LAWYER. Swanson expressly acknowledges that he has been informed
that he may consult with a lawyer of his choice, he has consulted with his
lawyer, and he has had sufficient time to consult with his lawyer prior to
executing this Agreement. Swanson further acknowledges that he has been informed
that he is entitled to a period of at least 21 days within which to consider
this Agreement, but that he may execute this Agreement at any time prior to the
expiration of the 21-day period.
15. REVOCATION RIGHT. Within 7 days following the date of Swanson's
execution of this Agreement, Swanson shall have the right to revoke this
Agreement by serving within such 7- day period written notice of his revocation
upon TDS's President and Chief Executive Officer. If Swanson does not revoke
this Agreement during this 7-day period, this Agreement shall become effective
on the eighth day after the date of Swanson's execution of this Agreement and
Swanson shall have no further right to revoke this Agreement.
16. KNOWING AND VOLUNTARY RELEASE. Swanson acknowledges that in
releasing and waiving any claims and rights that he has or may have against the
Released Parties, including those under the Age Discrimination in Employment
Act, he does so knowingly and voluntarily, in exchange for consideration in
addition to anything of value to which he already is entitled.
17. RETURN OF TDS PROPERTY. Immediately upon TDS's request and no later
than December 15, 1998, Swanson shall return to TDS all of TDS's property in his
possession that does not relate to his TDS Board responsibilities. This property
includes, but is not limited to, TDS's financial records, company credit cards,
tapes, records, manuals, employee lists, customer lists, brochures, files,
catalogs, price lists, cost information, keys, equipment, and all copies
thereof.
- 4 -
<PAGE>
18. CONFIDENTIAL AGREEMENT. The existence and the terms of this
Agreement are confidential. Accordingly, Swanson shall not disclose the
existence or terms of this Agreement to anyone other than to his attorney, his
immediate family, or as required by law.
19. NOTICES. All notices and other communications required or permitted
under this Agreement shall be deemed to have been duly given and made if in
writing and if served personally on the party for whom intended or by being
deposited, postage prepaid, certified or registered mail, return receipt
requested, in the United States mail bearing the address shown below for each
such party or such other address as that party may designate in writing
hereafter:
<TABLE>
<S> <C>
(a) If to TDS: (b) If to Swanson:
LeRoy T. Carlson, Jr. Murray L. Swanson
President and Chief Executive Officer 1118 Sheridan Rd.
Telephone and Data Systems, Inc. Evanston, Illinois 60202-1442
30 North LaSalle Street
Suite 4000
Chicago, Illinois 60602-2507
</TABLE>
20. WAIVER. TDS's future waiver of a breach by Swanson of any provision
of this Agreement or failure to enforce any such provision with respect to him
shall not operate or be construed as a waiver of any subsequent breach by
Swanson of any such provision or of Swanson's right to enforce any such
provision with respect to Swanson. No act or omission of TDS shall constitute a
waiver of any of its rights hereunder except for a written waiver signed by
TDS's President and Chief Executive Officer.
21. ENTIRE AGREEMENT. This Agreement embodies the entire agreement and
understanding of Swanson and TDS with regard to the matters described in this
Agreement, and supersedes any and all prior and/or contemporaneous agreements
and understandings, oral or written, between Swanson and TDS.
22. GOVERNING LAW. This Agreement shall be governed by the laws of the
State of Illinois without regard to its conflicts of laws rules.
- 5 -
<PAGE>
SWANSON AND TDS EXPRESSLY STATE THAT THEY HAVE READ THIS
AGREEMENT, THAT THEY UNDERSTAND EACH OF ITS TERMS, AND THAT
THEY INTEND TO BE BOUND THEREBY.
TELEPHONE AND DATA SYSTEMS, INC. MURRAY L. SWANSON
By: /S/ LEROY T. CARLSON, JR. /S/ MURRAY L. SWANSON
------------------------------------- ---------------------
LeRoy T. Carlson, Jr.
President and Chief Executive Officer
Dated: October 15, 1998 Dated: October 15, 1998
- 6 -
<PAGE>
EXHIBIT 12
TELEPHONE AND DATA SYSTEMS, INC.
RATIOS OF EARNINGS TO FIXED CHARGES
FOR THE YEAR ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS, EXCEPT RATIO AMOUNTS)
<TABLE>
<S> <C>
EARNINGS:
Income from Continuing Operations before Income Taxes.......................... $ 133,705
Add (Deduct):
Minority Share of Losses..................................................... (76,380)
Earnings on Equity Method.................................................... 29,250
Distributions from Minority Subsidiaries..................................... 28,912
Amortization of Capitalized Interest......................................... 1,261
Minority share of income in majority-owned subsidiaries that have fixed
charges.................................................................... 41,499
ADD FIXED CHARGES:
Consolidated interest expense................................................ 149,864
Interest Portion (1/3) of Consolidated Rent Expense.......................... 20,395
---------
$ 328,506
FIXED CHARGES:
Consolidated interest expense.................................................. $ 149,864
Capitalized interest........................................................... 132
Interest Portion (1/3) of Consolidated Rent Expense............................ 20,395
---------
$ 170,391
---------
---------
RATIO OF EARNINGS TO FIXED CHARGES............................................... 1.93
---------
---------
Tax-Effected Redeemable Preferred Dividends.................................... $ 163
Fixed Charges.................................................................. 170,391
---------
Fixed Charges and Redeemable Preferred Dividends............................. $ 170,554
---------
---------
RATIO OF EARNINGS TO FIXED CHARGES AND REDEEMABLE PREFERRED DIVIDENDS............ 1.93
---------
---------
Tax-Effected Preferred Dividends............................................... $ 3,022
Fixed Charges.................................................................. 170,391
---------
Fixed Charges and Preferred Dividends........................................ $ 173,413
---------
---------
RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS....................... 1.89
---------
---------
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
Selected Consolidated Financial Data 1
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Operating Revenues $1,805,725 $1,370,541 $1,075,127 $ 835,157 $ 633,971
Operating (Loss) Income from Ongoing Operations (9,498) 33,135 190,015 140,995 108,991
Gain on Sale of Cellular and Other Investments 262,698 41,438 138,735 86,625 7,457
Net Income (Loss) Available to Common 62,757 (11,441) 126,182 101,469 57,362
From Operations (71,805) (27,355) 61,710 60,819 51,598
From Gains $ 134,562 $ 15,914 $ 64,472 $ 40,650 $ 5,764
Weighted Average Shares Outstanding (000s) 60,982 60,211 60,464 57,456 53,295
Basic Earnings per Share $ 1.03 $ (.19) $ 2.09 $ 1.77 $ 1.08
Diluted Earnings per Share $ 1.03 $ (.19) $ 2.07 $ 1.74 $ 1.06
Pretax Profit on Revenues 7.4% 1.4% 23.4% 22.2% 16.0%
Effective Income Tax Rate 51.8% N/M 49.1% 43.8% 40.2%
Dividends per Common
and Series A Common Share $ .44 $ .42 $ .40 $ .38 $ .36
Cash and Cash Equivalents
and Temporary Investments $ 60,424 $ 75,567 $ 119,297 $ 80,851 $ 44,566
Working Capital (217,940) (496,302) (161,619) (153,681) (148,474)
Property, Plant and Equipment (Net) 2,672,589 2,543,959 1,873,208 1,315,114 1,077,613
Total Assets 5,527,545 4,971,601 4,200,969 3,469,082 2,790,127
Notes Payable 170,889 527,587 160,537 184,320 98,608
Long-term Debt (including current portion) 1,569,042 1,279,034 1,018,851 894,584 562,165
Common Stockholders' Equity 2,237,908 1,968,119 2,032,941 1,684,365 1,473,038
Capital Expenditures $ 558,332 $ 786,317 $ 550,204 $ 359,996 $ 319,701
Current Ratio .7 .5 .7 .6 .5
Common Equity per Share $ 36.12 $ 32.06 $ 33.23 $ 29.01 $ 26.85
Return on Equity 3.0% (.6%) 6.8% 6.4% 4.3%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
N/M - NOT MEANINGFUL
<PAGE>
- --------------------------------------------------------------------------------
2 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 provided high-quality telecommunications
services to approximately 3.0 million cellular telephone, telephone and personal
communications services ("PCS") customers in 35 states at December 31, 1998. The
Company conducts substantially all of its cellular telephone operations through
its 81.0%-owned subsidiary, United States Cellular Corporation ("U.S.
Cellular"), its telephone operations through its wholly-owned subsidiary, TDS
Telecommunications Corporation ("TDS Telecom") and its PCS operations through
its 82.3%-owned subsidiary, Aerial Communications, Inc.("Aerial"). In December
1998, TDS announced the withdrawal of its offers to exchange tracking stocks for
the outstanding Common Shares of U.S. Cellular and Aerial which it did not own.
TDS also announced that it was pursuing a tax-free spin-off of its 82.3%
interest in Aerial, as well as reviewing other alternatives. See Liquidity and
Note 1--Corporate Restructuring of Notes to Consolidated Financial Statements.
RESULTS OF OPERATIONS
The TDS results of operations in 1998 and 1997 reflect the rapid growth of U.S.
Cellular's operations, the steady growth of TDS Telecom operations, and Aerial's
developing operations. Revenues increased 32% in 1998 and 27% in 1997 as
customer units grew by 29% and 51%, respectively. Operating expenses increased
36% in 1998 and 51% in 1997 reflecting the growth in operations as well as the
start-up of Aerial's operations in 1997. Aerial's operating losses have offset
improvements in U.S. Cellular's operations and was the primary factor that
caused operating income to decrease by $18.7 million in 1998 and $155.6 million
in 1997. The Company has sold various majority and minority cellular interests
and certain other investments during the last few years resulting in significant
gains, particularly in 1998 and 1996. Investment and other income increased
$192.0 million in 1998 primarily as a result of a $221.3 million increase in
such gains. Interest expense and trust preferred securities distributions
increased $36.6 million and $22.0 million, respectively, in 1998 reflecting the
sale of debt and trust preferred securities in 1998, 1997 and 1996.
Net income available to common and diluted earnings per share totaled $62.8
million, or $1.03 per share, in 1998 compared to a net loss of $11.4 million, or
$.19 per share, in 1997 and net income of $126.2 million, or $2.07 per share, in
1996. Net income available to common was significantly affected by gains from
the sale of cellular interests and other investments and losses from the
start-up and launch of service in Aerial's markets. Gains increased net income
available to common by $134.6 million, or $2.21 per share, in 1998, $15.9
million, or $.26 per share, in 1997 and $64.5 million, or $1.05 per share, in
1996. Aerial losses decreased net income available to common by $181.1 million,
or $2.97 per share, in 1998, $129.4 million, or $2.15 per share, in 1997 and
$15.3 million, or $.25 per share, in 1996. Net income available to common and
diluted earnings per share, excluding gains and Aerial losses, totaled $109.3
million, or $1.79 per share, in 1998 compared to $102.1 million, or $1.70 per
share, in 1997 and $77.0 million, or $1.27 per share, in 1996.
The table below summarizes the effects of the business segments operations
and gains (along with the related impact of income taxes and minority interest)
on net income (loss) available to common and diluted earnings per share.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ---------------------------------------------------------------------------
(DOLLARS IN MILLIONS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net Income (Loss) Available to Common
U.S. Cellular $ 72.0 $ 77.1 $ 43.2
TDS Telecom 41.7 54.5 62.5
Aerial (181.1) (129.4) (15.3)
Parent and Other (4.4) (29.5) (28.7)
Gains 134.6 15.9 64.5
--------------------------------
$ 62.8 $(11.4) $ 126.2
--------------------------------
Diluted Earnings Per Share
U.S. Cellular $ 1.18 $ 1.28 $ .71
TDS Telecom .68 .91 1.03
Aerial (2.97) (2.15) (.25)
Parent and Other (.07) (.49) (.47)
Gains 2.21 .26 1.05
--------------------------------
$ 1.03 $ (.19) $ 2.07
- ---------------------------------------------------------------------------
</TABLE>
U.S. Cellular's net income to common, excluding gains, decreased in 1998
primarily as a result of decreased investment income and increased interest and
income tax expense offset somewhat by increased operating income due to rapid
customer growth. The decline in net income to common at TDS Telecom was a result
of slower growth in telephone operations and increased losses from new business
ventures. The increase in net loss at Aerial in 1998 was primarily a result of
efforts to expand the customer base. The increase in net income to common from
Parent and Other in 1998 related primarily to income tax benefits. Management
expects a significant reduction in gains in 1999 which may cause net income to
be lower. However, management expects U.S. Cellular's and TDS Telecom's net
income to grow as U.S. Cellular adds more customers and as TDS Telecom's
competitive local exchange carrier ("CLEC") operations add more customers. TDS
Telecom's net income was reduced in 1998 as a result of the costs to exit the
LAN wiring business.
<PAGE>
3
OPERATING REVENUES increased 32% ($435.2 million) during 1998 and 27% ($295.4
million) during 1997 reflecting primarily growth in customer units offset
somewhat by reductions in average service revenue per customer at U.S. Cellular
and Aerial. Customer units increased 29% in 1998 and 51% in 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Customer Units
U.S. Cellular 2,183,000 1,710,000 1,073,000
TDS Telecom 547,500 515,500 484,500
Aerial 311,900 125,000 --
---------------------------------------
3,042,400 2,350,500 1,557,500
- -----------------------------------------------------------------------------
</TABLE>
U.S. Cellular revenues increased $285.5 million in 1998 and $196.9 million in
1997 on 28% and 59% increases in customer units and 12% and 13% increases in
inbound roaming revenues, respectively. Aerial revenues increased $99.2 million
in 1998 and totaled $56.0 million in 1997 reflecting the growth in customer
units. TDS Telecom revenues increased $50.5 million in 1998 and $42.6 million in
1997 as a result of recovery of increased costs of providing long-distance
services, internal access line growth, increased network usage and growth in new
business ventures.
U.S. Cellular contributed 64% of consolidated revenue in 1998 compared to 64%
in 1997 and 63% in 1996. TDS Telecom contributed 27%, 32% and 37%, respectively,
of consolidated revenue in 1998, 1997 and 1996. Aerial contributed 9% and 4% of
consolidated revenue in 1998 and 1997, respectively.
OPERATING EXPENSES rose 36% ($477.8 million) in 1998 and 51% ($452.3
million) in 1997. U.S. Cellular operating expenses increased $239.0 million
during 1998 and $154.7 million during 1997 due to the expansion of the customer
base as well as the provision of service to the larger customer base. Aerial's
operating expenses increased $182.6 million in 1998 and totaled $252.5 million
in 1997 reflecting expenses to develop its markets and add customers. TDS
Telecom operating expenses increased $56.2 million during 1998 and $45.1 million
during 1997 due to growth in telephone operations and the development and
start-up of new business ventures.
OPERATING INCOME (LOSS) totaled a loss of $20.9 million in 1998, a loss
of $2.2 million in 1997 and income of $153.4 million in 1996 reflecting
significant increases in losses at Aerial offset somewhat by strong growth at
U.S. Cellular.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- -------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating Income (Loss)
U.S. Cellular $ 176,075 $ 129,543 $ 87,366
TDS Telecom 94,412 100,143 102,649
Aerial (279,985) (196,551) --
-------------------------------------
(9,498) 33,135 190,015
American Paging
Operating (Loss) (11,406) (35,307) (36,626)
-------------------------------------
$ (20,904) $ (2,172) $ 153,389
- -------------------------------------------------------------------------
</TABLE>
U.S. Cellular's operating income increased 36% ($46.5 million) in 1998 and
48% ($42.2 million) in 1997 reflecting the increase in customers and revenues.
U.S. Cellular's operating margin, as a percent of service revenues, has
increased steadily to 15.7% in 1998 from 15.2% in 1997 and 13.2% in 1996. TDS
Telecom's operating income decreased $5.7 million in 1998 and $2.5 million in
1997. The decrease in TDS Telecom's operating income primarily reflects CLEC
start-up losses. TDS Telecom's operating margin continued its decline to 19.3%
in 1998 from 22.9% in 1997 and 26.0% in 1996 due primarily to the impact of CLEC
start-up losses. Continued pressure on revenue streams, slightly higher
operating costs, improvements to the telephone network, expenditures to develop
programs which are aimed at improving customer satisfaction and resale of
lower-margin services also contributed to the decline in operating margin.
Aerial's operating loss totaled $280.0 million in 1998 and $196.6 million in
1997, reflecting the costs associated with launching service and developing a
customer base in its markets.
TDS contributed substantially all of the assets and certain limited
liabilities of American Paging Inc. ("American Paging") to TSR Wireless
Holdings, LLC ("TSR Wireless") effective March 31, 1998. American Paging's
revenues were netted against its expenses for the periods presented with the
resulting operating loss reported as American Paging Operating (Loss). American
Paging's operating revenues totaled $17.8 million and operating expenses totaled
$29.2 million for the three month period ended March 31, 1998. American Paging's
operating revenues totaled $94.4 million and $104.2 million in 1997 and 1996,
respectively, and operating expenses totaled $129.7 million and $140.8 million,
respectively. TDS incurred $8.7 million in expenses related to severance pay,
legal expenses, investment banker fees, etc. to exit the paging business in
1998. Beginning April 1, 1998, TDS followed the equity method of accounting for
its 30%
<PAGE>
4
interest in TSR Wireless and reported these results as a component of
Investment income. TDS's portion of TSR Wireless' results of operations and
the amortization of costs in excess of the underlying book value decreased
income $11.8 million.
INVESTMENT AND OTHER INCOME (EXPENSE) totaled $304.5 million in 1998,
$112.4 million in 1997 and $141.2 million in 1996. Investment and other
income (expense) includes interest and dividend income, investment income,
gain on sale of cellular and other investments, PCS development costs, other
(expense) income, net and minority share of (loss) income.
INVESTMENT INCOME, the Company's share of income from investments in which
the Company has a minority interest and follows the equity method of accounting,
primarily cellular investments, decreased 50% ($40.5 million) in 1998 and
increased 39% ($22.7 million) in 1997. Investment income decreased in 1998 as a
result of the sale of certain cellular minority interests to AirTouch
Communications, Inc. ("AirTouch") in 1998 and the transfer of certain cellular
minority interests to BellSouth Corporation ("BellSouth") in the fourth quarter
of 1997. See Financial Resources--Acquisitions, Exchanges and Sales.
GAIN ON SALE OF CELLULAR AND OTHER INVESTMENTS totaled $262.7 million in
1998, $41.4 million in 1997 and $138.7 million in 1996. TDS sold various
majority and minority cellular interests and other investments in the past
few years resulting in the recognition of gains.
PCS DEVELOPMENT COSTS totaled $21.6 million in 1997 and $43.9 million in
1996. Expenses incurred by Aerial prior to the launch of operations in March
1997, primarily to recruit an experienced management team, develop and
execute a business plan, raise capital and design and construct its PCS
networks, were reported in Investment and Other Income (Expense). Revenues
and expenses incurred subsequent to the launch of service are included as a
component of operating income.
OTHER (EXPENSE) INCOME, NET for the year 1998 includes additional
expenses relating to the corporate restructuring ($10.6 million), a LAN
wiring business and the cost to exit this business ($11.9 million), and costs
to exit the paging business ($8.7 million).
MINORITY SHARE OF (LOSS) INCOME includes U.S. Cellular's, Aerial's and
American Paging's minority public shareholders' share of net income or loss
and the minority shareholders' or partners' share of subsidiaries' net income
or loss. The change in 1998 and 1997 is primarily related to increased Aerial
losses allocated to its minority shareholders. A minority investor paid $200
million in 1998 for approximately a 19% interest in a subsidiary of Aerial.
Minority public shareholders of American Paging were not allocated losses
since 1996 because American Paging's shareholders' equity was negative.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Minority Share of (Income) Loss
U.S. Cellular
Minority Public
Shareholders' Share $(41,083) $(21,264) $(25,179)
Subsidiaries' Minority
Shareholders' or
Partners' Share (6,039) (12,298) (13,743)
---------------------------------
(47,122) (33,562) (38,922)
---------------------------------
Aerial
Minority Public
Shareholders' Share 52,354 43,038 4,944
Subsidiary's Minority
Shareholders' Share 23,620 -- --
---------------------------------
75,974 43,038 4,944
American Paging -- -- 6,368
Telephone Subsidiaries
and Other (339) (1,160) 1,294
---------------------------------
$ 28,513 $ 8,316 $(26,316)
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
INTEREST EXPENSE increased 41% ($36.6 million) in 1998 and 113% ($48.4
million) in 1997. Interest expense increased in 1998 due primarily to larger
long-term debt balances from U.S. Cellular's sale of debt in 1997, Aerial's
vendor financing and issuance of zero coupon notes in 1998, TDS's sale of notes
in 1998 ($27.6 million), and smaller amounts of capitalized interest ($10.9
million) offset somewhat by decreased short-term debt balances ($2.2 million).
Interest expense increased in 1997 due primarily to additional interest expense
from larger short-term debt balances ($19.6 million), a smaller amount of
capitalized interest ($16.6 million) and 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).
TDS and Aerial capitalized interest totaling $132,000 in 1998, $11.0
million in 1997 and $27.6 million in 1996 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 (Trust Preferred
Securities Distributions) totaled $23.5 million in 1998 and $1.5 million in
1997. The increase in 1998 reflects a full year of dividends on the
securities issued in 1997 as well as dividends on additional securities
issued in 1998. In November 1997, a wholly-owned subsidiary trust issued
$150,000,000 of 8.5% Trust Originated Preferred Securities. In February 1998,
another wholly-owned subsidiary trust issued $150,000,000 of 8.04% Trust
Originated Preferred Securities.
INCOME TAX EXPENSE was $69.3 million in 1998, $28.6 million in 1997, and
$123.6 million in 1996. The period to period change reflects primarily the
changes in pretax income.
<PAGE>
5
NET INCOME (LOSS) AVAILABLE TO COMMON was $62.8 million in 1998, ($11.4
million) in 1997 and $126.2 million in 1996. DILUTED EARNINGS PER COMMON SHARE
was $1.03 in 1998, ($.19) in 1997 and $2.07 in 1996.
CELLULAR TELEPHONE OPERATIONS
The Company provides cellular telephone service through United States Cellular
Corporation ("U.S. Cellular"), an 81.0%-owned subsidiary. U.S. Cellular owns,
manages and invests in cellular markets throughout the United States. In
December 1998, TDS announced the withdrawal of its offer to exchange tracking
stocks for the outstanding Common Shares of U.S. Cellular which it did not own.
See Note 1--Corporate Restructuring of Notes to Consolidated Financial
Statements.
Rapid growth in the customer base is the primary reason for the growth
in U.S. Cellular's results of operations in 1998 and 1997. The number of
customers increased 28% to 2,183,000 at December 31, 1998, and increased 59%
to 1,710,000 at December 31, 1997. U.S. Cellular added 454,000 net new
customers from its marketing efforts and 19,000 customers from acquisitions
in 1998 compared to 442,000 net new customers from its marketing efforts and
195,000 customers from acquisitions, primarily the exchange with BellSouth
which occurred at the end of October 1997.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996
- -------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS,
EXCEPT PER CUSTOMER AMOUNTS)
<S> <C> <C> <C>
Operating Revenues
Local retail $ 772,803 $568,578 $414,815
Inbound roaming 242,605 217,499 193,278
Long-distance and Other 108,046 66,914 54,588
---------------------------------------
Service Revenues 1,123,454 852,991 662,681
Equipment sales 39,013 23,974 17,387
---------------------------------------
1,162,467 876,965 680,068
---------------------------------------
Operating Expenses
System operations 193,625 153,137 117,368
Marketing and selling 228,844 178,984 130,310
Cost of equipment sold 94,378 82,302 74,023
General and administrative 262,766 200,620 162,162
Depreciation and
amortization 206,779 132,379 108,839
---------------------------------------
986,392 747,422 592,702
---------------------------------------
Operating Income $ 176,075 $129,543 $ 87,366
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Consolidated Markets:
Markets 138 134 131
Market penetration 8.84% 7.11% 4.94%
Cell sites in service 2,065 1,748 1,328
Average monthly service
revenue per customer $ 48.61 $ 54.18 $ 63.69
Churn rate per month 1.9% 1.9% 1.9%
Marketing cost per gross
customer addition $ 317 $ 318 $ 332
Employees 4,800 4,600 3,800
- -------------------------------------------------------------------------------
</TABLE>
OPERATING REVENUES increased 33% ($285.5 million) in 1998 and 29% ($196.9
million) in 1997. The revenue increases in 1998 and 1997 were driven by growth
in customer units and the 12% and 13% growth in inbound roaming revenues in 1998
and 1997, respectively. Increased promotional activity and improved consumer
awareness of wireless communications were key factors contributing to customer
growth. Lower negotiated roaming rates among carriers and lower revenue per
customer due to competitive pricing pressures, incentive plans and consumer
market penetration have partially offset the revenue growth resulting from the
increase in the customer base. Average monthly service revenue per customer was
$48.61 in 1998, $54.18 in 1997 and $63.69 in 1996. The addition of the markets
from the exchange with BellSouth in the fourth quarter of 1997 also contributed
to the decline in both local retail revenue per customer and inbound roaming
revenue per customer. These markets produced a lower amount of local retail
revenue per customer, and the addition of these markets caused the elimination
of certain inbound roaming revenues between U.S. Cellular's existing markets and
these markets. 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 REVENUES (charges to U.S. Cellular's customers for local
system usage) increased 36% ($204.2 million) in 1998 and 37% ($153.8 million) in
1997 due primarily to the growth in customers. Average monthly local retail
revenue per customer was $33.44 in 1998, $36.11 in 1997 and $39.87 in 1996.
Local minutes of use averaged 105 per month in 1998, 103 per month in 1997 and
107 per month in 1996. Average revenue per minute was $.32 in 1998, $.35 in 1997
<PAGE>
6
and $.37 in 1996. Competitive pressures and use of incentive programs that
encourage lower-priced weekend and off-peak usage, in order to stimulate overall
usage, resulted in the decrease in average monthly local retail revenue per
minute of use. The decrease in average monthly retail revenue per customer
primarily reflects the increasing level of competition for wireless services and
the continued penetration of the consumer market.
INBOUND ROAMING REVENUES (charges to other cellular service providers whose
customers use U.S. Cellular's cellular systems when roaming) increased 12%
($25.1 million) in 1998 and 13% ($24.2 million) in 1997. Minutes of use
increased 48% in 1998 and 27% in 1997. Average revenue per minute of use was
$.65 in 1998, $.83 in 1997 and $.92 in 1996, reflecting negotiated reductions in
roaming rates.
LONG-DISTANCE AND OTHER SERVICE REVENUES increased 61% ($41.1 million) in
1998 and 23% ($12.3 million) in 1997 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 32% ($239.0 million) in 1998 and 26% ($154.7
million) in 1997. Operating expenses as a percent of service revenue were 87.8%
in 1998, 87.6% in 1997 and 89.4% in 1996. The overall increase in operating
expenses is primarily due to increased general and administrative expenses
($62.1 million in 1998 and $39.7 million in 1997); the costs to expand the
customer base ($61.9 million in 1998 and $57.0 million in 1997); the cost of
providing service to the expanding customer base ($40.5 million in 1998 and
$35.8 million in 1997); and additional depreciation and amortization on the
increased investment in cell sites and equipment ($74.4 million in 1998 and
$23.5 million in 1997).
General and administrative expenses (costs of local business offices and
corporate expenses) as a percent of service revenues were 23.4% in 1998, 23.5%
in 1997 and 24.5% in 1996. The overall increases in administrative expenses
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.
Costs to expand the customer base represent marketing and selling expenses
and the cost of equipment sold. These expenses less equipment sales revenue
represent the cost to acquire a new customer. The cost to acquire a new cellular
customer was $317 in 1998, $318 in 1997 and $332 in 1996. The decrease in cost
per gross customer activation has been slowed somewhat by additional advertising
expenses incurred to promote U.S. Cellular and to distinguish U.S. Cellular's
service offerings from those of competitors. Gross customer activations
(excluding acquisitions) rose 20% in 1998 to 896,000 and 33% in 1997 to 746,000
from 563,000 in 1996.
Costs of providing service (system operations expenses) as a percent of
service revenues were 17.2% in 1998, 18.0% in 1997 and 17.7% in 1996. Systems
operations expenses include 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), and maintenance, utility and
cell site expenses.
Customer usage expenses were 11.6% of service revenues in 1998, 11.7% in
1997 and 11.4% in 1996. The overall increase in customer service expenses 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.
Maintenance, utility and cell site expenses were 5.7% of service
revenues in 1998, 6.3% in 1997 and 6.3% in 1996. The number of cell sites
operated increased to 2,065 in 1998 from 1,748 in 1997 and 1,328 in 1996.
Depreciation expense as a percent of service revenues was 14.9% in 1998,
11.4% in 1997 and 11.3% in 1996. Depreciation expense increased 71% ($69.6
million) in 1998 and 31% ($23.0 million) in 1997, reflecting increases in
average fixed asset balances of 27% and 35%, respectively. Increased fixed asset
balances in both years resulted from the addition
<PAGE>
7
of new cell sites built to improve coverage and capacity, from upgrades to
provide digital service and from the acquisition of markets from BellSouth in
late 1997. The increase in 1998 also reflects a reduction in useful lives of
certain assets beginning in 1998 which increased depreciation expense by $23.2
million. Depreciation expense is expected to increase by approximately the same
percentage as the increase in average fixed assets in 1999.
OPERATING INCOME increased 36% ($46.5 million) to $176.1 million in 1998
from $129.5 million in 1997 and $87.4 million in 1996. The improvement was
primarily driven by the substantial growth in customers and revenue.
Operating margin, as a percent of service revenue, improved to 15.7% in 1998
from 15.2% in 1997 and 13.2% in 1996.
Management believes U.S. Cellular's operating results reflect
seasonality 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 two and one-half years. U.S.
Cellular expects PCS operators to continue deployment of PCS in portions of
all its market clusters through 1999. U.S. Cellular has increased its
advertising, particularly brand advertising, to promote the United States
Cellular brand and distinguish its service from other wireless communications
providers. U.S. Cellular's management continues to monitor other wireless
communications providers' strategies to determine how this additional
competition is affecting U.S. Cellular's 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. However, management anticipates that customer growth
may be lower in the future, primarily as a result of the increase in the
number of competitors in its markets.
TELEPHONE OPERATIONS
The Company operates its landline telephone business through TDS
Telecommunications Corporation ("TDS Telecom"), a wholly-owned subsidiary.
TDS Telecom's incumbent local exchange carrier ("ILEC") subsidiaries served
547,500 access lines at the end of 1998 compared to 515,500 at the end of
1997 and 484,500 at the end of 1996 ("ILEC operations").
In late 1997, TDS Telecom began preparations to enter into competition
with incumbent local exchange carriers in certain markets in Wisconsin, not
served by TDS Telecom, by setting up TDS Metrocom, a competitive local
exchange company ("CLEC"). TDS Metrocom began operations in early 1998. TDS
Telecom also entered into certain markets in Minnesota as a CLEC through
USLink. USLink was primarily a long-distance provider prior to beginning CLEC
operations in 1998. TDS Metrocom and USLink are reported as CLEC operations.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT
PER ACCESS LINE AMOUNTS)
<S> <C> <C> <C>
Operating Revenues
ILEC Revenues
Local service $ 136,656 $ 122,826 $ 110,501
Network access and
Long-distance 256,272 235,725 213,113
Miscellaneous 68,432 57,759 49,400
-----------------------------------
Total ILEC Revenues 461,360 416,310 373,014
CLEC Revenues 29,743 23,007 23,103
Intercompany Revenues (2,999) (1,693) (1,058)
-----------------------------------
Total Operating Revenues 488,104 437,624 395,059
-----------------------------------
Operating Expenses
ILEC Expenses
Network operations 94,684 81,798 67,930
Depreciation and
amortization 108,173 96,488 86,025
Customer operations 72,949 67,877 55,682
Corporate operations 81,679 69,776 62,878
-----------------------------------
Total ILEC Expense 357,485 315,939 272,515
CLEC Expenses 39,206 23,235 20,953
Intercompany Expenses (2,999) (1,693) (1,058)
-----------------------------------
Total Operating Expenses 393,692 337,481 292,410
-----------------------------------
Operating Income $ 94,412 $ 100,143 $ 102,649
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
Access lines (ILEC) 547,500 515,500 484,500
Access lines (CLEC) 38,800 -- --
Growth in ILEC access lines
from prior year-end:
Acquisitions 6,500 3,200 33,100
Internal growth 25,500 27,800 25,500
Average monthly revenue
per ILEC access line $ 71.85 $ 69.43 $ 67.30
Employees 2,500 2,400 2,200
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
<PAGE>
8
OPERATING REVENUES totaled $488.1 million in 1998, up 12% ($50.5
million) from 1997 which totaled $437.6 million and was up 11% ($42.6
million) from 1996. The increase was due to the growth in ILEC operations
($45.0 million in 1998 and $43.3 million in 1997) and the start-up of CLEC
activities ($6.8 million in 1998). Average monthly revenue per ILEC access
line was $71.85 in 1998, $69.43 in 1997 and $67.30 in 1996 reflecting
primarily growth in miscellaneous and local service revenues.
LOCAL SERVICE REVENUES (provision of local telephone exchange service
within the franchise serving area of TDS Telecom's ILECs) increased 11%
($13.8 million) in 1998 and 11% ($12.3 million) in 1997. Average monthly
local service revenue per customer was $21.28 in 1998, $20.49 in 1997 and
$19.94 in 1996. Access line growth, excluding acquisitions, of 4.9% in 1998
and 5.7% in 1997 resulted in increases in revenues of $6.0 million and $5.7
million, respectively. The sale of custom-calling and advanced features
increased revenues by $4.4 million in 1998 and $3.1 million in 1997.
Acquisitions increased revenues by $1.9 million in 1998 and $2.7 million in
1997.
NETWORK ACCESS AND LONG-DISTANCE REVENUES (compensation for carrying
interstate and intrastate long-distance traffic on TDS Telecom's ILEC networks)
increased 9% ($20.5 million) in 1998 and 11% ($22.6 million) in 1997. Average
monthly network access and long-distance revenue per customer was $39.91 in
1998, $39.31 in 1997 and $38.45 in 1996. Revenue generated from access minute
growth due to increased network usage increased $8.2 million in 1998 and $5.7
million in 1997. Recovery of increased costs of providing long-distance services
resulted in increases in revenue of $5.9 million in 1998 and $12.1 million in
1997. An additional $2.2 million of additional cost recovery was recorded in
late 1998 as a result of the ice storm damage in the Northeast earlier in the
year. Acquisitions increased revenues by $5.5 million in 1998 and $4.5 million
in 1997.
MISCELLANEOUS REVENUES (charges for (i) leasing, selling, installing and
maintaining customer premise equipment, (ii) providing billing and collection
services, (iii) providing Internet services and (iv) selling of digital
broadcast satellites) increased 18% ($10.7 million) in 1998 and 17% ($8.4
million) in 1997. Average monthly miscellaneous revenue per customer was $10.66
in 1998, $9.63 in 1997 and $8.91 in 1996. Increased sales of customer premise
equipment, including digital broadcast satellites, increased revenues by $5.8
million in 1998 and $6.1 million in 1997. Revenues from providing Internet
service increased by $3.6 million in 1998 and $2.8 million in 1997. Acquisitions
increased revenues by $1.6 million in 1998 and $1.0 million in 1997.
CLEC operating revenues increased 29% ($6.7 million) to $29.7 million in
1998 and declined $100,000 to $23.0 million in 1997. TDS Metrocom generated $3.6
million of revenue in 1998 as it began operations while USLink increased
revenues by $3.1 million as it also began CLEC operations. Revenues in 1997 and
1996 were primarily from USLink long-distance services.
OPERATING EXPENSES totaled $393.7 million in 1998, up 17% ($56.2 million)
from 1997 and totaled $337.5 million in 1997, up 15% ($45.1 million) from 1996.
The increase in operating expenses is primarily due to increased costs to
provide advanced telecommunications services to customers ($12.9 million in 1998
and $13.9 million in 1997), corporate expenses ($11.9 million in 1998 and $6.9
million in 1997), costs to serve customers ($5.1 million in 1998 and $12.2
million in 1997), and additional depreciation and amortization on the increased
investment in equipment ($11.7 million in 1998 and $10.5 million in 1997).
Network operations expenses include network maintenance, costs of providing
advanced services, costs of customer premise equipment and costs of digital
satellites sold. Network operations expenses as a percent of revenue were 20.5%
in 1998, 19.6% in 1997 and 18.2% in 1996. Cost of goods sold for customer
premise equipment, including digital broadcast satellites, increased expenses by
$4.2 million in 1998 and $5.2 million in 1997. The costs to develop and maintain
the Network Management Center to provide more effective network monitoring and
maintenance increased expenses by $2.6 million in 1998 and $1.8 million in 1997.
Support payments made to the Federal high cost pool in 1998 increased expense by
$3.0 million. Emergency work related to the ice
<PAGE>
9
storm damage in the Northeast increased expenses by $2.4 million in 1998.
Acquisitions increased network operations expenses by $3.0 million in 1998 and
$1.5 million in 1997.
Corporate expenses as a percent of revenue were 17.7% in 1998, 16.8% in
1997 and 16.9% in 1996. Information systems expenses increased by $5.8
million in 1998 and $3.8 million in 1997. Acquisitions increased corporate
expenses by $2.0 million in 1998 and $1.3 million in 1997.
Costs to serve customers, including costs for marketing, sales and
product management, as a percent of revenues were 15.8% in 1998, 16.3% in
1997 and 14.9% in 1996. Information systems support increased expenses by
$1.1 million in 1998 and $3.8 million in 1997. Additional product management
increased expenses by $1.1 million in 1998 and product advertising for
digital broadcast satellites and advanced calling features increased expenses
by $4.7 million in 1997. Acquisitions increased customer expenses by $1.3
million in 1998 and $1.4 million in 1997.
Depreciation and amortization expenses as a percent of revenues were 23.4%
in 1998, 23.2% in 1997 and 23.1% in 1996.
CLEC operating expenses increased 69% ($16.0 million) in 1998 and 11%
($2.3 million) in 1997. TDS Metrocom increased expenses by $10.9 million in
1998 and $2.3 million in 1997 as it started operations in 1998. USLink
expenses increased by $5.1 million in 1998 reflecting costs of providing CLEC
services.
OPERATING INCOME decreased 6% ($5.7 million) in 1998 and 2% ($2.5 million)
in 1997 reflecting the CLEC start-up losses. Operating loss from CLEC operations
was $9.5 million in 1998, an increase of $9.3 million from $200,000 in 1997. The
1997 CLEC operations loss of $200,000 represented a decline of $2.4 million from
an operating income of $2.2 million in 1996. The decline in CLEC operating
income reflects the expenses associated with the development of the CLEC
businesses in 1997 and the start-up of operations in early 1998.
Operating income from ILEC operations increased $3.5 million to $103.9
million in 1998 from $100.4 million in 1997 and decreased $100,000 in 1997 from
$100.5 million in 1996. The effects of acquisitions increased operating income
1% ($1.2 million) in 1998 and 2% ($1.9 million) in 1997. The ILEC operating
margin was 22.5% in 1998, 24.1% in 1997 and 26.9% in 1996. The reduction in
operating margin was caused by continued pressure on revenue streams, slightly
higher operating costs, improvements to the telephone network, expenditures to
develop programs which are aimed at improving customer satisfaction and resale
of lower-margin services.
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.
PCS OPERATIONS
The Company provides PCS telephone services through Aerial Communications, Inc.
("Aerial"), an 82.3%-owned subsidiary. Aerial provides service in the Major
Trading Areas ("MTAs") of Minneapolis, Tampa-St. Petersburg-Orlando, Houston,
Pittsburgh, Kansas City and Columbus. Aerial served 311,900 customers at the end
of 1998 and 125,000 customers at the end of 1997. In December 1998, TDS
announced the withdrawal of its offer to exchange tracking stocks for the
outstanding Common Shares of Aerial which it did not own. TDS also announced
that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as
well as reviewing other alternatives. See Liquidity and Note 1 -- Corporate
Restructuring of Notes to Consolidated Financial Statements.
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, 1997, are
<PAGE>
10
reported as PCS development costs included in the "Investment and Other Income
(Expense)" section of the Consolidated Statements of Operations.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------
(DOLLARS IN THOUSANDS,
EXCEPT PER CUSTOMER AMOUNTS)
<S> <C> <C> <C>
Operating Revenues
Service $ 123,640 $ 32,307 $ --
Equipment sales 31,514 23,645 --
---------------------------------
155,154 55,952 --
---------------------------------
Operating Expenses
System operations 69,066 30,655 --
Marketing and selling 79,704 45,974 --
Cost of equipment sold 87,715 71,454 --
General and administrative 61,737 44,467 --
Customer service 53,516 20,882 --
Depreciation and
amortization 83,401 39,071 --
---------------------------------
435,139 252,503 --
---------------------------------
Operating (Loss) $(279,985) $(196,551) $ --
- -----------------------------------------------------------------------
- -----------------------------------------------------------------------
Market penetration 1.13% .45% --
Cell sites in service 1,180 1,044 --
Average monthly service
revenue per customer $ 50.96 $ N/M $ --
Churn rate per month 5.5% 4.5% --
Employees 1,900 1,400 400
- -----------------------------------------------------------------------
</TABLE>
N/M - NOT MEANINGFUL
OPERATING REVENUES totaled $155.2 million in 1998 and $56.0 million in
1997. SERVICE REVENUES (charges for access, airtime and value-added services
provided to Aerial's customers who use its network, charges to customers of
other wireless carriers who use Aerial's PCS network when roaming, and
charges for long-distance calls made on its systems) totaled $123.6 million
in 1998 and $32.3 million in 1997. The increase in 1998 is due to the
increase in customers served to 311,900 at the end of 1998 from 125,000
customers at the end of 1997 as well as the markets being in service for a
full year in 1998 versus a partial year in 1997. The average monthly service
revenue per customer was $50.96 in 1998. The average monthly service revenue
per customer in 1997 does not provide a meaningful comparison as the initial
users and usage patterns are not comparable to the current users and usage
patterns. EQUIPMENT SALES REVENUES consisting of units sold to retailers,
independent agents and customers totaled $31.5 million in 1998 and $23.6
million in 1997. The average revenue per unit sold was $95 in 1998 and $124
in 1997.
OPERATING EXPENSES totaled $435.1 million in 1998 and $252.5 million in
1997 reflecting the costs to build the customer base ($167.4 million in 1998
and $117.3 million in 1997), costs to provide service to the customer base
($69.1 million in 1998 and $30.7 million in 1997), general and administrative
expenses ($61.7 million in 1998 and $44.5 million in 1997), customer service
expenses ($53.5 million in 1998 and $20.9 million in 1997) and depreciation
and amortization expenses ($83.4 million in 1998 and $39.1 million in 1997).
Expenses in 1997 reflect the initiation of service in Aerial's markets by
mid-1997.
The cost to build the customer base represents marketing and selling
expenses and the cost of equipment sold. These expenses less equipment sales
revenue represent the cost to acquire a new customer. The cost to acquire a
new customer was $431 in 1998 and $661 in 1997. The decrease in the cost to
acquire a new customer reflects the increase in gross customer activations as
well as declining handset prices. Gross customer activations rose 122% in
1998 to 315,100 from 141,900 in 1997. The average cost per handset sold was
$265 in 1998 and $374 in 1997. Aerial's costs to build its customer base
reflect expenses for salaries and benefits of sales and marketing personnel,
sales commissions, the cost of promotions, the cost of print, radio and
television advertising and retail store rental costs.
The costs to provide service to the customer base consist primarily of
cell site expenses, landline interconnection and toll charges, and employee
costs. System operations expenses increased due to the increasing size of
Aerial's network and its fully operational status during all of 1998 as
compared to only a portion of 1997.
General and administrative expenses reflect the expenses associated with
the management and operating teams as well as overhead expenses. Aerial has
experienced increases in these areas in 1998 due to increased staffing to
support its growing PCS business.
Customer service expenses consist of salaries and benefits of customer
service employees, bad debt expense and costs of operating call centers.
Customer service expenses increased and have been higher than anticipated due
to the effects of higher than planned customer churn and related bad debt
costs as well as additional consulting and temporary service expenses
directed at reducing churn and bad debt. The churn rate increased to 5.5% in
1998 from 4.5% in 1997 primarily as a result of the initiation of a prepaid
program and an increased emphasis on collections. Prepaid programs typically
have a higher churn rate.
Depreciation expense increased due to rising fixed asset balances as a
result of Aerial's network buildout and the amount of time that network
assets have been in service in 1998 as compared to 1997. Amortization expense
increased reflecting the operational status of the markets in all of 1998 as
compared to only a portion of 1997.
OPERATING LOSS totaled $280.0 million in 1998 and $196.6 million in
1997. Management expects Aerial to generate significant losses at least
through 1999 as it continues to build its customer base.
<PAGE>
11
INFLATION
Management believes that inflation affects TDS's business to no greater
extent than the general economy.
ACCOUNTING FOR COMPUTER SOFTWARE DEVELOPED FOR OR OBTAINED FOR INTERNAL USE
The American Institute of Certified Public Accountants ("AICPA") issued
Statement of Position ("SOP") 98-1 "Accounting for Computer Software Developed
for or Obtained for Internal Use" which became effective January 1999. To
eliminate the diversity in practice in accounting and improve financial
reporting, SOP 98-1 provides guidance for accounting for software developed for
internal use. Management is currently analyzing the impact of this statement,
but does not anticipate that the effect on results of operations and financial
position will be material.
REPORTING ON COSTS OF START-UP ACTIVITIES
The AICPA issued SOP 98-5 "Reporting on the Costs of Start-up Activities" which
became effective January 1999. SOP 98-5 requires that costs of start-up
activities, including organizational costs, be charged to operations as
incurred. Management believes SOP 98-5 will have an immaterial effect on results
of operations and financial position.
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 subsidiaries have obtained substantial funds from external sources
to finance Aerial's operations and construction activities, to fund acquisitions
and for general corporate purposes. Although U.S. Cellular's increasing internal
cash flow and TDS Telecom's steady internal cash flow have reduced the overall
need for external financing, Aerial's working capital, operating expenses and
construction activities have nevertheless required substantial additional funds
from external sources.
CASH FLOWS FROM OPERATING ACTIVITIES. TDS is generating substantial
internal funds from the rapid growth in U.S. Cellular's customer units and
revenues and TDS Telecom's steady growth. The launch of Aerial's operations,
however, required substantial funds, thereby reducing the effect of increases
in cash flows from U.S. Cellular and TDS Telecom on operating activities in
1998 and 1997. Cash flows from operating activities totaled $356.2 million in
1998, $208.8 million in 1997 and $295.0 million in 1996. Operating cash flow
(operating income plus depreciation and amortization) increased 30% to $388.6
million in 1998 from $299.3 million in 1997 and $384.4 million in 1996. U.S.
Cellular's operating cash flow increased 46% ($120.9 million) to $382.9
million in 1998, and 33% ($65.7 million) to $261.9 million in 1997 while TDS
Telecom's operating cash flow increased 4% ($7.7 million) to $205.8 million
in 1998, and 4% ($7.2 million) to $198.2 million in 1997. Aerial's operations
reduced operating cash flow by $196.6 million in 1998 and $157.5 million in
1997. 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 $32.4 million in 1998, $90.6 million in
1997, and $89.4 million in 1996.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating cash flow
U.S. Cellular $382,854 $261,922 $196,205
TDS Telecom 205,814 198,164 190,995
Aerial (196,584) (157,480) --
American Paging (3,511) (3,267) (2,849)
----------------------------------
388,573 299,339 384,351
Other operating activities (32,410) (90,587) (89,357)
----------------------------------
$356,163 $208,752 $294,994
- ------------------------------------------------------------------------
- ------------------------------------------------------------------------
</TABLE>
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 63% of total capitalization at December 31, 1998,
compared to 59% and 68% at December 31, 1997 and 1996, respectively.
<PAGE>
12
Cash flows from financing activities totaled $137.2 million in 1998,
$547.6 million in 1997 and $124.9 million in 1996. TDS used short-term debt
to finance Aerial's construction, start-up and development activities and
operations, for acquisitions and for general corporate purposes in recent
years. TDS has taken advantage of attractive opportunities to reduce
short-term debt with proceeds from the sale of long-term debt and equity
securities, including sales of debt and equity securities by subsidiaries.
Proceeds from the sale of these debt and equity securities totaled $543.1
million, $391.8 million and $195.3 million in 1998, 1997 and 1996,
respectively. Proceeds from the sales of non-strategic cellular and other
investments from time to time in 1998, 1997 and 1996 have also been used to
reduce 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.
In 1998, the Company received net proceeds of $144.9 million on the sale
of 8.04% Trust Originated Preferred Securities, $198.2 million on the sale of
eight-year 7% notes, and $200.0 million from the sale of a 19% interest in a
subsidiary of Aerial. In 1997, TDS received net proceeds of $144.8 million on
the sale of 8.5% Trust Originated Preferred Securities, and U.S. Cellular
received $247.0 million on the sale of 10-year 7.25% notes. U.S. Cellular
used the proceeds to repay existing balances on its vendor financing
arrangements, to finance the cash requirements for the BellSouth exchange and
for general corporate purposes. In 1996, Aerial received $195.3 million from
an initial public offering of Common Shares.
Aerial and TDS Telecom have also used long-term debt to finance their
construction and development activities. Aerial has financed $200 million of
digital radio channel and switching equipment purchases through the issuance
of 10-year 8.05% zero coupon notes in 1998 and 10-year 8.34% zero coupon
notes in 1996. Aerial has also financed $45.5 million of network
infrastructure equipment and services with a vendor in 1998. TDS Telecom's
telephone subsidiaries borrowed $4.1 million in 1998, $15.0 million in 1997
and $12.2 million in 1996 under the Rural Utility Service and the Rural
Telephone Bank long-term federal government loan programs to finance their
telephone construction programs.
In December 1996, TDS authorized the repurchase of up to 3.0 million TDS
Common Shares over a period of three years. In 1997, TDS purchased 1.8
million TDS Common Shares for $69.9 million. A total of 1.0 million shares
have been subsequently reissued, primarily for acquisitions in 1997. TDS has
paid dividends of $.44, $.42 and $.40 per Common and Series A Common Share in
1998, 1997 and 1996, respectively. Aggregate dividends paid on Common and
Preferred Shares, excluding dividends reinvested, totaled $28.5 million in
1998, $27.2 million in 1997 and $26.2 million in 1996.
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 used for investing activities totaled $494.3 million in 1998,
$763.0 million in 1997 and $417.4 million in 1996 primarily for capital
expenditures and acquisitions. Cash expenditures for capital additions
totaled $558.3 million in 1998, $786.3 million in 1997 and $550.2 million in
1996. Cash used for acquisitions, excluding cash acquired, totaled $117.8
million in 1998, $129.0 million in 1997 and $31.0 million in 1996. The sale
of non-strategic cellular assets and other investments provided $131.0
million in 1998, $84.2 million in 1997 and $221.5 million in 1996.
Distributions from partnerships provided $28.9 million in 1998, $56.4 million
in 1997 and $25.5 million in 1996 and changes in temporary investments and
marketable securities provided $35.7 million in 1998 and $36.4 million in
1997 and required $30.8 million in 1996.
<PAGE>
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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
U.S. Cellular
Cell sites and equipment $184,032 $238,797 $133,832
Switching equipment 21,220 5,457 5,713
Systems development 46,042 40,949 28,753
Other 69,123 33,545 79,825
-------------------------------------
320,417 318,748 248,123
-------------------------------------
TDS Telecom
Central office 58,332 52,479 47,208
Outside plant 51,409 60,974 53,130
Systems development 20,497 9,127 20,497
Other 12,887 28,880 23,605
-------------------------------------
143,125 151,460 144,440
-------------------------------------
Aerial
Cell sites and equipment 43,790 291,922 150,386
Switching equipment 23,010 38,428 53,170
Systems development 27,533 55,553 26,277
Other 2,617 1,815 12,436
Prepaid network
infrastructure -- (70,300) 70,300
-------------------------------------
96,950 317,418 312,569
Less noncash items (22,370) (42,709) (199,630)
-------------------------------------
74,580 274,709 112,939
-------------------------------------
Other 20,210 41,400 44,702
-------------------------------------
$558,332 $786,317 $550,204
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
U.S. Cellular's capital additions include expenditures to build
additional cell sites and add radio channels to expand coverage and add
capacity. U.S. Cellular constructed 281 cell sites in 1998, 331 in 1997 and
242 in 1996. The increase in other capital additions for U.S. Cellular in
1998 was a result of the change over to centralized communications centers.
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. Aerial completed the initial build out
of its systems in 1997. The 1997 and 1996 expenditures included the
construction of five switching centers, the central Network Operations Center
and over 1,000 cell sites. Aerial continued to expand coverage and add
capacity in its markets in 1998 by adding cell sites in its markets.
ACQUISITIONS, EXCHANGES 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 $117.8
million in 1998, $129.0 million in 1997 and $31.0 million in 1996. TDS completed
the acquisition of controlling interests in five cellular markets and two
telephone companies in 1998, completed an exchange with BellSouth in 1997,
completed the acquisition of controlling interests in two cellular markets and
one telephone company in 1997 and two cellular markets and five telephone
companies in 1996, 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 $131.3 million, $174.7 million and $144.1 million, respectively.
In October 1997, U.S. Cellular completed an exchange with BellSouth.
Pursuant to the exchange, U.S. Cellular received majority interests
representing 4.0 million population equivalents ("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.
<PAGE>
The majority interests U.S. Cellular received are in 12 markets adjacent to its
Iowa/Missouri/Illinois/Indiana and Wisconsin/Illinois clusters.
In 1998, U.S. Cellular and TDS Telecom sold a majority interest in one
market and minority interests in certain markets for 5.2 million AirTouch
common shares and cash. In 1997, 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. In 1996, 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 two markets in 1996.
LIQUIDITY
The Company anticipates that the aggregate resources required in 1999 will
include approximately $300 million for cellular capital additions and $120
million for telephone capital additions. The Company intends to spin-off its PCS
operations in 1999. The aggregate resources required in 1999 for Aerial include
approximately $130 million for PCS capital additions, $125 million for working
capital and operating expenses and $80 million for interest expense.
TDS and its subsidiaries had cash and temporary investments totaling
$60.4 million and longer-term investments totaling $9.5 million at December
31, 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 had $598 million of bank lines of credit for general corporate
purposes at December 31, 1998, of which $427 million was unused. These line
of credit agreements provide for borrowings at negotiated rates up to the
prime rate.
U.S. Cellular's capital additions budget totals approximately $300
million to expand and enhance coverage, including adding digital service
capabilities to its systems and to enhance office systems. 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 $382.9 million in 1998 up 46% ($120.9 million) from 1997. U.S.
Cellular also received $27.7 million in distributions from minority
partnership interests and $148.3 million from the proceeds of investment
sales to supplement operating cash flow. At December 31, 1998, U.S. Cellular
had $500 million of bank lines of credit for general corporate purposes, all
of which was available.
TDS Telecom's capital additions budget totals approximately $120
million, including approximately $45 million for outside plant facilities and
$35 million for switching facilities in the ILEC markets and $12 million for
current CLEC markets. 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 $205.8 million in
1998 up 4% ($7.7 million) from 1997. At December 31, 1998, TDS Telecom's
telephone subsidiaries had $116.4 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 5.1%.
Management believes that 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 and if capital requirements, financial market conditions
and other factors warrant.
<PAGE>
15
CORPORATE RESTRUCTURING
In December 1997, the Board of Directors of TDS adopted a proposal, which was
approved by the shareholders in April 1998, to authorize three new classes of
common stock and to change the state of incorporation of TDS from Iowa to
Delaware. The three new classes of stock were intended to separately reflect the
performance of the Company's cellular telephone, telephone and personal
communications services businesses ("Tracking Stocks"). The reincorporation was
completed in May 1998.
In December 1998, TDS announced the withdrawal of its offers to exchange
tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial
which it did not own. An integral part of the tracking stock plan was the
offering of shares in the TDS Telecom Group, which TDS was not able to complete
at a reasonable offering price. In addition, TDS was unable to reach mutually
acceptable agreements with the special committees representing the minority
shareholders of U.S. Cellular and Aerial.
At the same time, TDS announced that it was pursuing a tax-free spin-off of
its 82.3% interest in Aerial, as well as reviewing other alternatives. There are
a number of conditions that must be met for a spin-off to occur, including the
receipt of a favorable Internal Revenue Service ruling on the tax-free status of
such a spin-off, final approval by the TDS Board of Directors, certain
government and third party approvals and review by the Securities and Exchange
Commission ("SEC") of appropriate SEC filings.
Prior to any spin-off, it is expected that Aerial will seek additional
financing so that Aerial would have the appropriate capitalization to operate as
a stand-alone entity. In connection with such financing, it is anticipated that
a substantial amount of Aerial's debt to TDS may be converted into equity. TDS
intends to seek shareholder approval of a proposal to distribute Aerial Series A
Common Shares, on a pro-rata basis, to holders of TDS Series A Common Shares and
to distribute Aerial Common Shares, on a pro-rata basis, to holders of TDS
Common Shares. There can be no assurance that a spin-off will be consummated or
that other alternatives will not be pursued. See Note 1--Corporate Restructuring
of Notes to Consolidated Financial Statements.
In September 1998, pursuant to a purchase agreement between TDS, Aerial,
Aerial Operating Company, Inc. ("AOC"), and Sonera Ltd., a limited liability
company organized under the laws of Finland ("Sonera"), Sonera purchased 2.4
million shares of common stock of AOC representing a 19.423% equity interest in
AOC, subject to adjustment under certain circumstances, for an aggregate
purchase price of $200 million. Sonera has the right, subject to adjustment
under certain circumstances, to exchange each share of AOC common stock which it
owns for 6.72919 Common Shares of Aerial. Upon the exchange of all of the AOC
shares, Sonera would own an 18.452% equity interest in Aerial, reflecting a
purchase price equivalent to $12.33 per Common Share of Aerial (the "Equivalent
Purchase Price").
Following the announcement by TDS in December 1998, that it intended to
distribute to its shareholders all of the capital stock of Aerial that it owns,
and that Aerial would seek additional financing from sources other than TDS in
connection therewith, Sonera contacted TDS to express certain concerns about the
announcement. Sonera has asserted that the TDS announcement reflects a change in
circumstances that warrant the renegotiation of certain matters related to its
investment in AOC, including an adjustment in the Equivalent Purchase Price, and
has raised the possibility of litigation in connection therewith. TDS and Aerial
intend to attempt to reach a mutually acceptable resolution of the concerns
raised by Sonera. There can be no assurance that this matter will not lead to
litigation, or that it will not have a material adverse effect on TDS or Aerial
or on the plans relating to the refinancing and spin-off of Aerial.
Aerial's capital additions budget totals approximately $130 million,
including approximately $100 million for cell sites and switching equipment and
$27 million for systems development. In addition, Aerial will require an
estimated $125 million for working capital and operating expenses and $80
million for interest expense. Aerial plans to finance its construction
expenditures and working capital requirements through external financing and
vendor financing. As part of the potential tax-free spin-off of Aerial, TDS and
Aerial are seeking short- and long-term financing so that Aerial would have the
appropriate capitalization to operate as a stand-alone entity.
In 1998, a vendor agreed to provide up to $150 million in financing to
Aerial for the purchase of network infrastructure equipment and services.
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 December 31, 1998,
Aerial had $104.5 million available under the agreement.
<PAGE>
16
In March 1999, TDS agreed to pay Aerial $114.5 million as a settlement
for tax losses incurred by Aerial and utilized by the TDS consolidated tax
group. Aerial used the funds to repay a portion of the existing indebtedness
to TDS thereby increasing the amount available under the revolving credit
agreement. Accordingly, available funding under Aerial's revolving credit
agreement with TDS is expected to last through June 1999. TDS has not
committed to any further financing of Aerial's operations. It is management's
intent for Aerial to obtain the necessary level of financial support from
sources other than TDS to enable Aerial to pay its debts as they become due.
Management believes Aerial has the ability to obtain that financial support.
Sources of additional capital may include vendor financing and public and
private equity and debt financings by Aerial or its subsidiaries. If
sufficient future funding is not available on terms and prices acceptable to
Aerial, Aerial would have to reduce its construction and operating
activities, which could have a material adverse impact on Aerial's financial
condition and results of operations.
MARKET RISK
The Company is subject to market rate risks due to fluctuations in interest
rates and equity markets. The majority of the Company's debt is in the form of
long-term fixed-rate notes, debentures and trust securities with original
maturities ranging from 1 to 40 years. Accordingly, fluctuations in interest
rates can lead to significant fluctuations in the fair value of such
instruments. TDS does not enter into financial derivatives to reduce its
exposure to interest rate risks. The table below provides the fair value and
average interest, or average dividend rate, of TDS's outstanding debt and trust
securities instruments at December 31, 1998. The fair value was estimated using
discounted cash flow analysis.
<TABLE>
<CAPTION>
EXPECTED MATURITY DATE
(DOLLARS IN THOUSANDS)
FAIR VALUE AS
TDS AND SUBSIDIARIES 1999 2000 2001 2002 2003 THEREAFTER TOTAL OF 12-31-98
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long-Term Debt $15,058 $60,432 $15,508 $15,253 $47,380 $2,087,525 $2,241,155 $1,606,333
Average Interest Rate 7.32% 5.81% 7.33% 7.30% 8.45% 7.15% 7.14%
Trust Securities -- -- -- -- -- $ 300,000 $ 300,000 $ 297,750
Average Dividend Rate -- -- -- -- -- 8.27% 8.27%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
TDS maintains a portfolio of available for sale marketable equity
securities which resulted from strategic acquisitions. The market value of
these investments, principally AirTouch common shares, amounted to $378.8
million at December 31, 1998. A hypothetical 10% decrease in the share prices
of these investments would result in a $37.9 million decline in the market
value of the investments.
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.
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 Year 2000 project teams at
each business unit 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 teams, to monitor the current status of
individual projects, to report periodically to the TDS Audit Committee, and
to promote the exchange of information between all business units to share
knowledge and solution techniques. Management of each business unit has made
the Year 2000 Issue a top priority. 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 critical vendors.
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
<PAGE>
17
an analysis of risk management factors such as contingency plans and legal
matters. The assessment phase was largely complete early 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. The
validation phase consists of 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. The Cellular Telecommunications Industry Association
("CTIA") has formed a working group to coordinate efforts of various carriers
and manufacturers to facilitate inter-network Year 2000 testing. Validation
of critical hardware, systems and applications 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
during the fourth quarter of 1999.
Management cannot provide assurance that its plan to achieve Year 2000
compliance will be successful as it is subject to various risks and
uncertainties. The Company's current schedule is subject to change depending
on developments that may arise through unforeseen circumstances in the
renovation, validation and implementation 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, financial institutions,
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, and cause a material
adverse effect on the Company's results of operations, financial positions
and cash flow.
The Company's Year 2000 worst case scenario may involve interruption of
telecommunications services and data processing services and/or interruption
of customer billing, operating and other information systems. As part of its
Year 2000 initiative, the Company is evaluating a variety of adverse
scenarios and is in the process of developing contingency and business
continuity plans tailored for adverse Year 2000-related occurrences. The
contingency and business continuity plans are expected to assess the
potential for business disruption in various scenarios, and to provide key
operational back-up, recovery and restorational alternatives.
The Company's contingency plan initiatives will include the following:
reviewing, assessing and updating existing
<PAGE>
18
business recovery plans; identifying teams who will be on call during the
millennium change to monitor the network, critical systems, operations centers
and business processes to react immediately to facilitate repairs;
re-prioritization of mission critical work processes and associated resources;
developing alternate processes to support critical customer functions in the
event information systems or mechanized processes experience Year 2000
disruptions; establishing replacement/repair parallel paths to provide for
repair and readiness of existing systems and components that are scheduled for
replacement by the year 2000, in the event the replacement schedules are not
met; developing alternate plans for critical suppliers of products/services that
fail to meet Year 2000 compliance commitment schedules; developing data
retention and recovery procedures to be in place for customer and critical
business data to provide pre-millennium backups with on-site as well as off-site
data copies. The Company anticipates having these contingency plans in place
before December 31, 1999.
The Company estimates that the total costs related to the Year 2000
project will be approximately $30 million. Through December 31, 1998, the
total costs associated with the Year 2000 Issue were $8 million. In recent
years, the Company has made capital expenditures, primarily related to
upgrades of the cellular network to provide digital capabilities as well as
certain financial systems, which are by design Year 2000 compliant but will
be tested. These costs are not considered to be directly related to the Year
2000 project because they were incurred as part of the Company's overall
operating strategies to add digital capabilities for competitive purposes,
and to improve financial systems and customer service. 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.
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; UNANTICIPATED
CHANGES IN GROWTH IN CELLULAR AND PCS 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.
<PAGE>
- --------------------------------------------------------------------------------
Consolidated Statements of Operations 19
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
OPERATING REVENUES
U.S. Cellular $ 1,162,467 $ 876,965 $ 680,068
TDS Telecom 488,104 437,624 395,059
Aerial 155,154 55,952 --
-----------------------------------------
1,805,725 1,370,541 1,075,127
-----------------------------------------
OPERATING EXPENSES
U.S. Cellular 986,392 747,422 592,702
TDS Telecom 393,692 337,481 292,410
Aerial 435,139 252,503 --
-----------------------------------------
1,815,223 1,337,406 885,112
-----------------------------------------
OPERATING INCOME (LOSS) FROM ONGOING OPERATIONS (9,498) 33,135 190,015
American Paging Operating (Loss) (11,406) (35,307) (36,626)
------------------------------------------
OPERATING INCOME (LOSS) (20,904) (2,172) 153,389
------------------------------------------
INVESTMENT AND OTHER INCOME (EXPENSE)
Interest and dividend income 10,952 13,660 15,569
Investment income 40,646 81,150 58,455
Amortization of costs related to minority investments (11,395) (6,450) (4,431)
Gain on sale of cellular and other investments 262,698 41,438 138,735
PCS development costs -- (21,614) (43,950)
Other (expense) income, net (26,941) (4,051) 3,187
Minority share of loss (income) 28,513 8,316 (26,316)
-------------------------------------------
304,473 112,449 141,249
-------------------------------------------
INCOME BEFORE INTEREST AND INCOME TAXES 283,569 110,277 294,638
Interest expense 126,360 89,744 42,853
Minority interest in income of subsidiary trust 23,504 1,523 --
------------------------------------------
INCOME BEFORE INCOME TAXES 133,705 19,010 251,785
Income tax expense 69,297 28,559 123,646
-----------------------------------------
NET INCOME (LOSS) 64,408 (9,549) 128,139
Preferred Dividend Requirement (1,651) (1,892) (1,957)
------------------------------------------
NET INCOME (LOSS) AVAILABLE TO COMMON $ 62,757 $ (11,441) $ 126,182
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE SHARES OUTSTANDING (000S) 60,982 60,211 60,464
BASIC EARNINGS PER SHARE $ 1.03 $ (.19) $ 2.09
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER SHARE $ 1.03 $ (.19) $ 2.07
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
DIVIDENDS PER SHARE $ .44 $ .42 $ .40
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ARE AN INTEGRAL PART OF THESE STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
20 Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 64,408 $ (9,549) $ 128,139
Add (Deduct) adjustments to reconcile net income (loss)
to net cash provided by operating activities
Depreciation and amortization 409,477 301,511 230,962
Deferred income taxes and investment tax credit, net 49,349 17,236 75,015
Investment income (40,646) (81,150) (58,455)
Minority share of income (loss) (28,513) (8,316) 26,316
Gain on sale of cellular and other investments (262,698) (41,438) (138,735)
Noncash interest expense 36,399 24,289 17,042
Other noncash expense 33,781 18,109 25,017
Change in accounts receivable (41,383) (41,900) (28,687)
Change in materials and supplies 10,674 (25,827) (2,395)
Change in accounts payable 82,619 32,498 23,531
Change in accrued taxes 24,030 7,612 (8,249)
Change in other assets and liabilities 18,666 15,677 5,493
------------------------------------------
356,163 208,752 294,994
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of long-term debt 202,277 260,099 15,846
Repayments of long-term debt (16,454) (121,958) (34,200)
Change in notes payable (356,698) 368,858 (27,133)
Trust preferred securities 144,880 144,788 --
Dividends paid (28,490) (27,193) (26,232)
Proceeds from issuance of subsidiaries' stock 200,000 -- 195,265
Repurchase of Common Shares -- (69,942) --
Other financing activities (8,283) (7,064) 1,350
-----------------------------------------
137,232 547,588 124,896
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (558,332) (786,317) (550,204)
Investments in and advances to investment entities and license costs (2,823) (20,084) (23,134)
Distributions from investments 28,912 56,413 25,453
Investments in PCS licenses -- (5,034) (26,548)
Proceeds from investment sales 130,957 84,230 221,542
Acquisitions, net of cash acquired (117,817) (128,979) (31,019)
Change in temporary investments and marketable securities 35,690 36,422 (30,797)
Other investing activities (10,907) 384 (2,666)
------------------------------------------
(494,320) (762,965) (417,373)
------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (925) (6,625) 2,517
CASH AND CASH EQUIVALENTS
BEGINNING OF PERIOD 51,008 57,633 55,116
------------------------------------------
END OF PERIOD $ 50,083 $ 51,008 $ 57,633
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
Consolidated Balance Sheets -- Assets 21
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 50,083 $ 51,008
Temporary investments 10,341 24,559
Accounts receivable
Due from customers, less allowance of $12,608 and $15,102, respectively 163,910 148,811
Other, principally connecting companies 120,700 98,487
Materials and supplies, at average cost 36,621 55,127
Other current assets 23,784 30,292
-------------------------
405,439 408,284
-------------------------
INVESTMENTS
Intangible Assets
Cellular license costs, net of amortization 1,200,653 1,079,080
Broadband PCS license costs, net of amortization 311,915 319,918
Franchise and other costs in excess of the underlying
book value of subsidiaries, net of amortization 181,517 180,669
Investments in unconsolidated entities 307,258 275,462
Marketable equity securities 378,812 1,621
Other investments 33,870 115,834
-------------------------
2,414,025 1,972,584
-------------------------
PROPERTY, PLANT AND EQUIPMENT, NET
U.S. Cellular 1,138,585 1,018,559
TDS Telecom 881,507 830,767
Aerial 621,281 604,104
Other 31,216 90,529
-------------------------
2,672,589 2,543,959
-------------------------
OTHER ASSETS AND DEFERRED CHARGES 35,492 46,774
-------------------------
$ 5,527,545 $ 4,971,601
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.
<PAGE>
- --------------------------------------------------------------------------------
22 Consolidated Balance Sheets -- Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
CURRENT LIABILITIES
Current portion of long-term debt $ 15,946 $ 14,816
Notes payable 170,889 527,587
Accounts payable 288,417 239,783
Advance billings and customer deposits 37,473 33,640
Accrued interest 24,290 18,284
Accrued taxes 30,449 6,961
Accrued compensation 29,584 23,386
Other current liabilities 26,331 40,129
-------------------------
623,379 904,586
-------------------------
DEFERRED LIABILITIES AND CREDITS
Net deferred income tax liability 314,858 202,680
Postretirement benefits obligation other than pensions 9,463 11,364
Other 22,668 21,602
-------------------------
346,989 235,646
-------------------------
LONG-TERM DEBT, excluding current portion 1,553,096 1,264,218
-------------------------
MINORITY INTEREST in subsidiaries 440,188 416,566
-------------------------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (a) 300,000 150,000
-------------------------
PREFERRED SHARES 25,985 32,466
-------------------------
COMMON STOCKHOLDERS' EQUITY
Common Shares, par value $.01 and $1 per share, respectively; authorized
100,000,000 shares; issued and outstanding
54,988,498 and 54,443,260 shares, respectively 550 54,443
Series A Common Shares, par value $.01 and $1 per share, respectively;
authorized 25,000,000 shares; issued and outstanding
6,949,904 and 6,936,277 shares, respectively 69 6,936
Capital in excess of par value 1,882,710 1,664,248
Treasury Shares, at cost, 761,220 and 794,576 shares, respectively (29,439) (30,682)
Accumulated other comprehensive income 75,609 683
Retained earnings 308,409 272,491
-------------------------
2,237,908 1,968,119
-------------------------
$ 5,527,545 $ 4,971,601
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART
OF THESE STATEMENTS.
(a) AS DESCRIBED IN NOTE 14, THE SOLE ASSET OF TDS CAPITAL
I IS $154.6 MILLION PRINCIPAL AMOUNT OF 8.5% SUBORDINATED DEBENTURES DUE 2037
FROM TDS, AND THE SOLE ASSET OF TDS CAPITAL II IS $154.6 MILLION PRINCIPAL
AMOUNT OF 8.04% SUBORDINATED DEBENTURES DUE 2038 FROM TDS.
<PAGE>
- --------------------------------------------------------------------------------
Consolidated Statements of Common Stockholders' Equity 23
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Accumulated
Series A Capital in Compre- Other Com-
Common Common Excess of Treasury hensive prehensive Retained
Shares Shares Par Value Shares Income Income Earnings
- -----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $ 51,137 $ 6,893 $ 1,419,002 $ -- $ 7 $ 207,326
Comprehensive Income
Net Income -- -- -- -- $ 128,139 -- 128,139
Net unrealized gains on securities -- -- -- -- 506 506 --
----------
Comprehensive Income $ 128,645
----------
----------
Dividends
Common and Series A
Common Shares -- -- -- -- -- (24,274)
Preferred Shares -- -- -- -- -- (1,958)
Acquisitions 2,645 -- 111,103 -- -- --
Dividend reinvestment, incentive
and compensation plans 100 27 4,487 -- -- --
Conversion of Preferred Shares 352 -- 4,422 -- -- --
Conversion of Series A
Common Shares 3 (3) -- -- -- --
Gain on sale of subsidiary stock -- -- 114,056 -- -- --
Other -- -- 8,971 -- -- --
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 54,237 6,917 1,662,041 -- 513 309,233
Comprehensive Income
Net (Loss) -- -- -- -- $ (9,549) -- (9,549)
Net unrealized gains on securities -- -- -- -- 170 170 --
----------
Comprehensive (Loss) $ (9,379)
----------
----------
Dividends
Common and Series A
Common Shares -- -- -- -- -- (25,300)
Preferred Shares -- -- -- -- -- (1,893)
Acquisitions 16 -- 3,585 39,084 -- --
Repurchase Common Shares -- -- -- (69,942) -- --
Dividend reinvestment, incentive
and compensation plans 122 19 4,707 176 -- --
Conversion of Preferred Shares 68 -- 1,419 -- -- --
Other -- -- (7,504) -- -- --
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 54,443 6,936 1,664,248 (30,682) 683 272,491
Comprehensive Income
Net Income -- -- -- -- $ 64,408 -- 64,408
Net unrealized gains on securities -- -- -- -- 74,926 74,926 --
----------
Comprehensive Income $ 139,334
----------
----------
Dividends
Common and Series A
Common Shares -- -- -- -- -- (26,850)
Preferred Shares -- -- -- -- -- (1,640)
Recapitalization (53,899) (6,867) 60,766 -- -- --
Acquisitions 2 -- 10,025 -- -- --
Dividend reinvestment, incentive
and compensation plans 1 -- 2,029 1,243 -- --
Conversion of Preferred Shares 3 -- 6,284 -- -- --
Gain on sale of subsidiary stock -- -- 148,357 -- -- --
Other -- -- (8,999) -- -- --
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ 550 $ 69 $ 1,882,710 $ (29,439) $ 75,609 $ 308,409
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN
INTEGRAL PART OF THESE STATEMENTS.
<PAGE>
- -------------------------------------------------------------------------------
24 Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
NOTE 1
CORPORATE RESTRUCTURING
In December 1997, the Board of Directors of Telephone and Data Systems, Inc.
adopted a proposal, which was approved by the shareholders in April 1998, to
authorize three new classes of common stock and to change the state of
incorporation of Telephone and Data Systems, Inc. ("TDS" or "the Company") from
Iowa to Delaware. The three new classes of stock were intended to separately
reflect the performance of the Company's cellular telephone, telephone and
personal communications services businesses ("Tracking Stocks"). The
reincorporation was completed in May 1998.
The Company intended to: a) offer and sell Telecom Group Shares in a public
offering for cash, b) issue Cellular Group Shares in exchange for all of the
Common Shares of United States Cellular Corporation ("U.S. Cellular") not owned
by the Company, c) issue Aerial Group Shares in exchange for all of the Common
Shares of Aerial Communications, Inc. ("Aerial") not owned by the Company, and
d) 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.
In December 1998, TDS announced the withdrawal of its offers to exchange
tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial
which it did not own. An integral part of the tracking stock plan was the
offering of shares in the TDS Telecom Group, which TDS was not able to complete
at a reasonable offering price. In addition, TDS was unable to reach mutually
acceptable agreements with the special committees representing the minority
shareholders of U.S. Cellular and Aerial.
At the same time, TDS announced that it was pursuing a tax-free spin-off of
its 82.3% interest in Aerial, as well as reviewing other alternatives. There are
a number of conditions that must be met for a spin-off to occur, including the
receipt of a favorable Internal Revenue Service ruling on the tax-free status of
such a spin-off, final approval by the TDS Board of Directors, certain
government and third party approvals and review by the Securities and Exchange
Commission ("SEC") of appropriate SEC filings.
Prior to any spin-off, it is expected that Aerial will seek additional
financing so that Aerial would have the appropriate capitalization to operate as
a stand-alone entity. In connection with such financing, it is anticipated that
a substantial amount of Aerial's debt to TDS may be converted into equity. TDS
intends to seek shareholder approval of a proposal to distribute Aerial Series A
Common Shares, on a pro-rata basis, to holders of TDS Series A Common Shares and
Aerial Common Shares, on a pro-rata basis, to holders of TDS Common Shares.
There can be no assurance that a spin-off will be consummated or that other
alternatives will not be pursued.
NOTE 2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
TDS is a diversified telecommunications company which provided high-quality
telecommunications services to approximately 3.0 million cellular telephone,
telephone and personal communications services ("PCS") customers in 35 states at
December 31, 1998. The Company conducts substantially all of its cellular
telephone operations through its 81.0%-owned subsidiary, United States Cellular
Corporation ("U.S. Cellular"), its telephone operations through its wholly-owned
subsidiary, TDS Telecommunications Corporation ("TDS Telecom"), and its PCS
operations through its 82.3%-owned subsidiary, Aerial Communications, Inc.
("Aerial"). In December 1998, TDS announced that it was pursuing a tax-free
spin-off of its 82.3% interest in Aerial, as well as reviewing other
alternatives. See Note 1 --Corporate Restructuring.
TDS contributed substantially all of the assets and certain, limited
liabilities of American Paging, Inc. ("American Paging") to TSR Wireless
Holdings, LLC ("TSR Wireless") for a 30% interest in TSR Wireless effective
March 31, 1998. American Paging's revenues are netted against its expenses in
the Consolidated Statements of Operations with the resulting operating loss
reported as American Paging Operating (Loss). American Paging's revenues totaled
$17.8 million and operating expenses totaled $29.2 million for the three month
period ended March 31, 1998. American Paging's revenues totaled $94.4 million
and $104.2 million in 1997 and 1996, respectively, and operating expenses
totaled $129.7 million and $140.8 million, respectively. Beginning April 1,
1998, TDS followed the equity method of accounting for its 30% interest in TSR
Wireless and reported these results as a component of Investment income.
<PAGE>
25
The following table summarizes the assets and liabilities which American
Paging contributed to TSR Wireless.
<TABLE>
<CAPTION>
MARCH 31, 1998
- -------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C>
Current assets
Cash $ 3,969
Accounts receivable 8,259
Materials and supplies 5,898
Other 1,494
Property, plant and equipment, net 37,899
Other investments - Narrowband PCS license 60,901
Deferred assets 10,108
Current liabilities
Advance billings and customer deposits (9,958)
Accrued taxes (541)
Other (1,128)
---------
$116,901
- -----------------------------------------------------------------------
- -----------------------------------------------------------------------
</TABLE>
See Note 20 -- Business Segment Information for summary financial
information on each business segment.
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.
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 non-equity securities (included in Other investments in the
Consolidated Balance Sheets) and are stated at amortized cost.
As part of its cash management program, the Company utilizes controlled
disbursement banking arrangements. Outstanding checks in excess of cash balances
totaled $28.7 million at December 31, 1998 and are classified as Accounts
payable in the Consolidated Balance Sheets. Sufficient funds were available to
fund these outstanding checks when presented for payment.
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.
The carrying amounts of Cash and cash equivalents and Temporary investments
approximate fair value due to the short-term nature of these investments.
REVENUE RECOGNITION
Revenues from cellular and PCS operations primarily consist of charges to
customers for monthly access, airtime, data usage, vertical services, roaming
charges, long-distance charges and equipment sales. Revenues are recognized as
services are rendered. Unbilled revenues, resulting from service provided from
the billing cycle date to the end of each month and from other cellular and PCS
carriers' customers using the Company's cellular and PCS systems for the last
half of each month, are estimated and recorded. Equipment sales are recognized
upon delivery to the customer or upon the shipment of goods to retailers and
independent agents.
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.Advertising expense
totaled $83.7 million, $66.9 million and $29.9 million in 1998, 1997 and 1996,
respectively.
ACCOUNTING FOR COMPUTER SOFTWARE
DEVELOPED FOR OR OBTAINED FOR INTERNAL USE
The American Institute of Certified Public Accountants ("AICPA") issued
Statement of Position ("SOP") 98-1 "Accounting for Computer Software Developed
for or Obtained for Internal Use" which became effective January 1999. To
eliminate the diversity in practice in accounting and improve financial
reporting, SOP 98-1 provides guidance for accounting for software developed for
internal use. Management is currently analyzing the impact of this statement,
but does not anticipate that the effect on results of operations and financial
position will be material.
<PAGE>
26
REPORTING ON THE COSTS OF START-UP ACTIVITIES
The AICPA issued SOP 98-5 "Reporting on the Costs of Start-up Activities" which
became effective January 1999. SOP 98-5 requires that costs of start-up
activities, including organizational costs, be charged to operations as
incurred. Management believes SOP 98-5 will have an immaterial effect on results
of operations and financial position.
NOTE 3
INCOME TAXES
TDS files a consolidated federal income tax return. Income tax provisions
charged to net income are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- -------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal $ 9,873 $ 4,533 $ 31,356
State 10,075 6,790 17,275
Deferred:
Federal 36,827 13,302 67,040
State 13,372 4,453 10,072
Amortization of deferred
investment tax credits (850) (519) (2,097)
-----------------------------------
Total income tax expense $ 69,297 $ 28,559 $123,646
- -------------------------------------------------------------------------
- -------------------------------------------------------------------------
</TABLE>
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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Statutory federal
income tax rate $46,797 $ 6,653 $ 88,125
State income taxes,
net of federal benefit 14,582 6,958 17,358
Amortization of license
acquisition costs and costs
in excess of book value 3,925 5,276 4,280
Dividend exclusion and
other permanent items 130 752 377
Amortization of deferred
investment tax credits (850) (519) (2,097)
Effects of corporations
not included in consolidated
federal tax return 1,855 1,409 2,351
Sale of cellular interests 2,580 5,549 12,337
Rate difference of federal
net operating loss -- 1,246 --
Resolution of prior
period tax issues 167 -- --
Other differences, net 111 1,235 915
--------------------------------
Income tax expense $69,297 $28,559 $123,646
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
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 $1.2 million and $3.7
million as of December 31, 1998 and 1997, respectively. The net current deferred
tax asset primarily represents the deferred tax effects of unearned revenues.
The temporary differences that gave rise to the noncurrent deferred tax
assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Deferred Tax Asset:
Net operating loss carryforwards $156,633 $ 55,363
Alternative minimum tax credit carryforward 28,830 21,205
Taxes on acquisitions 27,066 54,134
Partnership investments 7,300 --
Postretirement benefits 3,673 4,819
Amortization of deferred charges -- 1,614
Other 78 3,511
-------------------------
223,580 140,646
Less valuation allowance (54,685) (29,001)
-------------------------
Net Deferred Tax Asset 168,895 111,645
Deferred Tax Liability: -------------------------
Property, plant and equipment 174,292 134,672
Marketable equity securities 133,333 462
Equity investments 78,179 64,141
Licenses 62,673 55,756
Minority share of income 18,416 1,549
Partnership investments -- 25,687
Capitalized interest 15,678 18,721
Other 1,182 13,337
------------------------
Total Deferred Tax Liability 483,753 314,325
------------------------
Net Deferred Income Tax Liability $314,858 $202,680
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
TDS had $274.7 million of federal net operating loss carryforward
(generating a $90.7 million deferred tax asset) at December 31, 1998, expiring
between 2012 and 2013 which is available to offset future consolidated taxable
income. In addition, TDS had $965.3 million of state net operating loss
carryforward (generating a $65.9 million deferred tax asset) at December 31,
1998, expiring between 1999 and 2013 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. At December 31, 1998, TDS had $28.8 million of
federal alternative minimum tax credit carryforward available to offset regular
income tax payable in future years.
The financial reporting basis of the marketable equity securities was greater
than the tax basis at the date of acquisition, generating $73.6 million of
deferred taxes. Additionally, the value of the marketable equity securities has
appreciated since acquisition, generating $59.7 million of deferred taxes.
<PAGE>
27
NOTE 4
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings per Share," effective December 31, 1997. Earnings per Share
amounts for 1996 have been restated to conform to current period presentation.
The amounts used in computing Earnings per 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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(DOLLARS AND SHARES IN THOUSANDS)
<S> <C> <C> <C>
Net Income (Loss) $64,408 $ (9,549) $128,139
Preferred Dividend Requirement (1,651) (1,892) (1,957)
---------------------------------
Net Income (Loss) Available
to Common used in Basic
Earnings per Share 62,757 (11,441) 126,182
Reduction in preferred dividends
if Preferred Shares converted
into Common Shares 125 -- 671
Minority income adjustment (92) (100) (152)
---------------------------------
Net Income (Loss) Available
to Common used in
Diluted Earnings per Share $62,790 $(11,541) $126,701
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Weighted Average Number of
Common Shares used in
Basic Earnings per Share 60,982 60,211 60,464
Effect of Dilutive Securities:
Common Shares outstanding
if Preferred Shares converted 117 -- 543
Stock options and stock
appreciation rights 122 -- 165
Common Shares issuable 13 -- 28
---------------------------------
Weighted Average Number of
Common Shares used in Diluted
Earnings per Share 61,234 60,211 61,200
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
The following future issuances of Common Shares were not included in
computing Diluted Earnings per Share because their effects were antidilutive.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(SHARES IN THOUSANDS)
<S> <C> <C> <C>
Common Shares issuable upon
conversion of Preferred Shares 702 917 428
Stock options and stock
appreciation rights -- 130 --
Common Shares issuable in future -- 15 --
- ------------------------------------------------------------------------------
</TABLE>
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.
NOTE 5
INTANGIBLE ASSETS
Cellular license costs consist of costs incurred in acquiring Federal
Communications Commission ("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 $32.7 million, $27.2 million and $25.9 million in
1998, 1997 and 1996, respectively. Accumulated amortization of cellular
license costs was $153.9 million and $121.2 million at December 31, 1998 and
1997, respectively. Included in cellular license costs is approximately $242
million and $281 million at December 31, 1998 and 1997, respectively, of
goodwill related to various acquisitions structured to be tax-free. No
deferred taxes have been provided on this goodwill.
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 $8.0 million and $4.7 million in 1998 and 1997, respectively.
Accumulated amortization of Broadband PCS license costs was $12.7 million and
$4.7 million at December 31, 1998 and 1997, respectively. Interest capitalized
totaled $5.0 million and $22.7 million in 1997 and 1996, respectively.
Franchise and other costs include the costs in excess of the underlying
book value of acquired telephone companies. Costs aggregating $215.3 million
and $209.1 million at December 31, 1998 and 1997, respectively, relating to
acquisitions since November 1, 1970, are being amortized on a straight-line
basis over a 40-year period. Amortization amounted to $5.3 million, $5.2
million and $4.9 million in 1998, 1997 and 1996, respectively. Accumulated
amortization of excess cost was $40.2 million and $34.9 million at December
31, 1998 and 1997, 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 $141 million and $135 million at December 31, 1998 and 1997,
respectively, of goodwill related to various acquisitions structured to be
tax-free. No deferred taxes have been provided on this goodwill.
<PAGE>
28
NOTE 6
INVESTMENTS IN UNCONSOLIDATED ENTITIES
Investments in unconsolidated entities consists of investments in which the
Company 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 20% for corporations
and 3% for partnerships ($291.5 million and $266.0 million at December 31, 1998
and 1997, respectively). Income and losses from these entities are reflected in
the Consolidated Statements of Operations on a pretax basis as Investment
income. Investment income totaled $40.6 million, $81.2 million and $58.5 million
in 1998, 1997 and 1996, respectively. At December 31, 1998, the cumulative share
of income from minority investments accounted for under the equity method was
$185.7 million, of which $52.2 million was undistributed. The cost method of
accounting is followed for certain minority interests where the Company's
ownership interest is less than 20% for corporations and 3% for partnerships
($15.8 million and $9.5 million at December 31, 1998 and 1997, respectively).
Investments in unconsolidated entities includes cellular license costs and
costs in excess of the underlying book value of certain non-cellular minority
investments. These costs are being amortized from 10 to 40 years. Amortization
amounted to $9.7 million, $3.0 million and $3.0 million in 1998, 1997 and 1996,
respectively.
The Company's more significant investments in unconsolidated entities consist
of the following:
<TABLE>
<CAPTION>
PERCENTAGE OWNERSHIP
DECEMBER 31, 1998 1997
- -------------------------------------------------------------------------
<S> <C> <C>
Cellular
Los Angeles SMSA Limited Partnership 5.5% 5.5%
Oklahoma City SMSA Limited Partnership 14.6% 14.6%
Raleigh-Durham MSA Limited Partnership 8.0% 8.0%
Midwest Wireless Communication, LLC 14.7% 14.7%
Northeast Cellular Telephone Co., L.P. 49.0% 49.0%
Saco River Cellular Telephone Co. 40.0% 40.0%
Allentown SMSA Limited Partnership 8.1% 8.1%
Eau Claire Cellular Telephone Limited Partnership 44.5% 44.5%
Ohio RSA #9 49.0% 49.0%
Other
TSR Wireless Holdings, LLC 30.0% --
- -------------------------------------------------------------------------
</TABLE>
The following summarizes the unaudited combined assets, liabilities and
equity, and the unaudited combined results of operations of the entities for
which TDS's investments are accounted for by the equity method.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- --------------------------------------------------------------------------
(UNAUDITED, DOLLARS IN MILLIONS)
<S> <C> <C>
Assets
Current assets $ 620 $ 425
Due from affiliates 7 3
Property and other 1,156 1,159
--------------------
$1,783 $1,587
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
Liabilities and Equity
Current liabilities $ 397 $ 287
Due to affiliates 26 38
Deferred credits 3 9
Long-term debt 359 70
Partners' capital and stockholders' equity 998 1,183
--------------------
$1,783 $1,587
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(UNAUDITED, DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Results of Operations
Revenues $1,581 $1,740 $1,395
Costs and expenses 1,091 1,256 958
--------------------------------
Operating Income 490 484 437
--------------------------------
Other income (expense) (13) 5 7
Interest expense (5) (10) (6)
Income taxes (4) (6) (3)
Extraordinary item -- -- (2)
--------------------------------
Net income $ 468 $ 473 $ 433
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
NOTE 7
MARKETABLE EQUITY SECURITIES
Marketable equity securities include the Company's investments in equity
securities, primarily AirTouch Communications, Inc. ("AirTouch") common shares.
These securities are classified as available-for-sale and stated at fair market
value.
Information regarding the Company's marketable equity securities is
summarized below.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Available-for-sale Equity Securities
Aggregate Fair Value $378,812 $1,621
Original Cost 230,344 473
----------------------
Gross Unrealized Holding Gains 148,468 1,148
Tax Effect 59,661 465
----------------------
Unrealized Holding Gains, net of tax 88,807 $ 683
Minority Share of Unrealized Holding Gains 13,198 --
----------------------
Net Unrealized Holding Gains $ 75,609 $ 683
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
The Company's net unrealized holding gains are included as an increase to
Common Stockholders' Equity. Realized gains and losses are determined on the
basis of specific identification. During 1998, proceeds from the sale of
available- for-sale securities totaled $613,000 and gross realized gains
<PAGE>
29
totaled $300,000. During 1997, proceeds from the sale of available-for-sale
securities totaled $1.5 million and gross realized gains totaled $154,000.
NOTE 8
PROPERTY, PLANT AND EQUIPMENT
U.S. CELLULAR
U.S. Cellular property, plant and equipment is stated at cost and consists of:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cell site-related equipment $ 790,292 $ 725,544
Switching-related equipment 116,198 105,955
Office furniture and equipment 127,397 89,987
Land, buildings and leasehold improvements 237,361 199,108
System development 134,225 96,423
Work in process 70,197 44,000
Other operating equipment 59,152 47,981
----------------------------
1,534,822 1,308,998
Accumulated depreciation 396,237 290,439
----------------------------
$1,138,585 $1,018,559
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
Renewals and betterments of units of property are recorded as additions to
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 depreciation expense. Repairs and renewals of minor units of
property are charged to system operations expense.
TDS TELECOM
TDS Telecom 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") and
consists of:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ---------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cable and wire $ 772,749 $ 719,945
Central office equipment 460,323 399,016
Office furniture and equipment 145,851 112,921
Land and buildings 68,274 67,203
Other equipment 67,338 69,128
Work in process 28,696 52,677
------------------------
1,543,231 1,420,890
Accumulated depreciation 661,724 590,123
------------------------
$ 881,507 $ 830,767
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
</TABLE>
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.
AFUDC, a noncash item of non-operating income, totaled $403,000, $686,000 and
$825,000 in 1998, 1997 and 1996, respectively. The composite weighted average
rates were 5.9%, 5.5% and 7.3% in 1998, 1997 and 1996, 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.
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 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.
AERIAL
Aerial property, plant and equipment is stated at original cost and consists of:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cell site-related equipment $467,654 $422,927
Switching-related equipment 113,169 91,598
Information systems 89,422 83,950
Office equipment, leasehold
improvements and other 26,269 24,266
Work in process 37,444 19,381
-------------------------
733,958 642,122
Accumulated depreciation 112,677 38,018
-------------------------
$621,281 $604,104
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
</TABLE>
Renewals and betterments of units of property are recorded as additions to
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 operating expense. Repairs and renewals of minor units of property
are charged to system operations expense.
PCS work in process includes expenditures for the design, construction and
testing of Aerial's PCS networks, costs of developing information systems and
costs to relocate dedicated private microwave links currently operating in
Aerial's spectrum in its markets. Aerial capitalized interest on certain of its
work in process expenditures totaling $132,000, $6.0 million and $1.2 million in
1998, 1997 and 1996, respectively.
<PAGE>
30
OTHER
Other property, plant and equipment is stated at original cost and consists of:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ---------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Computer equipment $33,016 $ 34,602
System development 22,992 30,713
Other equipment 12,919 11,806
Land and buildings 7,840 12,947
Furniture and fixtures 6,649 6,741
Radio paging property and equipment -- 118,275
---------------------
83,416 215,084
Accumulated depreciation 52,200 124,555
---------------------
$31,216 $ 90,529
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
</TABLE>
The investment in radio paging property and equipment was contributed to TSR
Wireless along with certain other assets of American Paging. See Note 2 --
Summary of Significant Accounting Policies -- Nature of Operations.
DEPRECIATION
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 was as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
U.S. Cellular 13.0% 10.3% 10.8%
TDS Telecom 7.5 7.4 7.2
Aerial 11.5 10.9 20.2
Other 17.6% 19.5% 22.9%
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
Cellular depreciation as a percentage of depreciable property increased in
1998 due to the reduction in useful lives of certain assets in 1998, increasing
the provision for depreciation.
NOTE 9
SUPPLEMENTAL CASH FLOW DISCLOSURES
Following are supplemental cash flow disclosures for interest and income taxes
paid, acquisitions and certain noncash transactions.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Interest paid $83,567 $70,741 $ 52,835
Income taxes paid 7,404 10,743 67,967
Common Shares issued for
conversion of Preferred Shares 6,114 1,031 4,602
Increase in PCS network equipment
and prepaid infrastructure costs
through the issuance of long-term
debt and interim financing 65,423 84,355 100,000
Additions to property, plant
and equipment financed
through accounts payable
and accrued expenses $33,874 $69,916 $108,167
- ------------------------------------------------------------------------------
</TABLE>
TDS has acquired certain cellular licenses and operating companies, operating
telephone companies and certain other assets since January 1, 1996. In
conjunction with these acquisitions, the following assets were acquired and
liabilities assumed, and Common Shares and Preferred Shares issued:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ---------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Property, plant and equipment $ 26,560 $120,365 $ 55,692
Cellular licenses 94,590 137,409 95,447
Decrease in investment in
cellular minority-owned entities (2,317) (89,205) (3,641)
Franchise and other costs 5,983 2,452 17,679
Long-term debt (4,450) (4,857) (22,979)
Deferred credits (3,905) 1,104 (6,205)
Other assets and
liabilities, excluding
cash and cash equivalents 10,835 7,396 8,154
Common Shares issued
and issuable (9,479) (42,685) (113,128)
Preferred Shares issued -- (3,000) --
----------------------------------
Decrease in cash due
to acquisitions $117,817 $128,979 $ 31,019
- ---------------------------------------------------------------------------
- ---------------------------------------------------------------------------
</TABLE>
NOTE 10
ACQUISITIONS, EXCHANGES AND SALES
During 1998, 1997 and 1996, TDS and its subsidiaries completed the following
business combinations:
<TABLE>
<CAPTION>
Consideration
--------------------------------
TDS and U.S. Cellular
Common Stock, and TDS
Cash Preferred Shares
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Acquisitions During 1998
Cellular interests
(1,264,000 population equivalents) $117,319 $ 4,750
Telephone interests
(6,500 access lines) 498 8,725
Acquisitions During 1997
Cellular interests
(534,000 population equivalents) $128,828 $32,486
Telephone interests
(3,200 access lines) 151 13,200
Acquisitions During 1996
Cellular interests
(446,000 population equivalents) $ 13,596 $42,499
Telephone interests
(33,100 access lines) 17,423 70,663
- ----------------------------------------------------------------------------
</TABLE>
Assuming that these acquisitions, accounted for as purchases, had taken place
on January 1, 1997, unaudited pro forma results of operations from continuing
operations would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997
- ----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C>
Operating Revenues $1,828,240 $1,408,352
Net Income (Loss) 65,402 (10,704)
Basic Earnings per Share 1.04 (.21)
Diluted Earnings per Share $1.04 $ (.21)
- ----------------------------------------------------------------------------
</TABLE>
<PAGE>
31
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
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/Illinois/Indiana and Wisconsin/Illinois clusters.
SALES OF CELLULAR AND OTHER INVESTMENTS
The gains recorded in 1998, 1997 and 1996 reflect the sales of non-strategic
cellular and certain other investments. In 1998, U.S. Cellular and TDS Telecom
sold their minority interests in certain cellular markets to AirTouch for 5.2
million AirTouch common shares and cash. U.S. Cellular also sold its majority
interest in one market for cash. In 1997, 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. In 1996,
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 $131.0 million, $84.2 million and $221.5 million
in 1998, 1997 and 1996, respectively.
AMERICAN PAGING MERGER
TDS contributed substantially all of the assets and certain, limited liabilities
of American Paging to TSR Wireless for a 30% interest in TSR Wireless effective
March 31, 1998. See Note 2--Summary of Significant Accounting Policies--Nature
of Operations.
NOTE 11
NOTES PAYABLE
TDS has used short-term debt to acquire PCS licenses, to finance Aerial's
construction, start-up and development activities and operations, for
acquisitions and for general corporate purposes. Proceeds from the sale of
long-term debt and equity securities from time to time, including the sale of
debt and equity securities by subsidiaries, have been used to reduce such
short-term debt. Proceeds from the sale of non-strategic cellular and other
investments from time to time have also been used to reduce short-term debt.
TDS had $598 million of committed bank lines of credit for general corporate
purposes at December 31, 1998. Unused amounts of such lines totaled $427
million. These lines of credit consist of a $500 million TDS revolving credit
facility and $98 million in direct bank lines of credit.
TDS has a six-year $500 million revolving credit facility with a group of
banks ("TDS Revolving Credit Facility"). As of December 31, 1998, $384 million
was unused. The terms of the credit facility provide for borrowings with
interest, at the London InterBank Offered Rate ("LIBOR") plus 22.5 basis points.
Interest and principal are due the last day of the borrowing period, as selected
by the borrower, of either seven days or one, two, three or six months. The
credit facility expires in June 2002.
TDS also has $98 million in direct bank lines of credit. As of December 31,
1998, $43 million was unused. The terms of the direct bank lines of credit
provide for borrowings at negotiated rates up to the prime rate.
U.S. Cellular has a seven-year $500 million revolving credit facility with a
group of banks ("U.S. Cellular Revolving Credit Facility"). As of December 31,
1998, $500 million was unused. The terms of the credit facility provide for
borrowings with interest, at the LIBOR plus 26.5 basis points. Interest and
principal are due the last day of the borrowing period, as selected by the
borrower, of either seven days or one, two, three or six months. The credit
facility expires in August 2004.
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:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at end of year $170,889 $527,587 $160,537
Weighted average interest
rate at end of year 6.0% 6.3% 6.0%
Maximum amount outstanding
during the year $572,405 $587,683 $204,140
Average amount outstanding
during the year (1) $360,375 $407,965 $112,341
Weighted average interest
rate during the year (1) 5.7% 6.1% 5.8%
- -----------------------------------------------------------------------------
(1)THE AVERAGE WAS COMPUTED BASED ON MONTH-END BALANCES.
</TABLE>
<PAGE>
32
NOTE 12
LONG-TERM DEBT
Long-term debt is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Telephone and Data Systems, Inc. (Parent)
Medium-term notes, 8% to 10%,
(averaging 9%) due through 2025 $ 239,200 $ 239,200
7% Notes, maturing in 2006 200,000 --
Purchase contracts and other
long-term notes, 9% to 14%,
(averaging 10%) due through 2003 2,201 2,440
-------------------------
Total Parent 441,401 241,640
-------------------------
Subsidiaries
U.S. Cellular
6% zero coupon convertible redeemable
debentures, maturing in 2015 744,975 744,975
Unamortized discount (463,488) (479,645)
-------------------------
281,487 265,330
-------------------------
7.25% notes, maturing in 2007 250,000 250,000
TDS Telecom
RUS, RTB and FFB Mortgage
Notes, due through 2031, various
rates averaging 5.5% in 1998,
5.5% in 1997 and 5.4% in 1996 308,494 313,012
Other long-term notes, 0% to 12.6%
(averaging 7.2%), due through 2009 5,676 8,723
Aerial
8.34% zero coupon notes,
maturing in 2006 226,245 226,245
8.05% zero coupon notes,
maturing in 2008 219,975 --
Unamortized discount (213,682) (114,161)
-------------------------
232,538 112,084
-------------------------
Vendor credit agreement,
5.31% due in 2000 45,472 84,355
Other
Long-term notes, 7.92% to 8.23%,
due through 2002 3,974 3,890
-------------------------
Total Subsidiaries 1,127,641 1,037,394
-------------------------
Total long-term debt 1,569,042 1,279,034
Less current portion 15,946 14,816
-------------------------
Total long-term debt,
excluding current portion $1,553,096 $1,264,218
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
The Medium-Term Notes ("MTNs") carry original maturities of 12 to 30 years,
maturing at various times from 2003 to 2025. Interest is payable semi-annually.
The MTNs may be redeemed by the Company at par value beginning at various times
in 1999 to 2006.
The Company sold $200 million principal amount of 7% unsecured notes in 1998
with proceeds to the Company of $198.4 million. The notes are due August 2006
and interest is payable semi-annually. The notes are redeemable at any time at
the option of the Company, at a redemption price equal to the greater of (a)
100% of the principal amount of such notes, plus accrued but unpaid interest, or
(b) the sum of the present values of the remaining scheduled payments
of principal and interest thereon discounted to the redemption date on a
semi-annual basis at the Treasury Rate plus .25%.
The 6% yield to maturity zero coupon convertible redeemable 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 accreted interest.
U.S. Cellular sold $250 million principal amount of 7.25% unsecured senior
notes in 1997 with proceeds of $247.0 million. The notes are due 2007 and
interest is payable semi-annually. U.S. Cellular may redeem the notes beginning
2004 at principal amount plus accrued interest.
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.
Aerial sold $220 million principal amount at maturity, 10-year zero coupon
8.05% yield to maturity debt in 1998 and $226 million principal amount at
maturity, 10-year zero coupon 8.34% yield to maturity debt in 1996. The
unsecured notes are due in 2008 and 2006, respectively, and there is no periodic
payment of interest. The proceeds were paid to Aerial's equipment vendor in
satisfaction of $200 million of obligations. The notes are fully and
unconditionally guaranteed by TDS. The notes are subject to optional redemption
beginning in 2003 and 2001, respectively, at redemption prices which reflect
original issue discount accreted since issuance.
In 1998, 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 until June 30, 1999. These loans mature on June 30, 1999, however, the
maturity date may be extended to June 30, 2000, upon written notice and payment
of an extension fee by Aerial to Nokia. A second $75 million becomes available
commencing on June 30, 1999. All loans mature on June 30, 2000. Interest under
the agreement is payable monthly at a per annum rate equal to the 30-day LIBOR
plus .25%. The obligations of Aerial under the agreement are fully and
unconditionally guaranteed by TDS.
<PAGE>
33
The annual requirements for principal payments on long-term debt are
approximately $15.9 million, $61.2 million, $15.6 million, $15.4 million and
$47.4 million for the years 1999 through 2003, respectively.
The carrying value and estimated fair value of the Company's Long-term Debt
were $1,569 million and $1,606 million at December 31, 1998 and $1,279 million
and $1,270 million at December 31, 1997, 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 13
MINORIITY INTEREST IN SUBSIDIARIES
The following table summarizes the minority shareholders' and partners'
interests in the equity of consolidated subsidiaries.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- -----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
U.S. Cellular
Public shareholders $362,224 $305,478
Subsidiaries' partners and shareholders 43,609 53,908
----------------------------
405,833 359,386
Aerial
Public shareholders 3,527 33,692
Subsidiary's shareholders 5,835 --
----------------------------
9,362 33,692
TDS Telecom telephone subsidiaries 24,701 23,293
Other 292 195
----------------------------
$440,188 $416,566
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
SALE OF STOCK BY SUBSIDIARIES
In 1998, Sonera, Ltd. ("Sonera"), formerly Telecom Finland Ltd., purchased
approximately 2.4 million shares of common stock, representing a 19.423%
interest, of Aerial Operating Co., Inc. ("AOC") for $200 million. Prior to this
investment, AOC was a wholly-owned subsidiary of Aerial Communications, Inc.
("Aerial"). (AOC owns a 100% interest in each of Aerial's six operating
markets.) The Sonera investment 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 investment and increased capital in excess of par
value $148.4 million in 1998.
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 stock price, Sonera's ownership amount in AOC could
decline to approximately 15%.
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 14
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY
COMPANY SUBORDINATED DEBENTURES
In 1998, TDS Capital II, a subsidiary trust ("Capital II") of TDS, issued
6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable Preferred
Securities (the "1998 Preferred Securities") at $25 per Preferred Security. Net
proceeds totaled $144.9 million and were used to reduce 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.
In 1997, TDS Capital I, a subsidiary trust ("Capital I") of TDS, issued
6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred
Securities (the "1997 Preferred Securities") at $25 per Preferred Security. Net
proceeds totaled $144.8 million and were used to reduce 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.
The obligations of TDS Capital I and II under 1998 Preferred Securities and
1997 Preferred Securities (the "Preferred Securities") issued by TDS Capital I
and II are fully and unconditionally guaranteed by TDS. 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 8.04% and 8.5% Subordinated Debentures are redeemable by TDS, in whole or
in part, from time to time, on or after March 31, 2003, and November 18, 2002,
respectively, or, in whole but not in part, at any time in the event of certain
income tax circumstances. If the Subordinated Debentures are redeemed, TDS
Capital I and II 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
<PAGE>
34
the dissolution, winding up or termination of TDS Capital I and II, 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.
The carrying value and estimated fair value of the Company's Preferred
Securities were $300.0 million and $297.8 million at December 31, 1998 and
$150.0 million and $153.4 million at December 31, 1997, respectively. The fair
value of the Company's Preferred Securities was estimated using discounted cash
flow analysis based on the Company's current incremental borrowing rates for
similar types of arrangements.
NOTE 15
PREFERRED SHARES
At December 31, 1998, 259,847 Preferred Shares were authorized, issued and
outstanding. Certain series of Preferred Shares are redeemable at the option of
TDS at $100 per share, plus accrued and unpaid dividends. The average dividend
rate is $5.76 per share. At December 31, 1998, certain series of Preferred
Shares are convertible into TDS Common Shares. See Note 16 -- Common
Stockholders' Equity -- Convertible Preferred Shares.
In connection with the reincorporation of TDS into Delaware, each issued Iowa
Preferred Share, no par value, stated value of $100 per share, was converted
into a Delaware Preferred Share, $.01 par value. All Preferred Shares have a
liquidation value of $100 per share plus accrued and unpaid dividends.
Accordingly, Preferred Shares are stated on the balance sheet at $100 per share.
The following is a schedule of Preferred Shares activity.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of year $32,466 $30,858 $44,803
Add:
Acquisition -- 3,000 --
Stock Dividends -- -- 113
Less:
Conversion of preferred (6,114) (1,031) (4,602)
Redemption of preferred (367) (361) (9,456)
-----------------------------------
Balance, end of year $25,985 $32,466 $30,858
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
The carrying value and estimated fair value of the Company's Preferred Shares
were $26.0 million and $17.8 million at December 31, 1998 and $32.5 million and
$23.6 million at December 31, 1997, respectively. The fair value of the
Company's Preferred Shares was estimated using discounted cash flow analysis
based on the Company's current incremental borrowing rates for similar types of
arrangements.
NOTE 16
COMMON STOCKHOLDER'S EQUITY
COMMON STOCK
The following table summarizes the number of Common and Series A Common Shares
outstanding:
<TABLE>
<CAPTION>
Series A
Common Common Treasury
Shares Shares Shares
-----------------------------------------------------------------------------
(SHARES IN THOUSANDS)
<S> <C> <C> <C>
Balance December 31, 1995 51,137 6,893 --
Acquisitions of cellular and
telephone interests 2,645 -- --
Dividend reinvestment, incentive
and compensation plans 100 27 --
Conversion of Preferred Shares 352 -- --
Conversion of Series A
Common Shares 3 (3) --
--------------------------------
Balance December 31, 1996 54,237 6,917 --
Repurchase Common Shares -- -- (1,798)
Acquisitions of cellular and
telephone interests 16 -- 999
Dividend reinvestment, incentive
and compensation plans 122 19 4
Conversion of Preferred Shares 68 -- --
--------------------------------
Balance December 31, 1997 54,443 6,936 (795)
Acquisitions of cellular and
telephone interests 228 -- --
Dividend reinvestment, incentive
and compensation plans 39 14 34
Conversion of Preferred Shares 278 -- --
--------------------------------
Balance December 31, 1998 54,988 6,950 (761)
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
In connection with the reincorporation of TDS into Delaware, each issued,
Iowa Common and Series A Common Share, $1 par value, was converted into a
Delaware Common and Series A Common Share, $.01 par value. The December 31, 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.
CONVERTIBLE PREFERRED SHARES
TDS convertible Preferred Shares are convertible into 688,977 Common Shares. See
Note 15 -- Preferred Shares. TDS issued 274,634 Common Shares in 1998, 56,365 in
1997 and 347,707 in 1996 for TDS Preferred Shares converted. TDS also issued
3,780 Common Shares in 1998, 11,345 in 1997 and 3,781 in 1996 for subsidiary
preferred stock converted.
SERIES A COMMON SHARES
The holders of Common Shares and 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 6,949,904 Common Shares for possible
issuance upon such conversion.
<PAGE>
35
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 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. No Common Shares were repurchased in 1998. The Company reissued
33,400 and 4,700 Common Shares in 1998 and 1997, respectively, for incentive and
compensation plans and 998,800 Common Shares in 1997 for acquisitions.
ACCUMULATED OTHER COMPREHENSIVE INCOME
Effective January 1, 1998, the Company implemented the provisions of SFAS No.
130, "Reporting Comprehensive Income." Under SFAS No. 130, the Company is
required to report all changes in equity during a period, except those resulting
from investments and distributions by owners, in a financial statement for the
period in which they are recognized. The Company has chosen to disclose
Comprehensive Income, which encompasses Net Income and Net Unrealized Gains on
Securities, in the Consolidated Statements of Common Stockholders' Equity. Prior
years have been restated to conform to the requirements of SFAS No. 130. The
income tax effects allocated to and the cumulative balance of unrealized gains
on securities are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of year $ 683 $513 $ 7
Add:
Unrealized gains on securities 147,620 473 819
Income tax effect 59,316 210 313
---------------------------------
88,304 263 506
Minority share of
unrealized gains 13,198 -- --
---------------------------------
Net unrealized gains 75,106 263 506
---------------------------------
Deduct:
Gain on sales of securities 300 154 --
Income tax expense 120 61 --
---------------------------------
Net realized gains included
in Net Income 180 93 --
---------------------------------
Net Unrealized gains included
in Comprehensive Income 74,926 170 506
---------------------------------
Balance, end of year $ 75,609 $683 $513
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
NOTE 17
DIVIDEND REINVESTMENT, INCENTIVE AND COMPENSATION PLANS
The following table summarizes Common and Series A Common Shares issued,
including reissued Treasury Shares, for the employee stock ownership plans and
dividend reinvestment plans described below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Common Shares
Tax-deferred savings plan 13,270 32,354 36,269
Dividend reinvestment plan 14,883 25,273 28,827
Stock-based
compensation plans 44,662 69,109 35,273
---------------------------------
72,815 126,736 100,369
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Series A Common Shares
Dividend reinvestment plan 13,627 19,731 26,445
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
TAX-DEFERRED SAVINGS PLAN
TDS had reserved 158,695 Common Shares for issuance 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 or five nonaffiliated funds.
DIVIDEND REINVESTMENT PLANS
TDS had reserved 445,859 Common Shares for issuance under the Automatic Dividend
Reinvestment and Stock Purchase Plan and 158,896 Series A Common Shares for
issuance 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 Common Shares and holders of Series A Common Shares
to reinvest cash dividends in 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 3,013,795 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
<PAGE>
36
specified period not in excess of ten years. The options expire from 1999 to
2008 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 and $263,000 in 1997 and 1996, respectively. Had
compensation cost for all plans been determined consistent with SFAS No. 123
"Accounting for Stock-Based Compensation," the Company's net income (loss) and
earnings per share would have been reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net Income (Loss)
As Reported $ 64,408 $ (9,549) $128,139
Pro Forma 58,918 (13,506) 126,495
Basic Earnings per Share
As Reported 1.03 (.19) 2.09
Pro Forma .94 (.26) 2.06
Diluted Earnings per Share
As Reported 1.03 (.19) 2.07
Pro Forma $ .94 $ (.26) $ 2.05
- ------------------------------------------------------------------------------
</TABLE>
A summary of the status of the Company's stock option plans at December 31,
1998, 1997 and 1996 and changes during the years then ended is presented in the
table and narrative below:
<TABLE>
<CAPTION>
Weighted Weighted
Number Average Average
of Shares Option Prices Fair Values
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Stock Options:
Outstanding December 31, 1995
(240,160 exercisable) 516,445 $32.47
Granted 89,228 $41.00 $13.30
Exercised (11,025) $13.10
Canceled (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
Canceled (41,243) $40.78
--------
Outstanding December 31, 1997
(492,917 exercisable) 574,508 $35.87
Granted 463,433 $42.09 $11.73
Exercised (21,227) $30.36
Canceled (14,089) $47.45
--------
Outstanding December 31, 1998
(776,653 exercisable) 1,002,625 $38.70
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
Of the options outstanding at December 31, 1998, 776,653 options are
exercisable, have exercise prices between $4.15 and $47.60 with a weighted
average exercise price of $37.90, and a weighted average remaining contractual
life of 6.3 years. The remaining 225,972 options are not exercisable, have
exercise prices between $4.15 and $46.87 with a weighted average exercise price
of $41.47, and a weighted average remaining contractual life of 8.3 years.
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 1998, 1997 and 1996,
respectively: risk-free interest rates of 5.2%, 6.1% and 5.6%; expected dividend
yields of 1.0%, 1.0% and 1.0%; expected lives of 7.0 years, 5.0 years and 5.1
years and expected volatility of 20.4%, 19.2% and 20.5%.
STOCK APPRECIATION RIGHTS allow 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 Common Shares on the exercise
date. The following table summarizes outstanding rights which expired in 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 and 1996, respectively:
risk-free interest rates of 4.9% and 5.2%; expected dividend yields of 1.0% and
1.0%; expected lives of 0.1 year and 0.2 year; and expected volatility of 20.5%
and 18.4%.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C>
Outstanding beginning of period 10,070 16,034
Granted 630 5,923
Exercised (10,700) (11,887)
---------------------
Outstanding end of period -- 10,070
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN. TDS had reserved 138,765 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 of rights in 1998, 1997 and 1996, respectively: risk-free interest rate
of 5.4%, 5.6% and 5.6%; expected dividend yield of 1.0%, 1.0% and 1.0%; expected
lives of 2.0 years, 1.2 years and 0.5 year; and expected volatility of 17.4%,
16.9% and 15.3%.
<PAGE>
37
NOTE 18
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.
Total pension costs were $7.7 million, $5.3 million and $4.6 million in 1998,
1997 and 1996, 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's postretirement medical and life insurance plans are currently
underfunded.
The following table reconciles the beginning and ending balances of the
benefit obligation and the fair value of plan assets for the other
postretirement benefit plans:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Change in Benefit Obligation
Benefit obligation at beginning of year $21,339 $ 17,781
Service cost 933 875
Interest cost 1,486 1,346
Amendments 198 1,534
Actuarial gain (1,968) 276
Benefits paid (652) (473)
---------------------
Benefit obligation at end of year 21,336 21,339
---------------------
Change in Plan Assets
Fair value of plan assets at
beginning of year 14,604 10,259
Actual return on plan assets 723 2,469
Employer contribution 2,171 2,349
Acquisition 2,130 --
Benefits paid (652) (473)
---------------------
Fair value of plan assets at end of year 18,976 14,604
---------------------
Funded Status (2,360) (6,735)
Unrecognized net actuarial gain (8,517) (6,720)
Unrecognized prior service cost 1,414 2,091
---------------------
Prepaid (accrued) benefit cost $(9,463) $(11,364)
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
The following table sets forth the weighted average assumptions used in
accounting for the plans:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Discount rate 7.0% 7.0%
Expected return on plan assets 8.0% 8.0%
- ------------------------------------------------------------------------------
</TABLE>
For measurement purposes, a 9.9% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1998; the rate was assumed
to decrease over six years to 6.1% and to remain at 6.1% thereafter.
Net periodic benefit cost for the years ended December 31, 1998, 1997 and
1996 include the following components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 1997 1996
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Service cost $ 933 $ 875 $ 796
Interest cost on
accumulated postretirement
benefit obligation 1,486 1,346 1,125
Expected return on plan assets (1,271) (632) (753)
Net amortization and deferral (160) (344) 99
---------------------------------
Net postretirement cost $ 988 $1,245 $1,267
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
<PAGE>
38
The health care cost trend rate assumption has a significant effect on the
amounts reported. A one-percentage-point increase or decrease in assumed health
care cost trend rates would result in a $506,000 increase or decrease in the
total of service and interest cost components and a $3.5 million increase or
decrease in the postretirement benefit obligation, respectively.
NOTE 19
COMMITMENTS
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 U.S. Cellular capital additions budget
totals approximately $300 million for 1999, to expand and enhance coverage,
including adding digital service capabilities to its systems and to enhance
office systems. The TDS Telecom capital additions budget totals approximately
$120 million for 1999, including approximately $45 million for outside plant
facilities and $35 million for switching facilities in the Incumbent Local
Exchange Carrier ("ILEC") markets and $12 million for current Competitive Local
Exchange Carrier ("CLEC") operations. The Aerial capital additions budget totals
approximately $130 million for 1999, including approximately $100 million for
cell sites and switching equipment and $27 million for systems development. In
addition, Aerial will require an estimated $125 million for working capital and
operating expenses and $80 million for interest expense.
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 1998, 1997 and 1996, rent expense for
noncancelable, long-term leases was $52.1 million, $36.9 million and $20.9
million, respectively, and rent expense under cancelable, short-term leases was
$9.1 million, $8.7 million and $7.6 million, respectively. At December 31, 1998,
the aggregate minimum rental commitments under noncancelable, long-term
operating leases were as follows:
<TABLE>
<CAPTION>
MINIMUM FUTURE
RENTAL PAYMENTS
- ------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C>
1999 $45,875
2000 41,915
2001 36,590
2002 25,493
2003 16,865
Thereafter $87,983
- ------------------------------------------------------------------------------
</TABLE>
NOTE 20
BUSINESS SEGMENT INFORMATION
TDS is a diversified telecommunications service company with established
cellular telephone and local telephone operations and developing personal
communications services ("PCS") operations. The Company manages these operations
through separate subsidiaries as described below. For the year ended December
31, 1998, cellular operations provided 64% of the Company's consolidated
revenues, telephone operations provided 27% and PCS operations provided 9%. The
Company's long-term business development strategy is to expand its existing
operations through internal growth and acquisitions and to explore and develop
other telecommunications businesses that management believes will utilize the
Company's expertise in customer-based telecommunications.
The Company conducts substantially all of its cellular operations through
its 81.0%-owned subsidiary United States Cellular Corporation ("U.S.
Cellular"). At December 31, 1998, U.S. Cellular provided cellular telephone
service to 2,183,000 customers through 138 majority-owned and managed
("consolidated") cellular systems in 24 states. Cellular revenues primarily
consist of: (i) charges for access, airtime and value-added services provided
to U.S. Cellular's local retail customers who use the local systems operated
by U.S. Cellular; (ii) charges to customers of other systems who use U.S.
Cellular's cellular systems when roaming; (iii) charges for long-distance
calls made on U.S. Cellular's systems; and (iv) equipment sales.
The Company conducts its telephone operations through its wholly-owned
subsidiary TDS Telecommunications Corporation ("TDS Telecom"). At December
31, 1998, TDS Telecom operated 105 telephone companies serving 547,500 access
lines in 28 states. TDS Telecom is expanding by offering additional lines of
telecommunications products and services to existing customers and through
the selective acquisition of local exchange telephone companies serving rural
and suburban areas. Telephone revenues consist of: (i) local telephone
exchange service provided within the franchise serving area of TDS Telecom's
telephone subsidiaries; (ii) compensation for carrying interstate and
intrastate long-distance traffic on TDS Telecom's operating telephone
subsidiaries' networks; (iii) miscellaneous revenues related to (a) leasing,
selling, installing, maintaining and repairing customer premise
telecommunications equipment, such as telephone answering equipment or
business systems and associated peripheral equipment, and wiring, (b)
providing billing and collection services for interexchange carriers, (c)
leasing network facilities, (d) sale of satellite dishes (Digital Broadcast
Satellite or "DBS") and (e) providing Internet services; and (iv) revenues
from CLEC operations.
<PAGE>
39
The Company conducts its broadband PCS operations through its 82.3%-owned
subsidiary Aerial Communications, Inc. ("Aerial"). Aerial provides PCS service
in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas
City and Columbus Major Trading Areas ("MTAs"). Aerial has commenced service in
all its markets and provided service to 311,900 PCS telephones as of December
31, 1998. PCS revenues primarily consist of: (i) charges for access, airtime and
value-added services provided to Aerial's retail customers who use the network
operated by Aerial; (ii) charges for long-distance calls made on Aerial's
systems; and (iii) equipment sales revenue representing the sale of handsets and
related accessories to retailers, independent agents, and end user customers.
In December 1998, TDS announced that it was pursuing a tax-free spin-off of
its 82.3% interest in Aerial, as well as reviewing other alternatives. See Note
1 -- Corporate Restructuring.
TDS contributed substantially all of the assets and certain, limited
liabilities of American Paging, Inc. to TSR Wireless Holdings, LLC ("TSR
Wireless") for a 30% interest in TSR Wireless effective March 31, 1998. American
Paging's revenues are netted against its expenses in the Consolidated Statements
of Operations with the resulting operating loss reported as American Paging
Operating (Loss). American Paging revenues primarily consist of dispatch
services, subscriber device rental and equipment sales representing sales of
pagers to customers. Beginning April 1, 1998, TDS followed the equity method of
accounting for its 30% interest in TSR Wireless and reported these results as a
component of Investment income.
U.S. Cellular, TDS Telecom and Aerial are billed for all services they
receive from TDS, consisting primarily of information processing and general
management services. Such billings are based on expenses specifically
identified to U.S. Cellular, TDS Telecom and Aerial and on allocations of
common expenses. Such allocations are based on the relationship of U.S.
Cellular's, TDS Telecom's and Aerial's assets, employees, investment in plant
and expenses to the total assets, employees, investment in plant and expenses
of TDS. Management believes the method used to allocate common expenses is
reasonable and that all expenses and costs applicable to U.S. Cellular, TDS
Telecom and Aerial are reflected in the accompanying business segment
information on a basis which is representative of what they would have been
if U.S. Cellular, TDS Telecom and Aerial operated on a stand-alone basis.
Financial data for the Company's business segments for each of the years
ended December 31, 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1998 U.S. Cellular TDS Telecom Aerial All Other(1) Total
- -----------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Operating revenues $1,162,467 $ 488,104 $ 155,154 $ 17,783 $1,823,508
Operating cash flow 382,854 205,814 (196,584) (3,511) 388,573
Depreciation and amortization expense 206,779 111,402 83,401 7,895 409,477
Operating income (loss) 176,075 94,412 (279,985) (11,406) (20,904)
Significant noncash items:
Deferred taxes (2) 107,201 17,471 2,578 (77,901) 49,349
Investment income 42,451 1,121 (128) (2,798) 40,646
Minority share of (income) loss (6,039) (339) 23,620 11,271 28,513
Gain on sale of cellular and other investments 215,154 38,803 -- 8,741 262,698
Noncash interest expense 20,189 -- 16,210 -- 36,399
Total Assets 3,047,636 1,572,339 961,347 3,429,433 9,010,755
Investment in equity method investees 136,027 28,987 1,443 125,024 291,481
Capital expenditures $ 330,411 $ 143,125 $ 74,580 $ 10,216 $ 558,332
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1997 U.S. Cellular TDS Telecom Aerial All Other(1) Total
- -----------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Operating revenues $ 876,965 $ 437,624 $ 55,952 $ 94,413 $1,464,954
Operating cash flow 261,922 198,164 (157,480) (3,267) 299,339
Depreciation and amortization expense 132,379 98,021 39,071 32,040 301,511
Operating income (loss) 129,543 100,143 (196,551) (35,307) (2,172)
Significant noncash items:
Deferred taxes (2) 24,077 2,691 1,806 (11,338) 17,236
Investment income 77,121 3,285 (2,518) 3,262 81,150
Minority share of (income) loss (12,298) (1,155) -- 21,769 8,316
Gain on sale of cellular and other investments 30,318 722 -- 10,398 41,438
Noncash interest expense 15,948 -- 8,341 -- 24,289
Total Assets 2,508,916 1,406,060 960,648 3,560,782 8,436,406
Investment in equity method investees 197,786 42,167 510 25,501 265,964
Capital expenditures $ 318,748 $ 151,460 $ 274,709 $ 41,400 $ 786,317
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
40
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1996 U.S. Cellular TDS Telecom Aerial All Other(1) Total
- -----------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Operating revenues $ 680,068 $ 395,059 $ -- $ 104,187 $1,179,314
Operating cash flow 196,205 190,995 -- (2,849) 384,351
Depreciation and amortization expense 108,839 88,346 -- 33,777 230,962
Operating income (loss) 87,366 102,649 -- (36,626) 153,389
Significant noncash items:
Deferred taxes (2) 63,137 (2,659) 2,231 12,306 75,015
Investment income 51,518 6,906 (304) 335 58,455
Minority share of (income) loss (13,743) (1,300) -- (11,273) (26,316)
Gain on sale of cellular and other investments 132,718 -- 2,582 3,435 138,735
Noncash interest expense 15,674 -- 1,368 -- 17,042
Total Assets 2,085,899 1,363,900 672,827 2,837,543 6,960,169
Investment in equity method investees 254,281 50,639 6,149 24,076 335,145
Capital expenditures $ 248,123 $ 144,440 $ 112,939 $ 44,702 $ 550,204
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) CONSISTS OF THE TDS CORPORATE OPERATIONS, AMERICAN PAGING OPERATIONS AND
ALL OTHER BUSINESSES NOT INCLUDED IN THE U.S. CELLULAR, TDS TELECOM OR
AERIAL SEGMENTS.
(2) TAX BENEFITS ASSOCIATED WITH NET OPERATING LOSS CARRYFORWARDS REMAIN AT
THE TDS CORPORATE LEVEL.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Reconciliation of Segment Revenues to Consolidated Revenues:
Total Revenues for reportable segments $ 1,823,508 $ 1,464,954 $ 1,179,314
American Paging revenues included in "American Paging Operating (Loss)" (17,783) (94,413) (104,187)
-------------------------------------------
Consolidated Revenues $ 1,805,725 $ 1,370,541 $ 1,075,127
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Reconciliation of Segment Total Assets to Consolidated Total Assets:
Total Assets for reportable segments $ 9,010,755 $ 8,436,406 $ 6,960,169
Intercompany eliminations (3) (3,483,210) (3,464,805) (2,759,200)
-------------------------------------------
Consolidated Total Assets $ 5,527,545 $ 4,971,601 $ 4,200,969
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(3) INTERCOMPANY ELIMINATIONS CONSIST PRIMARILY OF THE ELIMINATION OF TDS'S
BOOK VALUE INVESTMENT IN ITS SUBSIDIARIES AND THE ELIMINATION OF
INTERCOMPANY RECEIVABLES.
<PAGE>
41
NOTE 21
CONTINGENCIES
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, results of operations or cash flows of the Company.
In September 1998, pursuant to a purchase agreement between TDS, Aerial,
Aerial Operating Company, Inc. ("AOC"), and Sonera Ltd., a limited liability
company organized under the laws of Finland ("Sonera"), Sonera purchased 2.4
million shares of common stock of AOC representing a 19.423% equity interest in
AOC, subject to adjustment under certain circumstances, for an aggregate
purchase price of $200 million. Sonera has the right, subject to adjustment
under certain circumstances, to exchange each share of AOC common stock which it
owns for 6.72919 Common Shares of Aerial. Upon the exchange of all of the AOC
shares, Sonera would own an 18.452% equity interest in Aerial, reflecting a
purchase price equivalent to $12.33 per Common Share of Aerial (the "Equivalent
Purchase Price").
Following the announcement by TDS in December 1998, that it intended to
distribute to its shareholders all of the capital stock of Aerial that it owns,
and that Aerial would seek additional financing from sources other than TDS in
connection therewith, Sonera contacted TDS to express certain concerns about the
announcement. Sonera has asserted that the TDS announcement reflects a change in
circumstances that warrant the renegotiation of certain matters related to its
investment in AOC, including an adjustment in the Equivalent Purchase Price, and
has raised the possibility of litigation in connection therewith. TDS and Aerial
intend to attempt to reach a mutually acceptable resolution of the concerns
raised by Sonera. There can be no assurance that this matter will not lead to
litigation, or that it will not have a material adverse effect on TDS or Aerial
or on the plans relating to the refinancing and spin-off of Aerial.
- -------------------------------------------------------------------------------
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. (a Delaware corporation) and Subsidiaries as of December 31,
1998 and 1997, 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, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Chicago, Illinois
January 27, 1999
<PAGE>
- -------------------------------------------------------------------------------
42 Consolidated Quarterly Income Information (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
QUARTER ENDED March 31 June 30 Sept. 30 Dec. 31
- ----------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
1998
Operating Revenues $390,069 $446,951 $473,808 $494,897
Operating Income (Loss) from Ongoing Operations (14,126) 5,493 25,083 (25,948)
Gain on Sale of Cellular and Other Investments 221,442 10,516 3,399 27,341
Net Income (Loss) Available to Common 73,730 (14,095) 5,910 (2,788)
From Operations (38,754) (19,218) 4,009 (17,610)
From Gains $112,484 $ 5,123 $ 1,901 $ 14,822
Weighted Average Shares Outstanding (000s) 60,750 60,984 61,036 61,157
Basic Earnings per Share $ 1.21 $ (.23) $ .10 $ (.05)
Diluted Earnings per Share 1.20 (.23) .10 (.05)
From Operations (.64) (.32) .07 (.29)
From Gains $ 1.84 $ .09 $ .03 $ .24
1997
Operating Revenues $289,487 $331,513 $362,899 $386,642
Operating Income (Loss) from Ongoing Operations 50,466 14,769 5,310 (37,410)
Gain on Sale of Cellular and Other Investments -- 10,598 13,767 17,073
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 Shares Outstanding (000s) 61,184 60,051 59,511 60,099
Basic Earnings per Share $ .15 $ .11 $ .14 $ (.59)
Diluted Earnings per Share .15 .11 .14 (.59)
From Operations .15 .04 -- (.65)
From Gains $ -- $ .07 $ .14 $ .06
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE: CERTAIN 1997 AMOUNTS WERE RECLASSIFIED FOR CURRENT PERIOD PRESENTATION.
NET INCOME AVAILABLE TO COMMON FOR 1998 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 DILUTED EARNINGS PER
SHARE.
MANAGEMENT BELIEVES U.S. CELLULAR'S OPERATING RESULTS REFLECT SEASONALITY
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 THE SECOND QUARTER OF 1997. THE
SIGNIFICANT DECREASE IN OPERATING INCOME (LOSS) FROM ONGOING OPERATIONS AND
NET INCOME (LOSS) AVAILABLE TO COMMON BEGINNING IN THE SECOND QUARTER OF 1997
IS PRIMARILY A RESULT OF THE COMMENCEMENT OF PCS OPERATIONS.
<PAGE>
- -------------------------------------------------------------------------------
Shareowners' Information 43
- -------------------------------------------------------------------------------
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 26, 1999, TDS
Common Shares were held by 3,556 record owners and the Series A Common Shares
were held by 97 record owners. TDS has paid cash dividends on Common Shares
since 1974, and paid dividends of $.44 and $.42 per Common and Series A Common
Share during 1998 and 1997, respectively.
The Common Shares of United States Cellular Corporation, an 81.0%-owned
subsidiary of TDS, are listed on the AMEX under the symbol "USM" and in the
newspapers as "US Cellu." The Common Shares of Aerial Communications, Inc., an
82.3%-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:
1998 1st 2nd 3rd 4th
- ----------------------------------------------------------------
High $50.13 49.75 44.25 47.88
Low $43.19 38.25 30.94 30.63
Dividends Paid $ .11 .11 .11 .11
- ----------------------------------------------------------------
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
- ----------------------------------------------------------------
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
EXHIBIT 21
<TABLE>
<CAPTION>
TDS COMPANIES
-------------
<S> <C>
TELEPHONE COMPANIES
- -------------------
TDS TELECOMMUNICATIONS CORPORATION DELAWARE
NORTHEAST REGION
- ----------------
THE CHICHESTER TELEPHONE COMPANY NEW HAMPSHIRE
DEPOSIT TELEPHONE COMPANY, INC. NEW YORK
EDWARDS TELEPHONE COMPANY, INC. NEW YORK
HAMPDEN TELEPHONE COMPANY MAINE
HARTLAND & ST. ALBANS TELEPHONE COMPANY MAINE
THE ISLAND TELEPHONE COMPANY MAINE
KEARSARGE TELEPHONE COMPANY NEW HAMPSHIRE
LUDLOW TELEPHONE COMPANY VERMONT
MAHANOY & MAHANTANGO TELEPHONE COMPANY PENNSYLVANIA
MERIDEN TELEPHONE COMPANY, INC. NEW HAMPSHIRE
NORTHFIELD TELEPHONE COMPANY VERMONT
ORISKANY FALLS TELEPHONE CORP. NEW YORK
PERKINSVILLE TELEPHONE COMPANY, INC. VERMONT
PORT BYRON TELEPHONE COMPANY NEW YORK
SOMERSET TELEPHONE COMPANY MAINE
SUGAR VALLEY TELEPHONE COMPANY PENNSYLVANIA
VERNON TELEPHONE COMPANY NEW YORK
WARREN TELEPHONE COMPANY MAINE
WEST PENOBSCOT TELEPHONE & TELEGRAPH COMPANY MAINE
SOUTHEAST REGION
- ----------------
AMELIA TELEPHONE CORPORATION VIRGINIA
BARNARDSVILLE TELEPHONE COMPANY NORTH CAROLINA
BLUE RIDGE TELEPHONE COMPANY GEORGIA
BUTLER TELEPHONE COMPANY, INC. ALABAMA
CALHOUN CITY TELEPHONE COMPANY, INC. MISSISSIPPI
CAMDEN TELEPHONE AND TELEGRAPH COMPANY GEORGIA
CONCORD TELEPHONE EXCHANGE, INC. TENNESSEE
HUMPHREYS COUNTY TELEPHONE COMPANY TENNESSEE
LESLIE COUNTY TELEPHONE COMPANY KENTUCKY
LEWISPORT TELEPHONE COMPANY, INC. KENTUCKY
McCLELLANVILLE TELEPHONE COMPANY, INC. SOUTH CAROLINA
MYRTLE TELEPHONE COMPANY MISSISSIPPI
NELSON BALLGROUND TELEPHONE COMPANY GEORGIA
NEW CASTLE TELEPHONE COMPANY VIRGINIA
NORWAY TELEPHONE COMPANY SOUTH CAROLINA
OAKMAN TELEPHONE COMPANY, INC. ALABAMA
PEOPLES TELEPHONE COMPANY ALABAMA
QUINCY TELEPHONE COMPANY FLORIDA
SALEM TELEPHONE COMPANY, INC. KENTUCKY
SALUDA MOUNTAIN TELEPHONE COMPANY NORTH CAROLINA
SERVICE TELEPHONE COMPANY, INC. NORTH CAROLINA
SOUTHEAST MISSISSIPPI TELEPHONE COMPANY MISSISSIPPI
ST STEPHEN TELEPHONE COMPANY SOUTH CAROLINA
TELLICO TELEPHONE COMPANY, INC. TENNESSEE
TENNESSEE TELEPHONE COMPANY TENNESSEE
VIRGINIA TELEPHONE COMPANY VIRGINIA
WILLISTON TELEPHONE COMPANY SOUTH CAROLINA
</TABLE>
Page 1
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
WESTERN DIVISION
- ----------------
ARIZONA TELEPHONE COMPANY ARIZONA
ASOTIN TELEPHONE COMPANY WASHINGTON
CLEVELAND COUNTY TELEPHONE CO., INC. ARKANSAS
DECATUR TELEPHONE COMPANY ARKANSAS
DELTA COUNTY TELE-COMM, INC. COLORADO
HAPPY VALLEY TELEPHONE COMPANY CALIFORNIA
HOME TELEPHONE COMPANY OREGON
HORNITOS TELEPHONE COMPANY CALIFORNIA
LEWIS RIVER TELEPHONE COMPANY WASHINGTON
MCDANIEL TELEPHONE COMPANY DELAWARE
MID-AMERICA TELEPHONE, INC. OKLAHOMA
NEW LONDON TELEPHONE COMPANY MISSOURI
OKLAHOMA COMMUNICATION SYSTEMS, INC. OKLAHOMA
ORCHARD FARM TELEPHONE COMPANY MISSOURI
POTLATCH TELEPHONE COMPANY IDAHO
SOUTHWESTERN TELEPHONE COMPANY ARIZONA
STOUTLAND TELEPHONE COMPANY MISSOURI
STRASBURG TELEPHONE COMPANY COLORADO
TROY TELEPHONE COMPANY, INC. IDAHO
WINTERHAVEN TELEPHONE COMPANY CALIFORNIA
WYANDOTTE TELEPHONE CO. OKLAHOMA
MIDWEST REGION
- --------------
ARVIG TELEPHONE COMPANY MINNESOTA
BADGER TELECOM, INC. WISCONSIN
BLACK EARTH TELEPHONE COMPANY, INC. WISCONSIN
BONDUEL TELEPHONE COMPANY WISCONSIN
BRIDGE WATER TELEPHONE COMPANY MINNESOTA
BURLINGTON, BRIGHTON & WHEATLAND TELEPHONE COMPANY WISCONSIN
CENTRAL STATE TELEPHONE COMPANY WISCONSIN
DANUBE COMMUNICATIONS, INC. MINNESOTA
EASTCOAST TELECOM, INC. WISCONSIN
GRANTLAND TELECOM, INC. WISCONSIN
MIDWAY TELEPHONE COMPANY WISCONSIN
MID-STATE TELEPHONE COMPANY MINNESOTA
MT VERNON TELEPHONE COMPANY WISCONSIN
RIVERSIDE TELECOM, INC. WISCONSIN
SCANDINAVIA TELEPHONE COMPANY WISCONSIN
STOCKBRIDGE & SHERWOOD TELEPHONE COMPANY, INC. WISCONSIN
TENNEY TELEPHONE COMPANY WISCONSIN
UTELCO, INC. WISCONSIN
WAUNAKEE TELEPHONE COMPANY, INC. WISCONSIN
WINSTED TELEPHONE COMPANY MINNESOTA
</TABLE>
Page 2
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
MID-CENTRAL DIVISION
- --------------------
ARCADIA TELEPHONE COMPANY OHIO
CAMDEN TELEPHONE COMPANY INDIANA
CHATHAM TELEPHONE COMPANY MICHIGAN
COMMUNICATION CORPORATION OF MICHIGAN MICHIGAN
COMMUNICATIONS CORPORATION OF INDIANA INDIANA
COMMUNICATIONS CORPORATION OF SOUTHERN INDIANA INDIANA
CONTINENTAL TELEPHONE COMPANY OHIO
HOME TELEPHONE COMPANY, INC. INDIANA
HOME TELEPHONE COMPANY OF PITTSBORO, INC. INDIANA
ISLAND TELEPHONE COMPANY MICHIGAN
LITTLE MIAMI COMMUNICATIONS CORPORATION OHIO
OAKWOOD TELEPHONE COMPANY OHIO
S & W TELEPHONE COMPANY, INC. INDIANA
SHIAWASSEE TELEPHONE COMPANY MICHIGAN
TIPTON TELEPHONE COMPANY, INC. INDIANA
TRI-COUNTY TELEPHONE COMPANY, INC. INDIANA
TOWNSHIP TELEPHONE CO. DELAWARE
VANLUE TELEPHONE COMPANY OHIO
WOLVERINE TELEPHONE COMPANY MICHIGAN
MANAGEMENT SERVICES
- -------------------
TDS TELECOM INC.(f.k.a. Central Region TSSD, Inc.) IOWA
ARVIG CELLULAR, INC. MINNESOTA
ARVIG TELCOM, INC. MINNESOTA
CAMDEN CELLULAR, INC. DELAWARE
GEORGIA RSA # 12 PARTNERSHIP GEORGIA
METROPLEX COMMUNICATIONS CORPORATION WASHINGTON
METROPLEX RSA-7 CELLULAR COMMUNICATIONS CORPORATION WASHINGTON
METROPLEX SECURITY COMPANY WASHINGTON
U.S. LINK, INC. MINNESOTA
CABLE COMPANIES
- ---------------
ACORN CABLE COMPANY WASHINGTON
CAROLINA CABLE T.V. CO., INC. SOUTH CAROLINA
COMVIDEO SYSTEMS, INC. CALIFORNIA
DELTA COUNTY CATV, INC. DELAWARE
INTERLAKE CABLEVISION, INC. MINNESOTA
LEWISPORT CABLE TV COMPANY KENTUCKY
METROPLEX CABLE INC. WASHINGTON
TDS CABLE COMMUNICATIONS COMPANY, INC. IOWA
TRI-COUNTY COMMUNICATIONS CORPORATION INDIANA
VOLUTEER TV CABLE CO. TENNESSEE
WARREN CABLE COMPANY MAINE
</TABLE>
Page 3
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
SERVICE COMPANIES
- -----------------
AFFILIATE FUND DELAWARE
AMERICAN COMMUNICATIONS CONSULTANTS, INC. TENNESSEE
AMERICAN RADIO COMMUNICATIONS, INC. DELAWARE
COMMVEST, INC. DELAWARE
NATIONAL TELEPHONE & TELEGRAPH COMPANY CALIFORNIA
RUDEVCO, INC. CALIFORNIA
S & W NEWCO, INC. INDIANA
SUTTLE PRESS INC. WISCONSIN
TDS DATACOM, INC. DELAWARE
TDS METROCOM, INC. DELAWARE
TDSNET ALABAMA
TDS REAL ESTATE INVESTMENT CORPORATION WISCONSIN
TEL RADIO COMMUNICATION PROPERTIES, INC. WISCONSIN
TELECOMMUNICATION TECHNOLOGIES FUND, INC. MARYLAND
TDS CAPITAL TRUST I DELAWARE
TDS CAPITAL TRUST III DELAWARE
TDS CAPITAL TRUST III DELAWARE
RADIO PAGING COMPANIES
- ----------------------
AMERICAN MESSAGING SERVICES, LLC MINNESOTA
AMERICAN PAGING, INC. (OF CALIFORNIA) CALIFORNIA
API MERGER CORP. (f.k.a. American Paging, Inc.) DELAWARE
APIXUS, INC. MINNESOTA
PAGING HOLDING CO. DELAWARE
PERSONAL COMMUNICATON SERVICE COMPANIES
- ---------------------------------------
AERIAL COMMUNICATIONS, INC. DELAWARE
AERIAL OPERATING COMPANY, INC. (f.k.a. APT OPERATING CO.) DELAWARE
APT COLUMBUS, INC. DELAWARE
APT HOUSTON, INC. DELAWARE
APT KANSAS CITY, INC. DELAWARE
APT MINNEAPOLIS, INC. DELAWARE
APT TAMPA / ORLANDO, INC. DELAWARE
APT PITTSBURGH GENERAL PARTNER, INC. PENNSYLVANIA
APT PITTSBURGH LIMITED PARTNERSHIP Partnership
</TABLE>
Page 4
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
CELLULAR COMPANIES
- ------------------
CELLULAR OPERATING MSA
- ----------------------
UNITED STATES CELLULAR CORPORATION DELAWARE
BANGOR CELLULAR TELEPHONE CO., L.P. DELAWARE
CALIFORNIA RURAL SERVICE AREA #1, INC. CALIFORNIA
CAMDEN CELLULAR TELEPHONE COMPANY, INC. DELAWARE
CAROLINA CELLULAR, INC. NORTH CAROLINA
CARRYPHONE, INC. DELAWARE
CEDAR RAPIDS CELLULAR TELEPHONE, L.P. Partnership
CELLVEST, INC. DELAWARE
CENTRAL CELLULAR TELEPHONES, LTD. ILLINOIS
CENTRAL FLORIDA CELLULAR TELEPHONE COMPANY, INC. FLORIDA
CHARLOTTESVILLE MSA CELLULAR PARTNERSHIP Partnership
COMMUNITY CELLULAR TELEPHONE COMPANY TEXAS
CROOK COUNTY RSA LIMITED PARTNERSHIP Partnership
DAVENPORT CELLULAR TELEPHONE COMPANY, GP Partnership
DAVENPORT CELLULAR TELEPHONE COMPANY, INC. DELAWARE
DUBUQUE CELLULAR TELEPHONE, L.P. DELAWARE
EAU CLAIRE MSA, INC. WISCONSIN
EVANSVILLE CELLULAR TELEPHONE COMPANY, L.P. Partnership
FARMERS CELLULAR TELEPHONE COMPANY, INC. DELAWARE
FARMERS MUTUAL CELLULAR TELEPHONE COMPANY, INC. DELAWARE
FLORIDA RSA # 8, INC. DELAWARE
GEORGIA RSA # 11, INC. (f.k.a. USCOC of Georgia RSA #14, Inc) GEORGIA
GRAY BUTTE JOINT VENTURE Partnership
GREEN BAY CELLTELCO PARTNERSHIP Partnership
HARDY CELLULAR TELEPHONE COMPANY DELAWARE
HBM, INC. DELAWARE
ILLINOIS RSA # 3, INC. ILLINOIS
INDIANA RSA # 4, INC. DELAWARE
INDIANA RSA # 5, INC. INDIANA
INDIANA RSA NO. 5 LIMITED PARTNERSHIP Partnership
IOWA # 13, INC. DELAWARE
IOWA RSA # 12, INC. DELAWARE
IOWA RSA # 3, INC. DELAWARE
IOWA RSA # 9, INC. DELAWARE
IOWA RSA NO. 12 LIMITED PARTNERSHIP DELAWARE
JACKSONVILLE CELLULAR PARTNERSHIP Partnership
JACKSONVILLE CELLULAR TELEPHONE CO. (f.k.a. GTE Mobilnet of Jacksonville II, Inc.) DELAWARE
JANESVILLE CELLULAR TELEPHONE COMPANY, INC. DELAWARE
JEFFERSON CELLULAR TELEPHONE COMPANY, INC. IOWA
JOPLIN CELLULAR TELEPHONE COMPANY, INC. DELAWARE
JOPLIN CELLULAR TELEPHONE COMPANY, L.P. Partnership
KANSAS RSA # 15, INC. (f.k.a. Ohio RSA # 1, Inc.) OHIO
KENOSHA CELLULAR TELEPHONE, L.P. (f.k.a. Owensboro Cellular Telephone, L.P.) Partnership
LACROSSE CELLULAR TELEPHONE COMPANY, INC. DELAWARE
LAR-TEX CELLULAR TELEPHONE COMPANY, INC. DELAWARE
LEAF RIVER VALLEY CELLULAR TELEPHONE COMPANY ILLINOIS
LEWISTON CELLTELLCO PARTNERSHIP Partnership
MADISON CELLULAR TELEPHONE COMPANY Partnership
MAINE RSA # 1, INC. MAINE
</TABLE>
Page 5
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
MAINE RSA # 4, INC. MAINE
MAINE RSA NO. 4 LIMITED PARTNERSHIP Partnership
MANCHESTER-NASHUA CELLULAR TELEPHONE, L.P. Partnership
MARGARETVILLE CELLULAR TELEPHONE COMPANY NEW YORK
MCDANIEL CELLULAR TELEPHONE COMPANY DELAWARE
MIDWEST PAYROLL CORPORATION DELAWARE
MINFORD CELLULAR TELEPHONE COMPANY DELAWARE
MINNESOTA INVCO OF RSA # 10, INC. DELAWARE
MINNESOTA INVCO OF RSA # 11, INC. DELAWARE
MINNESOTA INVCO OF RSA # 5, INC. DELAWARE
MINNESOTA INVCO OF RSA # 7, INC. DELAWARE
MINNESOTA INVCO OF RSA # 8, INC. DELAWARE
MINNESOTA INVCO OF RSA # 9, INC. DELAWARE
MISSOURI # 15 RURAL CELLULAR, INC. MISSOURI
MISSOURI RSA 11, INC. DELAWARE
NH #1 RURAL CELLULAR, INC. NEW HAMPSHIRE
NORTH CAROLINA RSA # 4, INC. DELAWARE
NORTH CAROLINA RSA # 6, INC. CALIFORNIA
NORTH CAROLINA RSA # 9, INC. NORTH CAROLINA
NORTH CAROLINA RSA 1 PARTNERSHIP Partnership
OHIO STATE CELLULAR PHONE COMPANY, INC. FLORIDA
OREGON RSA # 2, INC. OREGON
OREGON RSA # 3, INC. OREGON
OREGON RSA # 6, INC. OREGON
OREGON RSA NO. 2 LIMITED PARTNERSHIP Partnership
OREGON RSA NO. 3 LIMITED PARTNERSHIP Partnership
PEACE VALLEY CELLULAR TELEPHONE COMPANY DELAWARE
PINE ISLAND CELLULAR TELEPHONE COMPANY DELAWARE
RACINE CELLULAR TELEPHONE COMPANY Partnership
ROCHESTER CELLULAR TELEPHONE COMPANY, L.P. Partnership
SCOTT COUNTY CELLULAR TELEPHONE COMPANY DELAWARE
SHEBOYGAN CELLULAR TELEPHONE CO. DELAWARE
SOUTH CANAAN CELLULAR TELEPHONE CO. (DELAWARE) DELAWARE
ST. LAWRENCE SEAWAY RSA CELLULAR, LP Partnership
TENNESSEE # 4 SUB 2, INC. TENNESSEE
TENNESSEE RSA # 3, INC. DELAWARE
TEXAHOMA CELLULAR TELEPHONE COMPANY TEXAS
TEXAHOMA CELLULAR, L.P. Partnership
TEXAS # 20 RURAL CELLULAR, INC. TEXAS
TEXAS INVCO OF RSA # 6, INC. DELAWARE
TOWNSHIP CELLULAR TELEPHONE CO. DELAWARE
TRI-STATES CELLULAR COMMUNICATIONS, INC. MISSOURI
TULSA GENERAL PARTNERS, INC. DELAWARE
UNITED STATES CELLUALAR OPERATING COMPANY OF CUMBERLAND, INC. MARYLAND
UNITED STATES CELLULAR INVESTMENT CO. OF ALLENTOWN PENNSYLVANIA
UNITED STATES CELLULAR INVESTMENT CO. OF OKLAHOMA CITY, INC. OKLAHOMA
UNITED STATES CELLULAR INVESTMENT COMPANY DELAWARE
UNITED STATES CELLULAR INVESTMENT COMPANY OF EAU CLAIRE, INC. WISCONSIN
UNITED STATES CELLULAR INVESTMENT COMPANY OF GREEN BAY, INC. WISCONSIN
UNITED STATES CELLULAR INVESTMENT COMPANY OF PORTSMOUTH, INC. NEW HAMPSHIRE
UNITED STATES CELLULAR INVESTMENT COMPANY OF ROCKFORD (f.k.a. ACC of Rockford) DELAWARE
UNITED STATES CELLULAR INVESTMENT CORPORATION OF LOS ANGELES INDIANA
UNITED STATES CELLULAR OPERATING COMPANY DELAWARE
</TABLE>
Page 6
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
UNITED STATES CELLULAR OPERATING COMPANY OF BANGOR MAINE
UNITED STATES CELLULAR OPERATING COMPANY OF CEDAR RAPIDS DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY OF COLUMBIA MISSOURI
UNITED STATES CELLULAR OPERATING COMPANY OF DES MOINES IOWA
UNITED STATES CELLULAR OPERATING COMPANY OF DUBUQUE IOWA
UNITED STATES CELLULAR OPERATING COMPANY OF EVANSVILLE INDIANA
UNITED STATES CELLULAR OPERATING COMPANY OF FT. PIERCE FLORIDA
UNITED STATES CELLULAR OPERATING COMPANY OF JOPLIN MISSOURI
UNITED STATES CELLULAR OPERATING COMPANY OF KENOSHA (f.k.a. USCOC of Owensboro) DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY OF KNOXVILLE TENNESSEE
UNITED STATES CELLULAR OPERATING COMPANY OF LACROSSE WISCONSIN
UNITED STATES CELLULAR OPERATING COMPANY OF LEWISTON-AUBURN MAINE
UNITED STATES CELLULAR OPERATING COMPANY OF MANCHESTER-NASHUA, INC. NEW HAMPSHIRE
UNITED STATES CELLULAR OPERATING COMPANY OF MEDFORD OREGON
UNITED STATES CELLULAR OPERATING COMPANY OF RICHLAND WASHINGTON
UNITED STATES CELLULAR OPERATING COMPANY OF ROCHESTER MINNESOTA
UNITED STATES CELLULAR OPERATING COMPANY OF TEXAHOMA TEXAS
UNITED STATES CELLULAR OPERATING COMPANY OF TULSA, INC. OKLAHOMA
UNITED STATES CELLULAR OPERATING COMPANY OF WATERLOO IOWA
UNITED STATES CELLULAR OPERATING COMPANY OF WAUSAU, INC. WISCONSIN
UNITED STATES CELLULAR OPERATING COMPANY OF YAKIMA WASHINGTON
UNITED STATES CELLULAR TELEPHONE COMPANY (GREATER KNOXVILLE), L.P. Partnership
UNITED STATES CELLULAR TELEPHONE COMPANY GREATER TULSA, L.L.C. OKLAHOMA
UNIVERSAL CELLULAR FOR EAU CLAIRE MSA, INC. WISCONSIN
USCC PAYROLL CORPORATION DELAWARE
USCC REAL ESTATE CORPORATION DELAWARE
USCIC OF AMARILLO, INC. DELAWARE
USCIC OF BROWNSVILLE, INC. DELAWARE
USCIC OF FRESNO, INC. CALIFORNIA
USCIC OF JACKSON, INC. DELAWARE
USCIC OF MCALLEN, INC. DELAWARE
USCIC OF NORTH CAROLINA RSA # 1, INC. DELAWARE
USCOC OF CHARLOTTESVILLE, INC. VIRGINIA
USCOC OF CORPUS CHRISTI, INC. TEXAS
USCOC OF GREATER IOWA, INC. (f.k.a. Canton Cellular Telephone Company) PENNSYLVANIA
USCOC OF HAWAII 3, INC. DELAWARE
USCOC OF IDAHO RSA # 5, INC. DELAWARE
USCOC OF ILLINOIS RSA # 1, INC. VIRGINIA
USCOC OF ILLINOIS RSA # 4, INC. ILLINOIS
USCOC OF IOWA RSA # 1, INC. IOWA
USCOC OF IOWA RSA # 16, INC. DELAWARE
USCOC OF JACKSONVILLE, INC. (f.k.a. GTE Mobilnet of Jacksonville, Inc.) NORTH CAROLINA
USCOC OF JACK-WIL, INC. DELAWARE
USCOC OF MISSOURI RSA # 13, INC. DELAWARE
USCOC OF MISSOURI RSA # 5, INC. ILLINOIS
USCOC OF NEW HAMPSHIRE RSA # 2, INC. DELAWARE
USCOC OF NORTH CAROLINA RSA # 7, INC. NORTH CAROLINA
USCOC OF OKLAHOMA RSA # 10, INC. OKLAHOMA
USCOC OF OREGON RSA # 5, INC. DELAWARE
USCOC OF PENNSYLVANIA RSA NO. 10-B2, INC. DELAWARE
</TABLE>
Page 7
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31, 1998
<TABLE>
<CAPTION>
<S> <C>
USCOC OF PORTLAND, INC. MAINE
USCOC OF ROCKFORD, INC. (f.k.a. ACC of Rockford, Inc.) ILLINOIS
USCOC OF SOUTH CAROLINA RSA # 4, INC. SOUTH CAROLINA
USCOC OF TALLAHASSEE FLORIDA
USCOC OF VICTORIA, INC. TEXAS
USCOC OF VIRGINIA RSA # 2, INC. VIRGINIA
USCOC OF VIRGINIA RSA # 3, INC. VIRGINIA
USCOC OF WASHINGTON 4, INC. DELAWARE
USCOC OF WILMINGTON, INC. (f.k.a. GTE Mobilnet of Wilmington, Inc.) NORTH CAROLINA
VENUS CELLULAR TELEPHONE COMPANY, INC. DELAWARE
VERMONT RSA NO. 2-B2, INC. DELAWARE
VICTORIA CELLULAR CORPORATION TEXAS
VICTORIA CELLULAR PARTNERSHIP Partnership
VIRGINIA RSA # 4, INC. VIRGINIA
VIRGINIA RSA # 7, INC. VIRGINIA
WARD BUTTE JOINT VENTURE Partnership
WASHINGTON RSA # 5, INC. WASHINGTON
WATERLOO / CEDAR FALLS CELLTELCO PARTNERSHIP Partnership
WESTERN SUB-RSA LIMITED PARTNERSHIP Partnership
WILMINGTON CELLULAR PARTNERSHIP Partnership
WILMINGTON CELLULAR TELEPHONE CO. (f.k.a. GTE Mobilnet of Wilmington II, Inc.) NORTH CAROLINA
WISCONSIN RSA # 7, INC. (f.k.a. Wisconsin RSA # 7, Inc.) DELAWARE
YAKIMA MSA LIMITED PARTNERSHIP Partnership
YAKIMA VALLEY PAGING LIMITED PARTNERSHIP Partnership
</TABLE>
Page 8
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
by reference in this Form 10-K of Telephone and Data Systems, Inc. of our
report dated January 27, 1999 on the consolidated financial statements of
Telephone and Data Systems, Inc. and Subsidiaries, (the "Company") included in
the Company's 1998 Annual Report to Shareholders, to the inclusion in this
Form 10-K of our report dated January 27, 1999 on the financial statement
schedules of the Company and to the incorporation by reference of such
reports into the Company's previously filed S-8 Registration Statements, File
No. 33-1192, File No. 33-35172, File No. 33-57257, File No. 33-64035, File
No. 333-01041, File No. 333-23947, File No. 333-58121 and File No. 333-58127,
and into the Company's previously filed S-3 Registration Statements, File No.
33-8564, File No. 33-8857, File No. 33-68456, File No. 33-59435 and File No.
333-38355, and into the Company's previously filed S-4 Registration
Statements, File No. 33-45570, File No. 33-64293 and File No. 333-42535.
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 30, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated financial statements of Telephone and Data Systems, Inc. as
of December 31, 1998, and for the year then ended, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 50,083
<SECURITIES> 388,359
<RECEIVABLES> 219,691
<ALLOWANCES> 12,608
<INVENTORY> 36,621
<CURRENT-ASSETS> 405,439
<PP&E> 3,895,427
<DEPRECIATION> 1,222,838
<TOTAL-ASSETS> 5,527,545
<CURRENT-LIABILITIES> 623,379
<BONDS> 1,553,096
0
25,985
<COMMON> 619
<OTHER-SE> 2,237,289
<TOTAL-LIABILITY-AND-EQUITY> 5,527,545
<SALES> 0
<TOTAL-REVENUES> 1,805,725
<CGS> 0
<TOTAL-COSTS> 1,815,223
<OTHER-EXPENSES> (293,067)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 149,864
<INCOME-PRETAX> 133,705
<INCOME-TAX> 69,297
<INCOME-CONTINUING> 64,408
<DISCONTINUED> 0
<EXTRAORDINARY> 0
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<NET-INCOME> 64,408
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</TABLE>
