<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-8251
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TELEPHONE AND DATA SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
- - --------------------------------------------------------------------------------
<TABLE>
<S> <C>
IOWA 36-2669023
- - -------------------------------- --------------------------------
(State or other jurisdiction (IRS Employer Identification
of incorporation or No.)
organization)
</TABLE>
30 NORTH LASALLE STREET, CHICAGO, ILLINOIS 60602
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER: (312) 630-1900
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<S> <C>
Name of each exchange
Title of each class on which registered
- - ----------------------------- -----------------------------
Common Shares, $1 par value American Stock Exchange
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
-------------------
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 28, 1997, the aggregate market values of the registrant's
Common Shares, Series A Common Shares and Preferred Shares held by nonaffiliates
were approximately $2.2 billion, $15.4 million and $40.8 million, respectively.
The closing price of the Common Shares on February 28, 1997, was $40.00, 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 $40.00 times the number of Common Shares into
which it was convertible on February 28, 1997.
The number of shares outstanding of each of the registrant's classes of
common stock, as of February 28, 1997, is 54,145,158 Common Shares, $1 par
value, and 6,916,546 Series A Common Shares, $1 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Those sections or portions of the registrant's 1996 Annual Report to
Shareholders, and of the registrant's Notice of Annual Meeting and Proxy
Statement for its 1997 Annual Meeting of Shareholders, described in the cross
reference sheet and table of contents attached hereto are incorporated by
reference into Part II of this report.
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<PAGE>
CROSS REFERENCE SHEET
AND
TABLE OF CONTENTS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PAGE NUMBER
OR REFERENCE(1)
---------------
<C> <S> <C>
Item 1. Business............................................. 3
Item 2. Properties........................................... 38
Item 3. Legal Proceedings.................................... 38
Item 4. Submission of Matters to a Vote of Security
Holders............................................ 38
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................ 39 (2)
Item 6. Selected Financial Data.............................. 39 (3)
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................ 39 (4)
Item 8. Financial Statements and Supplementary Data.......... 39 (5)
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................ 39
Item 10. Directors and Executive Officers of the Registrant... 40 (6)
Item 11. Executive Compensation............................... 40 (7)
Item 12. Security Ownership of Certain Beneficial Owners and
Management......................................... 40 (8)
Item 13. Certain Relationships and Related Transactions....... 40 (9)
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................ 41
</TABLE>
- - ---------
(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, 1996 ("Annual Report"), and
from the registrant's Notice of Annual Meeting of Shareholders and Proxy
Statement for its 1997 Annual Meeting of Shareholders (the "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 Income,"
"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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<PAGE>
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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 established cellular telephone, local
telephone and radio paging operations and developing personal communications
services ("PCS") operations. At December 31, 1996, the Company served
approximately 2.3 million customer units in 37 states, including 1,073,000
cellular telephones, 484,500 telephone access lines and 777,400 pagers. For the
year ended December 31, 1996, cellular operations provided 58% of the Company's
consolidated revenues; telephone operations provided 33%; and paging 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 80.6%-owned subsidiary, United States Cellular Corporation [AMEX: USM]. U.S.
Cellular provides cellular telephone service to 1,073,000 customers through 131
majority-owned and managed ("consolidated") cellular systems serving
approximately 16% of the geography and approximately 8% of the population of the
48 contiguous United States. Since 1985, when the Company began providing
cellular service in Knoxville, Tennessee, the Company has expanded its cellular
networks and customer service operations to cover 140 managed markets in 27
states as of December 31, 1996. In total, the Company now operates nine market
clusters, of which five have a total population of more than two million, and
each of which has a total population of more than one million, plus one other
unclustered market. Overall, 81% of the Company's 25.1 million population
equivalents are in markets which are consolidated, 1% are in managed but not
consolidated markets and 18% are 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").
TDS Telecom currently operates 105 telephone companies serving 484,500 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 22 telephone companies and divested one
telephone company since the beginning of 1992. These net acquisitions added
90,400 access lines during this five-year period, while internal growth added
90,100 lines.
The Company conducts substantially all of its broadband personal
communications services operations through its 82.8%-owned subsidiary, Aerial
Communications, Inc. [NASDAQ: AERL], formerly American Portable Telecom, Inc.
[NASDAQ: APTI]. In March 1995, Aerial was the successful bidder for eight
broadband PCS licenses. The six 30 megahertz PCS licenses that are being
developed
3
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cover the Major Trading Areas of Minneapolis, Tampa-St. Petersburg-Orlando,
Houston, Pittsburgh, Kansas City and Columbus, and account for 27.6 million
population equivalents. Aerial has sold its licenses covering the Guam and
Alaska MTAs.
The Company conducts substantially all of its radio paging operations
through its 82.3%-owned subsidiary, American Paging, Inc. [AMEX: APP]. American
Paging offers radio paging and related services through its subsidiaries. Since
the beginning of 1992, the number of pagers in service increased from 236,800 to
777,400 at December 31, 1996, primarily from internal growth. APP provides
service in 21 states and the District of Columbia through 51 sales and service
offices. American Paging's service areas cover a total population of
approximately 76 million.
The Company was incorporated in Iowa in 1968. 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 "APP" or "American Paging" refer to American Paging, Inc. and its
subsidiaries; (vi) 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; (vii) references to "RSA" refer
to the Rural Service Area, as used by the FCC in designating non-MSA cellular
market areas; (viii) references to cellular "markets" or "systems" refer to
MSAs, RSAs or both; (ix) references to "MTA" refer to Major Trading Areas, as
used by the FCC in designating Personal Communications Services ("PCS") markets;
(x) references to "population equivalents" mean the population of a market,
based on 1996 Donnelley Marketing Service 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; start-up of PCS operations; and
unanticipated changes in growth in cellular customers, penetration rates, churn
rates and the mix of products and services offered in the Company's markets.
Readers should evaluate any statements in light of these important factors.
CELLULAR TELEPHONE OPERATIONS
The Company's cellular operations are conducted through U.S. Cellular and
subsidiaries. U.S. Cellular serves 1,073,000 customers through 131
majority-owned and managed cellular systems at December 31, 1996. Overall, U.S.
Cellular owned 25.1 million population equivalents in 204 markets.
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
4
<PAGE>
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 and radio paging. PCS has become
available in certain areas of the United States, including U.S. Cellular's
markets, and U.S. Cellular expects PCS competitors to initiate service in all of
its markets in the next one or two years. Additionally, emerging 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 U.S. Cellular 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 are 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 available because technical standards require
that analog cellular telephones be compatible in all market areas in the United
States. The system that provides the service to these roamers will generate
usage revenue. Many operators, including U.S. Cellular, charge premium rates for
this roaming service.
There are a number of recent technical developments in the cellular
industry. Currently, while most of the MTSOs process information digitally, most
of 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 Tulsa, Oklahoma and its Florida/Georgia
market cluster. Another digital technology, Code Division Multiple Access
("CDMA"), is expected to be deployed by U.S. Cellular in a commercial trial
during 1997. The Company may also deploy some CDMA digital radio channels in
other markets on a trial basis in the near future. Digital radio technology
offers several advantages including greater privacy, less transmission noise,
greater system capacity and potentially lower incremental costs for additional
customers. The conversion from analog to digital radio technology has begun on
an industry-wide basis; however this process is expected to take a number of
years.
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.
5
<PAGE>
CELLULAR OPERATIONS
A significant portion of the aggregate market value of TDS's Common Shares
is represented by the market value of TDS's interest in USM. From its inception
in 1983 until 1993, U.S. Cellular has principally been in a start-up phase.
Until that time, 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 three years, U.S. Cellular
generated operations-driven net income and has significantly increased its
operating cash flows during that time. Management anticipates increasing 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 flow and
operating income during the period of accelerated 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 1994,
1995 and 1996, 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)
the introduction of competition from PCS and other emerging technologies; and
(vi) continuing technological advances which may provide 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: Iowa, Wisconsin/Illinois, Missouri, Eastern
North Carolina/South Carolina, Virginia, West Virginia/Maryland/Pennsylvania,
Oregon/California, Washington/Oregon/Idaho, Indiana/Kentucky/Ohio, Maine/New
Hampshire/Vermont, Eastern Tennessee/Western North Carolina,
Oklahoma/Missouri/Kansas, Texas/Oklahoma, Florida/Georgia and Southwestern
Texas. See "U.S. Cellular's Cellular Interests." U.S. Cellular has acquired its
cellular interests through the wireline application process (21%), including
settlements and exchanges with other applicants, and through acquisitions (79%),
including acquisitions from TDS and third parties.
CELLULAR SYSTEMS DEVELOPMENT
ACQUISITIONS. During the last five years, U.S. Cellular has expanded its
size, particularly in contiguous or adjacent markets, through acquisitions which
have been aimed at strengthening U.S. Cellular's position in the cellular
industry. This growth has resulted primarily from acquisitions of interests in
mid-sized and rural markets and has been based on obtaining interests with
rights to manage the underlying market.
U.S. Cellular has increased its population equivalents by 31% from
approximately 19.1 million at December 31, 1991, to approximately 25.1 million
at December 31, 1996. Markets managed by U.S. Cellular have increased from 91
markets at December 31, 1991, to 140 markets at December 31, 1996. As of
December 31, 1996, 82% of the Company's population equivalents represented
interests in markets U.S. Cellular manages compared to 66% at December 31, 1991.
Recently, the pace of acquisitions has slowed as industry-wide consolidation
has reduced the number of markets available for acquisition. U.S. Cellular's
population equivalents grew at a compound annual rate of over 5% over the last
five years due to the increased number of exchange and divestiture transactions
in the past few years.
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. 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
6
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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.
U.S. Cellular, or TDS for the benefit of U.S. Cellular, has historically
negotiated acquisitions of cellular interests from third parties primarily in
consideration for U.S. Cellular's or TDS's equity securities. Cellular interests
acquired by TDS in these transactions have been assigned to U.S. Cellular. At
that time, U.S. Cellular reimbursed TDS for the value of TDS securities issued
in such transactions, generally by issuing Common Shares to TDS or by increasing
the balance due TDS under U.S. Cellular's Revolving Credit Agreement in amounts
equal to the value of TDS securities delivered at the time the acquisitions were
completed. The fair market value of the U.S. Cellular securities issued to TDS
in connection with these transactions was equal to the fair market value of the
TDS securities delivered in the transactions and was determined at the time the
transactions were completed.
In the past three years, U.S. Cellular has also negotiated substantial
divestitures and exchanges of cellular interests with third parties. The
consideration received from these divestitures of non-strategic markets has
primarily been cash, which has been used to reduce debt or for general corporate
purposes. The exchanges have included the divestiture of controlling interests
in non-strategic markets in exchange for controlling interests in markets which
further enhance U.S. Cellular's clusters.
COMPLETED ACQUISITIONS. During 1996, U.S. Cellular, or TDS for the benefit
of U.S. Cellular, completed the acquisition of controlling interests in two
markets and several additional minority interests representing approximately
400,000 population equivalents for an aggregate consideration of $56.1 million.
The consideration consisted of 1.1 million TDS Common Shares, 1,000 U.S.
Cellular Common Shares and $13.6 million in cash. U.S. Cellular reimbursed TDS
for TDS securities issued in the acquisitions through the issuance to TDS of 1.3
million U.S. Cellular Common Shares. U.S. Cellular also acquired several
minority interests representing approximately 600,000 pops from TDS for $102.8
million in cash.
COMPLETED DIVESTITURES AND EXCHANGES. During 1996, U.S. Cellular completed
the divestiture of controlling interests in eight markets plus one market
partition and minority interests in two other markets representing approximately
1.2 million population equivalents for an aggregate consideration of $176.5
million in cash. Also during 1996, U.S. Cellular completed an exchange
transaction which resulted in the acquisition of a controlling interest in one
market, representing 116,000 population equivalents, and the divestiture of one
market representing 97,000 population equivalents. U.S. Cellular also received
$11.3 million in cash pursuant to this exchange.
PENDING ACQUISITIONS, DIVESTITURES, AND EXCHANGES. At December 31, 1996,
U.S. Cellular had entered into an agreement to purchase a controlling interest
in one market representing approximately 213,000 population equivalents. U.S.
Cellular has also entered into an agreement with TDS to acquire minority
interests in two markets from TDS representing 104,000 population equivalents.
These pending transactions are expected to be completed during 1997.
In February 1997, U.S. Cellular announced that it had entered into an
exchange agreement with BellSouth Corporation, pursuant to which U.S. Cellular
will receive controlling interests in twelve contiguous markets adjacent to its
Iowa and Wisconsin/Illinois clusters. In exchange, U.S. Cellular will trade its
controlling interest in ten markets and investment interests in 13 markets and
pay cash, the amount of which is dependent upon certain factors. The transaction
is subject to various regulatory and other approvals.
TDS and U.S. Cellular maintain shelf registration of their respective Common
Shares and Preferred Shares under the Securities Act of 1933 for issuance
specifically in connection with acquisitions.
The Company has had voting control of U.S. Cellular since U.S. Cellular's
incorporation. TDS owned an aggregate of 69,396,227 shares of common stock of
U.S. Cellular at December 31, 1996, representing over 80% of the combined total
of U.S. Cellular's outstanding Common and Series A Common Shares and over 95% of
their combined voting power.
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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
are not essential to its long-term strategies.
U.S. Cellular owned interests in cellular telephone systems in 204 markets
at December 31, 1996, representing 25.1 million population equivalents.
Including the controlling interest to be acquired from a third party and the two
minority interests to be acquired from TDS, U.S. Cellular owned or had the right
to acquire interests in cellular telephone systems in 207 markets at December
31, 1996, representing 25.4 million population equivalents. 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,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(THOUSANDS OF POPULATION EQUIVALENTS)(1)
<S> <C> <C> <C> <C> <C>
Operational Markets:
Majority-Owned and Managed........................................... 20,276 19,958 18,556 18,807 14,749
Minority-Owned and Managed (2)....................................... 401 513 1,206 1,179 2,069
Markets to be Managed, Net of Markets to be Divested (3)
To Be Majority-Owned................................................. 213 272 2,212 1,026 1,859
To Be Minority-Owned (2)............................................. -- -- -- 8 5
--------- --------- --------- --------- ---------
Total Markets Managed and to be Managed.............................. 20,890 20,743 21,974 21,020 18,682
Minority Interest in Markets Managed by Others......................... 4,501 3,990 3,745 3,547 3,642
--------- --------- --------- --------- ---------
Total................................................................ 25,391 24,733 25,719 24,567 22,324
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
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(1) Based on 1996 Donnelley Marketing Services estimates for all years.
(2) Includes markets where U.S. Cellular 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, 1996. The table
presented therein lists clusters of markets that U.S. Cellular manages or
anticipates managing. 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.
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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 and TDS owned or had the right to
acquire pursuant to definitive agreements as of December 31, 1996.
<TABLE>
<CAPTION>
TOTAL CURRENT
AND ACQUIRABLE
POPULATION
CLUSTER/MAJOR SERVICE AREA 1996 POPULATION EQUIVALENTS
- - ------------------------------------------------------------------------------------------------ --------------- ---------------
<S> <C> <C>
MIDWEST REGIONAL MARKET CLUSTER:
Iowa.......................................................................................... 2,732,000 2,512,000
Wisconsin/Illinois............................................................................ 2,032,000 1,930,000
Missouri...................................................................................... 686,000 686,000
--------------- ---------------
Total Midwest Regional Market Cluster....................................................... 5,450,000 5,128,000
--------------- ---------------
MID-ATLANTIC REGIONAL MARKET CLUSTER:
Eastern North Carolina/South Carolina......................................................... 2,349,000 2,319,000
Virginia...................................................................................... 949,000 941,000
West Virginia/Maryland/Pennsylvania........................................................... 1,138,000 1,138,000
--------------- ---------------
Total Mid-Atlantic Regional Market Cluster.................................................. 4,436,000 4,398,000
--------------- ---------------
NORTHWEST REGIONAL MARKET CLUSTER:
Oregon/California............................................................................. 1,029,000 957,000
Washington/Oregon/Idaho....................................................................... 1,471,000 1,247,000
--------------- ---------------
Total Northwest Regional Market Cluster..................................................... 2,500,000 2,204,000
--------------- ---------------
INDIANA/KENTUCKY/OHIO MARKET CLUSTER:........................................................... 2,352,000 1,972,000
--------------- ---------------
MAINE/NEW HAMPSHIRE/VERMONT MARKET CLUSTER:..................................................... 1,689,000 1,631,000
--------------- ---------------
EASTERN TENNESSEE/WESTERN NORTH CAROLINA MARKET CLUSTER:........................................ 1,769,000 1,458,000
--------------- ---------------
TEXAS/OKLAHOMA/MISSOURI/KANSAS REGIONAL MARKET CLUSTER:
Oklahoma/Missouri/Kansas...................................................................... 1,412,000 874,000
Texas/Oklahoma................................................................................ 694,000 498,000
--------------- ---------------
Total Texas/Oklahoma/Missouri/Kansas Regional Market Cluster:............................... 2,106,000 1,372,000
--------------- ---------------
FLORIDA/GEORGIA MARKET CLUSTER.................................................................. 1,520,000 1,373,000
SOUTHWESTERN TEXAS MARKET CLUSTER:.............................................................. 1,224,000 1,213,000
--------------- ---------------
Other Operations:............................................................................... 141,000 141,000
--------------- ---------------
Total Managed Markets........................................................................... 23,187,000 20,890,000
Markets Managed by Others....................................................................... 4,501,000
---------------
Total Population Equivalents.................................................................... 25,391,000
---------------
---------------
</TABLE>
9
<PAGE>
Upon completion of the exchange transaction with BellSouth, U.S. Cellular
will acquire and divest interests in certain markets. The effect on population
and population equivalents is summarized below.
<TABLE>
<CAPTION>
TOTAL POPULATION
EQUIVALENTS TO
BE ACQUIRED
1996 POPULATION (DIVESTED)
--------------- ----------------
<S> <C> <C>
Markets to be acquired from BellSouth......................................................... 4,050,000 3,952,000
Markets to be traded to BellSouth:
Markets Managed by U.S. Cellular (1)........................................................ 1,960,000 (1,916,000)
Markets Managed by Others (2)............................................................... (1,405,000)
----------------
Total Markets to be traded to BellSouth................................................... (3,321,000)
Markets to be Divested (3)
Markets Managed by U.S. Cellular............................................................ 236,000 (174,000)
Markets Managed by Others................................................................... (110,000)
----------------
Total Markets to be Divested.............................................................. (284,000)
----------------
Net Population Equivalents to be Acquired Related to BellSouth Transaction.............. 347,000
----------------
----------------
Summary of U.S. Cellular's Cellular Interests After the Completion of the Transaction with
BellSouth:
Total Managed Markets....................................................................... 25,041,000 22,752,000
Total Population Equivalents of Markets Managed by Others................................... 2,986,000
----------------
25,738,000
----------------
----------------
</TABLE>
- - ---------
(1) Pursuant to the agreement with BellSouth, U.S. Cellular has agreed to
transfer to BellSouth a 100% interest in these markets. If U.S. Cellular
owns less than 100% of these markets at the time of completion of the
transaction, U.S. Cellular will pay cash to BellSouth in lieu of any
interests U.S. Cellular does not own at the time.
(2) In addition to these interests, U.S. Cellular will deliver to BellSouth
interests in two markets which are currently owned by TDS.
(3) As a result of the transaction with BellSouth, U.S. Cellular expects to
divest its interest in these markets.
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, generally 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, primarily analog radio transmission is used between
cell sites and the cellular telephones themselves.
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
or has a right to acquire 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 or microwave links
owned by others 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
10
<PAGE>
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 both systems.
U.S. Cellular has continued to expand its internal network in 1996 to
encompass all of its managed markets. This network provides automatic call
delivery for U.S. Cellular's customers and handoff between adjacent markets. The
network has also been extended through links with certain systems operated by
several other carriers, including GTE, US West, Ameritech, BellSouth, Centennial
Cellular Corp., Southwestern Bell, AT&T Wireless Communications, Vanguard
Cellular Systems and others. Additionally, U.S. Cellular has implemented four
Signal Transfer Points which have allowed it to interconnect efficiently with
network providers such as Illuminet and the North American Cellular Network.
During 1997, U.S. Cellular intends to extend the network for its customers
through interconnection with additional system operators for call delivery and
hand-off. This expanded network will increase the area in which customers can
automatically receive incoming calls, and should also reduce the incidence of
"tumbling" electronic serial number fraud due to the pre-call validation feature
of networked systems. In addition, the extension of these networks will allow
for the termination of wireless-to-wireless traffic without the inherent costs
that are otherwise incurred if this traffic is routed through the landline
network.
U.S. Cellular 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.
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. In late 1996, U.S. Cellular implemented its
new site on the WorldWideWeb to support its marketing efforts and to be a future
distribution channel. These U.S. Cellular-owned and managed locations are
designed to market cellular service to the consumer segment in a familiar
setting.
U.S. Cellular manages each cluster of markets from an administrative office
with a local staff, which typically includes 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 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
11
<PAGE>
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
220 stand-alone retail stores by the end of 1996. These U.S. Cellular-owned and
operated businesses utilize rental facilities in high-traffic areas. U.S.
Cellular has implemented a uniform appearance of 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 1996, U.S. Cellular further expanded
its retail presence by opening smaller retail kiosks within larger merchandiser
and grocery stores. At December 31, 1996, U.S. Cellular had opened over 150
"stores within a store" in Wal-Mart and Kroger locations.
In addition to its own retail centers, U.S. Cellular actively pursues
national retail accounts, as agents for U.S. Cellular, which yield new customer
additions in multiple markets. Agreements have been entered into with such
national distributors as Chrysler Corporation, Ford Motor Company, General
Motors, MCI, Radio Shack, Best Buy and Sears, Roebuck & Co. 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 uses a variety of direct mail, billboard, radio, television
and newspaper advertising to stimulate interest by prospective customers in
purchasing its cellular service and to establish familiarity with U.S.
Cellular's name. Advertising is directed at gaining customers, improving
customers' awareness of the United States Cellular 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 to
enhance public awareness of U.S. Cellular, such as providing telephones and
service for public events and emergency uses.
CUSTOMERS AND SYSTEM USAGE
Cellular customers come from a wide range of occupations. They 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 security purposes. Although many 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 systems used their cellular systems
approximately 107 minutes per unit each month and generated retail revenue of
approximately $43 per month during 1996, compared to 95 minutes and $44 per
month in 1995. Revenue generated by roamers, 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 $66 during 1996. Average
monthly service revenue per customer unit decreased approximately 8% during
1996. This decrease is related to the industry-wide trend of newer customers
tending to use fewer minutes during peak business hours, which has reduced the
average local retail revenue per minute, and to declining contribution of
inbound roaming revenue per customer. U.S. Cellular believes that its customer
base is growing faster than that of the cellular industry as a whole, which has
a dilutive effect on inbound roaming revenue per customer. U.S. Cellular
anticipates that average monthly service revenue per customer unit will continue
to decline as its distribution channels provide additional customers who
generate lower revenue per local minute of use and as roaming revenues grow more
slowly. 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 several years.
12
<PAGE>
In addition to revenue from local retail customers, U.S. Cellular generates
revenue from roaming customers and other services. 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 market area. U.S. Cellular has entered into
"roaming agreements" with operators of other cellular systems covering virtually
all systems in the United States and Canada. These agreements offer customers
the opportunity to roam in these systems. These reciprocal agreements
automatically pre-register the customers of U.S. Cellular's systems in the other
carriers' systems. Also, a customer of a participating system roaming (i.e.
traveling) in a U.S. Cellular market where this arrangement is in effect is able
to make and receive calls on U.S. Cellular's system. 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 managed operations.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
--------------------------------------------------------------
1996 1995 1994 1993
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Majority-owned and managed markets:
Cellular markets in operation (1).................... 131 137 130 116
Total population of markets in service (000s)........ 21,712 22,309 21,314 19,383
Customer Units:
at beginning of period (2)......................... 710,000 421,000 261,000 150,800
additions during period (2)........................ 561,000 426,000 250,000 165,300
disconnects during period (2)...................... 198,000 137,000 90,000 55,100
at end of period (2)............................... 1,073,000 710,000 421,000 261,000
Market penetration at end of period (3).............. 4.94% 3.18% 1.98% 1.35%
Consolidated revenues.................................. $ 707,820 $ 492,395 $ 332,404 $ 214,310
Depreciation expense................................... 74,631 57,302 39,520 25,665
Amortization expense................................... 34,208 32,156 25,934 19,362
Operating income (loss)................................ 87,366 42,755 17,385 (8,656)
Construction expenditures.............................. 248,123 210,878 167,164 92,915
Identifiable assets.................................... $ 2,116,592 $ 1,890,621 $ 1,584,142 $ 1,275,569
<CAPTION>
1992
------------
<S> <C>
Majority-owned and managed markets:
Cellular markets in operation (1).................... 92
Total population of markets in service (000s)........ 15,014
Customer Units:
at beginning of period (2)......................... 97,000
additions during period (2)........................ 88,600
disconnects during period (2)...................... 34,800
at end of period (2)............................... 150,800
Market penetration at end of period (3).............. 1.00%
Consolidated revenues.................................. $ 139,929
Depreciation expense................................... 16,606
Amortization expense................................... 13,033
Operating income (loss)................................ (12,705)
Construction expenditures.............................. 56,033
Identifiable assets.................................... $ 858,795
</TABLE>
- - ------------
(1) Represents the number of markets in which U.S. Cellular owned at least a 50%
interest and which it managed, including its reseller operation in 1992. 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 Donnelley
Marketing Service for the respective years.
13
<PAGE>
The following table summarizes, by operating cluster, the total population,
U.S. Cellular's customer units and penetration for U.S. Cellular's consolidated
markets as of December 31, 1996.
<TABLE>
<CAPTION>
OPERATING CLUSTERS POPULATION CUSTOMERS PENETRATION
- - ----------------------------------------------------------------- ---------- ---------- ------------
<S> <C> <C> <C>
Iowa............................................................. 2,462,000 145,000 5.89%
Wisconsin/Illinois............................................... 2,032,000 71,000 3.49
Missouri......................................................... 686,000 32,000 4.66
Eastern North Carolina/South Carolina............................ 2,349,000 98,000 4.17
Virginia......................................................... 949,000 42,000 4.43
West Virginia/Maryland/Pennsylvania.............................. 1,138,000 46,000 4.04
Oregon/California................................................ 1,029,000 47,000 4.57
Washington/Oregon/Idaho.......................................... 1,370,000 74,000 5.40
Indiana/Kentucky/Ohio............................................ 1,801,000 88,000 4.89
Maine/New Hampshire/Vermont...................................... 1,476,000 73,000 4.95
Eastern Tennessee/Western North Carolina......................... 1,429,000 90,000 6.30
Oklahoma/Missouri/Kansas......................................... 1,412,000 93,000 6.59
Texas/Oklahoma................................................... 694,000 32,000 4.61
Florida/Georgia.................................................. 1,520,000 82,000 5.39
Southwestern Texas............................................... 1,224,000 47,000 3.84
Other Operations................................................. 141,000 13,000 9.22
---------- ---------- ---
21,712,000 1,073,000 4.94%
---------- ---------- ---
---------- ---------- ---
</TABLE>
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 hand-held portable cellular telephones. Features offered in
some of the cellular telephones include hands-free calling, repeat dialing, horn
alert and others.
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.
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. In 1996, the Company developed and introduced its new consumer line of
products under the CarryPhone brand. These products include a) Express, a
pre-packaged phone plus price plan aimed at the convenience buyer; b)
TalkTracker, a cellular phone with usage prepaid; and c) Home and Away, a
combination cordless and cellular phone in a single package. 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.
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 the Company. The construction,
operation and transfer of cellular systems in the United States are regulated to
varying
14
<PAGE>
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 and makes regulation unnecessary. 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.
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. U.S. Cellular is currently engaged in this
registration process. All new towers must be registered at the time of
construction and existing towers are being registered on a staggered
state-by-state basis, to be concluded in May 1998. The FCC is currently
considering whether to take action to pre-empt moratoria imposed by certain
localities on the construction of wireless towers. U.S. Cellular has supported
such FCC action.
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.
U.S. Cellular's Tulsa and Knoxville licenses were renewed in 1995, and U.S.
Cellular's Des Moines, Iowa; Peoria, Illinois; and Roanoke, Virginia licenses
were renewed in 1996. U.S. Cellular's next renewal applications for several
markets are due to be filed in 1997.
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
15
<PAGE>
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. U.S. Cellular's strategy with respect to system construction in its
markets has been and will be 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 would enable cellular systems to determine
the precise location of the person making the emergency call. 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, and will require cellular systems to improve their ability to
locate wireless 911 callers over a five-year period.
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 the subscribers involved have no pre-existing service relationship with
that 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
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, at the same location, 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 have implementation deadlines by the end of 1998.
Broadband PCS, cellular and certain other wireless providers have phased
implementation deadlines in 1998 and 1999.
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. The U.S. Court of
Appeals for the Eighth Circuit has stayed the effect of the rules prescribing
interim rates because it has held that the 1996 Act requires that rate issues
are to be decided by the states. However, the FCC's rules requiring reciprocal
and symmetrical compensation remain in effect. If the U.S. Court of Appeals
sustains its earlier ruling, interconnection rate issues will be decided by the
states. Whether the issue is decided by the states or the federal government,
cellular carriers 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 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-
16
<PAGE>
state Joint Board. Much of this implementation is proceeding in numerous,
concurrent proceedings with aggressive deadlines. The Company cannot predict the
full extent, nature 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
tele-communications 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 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, it retains limited authority to
regulate certain competitive practices in rural telephone company service areas.
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. The FCC is now considering how to implement 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. It is expected that the obligation to make some
kind of payments to support universal service will be expanded to include other
telecommunications service providers, including cellular carriers. It is not
known how those payments may be calculated or what revenue base may be used.
However, it is also possible that cellular carriers may become eligible to
receive universal service support payments in certain circumstances under the
new system.
The FCC has also allocated a total of 140 megahertz ("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.
The FCC licensed the first two 30 MHz MTA frequency blocks in 1995 and the
30 MHz block which is reserved for small business entities in 1996, and has
announced the winning bidders in the D, E and F Block auctions in 1997. TDS's
subsidiary, Aerial Communications, Inc. ("Aerial"), was licensed in eight MTAs
for 30 MHz blocks but has sold its licenses for the Guam and Alaska MTAs. It is
now constructing PCS systems in the other six MTAs. See "Broadband PCS
Operations."
In compliance with FCC restrictions on common ownership of cellular and
broadband PCS interests in overlapping market areas, U.S. Cellular entered into
a series of arrangements for the divestiture or restructuring of certain of its
cellular interests in market areas where Aerial was awarded broadband PCS
licenses. A number of these proposed arrangements required FCC approval of
assignment or transfer of control applications before they could be consummated.
All of these applications have been approved by the FCC and have been
consummated. U.S. Cellular believes that it has taken reasonable steps to comply
with the FCC's cross-interest policies.
PCS technology is currently under development and 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
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services and will result in increased competition with U.S. Cellular's
operations. The ability of these future 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.
Media reports have suggested that certain radio frequency ("RF") emissions
from portable cellular telephones might be linked to cancer. U.S. Cellular has
reviewed relevant scientific information and, based on such information, is not
aware of any credible evidence linking the usage of portable cellular telephones
with cancer. In 1996 the FCC announced rules, now scheduled to go into effect in
September 1997, dealing, INTER ALIA, with RF emissions from cellular towers of
less than 10 meters in height and cellular telephones. It is anticipated that
U.S. Cellular will be able to comply with RF tower emission standards and U.S.
Cellular believes that the cellular telephones it currently sells comply with
the standards.
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. 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.
U.S. Cellular and its subsidiaries have been and intend to remain active
participants in proceedings before the FCC and, through its membership in state
associations of wireless providers, before 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, among other technologies, conventional mobile
telephone and SMR systems, both of which are able to connect with the landline
telephone network. U.S. Cellular believes that conventional mobile telephone
systems and conventional SMR systems are competitively disadvantaged because of
technological limitations on the capacity of such systems. The FCC has
previously given approval, through waivers of its rules, to ESMR, an enhanced
SMR system. ESMR systems may have cells and frequency reuse like cellular
thereby potentially eliminating any current technological limitation. The first
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ESMR systems were implemented in 1993 in Los Angeles and are being implemented
in many other cities across the United States. ESMR providers have initiated
service in several areas where U.S. Cellular operates cellular systems. Although
less directly a substitute for cellular service, wireless data services and
one-way paging service (and in the future, two-way paging services) may be
adequate for those who do not need full two-way voice service.
PCS providers have initiated service in several markets across the United
States, including markets where U.S. Cellular has operations. PCS providers
offer digital, wireless communications services to their customers. Similar
technological advances or regulatory changes in the future may make available
other alternatives to cellular service, thereby creating additional sources of
competition. U.S. Cellular expects PCS operators to continue deployments of PCS
across all of the U.S. Cellular markets over the next one or two years. U.S.
Cellular anticipates that PCS competitors will build out the larger metropolitan
areas before the mid-sized metropolitan and rural areas where U.S. Cellular
operates. As a result, the effects of PCS competition may not reach U.S.
Cellular's markets as quickly as they may in other cellular operators' markets.
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.
TELEPHONE OPERATIONS
The Company's telephone operations are conducted through TDS Telecom and 105
telephone subsidiaries. These telephone companies, ranging in size from less
than 500 to more than 40,000 access lines, serve 484,500 access lines in 28
states.
TDS Telecom provides modern, high-quality local and long-distance telephone
service. Local service is provided by TDS Telecom's operating telephone
subsidiaries. Long-distance or toll service is provided through connections with
long-distance carriers, primarily AT&T and the Bell Operating Companies
("BOCs").
Future growth in telephone operations is expected to be derived from the
acquisition of additional telephone companies, from providing service to new or
presently unserved establishments, from business expansion in the areas served
by TDS Telecom, from upgrading existing customers to higher grades of service,
from increased usage of the network through both local and long-distance calling
and from providing additional services made possible by advances in technology.
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The following table summarizes certain information regarding TDS Telecom's
telephone operations.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
--------------------------------------------------------------------------
1996 1995 1994 1993 1992
--------------- --------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Telephone Operations
Access lines*..................................... 484,500 425,900 392,500 356,200 321,700
% Residential................................... 79.9 80.6 81.3 82.0 83.1
% Business (nonresidential)..................... 20.1 19.4 18.7 18.0 16.9
Total revenues.................................... $ 402,629 $ 354,841 $ 306,341 $ 268,122 $ 238,095
% Local service................................. 27.4 26.8 26.8 26.9 27.4
% Network access and long-distance.............. 58.5 61.6 60.0 59.3 57.9
Depreciation and amortization expense............. $ 88,967 $ 77,354 $ 68,878 $ 59,562 $ 51,946
Operating income.................................. 103,358 98,240 91,606 79,110 72,217
Construction expenditures......................... 144,440 104,372 115,483 80,818 65,652
Total identifiable assets......................... $ 1,181,084 $ 1,058,241 $ 984,563 $ 829,489 $ 723,855
</TABLE>
- - ---------
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
TELEPHONE ACQUISITIONS
TDS continually reviews attractive opportunities to acquire operating
telephone companies. Since January 1, 1992, TDS has acquired 22 telephone
companies serving a total of 90,400 access lines for an aggregate consideration
totaling $297.1 million. The consideration consisted of $59.5 million in cash
and notes, 155,000 Preferred Shares and 5.2 million Common Shares of the
Company. TDS also sold one telephone company serving 1,100 access lines in 1995.
The Company continually evaluates acquisition opportunities. 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. While management believes that it will be
successful in making additional acquisitions, there can be no assurance that the
Company will be able to negotiate additional acquisitions on terms acceptable to
it or that regulatory approvals, where required, will be received.
The Company maintains shelf registration of its Common Shares and Preferred
Shares under the Securities Act of 1933 for issuance specifically in connection
with acquisitions.
It is the Company's policy to preserve, insofar as possible, the local
management of each telephone company it acquires. The Company 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 the following areas:
finance, accounting and treasury services; marketing; customer service; traffic;
engineering and construction; customer billing; rate administration; credit and
collection; and the development of administrative and procedural practices.
CONSTRUCTION AND DEVELOPMENT PROGRAM
In 1996, and continuing in 1997, TDS Telecom has expanded and upgraded its
service providing network in accordance with its first-to-market service
provisioning strategy. Utilizing state-of-the-art technologies such as Signaling
System 7 ("SS7"), Advance Calling Services ("ACS"), and fiber-fed Digital
Serving Areas ("DSA") to condition the network for the Integrated Services
Digital Network ("ISDN"), TDS Telecom will bring cutting edge telecommunications
services to its predominantly rural markets. TDS Telecom intends to utilize this
world-class network as a competitive advantage to protect and grow its customer
base in the increasingly competitive telecommunications industry. TDS Telecom
made significant progress in 1996 in network modernization through the
deployment of 425 miles of fiber optic cable and 207 DSAs. TDS Telecom further
embraced its strategic alliance with Lucent Technologies and Siemens Stromberg
Carlson by continuing its program of upgrading switching platforms. In 1996, 35
new switching systems, including eight hosts, were installed representing an
additional 50,900 lines
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and making available an additional 50,900 lines of ISDN, SS7 and ACS. TDS
Telecom plans to install 530 additional miles of fiber optic cable and 214
additional DSAs in 1997. TDS Telecom's 1997 switching platform upgrade plans
include 45 additional switching systems including eight additional hosts
representing 43,900 lines, to bring the cumulative total Lucent and Siemens
installed lines to 276,000. As a result, TDS Telecom will make available to its
customers 45,300 additional lines of ISDN, SS7 and ACS. By the end of 1997, TDS
Telecom projects having 289,338 ISDN, 344,686 SS7, and 320,183 ACS cumulative
equipped lines representing 57%, 68% and 63%, respectively, of all equipped
lines.
In 1996, TDS Telecom continued its efforts to reduce costs while improving
its customer responsiveness by further deployment of its Transmission Control
Protocol/Internet Protocol ("TCP/IP") data network to an additional 55 operating
locations. The TCP/IP network is utilized by TDS Telecom's centralized network
management center ("NEMAC") to monitor the switching network for errors and
provide corrective action even before the customer realizes that a fault has
occurred. The TCP/IP data network also provides transport for TDS Telecom's
support and service centers, allowing for increased coverage of customer
inquiries and their related customer care systems. Rollout of the data network
to additional operating locations is planned for 1997.
TDS Telecom supplemented its revenue in 1996 with the deployment of
additional Internet nodes through its wholly owned Internet subsidiary, TDSNET.
TDSNET deployed 61 additional operating nodes in 1996 and expects to deploy at
least 30 more nodes in 1997. In 1996, voicemail deployment continued to 16 more
serving areas. TDS Telecom will continue to enhance its voice mail revenues in
1997 through the installation of an additional seven systems.
TDS Telecom's total 1997 capital budget is $130.0 million compared to actual
capital expenditures of $144.4 million in 1996 and $104.4 million in 1995.
Financing for the 1997 capital additions will be primarily provided by
internally generated funds and supplemented by federal long-term financing.
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 make hardship loans at a 5% interest 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 (6.42% for its fiscal year ended September 30, 1996), 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 (6.72%
for a 35-year note at December 31, 1996).
Substantially all of TDS Telecom's telephone plant is pledged or is 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. Of the $301.6 million of underlying retained
earnings of telephone subsidiaries at December 31, 1996, $212.0 million was
available for the payment of dividends on the subsidiaries' common stock.
At December 31, 1996, TDS Telecom's operating telephone companies had
unadvanced loan commitments under the RUS, RTB and FFB loan programs aggregating
approximately $129.8 million, at a weighted average annual interest rate of
6.15%, to finance specific construction activities in 1997 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.
ACCESS REVENUES
TDS Telecom's operating telephone subsidiaries receive access revenue from
interstate and intrastate long- distance carriers as compensation for
originating and terminating their traffic. The interstate
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and intrastate access rates charged include the cost of providing service plus a
fair rate of return. Access revenues account for approximately 55% of the
revenue generated by TDS Telecom's local exchange carrier ("LEC") subsidiaries.
TDS Telecom will file an interstate access rate tariff for one of its
operating subsidiaries in 1997. However TDS Telecom concurs in the National
Exchange Carrier Association ("NECA") interstate common line and traffic
sensitive tariffs for the remainder of its LEC 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 operates subject to FCC rules and oversight.
The FCC regulates interstate toll rates and other matters relating to
interstate telephone service. On December 23, 1996, the FCC released a notice of
proposed rulemaking regarding interstate access revenues. In the notice, the FCC
stated its intention to reform the existing interstate access charge rules and
policies and sought comment from interested parties. The FCC did not indicate
what changes it will propose; however, final rules are expected by May 8, 1997.
The outcome of this and other rulemaking proceedings may affect the source and
nature of the operating companies' recovery of costs from the interstate
jurisdiction. In the past, the FCC has generally adopted transition rules when
changing cost recovery mechanisms to prevent abrupt rate and revenue changes.
The 1996 Act provides for reciprocal compensation for parties of any
interconnection arrangement. The FCC issued a 1996 order governing the
compensation arrangements between LECs and wireless providers. LECs must charge
wireless carriers cost-based rates and must now pay access charges to wireless
carriers that terminate calls from LEC customers. Since this order raises
interconnection costs, the operating companies may adjust their charges to
recover such increased costs.
The FCC has also stated its intention to initiate review of current
procedures for separating incumbent LECs' service costs between the state and
federal jurisdictions. To the extent that cost allocations have been used in the
past to limit the costs a LEC must recover in local or intrastate access rates,
the proceeding may seek to shift costs to the states. To the extent that such
support is not made up in the new federal and state universal service
mechanisms, TDS Telecom may seek rate increases to offset any reductions in
interstate revenues.
Where applicable and subject to state regulatory approval, TDS Telecom's LEC
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 LECs, 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.
The impact of the 1996 Act is likely to accelerate the pace of regulatory
re-evaluation at both the state and federal level. To the extent that state-
ordered access charge revisions reduce revenues, TDS Telecom may seek
adjustments in other rates. Given the many regulatory issues still unresolved,
TDS Telecom cannot predict the cumulative nature or extent of impacts from
regulatory reform.
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 LEC subsidiaries provide
telephone service in rural areas and virtually all of them offer service to
low-income customers. To control the cost of universal service, the FCC capped
and indexed the universal service fund through 1996.
The 1996 Act codified universal service; set forth clear principles for
ensuring affordable access to modern telephone service nationwide; established
discounts for rural schools, libraries and 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.
The joint board convened and released its recommendation to the FCC on November
8, 1996. The joint board and FCC are considering controlling and reducing the
total amount of universal service support. The joint board has proposed not only
using forward-looking proxy costs to measure high cost support, but also using a
nationwide
22
<PAGE>
average revenues-per-line benchmark that has the potential to underestimate
rural LECs' high costs and thus limit their high cost support. The FCC opened a
comment cycle on the joint board recommendation and TDS Telecom has filed
comments and reply comments.
One major principle of the 1996 Act is that support shall be specific,
predictable and sufficient. In its comments to the FCC, TDS Telecom stated its
position that rural telephone companies, as defined in the 1996 Act, should
continue to base their costs on embedded (historical) rather than proxy
(forward-looking) costs proposed by the joint board. This would ensure that
support is predictable and sufficient. Because the 1996 Act also attempted to
eliminate implicit subsidies, TDS Telecom also suggested in its filing with the
FCC that the cost to support universal service should be added to the end user
bills generated by all telecommunications carriers. Such an explicit surcharge
would ensure adequate support and eliminate the need for LECs to pursue local
service rate increases for the potential changes. The FCC is expected to issue
an Order on universal service by May 8, 1997.
The final rules to implement the universal service provisions of the 1996
Act could 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 decrease,TDS Telecom's LEC subsidiaries may
pursue local service rate increases to recover the difference.
Telephone company acquisition and investment decisions assume the ability to
recover the cost and a reasonable rate of return though local service, access
and support revenues. Significant changes in the universal service funding
system might affect the Company's acquisition strategy. TDS Telecom is pursuing
a strategy of network modernization to maintain a strong competitive position.
The speed of such network modernization may depend on favorable support and
access policies on the federal and state levels.
REGULATION
TDS Telecom's LEC 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, is subject to state commission approval. 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, accounting
and related matters. 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, it
retains limited authority to regulate certain competitive practices in rural
telephone company service areas.
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.
Unless exempted, or granted suspension or modification, incumbent LECs 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 provide only those elements they choose to provide; (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.
As defined in the 1996 Act, TDS Telecom's LEC subsidiaries qualify as rural
telephone companies. Therefore, they enjoy an exemption from the incumbent LEC
requirements until they receive a bonafide
23
<PAGE>
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 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.
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
ensure that any telecommunications reform measures treat rural areas fairly. The
ongoing changes in public policy and introduction of competition might affect
the earnings of the operating subsidiaries and TDS Telecom is not able to
predict the impact.
While the majority of TDS Telecom's LEC subsidiaries continue to operate in
a rate-of-return environment, a number of state commissions are proactively
negotiating alternative regulation plans with LECs. Price regulation, the most
common form of alternative regulation, focuses on the price of telecommunication
services. TDS Telecom's LEC subsidiaries in both Alabama and Michigan are
currently operating in a price-regulated environment, whereby the commissions in
those states are no longer reviewing earnings. For several years, the RBOCs and
some of the nation's larger LECs have operated under an FCC "price cap" plan,
where earnings can only be increased through productivity improvements. The LECs
determine the amount of productivity gains above an allowed return and then must
share the excess gains with their customers.
For 1997, TDS Telecom's telephone subsidiaries have neither elected price
caps nor the alternative FCC plan, which was designed for smaller LECs. Instead,
the operating subsidiaries will continue to abide by traditional rate-of-return
regulation for interstate purposes. 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 is currently considering whether to initiate a proceeding to
lower the allowed rate-of-return for rate-of-return LECs.
NECA filed a Petition for Rulemaking with the FCC, which proposes rule
revisions to allow incentive settlement options within the NECA pools. The FCC
has not acted on this petition yet. The settlement options allow LECs to remain
in the NECA pools and still enjoy incentives previously available only to
non-NECA participants. Management continues to evaluate opportunities under all
forms of regulation.
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 should not be higher in rural areas than in urban areas. The
statute is intended to ensure affordable long distance services even in TDS
Telecom's most remote exchanges.
COMPETITION
The 1996 Act will help 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 applies expanded interconnection and other
requirements to local exchange telephone companies for the purpose of
stimulating competition. The Act establishes a framework for local service
competition and it establishes different standards for different types of
telecommunications carriers. The Act defines rural telephone companies ("RTC")
and provides them with an exemption from certain incumbent LEC obligations. All
TDS Telecom LECs meet the RTC definition and fall under the exemption. At a
minimum, this likely will delay certain forms of competition occurring in our
LECs while additional regulatory issues are resolved.
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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. Accordingly, 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. To
face this increasing competition, TDS Telecom has strategically positioned
itself to provide customer intimacy and to provide complete solutions to
customers' telecommunication needs.
To position TDS Telecom as a customer-intimate organization, TDS Telecom is
dedicating resources to establishing a Virtual Business Office ("VBO"). The VBO
is an environment that is technically equipped to enable multiple local business
offices to perform customer contact functions as if they were a "virtual" office
in the eyes of the customer. VBO is TDS Telecom's solution to connect offices
together to better use resources and preserve local presence. Through extended
availability that coincides with customers' schedules and expectations, VBO will
help provide greater market coverage and customer service on the customer's
terms. It will also enable the business office teams to deliver high-quality
service to the customer through more efficient call answering capabilities,
provide continued focused local service to walk-in customers, and leverage voice
and customer service application technology.
TDS Telecom is providing the operating telephone companies with the most
advanced central office switching equipment possible in order to offer customers
up-to-date technology such as ISDN, Advanced Calling Services, High-Speed Data
access and Internet access. TDS Telecom sees expanded competition as an
opportunity to provide a broader range of services to a greater number of
potential customers. TDS Telecom plans to provide its customers bundled service
offerings and become a "one stop shop" for all its customers telecommunications
needs. In 1996,TDS Telecom entered into new competitive markets with products
like LAN and data structured wiring (connecting computers in multiple customer
locations), and resale of Direct Broadcast Satellite. TDS Telecom also expanded
its Internet access service through its subsidiary, TDSNET. TDS Telecom will
continue to seek additional attractive opportunities in competitive markets in
1997.
BROADBAND PCS OPERATIONS
The Company's broadband PCS operations are conducted through Aerial
Communications, Inc. and subsidiaries. Aerial is currently developing its PCS
licenses covering the MTAs of Minneapolis, Tampa-St. Petersburg-Orlando,
Houston, Pittsburgh, Kansas City and Columbus. Aerial has commenced development
of a marketing program, intends to launch commercial services in its first
market in March 1997, and expects to complete initial construction of its PCS
networks within twelve months of launch of commercial service.
THE WIRELESS TELECOMMUNICATIONS INDUSTRY
PCS is the term used to describe the wireless telecommunications services
that will be offered by those companies that acquired or will acquire licenses
for radio spectrum (frequency range 1850-1990 MHz) in the FCC auctions and are
the newest entrants in the wireless telecommunications market. PCS will
initially compete directly with existing cellular telephone, paging and mobile
radio services. PCS will also include features which have not traditionally been
offered by cellular providers, such as: (i) the provision of all services to one
untethered, mobile number; (ii) lower-priced service options; and (iii) in the
near future, medium-speed data transmissions to and from portable computers,
advanced paging services and facsimile services. Aerial believes that these
enhanced features will contribute to the acceleration of growth in the wireless
telecommunications market. Aerial believes that PCS providers will be the first
wireless direct competitors to cellular providers and the first to offer mass
market all-digital mobile networks. In addition, 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.
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
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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
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.
Global System for Mobile Communications ("GSM"), Aerial's technology choice,
is not directly 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.
Dual-mode handsets are expected to be available in late 1997. Because analog
cellular service is available nationwide, Aerial expects the PCS customers will
be able to roam into many service areas by analog cellular providers.
To date, in North America, nearly 20 PCS companies have chosen or are
expected to choose GSM. With the completion of the U.S. broadband PCS auctions,
license areas of GSM committed operators now total more than 260 million
population equivalents (representing 98.3% of the U.S. population). Aerial
anticipates that its customers will be able to roam throughout the United States
and Canada, either on other GSM-based PCS networks or by using dual-mode
handsets that also can be used on existing cellular networks.
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.
PRODUCTS AND SERVICES
Aerial's fundamental customer proposition will be an affordable, reliable,
high-quality mobile voice communications service. At the commencement of
commercial service, Aerial intends to offer 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 is competitive with that of current
cellular operators. Aerial will also provide roaming capabilities, through
agreements with other GSM operators and cellular operators.
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Aerial will provide several distinct services and features, certain of which
are currently available only on PCS networks. These include:
THE SMART CARD. GSM technology employs a credit-card sized Smart Card which
contains a microchip containing detailed information about a customer's service
profile. The Smart Card will allow 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 will
provide easy-to-use, interactive menu-driven phones that will enable customers
to utilize the features available in a GSM network. These handsets will
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 will provide greater security from
eavesdropping and cloning than existing 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.
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 will be 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 will emphasize the value of Aerial's
high-quality, innovative services and will be supported by heavily promoting the
Aerial brand name. This will be supported by a substantial advertising program.
Aerial plans to offer 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 will utilize traditional sales channels
which include mass merchandisers and retail outlets, company retail stores,
sales agents and a direct sales force. 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, neighborhood sales
and on-line sales.
AERIAL'S PCS MARKETS
The PCS markets cover large areas with attractive demographic
characteristics including growing populations, high population densities,
favorable commuting patterns, high median household incomes and favorable
business climates. Aerial believes the geographic diversity of the PCS markets
mitigates adverse consequences which may result from an economic slowdown in one
particular region.
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.
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Aerial anticipates that market prices for two-way wireless services
generally will decline in the future based upon 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.
Aerial will compete 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). Each of these PCS
licensees is designing and constructing its respective networks. PCS PrimeCo's
networks are commercially operational in Houston and Tampa. Sprint Spectrum has
launched commercial service in Pittsburgh. The FCC has awarded the initial
licenses for the Block C spectrum and has recently announced the winning bidders
for the D, E and F Blocks. Aerial also expects that existing cellular providers
in the PCS markets, most of which have an infrastructure in place and have been
operational for a number of years, will upgrade 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., U S WEST
NewVector Group, Inc., Bell Atlantic-NYNEX Mobile and Ameritech Cellular.
Aerial also expects to compete with other communications technologies that
now exist, such as paging, ESMR and global satellite networks, and expects to
compete with cellular and PCS resellers. 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. In addition, Aerial may face
competition from technologies that may be introduced in the future.
All of such competition is expected to be 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.
Handsets used for GSM-based PCS networks will not be automatically
compatible with cellular systems, and vice versa. Aerial expects dual-mode
handsets to be available in late 1997, which will permit its customers to roam
by using the existing cellular wireless network in other markets. Until then,
this lack of interoperability may impede Aerial's ability to attract current
cellular customers or potential new wireless communication customers that desire
the ability to access different service providers in the same market.
REGULATION
REGULATORY ENVIRONMENT. The FCC regulates the licensing, construction,
operation and acquisition of wireless telecommunications systems in the U.S.
pursuant to the Communications Act, 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 forfeitures for
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
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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 unnecessary. The FCC promulgated and
continues to promulgate regulations governing construction and operation of
wireless providers, 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 BTA in every
block, for a total of more than 2,000 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. The FCC has awarded the initial licenses for the C Block spectrum
and has recently announced the winning bidders for the D, E and F Blocks.
An appeal has been taken to the FCC from the Bureau order by a party
alleging that some of the authorizations were granted to parties which had
engaged in collusion in the competitive bidding process. That party has also
sought review of the denial of its motion for a stay of the grant of A and B
Block authorizations. No allegation of collusion was made against TDS or Aerial.
Aerial would defend vigorously any challenges to the authorizations it has been
granted.
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.
In compliance with FCC restrictions on common ownership of cellular and
broadband PCS interests in overlapping market areas, United States Cellular,
another subsidiary of TDS, entered into a series of arrangements for the
divestiture or restructuring of certain of its cellular interests in market
areas where Aerial was awarded broadband PCS licenses. A number of these
proposed arrangements required FCC approval of assignment or transfer of control
applications before they could be consummated. These applications have been
approved by the FCC and have been consummated.
The grants of licenses to Aerial are also 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 license grant and
coverage of two-thirds of that population within ten years. A significant factor
affecting the schedule and cost of Aerial's network implementation will be the
relocation of existing private microwave facilities which operate on the same
frequencies to be used for Aerial's broadband PCS operations. Under the FCC's
policies, if Aerial decides that any existing microwave facility must be
relocated, it is required to provide substitute facilities at its own expense so
that the companies using these existing facilities may continue to have access
to the same or equivalent communications capabilities. The FCC concluded
proceedings in 1996 clarifying and changing its requirements for permissible
relocation costs, adopting incentives to encourage reliance on voluntary
relocation agreements and requiring the sharing of relocation costs where the
relocation of private microwave facilities benefits multiple broadband PCS
licenses.
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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"
performance, 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. The FCC adopted certain significant decisions during 1996.
In one decision, the FCC required that all licensees register and obtain FCC
registration numbers for all of their antenna towers which require prior FAA
clearance. The FCC also amended its environmental protection rules to adopt new
guidelines and procedures for evaluating the environmental effects of RF
emissions.
The FCC has also imposed new "enhanced 911" regulations in broadband PCS
systems to determine the precise location of the person making the emergency
call. The new rules require broadband PCS providers to work with local public
safety officials to process 911 calls, including those made from mobile
telephones not registered with the broadband PCS provider, and to meet phased
deadlines for implementing these capabilities.
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 the subscribers involved have no pre-existing service relationship with
that 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
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, at the same location, 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 have
implementation deadlines by the end of 1998. Broadband PCS, cellular and certain
other wireless providers have phased implementation deadlines in 1998 and 1999.
The FCC is also proceeding 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 is proceeding in numerous, concurrent proceedings with aggressive
deadlines. Aerial cannot predict the full extent, nature 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 -- 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
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quality and consumer rights. While a state may not impose requirements that
effectively function as barriers to entry, it retains limited authority to
regulate certain competitive practices in rural telephone company service areas.
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 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
have been taken to the United States Court of Appeals for the Eighth Circuit
from these FCC orders by numerous parties alleging that the FCC has exceeded its
statutory mandate, among other matters. The Eighth Circuit Court granted a stay
of certain rules adopted in the FCC orders pending its decision on the merits of
these appeals.
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. The FCC has proceedings pending to address
recommendations made by the Joint Board with respect to the implementation of
the universal service provisions of the 1996 Act, including, among other issues,
the size of the universal service fund and the assessment mechanism to determine
how much individual wireless carriers will be required to contribute.
STATE AND LOCAL REGULATION. The scope of state 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 pre-emption 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 pre-emption 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 and local 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.
RADIO PAGING OPERATIONS
The Company manages its radio paging business through American Paging, Inc.
and subsidiaries. American Paging provides wireless communications messaging
services in the United States with operations concentrated in Florida and in the
Mid-Atlantic and Midwest regions.
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WIRELESS MESSAGING INDUSTRY
Paging is a wireless communications messaging technology which uses an
assigned radio frequency, licensed by the FCC, to contact a paging customer
within a geographic service area. Pagers are small, lightweight, easy-to-use,
battery-operated devices which receive messages by the broadcast of a radio
signal. To contact a customer, a message is initiated by placing a telephone
call to the customer's pager number or through computer software which enables a
computer to transmit a text message via the modem line. The message is received
by a computerized paging switch which generates a signal sent to
microprocessor-controlled radio transmitters within the service area. These
radio transmitters are connected to the paging terminal either through land-line
or satellite links. The transmitters broadcast a digital or analog signal that
is received by the pager and delivered as alphanumeric text, numerical display,
tone or voice message.
The paging industry started in 1949 when the FCC allocated certain radio
frequencies for exclusive use in providing one-way and two-way types of mobile
communications services. The industry grew slowly during its first thirty years
as the quality and reliability of equipment was developed and the market began
to perceive the benefits of wireless communications. Until the 1980s, the
industry was highly fragmented with a large number of small, local operators.
During that decade, acquisitions of many firms by regional telephone companies
and others greatly consolidated the industry. Several large industry
acquisitions occurred in the 1990s which has resulted in the further
consolidation of the paging industry.
Manufacturers of pagers and transmission equipment have produced innovative
technological advances which are expected to continue to broaden the potential
market size for paging services and support the industry's rapid growth rate.
Micro circuitry, liquid crystal display technology and digital signal processing
have all expanded the capability and capacity of paging services while reducing
equipment and airtime costs and equipment size. Narrowband PCS technology is
expected to greatly expand the messaging capacity of the paging infrastructure
and provide advanced two-way messaging and data services. Future service
offerings are expected to include acknowledgment paging, which allows customers
to confirm a message to the originator, as well as digitized voice paging,
two-way data conveyance to highly mobile devices such as lap-top computers and
Personal Digital Assistants ("PDA"), and other data transfer applications.
The following table summarizes certain information about American Paging's
operations.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
------------------------------------------------------------------
1996 1995 1994 1993 1992
------------ ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Pagers in service......................................... 777,400 784,500 652,800 460,900 322,200
Total revenues............................................ $ 104,187 $ 107,150 $ 92,065 $ 75,363 $ 54,716
Depreciation and amortization expense..................... 33,777 24,692 17,178 13,392 10,412
Operating (loss).......................................... (36,626) (8,997) (169) (721) (5,447)
Additions to property and equipment....................... 32,517 26,527 28,966 21,454 14,277
Identifiable assets....................................... $ 153,374 $ 159,170 $ 146,107 $ 74,923 $ 57,080
</TABLE>
COMPANY DEVELOPMENT
American Paging's business strategy is to promote above industry average
growth in customers, service revenue and operating cash flow by providing the
highest quality service through one of the industry's most technologically
advanced digital transmission systems with a focus on strong customer service
and competitive pricing.
SPECTRUM DEVELOPMENT. American Paging owns five regional narrowband PCS
licenses which provide coverage equivalent to that of a nationwide license. Each
of the five licenses consists of a 50 kHz outbound channel on frequency 930.625
MHz paired with a 12.5 kHz return channel on frequency 901.80625 MHz. The
licenses will eventually enable American Paging to introduce two-way wireless
messaging communications services including acknowledgment paging, data and
telemetry services, wireless e-mail and digitized voice messaging throughout the
United States. However, commerical unavailability of the
ReFLEX25-Registered Trademark- protocol and related infrastructure and
subscriber device equipment necessary to offer these services has resulted in
American Paging suspending development of its PCS licenses. American Paging also
intends to continue exploring synergies with affiliated companies, such as
United States Cellular Corporation and Aerial Communications, Inc.
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American Paging also owns an exclusive nationwide Private Carrier Paging
("PCP") channel on frequency 929.3375 MHz. American Paging believes this license
will enable it to offer competitive regional and nationwide wireless messaging
services. American Paging's Minnesota, Oklahoma, Texas and Washington, D.C.
systems currently utilize this frequency.
The narrowband PCS licenses and the PCP license will provide American Paging
with significant spectrum capacity upon which to offer future wireless messaging
services. Significant funds will be required when American Paging proceeds with
development of its narrowband PCS licenses and PCP license. There can be no
assurance that American Paging will be successful in developing these licenses
due to such factors as the inability to obtain sufficient financing at a
reasonable cost, availability of the supporting infrastructure and related
subscriber device equipment, competition, regulatory developments or other
factors.
ALLIANCES AND AFFILIATES. American Paging is a joint venture partner with
Nexus Telecommunication Systems Ltd. of Israel ("Nexus") in American Messaging
Services, LLC ("AMS"). AMS was formed to develop multiple applications and
distribution channels worldwide for a patented communications network that
provides two-way paging, location and telemetry services. In June 1996, AMS
constructed a beta-test system in Chicago to perform radio frequency and
infrastructure tests. The system is still being tested, while also serving as a
demonstration system for prospective customers of a Nexus-based technology.
American Paging has notified Nexus that it will stop funding AMS as of June 30,
1997. As a result, American Paging's interest in AMS may be diluted.
American Paging also has an agreement with Liazon, Inc. of Toronto for the
coordinated development and use of narrowband PCS and conventional PCP paging
frequencies in North America. Under the terms of the agreement, each company
will pursue its own PCS build out plans, but will have the added potential to
market North American coverage of advanced wireless messaging services. In a
related action, both the FCC and Industry Canada have provided conditional
authority for both companies to construct and operate transmitters in previously
restricted areas.
APP RESTRUCTURING
During the third quarter of 1995, American Paging began restructuring three
key operating areas: sales and marketing, administration, and customer service.
The impact on operations from these restructuring efforts was more severe than
originally anticipated, and results from operations were negatively impacted in
1995 and 1996. The changes implemented in 1996 caused disruptions in many
aspects of the business, and also resulted in additional restructuring costs
being recorded during 1996. These disruptions led to several senior management
changes including the appointment of a new President and Chief Executive Officer
and a new Vice President-Sales, Marketing and Field Operations in the second
half of 1996. Additionally, American Paging recently added a new Vice
President-Development and Engineering and a new Vice President-Finance and Chief
Financial Officer.
The first goal of the restructuring effort was to increase sales
productivity through improved direct sales efforts and improved customer mix.
Towards this end, American Paging increased the number of direct sales
representatives with the goal of increasing growth in units in service, revenue
and average monthly service revenue per unit ("ARPU"). During 1996, American
Paging increased the number of employees involved in the sales function to
approximately 60% of total employees, but improvements in units in service,
service revenue and ARPU growth were not achieved due to dislocations from
restructuring-related activities within the sales and customer support areas.
American Paging's strategy is to organize the department on a market segment
basis so that the sales and marketing employees will be better able to address
current customer demands, and also be more responsive to changes within those
market segments.
The second and third goals of the restructuring effort were to reduce
administrative expense and improve customer service. An integral part of
achieving these two goals was the consolidation of 17 geographically-dispersed
customer service and administrative units into a centralized Customer Telecare
Center ("CTC") located in Oklahoma City, Oklahoma. The CTC, opened in April
1996, now handles all back office activities including customer service, order
fulfillment, customer billing and collections, and is available 24 hours-a-day,
seven days-a-week. The process of implementing the CTC, as well as changing the
way American Paging sells, services and supports its customers, was very
disruptive to operations during 1996. As a result, restructuring-related
expenses recorded during 1996 include a
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<PAGE>
write-down of inventory identified as obsolete upon centralization of inventory
management at the CTC, as well as costs for duplicate staffing, employee
severance, and consulting and legal fees. In addition, during the consolidation
of customer information databases at the CTC, it became apparent that American
Paging's customer management and billing system did not provide the flexibility
necessary to support its future customer growth and retention. The creation and
successful operation of the CTC is critical to achieving American Paging's
objective of growth in units, service revenue and ARPU.
PAGING OPERATIONS
American Paging provides local, statewide, regional and nationwide advanced,
one-way digital wireless messaging communications services to customers in 21
states and the District of Columbia through its 51 sales and service offices. It
offers local and regional paging coverage throughout Florida, the Midwest
(including all or parts of Minnesota, Wisconsin, Missouri, Illinois, Indiana,
and Kentucky), the Mid-Atlantic (including all or parts of Maryland,
Pennsylvania, Virginia, and Washington, D.C.), and in portions of Oklahoma,
Texas, Arizona and Utah. One-way paging services are also offered in portions of
Ohio, Iowa and Southern California through various transmitter-sharing
agreements with nonaffiliated service providers. Nationwide one-way and two-way
paging services are offered through American Paging's alliances with
nonaffiliated service providers.
Generally, a paging system consists of a control center, transmitters and
dedicated links (wire, fiber optic, radio, or satellite) between the control
center and the transmitters and the pagers themselves. The control center is
interconnected with the public switched telephone network ("PSTN") and receives
messages from landline telephones. Messages received at the control center are
matched to each pager's unique telephone number, or "cap code," translated into
digital signals and forwarded over dedicated links to transmitters that
broadcast the message over a specified frequency. If the pager to which the
message is directed is in the transmitter coverage area, it will recognize its
"cap code" and indicate to its wearer that it has received a page.
American Paging currently provides four types of pagers in all of its
markets: alphanumeric text display, numeric display, tone and voice.
Alphanumeric text display service allows customers to receive, store, and
display full text messages, consisting of both numbers and letters up to 240
characters long, which are sent from either a data entry device, message
dispatch operator or via computer modem through messaging software. A numeric
display pager permits a caller to transmit to the customer a numeric message
that may consist of a telephone number, an account number or coded numeric
information. It has the memory capability to store several numeric messages
which can be recalled by the customer when desired. A tone pager notifies the
customer that a message has been received by emitting an audible beep,
displaying a flashing light or vibrating. In the case of voice service, the
notification is followed by a brief voice message.
MARKETING STRATEGY
American Paging directs its marketing efforts at value-oriented customers
who appreciate its high degree of technical reliability and high level of
customer service. American Paging's marketing strategy is designed to increase
market share and operating cash flow by achieving rapid growth at modest cost
per net customer unit added. Continuing quality improvements, including new
services and products, help stimulate this growth while controlling costs.
American Paging generates its revenues from (i) service usage billed on a
flat-rate or measured-service basis, (ii) pager rentals, (iii) pager warranties,
maintenance and repair, (iv) loss protection, (v) voice mail usage on a
flat-rate or measured-service basis, (vi) activation fees, (vii) the sale of
pager accessories and (viii) service usage of value-added services such as
information services, text dispatching, second telephone numbers or group calls.
Service to end users is provided directly by American Paging in most cases.
American Paging markets its services directly through its direct sales
force, company-owned retail stores and indirectly through third-party resellers
and agents. The direct sales staff is responsible for the development of large
and medium business accounts and for the promotion of nationwide paging
services. Company-owned retail stores focus on serving consumer and small
business accounts as do
34
<PAGE>
indirect agents. American Paging sells pagers to agents at a small mark-up or at
cost. Agents then sell the pagers to customers who purchase the services
directly from American Paging. American Paging provides sales support to its
agents, including promotional material and end-user information.
American Paging provides services under marketing agreements with
third-party marketing organizations, or resellers. American Paging offers paging
air time in bulk quantities at wholesale rates to resellers who then "re-sell"
the air time to end users at a mark-up. Resellers incur the cost to acquire
customers as well as to service, bill and collect revenues from the customer.
They also assume the cost of the paging unit for those who rent rather than
purchase.
COMPETITION
American Paging faces significant competition in all of its markets.
Competition for subscribers in most geographic markets American Paging serves is
based primarily on price, quality of services offered and the geographic area
covered. A number of American Paging's competitors, which include local,
regional and national paging companies and certain regional telephone companies,
possess greater financial, technical and other resources than American Paging.
Moreover, certain competitors in the paging business offer wider coverage in
certain geographic areas than does American Paging and certain competitors
follow a low-price discounting strategy to expand market share. If any of such
companies were to devote additional resources to the paging business or increase
competitive pressure in American Paging's markets, American Paging's results of
operations could be adversely affected.
A number of wireless communication technologies, including cellular
telephone service, broadband PCS, enhanced SMR and others, are competitive forms
of technology used in, or projected to be used for, wireless two-way
communications. Cellular telephone technology provides an alternative
communications system for customers who are frequently away from fixed-wire or
landline communications systems (i.e., ordinary telephones). American Paging
believes that paging will remain one of the lowest-cost forms of wireless
messaging due to the low-cost infrastructure associated with paging systems, as
well as advances in technology that will provide for reduced paging costs.
Broadband PCS technology is currently available in selected markets and
development continues in many other markets throughout the United States.
Broadband PCS Technology is similar in design to cellular technology and will
offer increased capacity for wireless two-way communication as well as
short-text messaging. Accordingly, this technology is expected to result in
increased competition for American Paging.
American Paging believes the services offered by narrowband PCS technology
will be complementary to the services and functionality of cellular and
broadband PCS. Future technological developments in the wireless
telecommunications industry and the enhancement of current technologies will
likely create new products and services that are competitive with the paging
services currently offered by American Paging. There can be no assurance that
American Paging would not be adversely affected by such technology changes.
REGULATION
REGULATORY ENVIRONMENT. American Paging's paging operations are subject to
regulation by the FCC and by state regulatory agencies. The FCC exercises broad
authority to regulate market entry and rates and shares responsibilities with
state regulatory authorities over a broad range of other matters.
The construction, operation and transfer of American Paging's systems in the
United States are regulated to varying degrees by the FCC pursuant to the
Communications Act. 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 unnecessary. The FCC has promulgated regulations
governing construction and operation of wireless systems, licensing (including
renewal of licenses) and technical standards for the provision of wireless
services under the Communications Act, and is implementing the legislative
objectives of the 1996 Act, as discussed below.
LICENSING. The FCC is responsible for awarding licenses for radio
frequencies used by American Paging and its subsidiaries to provide its one-way
and two-way message and other service offerings. It
35
<PAGE>
also establishes and enforces the licensing, technical and operating rules which
govern operations on those frequencies, the terms and conditions under which the
wireless systems of American Paging and its subsidiaries are interconnected with
and obtain services and facilities from other service providers such as local
exchange carriers and others with respect to interstate services and adjudicates
any consumer or other complaints filed under the Communications Act with respect
to service providers subject to its jurisdiction.
The FCC licenses granted to American Paging are issued for up to ten years
at the end of which time renewal applications must be filed with the FCC. Most
of American Paging's current licenses expire between 1998 and 2001. FCC renewals
are generally granted so long as American Paging is in compliance with FCC
regulations. Although American Paging is unaware of any circumstances which
would prevent the approval of any pending or future renewal applications, no
assurance can be given that American Paging'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. No
license granted to American Paging has ever been involuntarily revoked or
modified.
The Communications Act requires licensees, such as American Paging, to
obtain prior approval from the FCC for the assignment or transfer of control of
any construction permit or station license, or any rights thereunder. The
Communications Act also requires prior approval by the FCC of acquisitions of
other paging companies by American Paging. The FCC has approved all transfers of
control for which American Paging has sought approval. American Paging also
routinely applies for FCC authority to use frequencies, modify the technical
parameters of existing licenses, expand its service territory and provide new
services. Although there can be no assurance that any future requests for
approval or applications filed by American Paging will be approved or acted upon
in a timely manner by the FCC, or that the FCC will grant the relief requested,
American Paging has no reason to believe that any such requests, applications or
relief will not be approved or granted.
Pursuant to 1993 amendments to the Communications Act, a paging service is
classified as a CMRS, to the extent that it is a service offered to the public,
for a fee, which is interconnected to the public switched telephone network.
These 1993 amendments prohibit state and local authorities from limiting CMRS
market entry and regulating CMRS rates.
RECENT EVENTS. The FCC adopted certain significant decisions during 1996.
In one decision, the FCC amended its rules to allow paging and narrowband PCS
carriers to offer fixed wireless service on a co-primary basis with mobile
services. In another decision, the FCC required that all licensees register and
obtain FCC registration numbers for all of their antenna towers which require
prior FAA clearance. The FCC also amended its environmental protection rules to
adopt new guidelines and procedures for evaluating the environmental effects of
RF emissions.
In addition, the FCC initiated proceedings proposing to adopt market area
licensing to replace site-by-site licensing of paging base stations, to permit
geographic partitioning and spectrum disaggregation in the event market area
licensing is adopted, and to make changes affecting the licensing of local and
response channels in narrowband PCS services. The FCC has also announced its
intention to hold spectrum auctions for paging and narrowband PCS spectrum in
1997 if its market area licensing and narrowband PCS rule revisions are adopted.
The FCC also established a phased program which requires per-call
compensation to be paid to pay-phone service providers by subscribers to 800
numbers, among others. American Paging and numerous other paging providers who
offer 800 number calling features as a means of accessing their networks will be
required to compensate pay phone service providers under these new requirements.
During 1996 the FCC implemented significant changes in existing regulation
of the telecommunications industry under the 1996 Act. Some of these specific
changes, potentially affecting CMRS providers, including paging and narrowband
PCS providers, are summarized below.
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
36
<PAGE>
proceeding in numerous, concurrent proceedings with aggressive deadlines. The
Company cannot predict the full extent, nature 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 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, it retains limited authority to
regulate certain competitive practices in rural telephone company service areas.
Since enactment, the FCC has adopted orders implementing the local
competition provisions of the 1996 Act. The FCC found that certain wireless
providers 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 have been taken to
the United States Court of Appeals for the Eighth Circuit from these FCC orders
by numerous parties alleging that the FCC has exceeded its statutory mandate,
among other matters. The Eighth Circuit Court of Appeals granted a stay of
certain rules adopted in the FCC orders pending its decision on the merits of
these appeals.
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. The FCC has proceedings pending to address
recommendations made by the joint board with respect to the implementation of
the universal service provisions of the 1996 Act, including, among other issues,
the size of the universal service fund and the assessment mechanism to determine
how much individual wireless carriers will be required to contribute.
STATE AND LOCAL REGULATION. The scope of state regulatory authority, while
excluding market entry and rate regulation, covers such matters as the terms and
conditions of interconnection between local exchange carriers and wireless
carriers with respect to intrastate services, customer billing information and
practices, billing disputes, other consumer protection matters, facilities setup
issues and transfers of control, among other matters. In these areas,
particularly the terms and conditions of interconnection between local exchange
carriers 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 pre-emption 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 pre-emption 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 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.
American Paging and its subsidiaries have been and intend to remain active
participants in proceedings before the FCC and, through its membership in state
associations of wireless providers, before 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
37
<PAGE>
among wireless providers and the relationships between wireless providers and
other carriers. American Paging is unable to predict the scope, pace or
financial impact of policy changes which could be adopted in these proceedings.
OTHER SUBSIDIARIES
Subsidiaries of the Company provide custom printing (Suttle Press, Inc.);
and telemessaging services (Integrated Communications Services, Inc.).
EMPLOYEES
The Company enjoys satisfactory employee relations. As of December 31, 1996,
7,718 persons were employed by the Company, 153 of whom are represented by
unions.
- - --------------------------------------------------------------------------------
ITEM 2. PROPERTIES
The property of TDS consists principally of switching and cell site
equipment related to cellular telephone operations; telephone lines, central
office equipment, telephone instruments and related equipment, and land and
buildings related to telephone operations; and radio pagers and transmitting
equipment related to radio paging operations. As of December 31, 1996, TDS's
gross property, plant and equipment of approximately $2.7 billion consisted of
the following:
<TABLE>
<S> <C>
Cellular telephone........................... 31.8 %
Telephone.................................... 48.9
PCS.......................................... 12.2
Radio paging................................. 4.3
Other........................................ 2.8
------
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 and most of the tangible assets of the
cellular subsidiaries are subject to the lien of the mortgages securing the
funded debt of such companies. The Company owns substantially all of its central
office buildings, local administrative buildings, warehouses, and storage
facilities used in its telephone operations and leases most of its offices and
transmitter sites used in its cellular and paging businesses. All of the
Company's telephone lines and cell and transmitter sites 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. In some cases, the litigation involves
disputes regarding rights to certain landline or cellular telephone systems and
other interests. The Company does not believe that any such proceeding should
have a material adverse impact on the Company.
- - --------------------------------------------------------------------------------
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 1996.
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<PAGE>
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PART II
- - --------------------------------------------------------------------------------
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Except for information provided below, such information is incorporated by
reference from Exhibit 13, Annual Report sections entitled "TDS Stock and
Dividend Information" and "Market Price per Common Share by Quarter."
On November 4, 1996, AERL issued $226.2 million in aggregate principal
amount at maturity of Series A Zero Coupon Notes ("Notes") due in 2006. The
issue price of the Notes was 44.2% of the principal amount at maturity or $100
million, and there is no periodic payment of interest. The $100 million in
proceeds from the sale of the Notes were paid to Nokia Telecommunications, Inc.,
in satisfaction of all outstanding obligations and future obligations up to $100
million of AERL under a Credit Agreement dated June 19, 1996. The Notes and the
obligations under the Credit Agreement are fully and unconditionally guaranteed
by TDS at an annual fee rate of 3%. Such Notes and the TDS quarantee were issued
without registration under the Securities Act of 1933, as amended, pursuant to
an exemption therefrom in Rule 144A under such act.
- - --------------------------------------------------------------------------------
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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated by reference from Exhibit 13, Annual Report sections entitled
"Consolidated Statements of Income," "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.
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<PAGE>
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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. SECURITY 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."
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<PAGE>
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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 Income.................................. 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 44
I. Condensed Financial Information of Registrant-Balance Sheets as of December
31, 1996 and 1995 and Statements of Income and Statements of Cash Flows for
each of the Three Years in the Period Ended December 31, 1996.............. page 45
II. Valuation and Qualifying Accounts for each of the Three Years in the Period
Ended December 31, 1996.................................................... page 49
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.
</TABLE>
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<PAGE>
(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
- - ------------------------------------------------------------------------------------------------------------
<C> <S>
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 Stock Option Agreement, dated February 25, 1987, between the Company and Murray L. Swanson is hereby
incorporated by reference to an exhibit to the Company's Annual Report on Form 10-K for the year
ended December 31, 1988.
10.4 Stock Appreciation Rights Award and Non-Qualified Stock Option Agreement, dated March 14, 1988,
between the Company and LeRoy T. Carlson, Jr., is hereby incorporated by reference to an exhibit to
the Company's Annual Report on Form 10-K for the year ended December 31, 1988.
10.5 Stock Option and Stock Appreciation Rights Award Agreement dated January 15, 1990 between the
Company and James Barr III, is hereby incorporated by reference to Exhibit 10.13 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1991.
10.6(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.
10.6(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.
10.6(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.
10.7 1985 Incentive Stock Option 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 April 24, 1986.
10.8(a) 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).
10.8(b) Form of 1994 Long-Term Stock Option Agreement (Transferable Form) is hereby incorporated by
reference to Exhibit 99.2 to the Company's Registration Statement on Form S-8 (Registration No.
33-57257).
10.8(c) Form of 1994 Long-Term Stock Option Agreement (Nontransferable Form) is hereby incorporated by
reference to Exhibit 99.3 to the Company's Registration Statement on Form S-8 (Registration No.
33-57257).
10.8(d) Form of 1995 Performance Stock Option Agreement (Transferable Form) is hereby incorporated by
reference to Exhibit 99.4 to the Company Registration statement on Form S-8 (Registration No.
33-57257).
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- - ------------------------------------------------------------------------------------------------------------
<C> <S>
10.8(e) Form of 1995 Performance Stock Option Agreement (Nontransferable Form) is hereby incorporated by
reference to Exhibit 99.5 to the Company's Registration Statement on Form S-8 (Registration No.
33-57257).
10.9 Supplemental Executive Retirement Plan of the Company is hereby incorporated by reference to Exhibit
10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994.
10.10 Deferred Compensation Agreement for Rudolph E. Hornacek dated November 30, 1995, is hereby
incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1995.
10.14 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.
10.15 Description of Terms of Signing Letter with Donald W. Warkentin dated June 7, 1995.
</TABLE>
(b) Reports on Form 8-K filed during the quarter ended December 31, 1996.
TDS filed a Current Report on Form 8-K on December 19, 1996 dated December 16,
1996, which included a news release that announced the Company's Board of
Directors had authorized repurchases of up to 3,000,000 TDS Common Shares.
43
<PAGE>
- - --------------------------------------------------------------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
To the Shareholders 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 to Shareholders incorporated by reference in this
Form 10-K, and have issued our report thereon dated January 29, 1997 (except
with respect to the matter discussed in Note 16, as to which the date is
February 4, 1997). 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 29, 1997
(except with respect to the matter
discussed in Note 16, as to
which the date is February 4, 1997)
44
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
- - --------------------------------------------------------------------------------
Telephone and Data Systems, Inc. (Parent)
BALANCE SHEETS
ASSETS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
(DOLLARS IN THOUSANDS) 1996 1995
- - -------------------------------------------------------------------------------------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 141 $ 1,867
Temporary investments 154 99
Notes receivable from affiliates 94,421 55,156
Advances to affiliates 1,616 1,816
Accounts receivable
Due from subsidiaries--Income taxes 16,211 25,890
Due from subsidiaries--Other 16,790 25,914
Other 2,903 4,895
Other current assets 2,572 2,710
----------------------
134,808 118,347
- - -------------------------------------------------------------------------------------------
INVESTMENT IN SUBSIDIARIES
Underlying book value 2,351,057 2,121,651
Cost in excess of underlying book value at date of acquisition 112 1,987
----------------------
2,351,169 2,123,638
- - -------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Minority interests in telephone and cellular companies and other
investments 44,256 28,103
- - -------------------------------------------------------------------------------------------
PROPERTY, PLANT and EQUIPMENT
Property, Plant and Equipment, net of accumulated depreciation 21,394 18,586
- - -------------------------------------------------------------------------------------------
OTHER ASSETS AND DEFERRED CHARGES
Debt issuance expenses 2,030 2,175
Development and acquisition expenses 2,148 1,703
Other 54 3,700
----------------------
4,232 7,578
- - -------------------------------------------------------------------------------------------
$2,555,859 $2,296,252
- - -------------------------------------------------------------------------------------------
- - -------------------------------------------------------------------------------------------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
45
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
- - --------------------------------------------------------------------------------
Telephone and Data Systems, Inc. (Parent)
BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
(DOLLARS IN THOUSANDS) 1996 1995
- - -------------------------------------------------------------------------------------------
<S> <C> <C>
CURRENT LIABILITIES
Current portion of long-term debt and preferred stock $ 1,810 $ 15,061
Notes payable 157,227 180,760
Notes payable to affiliates 47,990 37,086
Advances from affiliates -- 2,464
Accounts payable
Due to subsidiaries--Federal income taxes 8,407 14,405
Due to subsidiaries--Other 1,867 31,495
Other 1,108 5,379
Accrued interest 10,987 10,878
Accrued taxes (19,126) (6,837)
Other 7,711 4,931
----------------------
217,981 295,622
- - -------------------------------------------------------------------------------------------
DEFERRED LIABILITIES AND CREDITS
Investment tax credits (2,697) (1,934)
Income taxes 30,763 20,593
Postretirement benefits obligation other than pensions 626 11,216
Other 4,823 7,921
----------------------
33,515 37,796
- - -------------------------------------------------------------------------------------------
LONG-TERM DEBT, excluding current portion (Note B) 242,143 242,960
- - -------------------------------------------------------------------------------------------
REDEEMABLE PREFERRED SHARES, excluding current portion (Note A) 280 2,260
- - -------------------------------------------------------------------------------------------
NONREDEEMABLE PREFERRED SHARES 29,000 29,710
- - -------------------------------------------------------------------------------------------
COMMON STOCKHOLDERS' EQUITY
Common Shares, par value $1 per share; authorized 100,000,000
shares; issued and outstanding 54,237,180 and 51,137,426 shares,
respectively 54,237 51,137
Series A Common Shares, par value $1 per share; authorized
25,000,000 shares; issued and outstanding 6,916,546 and
6,893,101 shares, respectively 6,917 6,893
Common Shares issuable, 30,977 and 31,431 shares, respectively 1,461 1,496
Capital in excess of par value 1,661,093 1,417,514
Retained earnings 309,232 210,864
----------------------
2,032,940 1,687,904
----------------------
$2,555,859 $2,296,252
- - -------------------------------------------------------------------------------------------
- - -------------------------------------------------------------------------------------------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
46
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
- - --------------------------------------------------------------------------------
Telephone and Data Systems, Inc. (Parent)
STATEMENTS OF INCOME
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994
- - ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating service revenues $ 61,239 $ 58,071 $ 49,455
Cost of sales and operating expenses 57,538 54,682 46,921
-------------------------------
Net operations 3,701 3,389 2,534
-------------------------------
Other income
Interest income received from affiliates 7,385 26,134 13,832
Other, net 4,843 (4,729) (1,707)
-------------------------------
12,228 21,405 12,125
-------------------------------
Income before interest and income taxes 15,929 24,794 14,659
Interest expense 15,790 32,233 22,954
Federal income tax expense (credit) (24,974) 7,340 2,205
-------------------------------
Corporate operations 25,113 (14,779) (10,500)
Equity in net income of subsidiaries and other
investments 103,026 123,395 70,321
-------------------------------
Net income $ 128,139 $ 108,616 $ 59,821
- - ----------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
<TABLE>
<S> <C>
Note A: The annual requirements for redemption of Redeemable Preferred Shares are $1.6
million, $103,000, $100,000, and $77,000 for the years 1997 through 2000,
respectively.
Note B: The annual requirements for principal payments on long-term debt are $232,000,
$742,000, $248,000, $258,000 and $270,000 for the years 1997 through 2001,
respectively.
Note C: In 1996, the data processing subsidiary of the Parent company was merged into the
Parent company. Prior years' financial statements have been restated to conform to
current presentation.
</TABLE>
47
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
- - --------------------------------------------------------------------------------
Telephone and Data Systems, Inc. (Parent)
STATEMENTS OF CASH FLOWS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994
<S> <C> <C> <C>
- - -------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 128,139 $ 108,616 $ 59,821
Add (Deduct) adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization 11,047 6,541 7,294
Gain on sale of investments (3,434) (408) --
Deferred taxes 5,432 5,364 8,804
Equity income (103,026) (123,395) (70,321)
Other noncash expense 677 1,317 691
Change in accounts receivable 20,795 (30,674) (2,194)
Change in accounts payable (39,897) 40,866 3,129
Change in accrued taxes (12,289) (4,713) (4,587)
Change in other assets and liabilities 2,849 1,401 (638)
-------------------------------------------
10,293 4,915 1,999
- - -------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Long-term debt borrowings -- 38,909 (130)
Repayment of long-term debt (2,815) (3,012) (3,137)
Change in notes payable (23,533) 83,131 91,629
Change in notes payable to affiliates 104,843 28,535 1,534
Change in advances from affiliates (2,464) 2,118 (3)
Common stock issued 5,114 8,078 11,185
Redemption of preferred shares (605) (9,609) (644)
Dividends paid (26,232) (23,971) (20,906)
-------------------------------------------
54,308 124,179 79,528
- - -------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions
Value of assets acquired (121,053) (129,005) (215,658)
Common Shares issued 113,128 127,836 173,658
Preferred Shares issued -- -- 12,500
-------------------------------------------
Net cash paid for acquisitions (7,925) (1,169) (29,500)
Additions to property, plant and equipment (13,362) (7,899) (5,655)
Proceeds from sale of investments 500 4,800 --
Investments in subsidiaries (19,533) (302,722) (527)
Dividends from subsidiaries 17,953 17,690 17,373
Other investments (8,941) 1,169 (2,000)
Change in notes receivable from affiliates (35,165) 139,849 (65,350)
Change in advances to affiliates 200 20,200 (20,400)
Change in temporary investments (54) 85 (127)
-------------------------------------------
(66,327) (127,997) (106,186)
- - -------------------------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,726) 1,097 (24,659)
CASH AND CASH EQUIVALENTS
Beginning of period 1,867 770 25,429
-------------------------------------------
End of period $ 141 $ 1,867 $ 770
- - -------------------------------------------------------------------------------------------------------------------------------
- - -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The Notes to Consolidated Financial Statements, included in the Annual
Report, are an integral part of these statements.
48
<PAGE>
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COLUMN A
DESCRIPTION COLUMN B COLUMN C-1 COLUMN C-2 COLUMN E
- - ---------------------------------------------------------- BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER COLUMN D END OF
(DOLLARS IN THOUSANDS) PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
------------ ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
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)
FOR THE YEAR ENDED DECEMBER 31, 1995
Deducted from deferred state tax asset:
For unrealized net operating losses (8,962) 3,905 (5,004) -- (10,061)
Deducted from accounts receivable:
For doubtful accounts (2,785) (16,648) -- 14,329 (5,104)
FOR THE YEAR ENDED DECEMBER 31, 1994
Deducted from deferred state tax asset:
For unrealized net operating losses (8,704) 327 (585) -- (8,962)
Deducted from accounts receivable:
For doubtful accounts (2,093) (9,710) -- 9,018 (2,785)
Deducted from marketable equity securities:
For unrealized loss (626) -- 626 -- --
- - -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
49
<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.
<TABLE>
<S> <C> <C>
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/ MURRAY L. SWANSON
------------------------------------------
Murray L. Swanson,
EXECUTIVE VICE PRESIDENT-FINANCE
(CHIEF FINANCIAL OFFICER)
By: /S/ GREGORY J. WILKINSON
------------------------------------------
Gregory J. Wilkinson,
VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
</TABLE>
Dated March 20, 1996
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
- - -------------------------------------------------------------------- ----------- ---------------------
<S> <C> <C>
/S/ LEROY T. CARLSON DIRECTOR March 20, 1997
-----------------------------------------------
Leroy T. Carlson
/S/ LEROY T. CARLSON, JR. DIRECTOR March 20, 1997
-----------------------------------------------
LeRoy T. Carlson, Jr.
/S/ MURRAY L. SWANSON DIRECTOR March 20, 1997
-----------------------------------------------
Murray L. Swanson
/S/ JAMES BARR III DIRECTOR March 20, 1997
-----------------------------------------------
James Barr III
/S/ RUDOLPH E. HORNACEK DIRECTOR March 20, 1997
-----------------------------------------------
Rudolph E. Hornacek
/S/ DONALD C. NEBERGALL DIRECTOR March 20, 1997
-----------------------------------------------
Donald C. Nebergall
/S/ HERBERT S. WANDER DIRECTOR March 20, 1997
-----------------------------------------------
Herbert S. Wander
/S/ WALTER C.D. CARLSON DIRECTOR March 20, 1997
-----------------------------------------------
Walter C.D. Carlson
/S/ LETITIA G.C. CARLSON DIRECTOR March 20, 1997
-----------------------------------------------
Letitia G.C. Carlson
/S/ DONALD R. BROWN DIRECTOR March 20, 1997
-----------------------------------------------
Donald R. Brown
/S/ GEORGE W. OFF DIRECTOR March 20, 1997
-----------------------------------------------
George W. Off
</TABLE>
<PAGE>
- - --------------------------------------------------------------------------------
INDEX TO EXHIBITS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- - ------------ ------------------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Articles of Incorporation, as amended, are hereby incorporated by reference to an exhibit to the Company's Report
on Form 8-A/A-2 dated December 20, 1994.
3.2 By-laws, as amended, are hereby incorporated by reference to an exhibit to the Company's Report on Form 8-A/A-2
dated December 20, 1994.
4.1 Articles of Incorporation, as amended, are hereby incorporated by reference to an exhibit to the Company's Report
on Form 8-A/A-2 dated December 20, 1994.
4.2 By-laws, as amended, are hereby incorporated by reference to an exhibit to the Company's Report on Form 8-A/A-2
dated December 20, 1994.
4.3 The Indenture and Supplemental Indentures for the Company's Series A, B, C, D, E and F Subordinated Debentures are
not being filed as exhibits because the total authorized subordinated debentures do not exceed 10% of the total
assets of the Company and its Subsidiaries. The Company agrees to furnish a copy of such Indentures and
Supplemental Indentures if so requested by the Commission.
4.4 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.
4.5 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.
4.6 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 Form 8-K filed on November 29, 1996.
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.
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.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- - ------------ ------------------------------------------------------------------------------------------------------------------
<C> <S>
10.3 Stock Option Agreement, dated February 25, 1987, between the Company and Murray L. Swanson, is hereby incorporated
by reference to an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1988.
10.4 Stock Appreciation Rights Award and Non-Qualified Stock Option Agreement, dated March 14, 1988, between the
Company and LeRoy T. Carlson, Jr., is hereby incorporated by reference to an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1988.
10.5 Stock Option and Stock Appreciation Rights Award Agreement dated January 15, 1990 between the Company and James
Barr III, is hereby incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1991.
10.6(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.
10.6(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.
10.6(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.
10.7 1985 Incentive Stock Option 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 April 24, 1986.
10.8(a) 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).
10.8(b) Form of 1994 Long-Term Stock Option Agreement (Transferable Form) is hereby incorporated by reference to Exhibit
99.2 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257).
10.8(c) Form of 1994 Long-Term Stock Option Agreement (Nontransferable Form) is hereby incorporated by reference to
Exhibit 99.3 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257).
10.8(d) Form of 1995 Performance Stock Option Agreement (Transferable Form) is hereby incorporated by reference to Exhibit
99.4 to the Company Registration statement on Form S-8 (Registration No. 33-57257).
10.8(e) Form of 1995 Performance Stock Option Agreement (Nontransferable Form) is hereby incorporated by reference to
Exhibit 99.5 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257).
10.9 Supplemental Executive Retirement Plan of the Company is hereby incorporated by reference to Exhibit 10.9 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1994.
10.10 Deferred Compensation Agreement for Rudolph E. Hornacek dated November 30, 1995 is hereby incorporated by
reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
10.11 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.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
- - ------------ ------------------------------------------------------------------------------------------------------------------
<C> <S>
10.12 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.
10.13 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.
10.14 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.
10.15 Description of Terms of Signing Letter with Donald W. Warkentin dated June 7, 1995.
11 Statement regarding computation of per share earnings.
12 Statements regarding computation of ratios.
13 Incorporated portions of 1996 Annual Report to Security Holders.
21 List of Subsidiaries of the Company.
23 Consent of independent public accountants.
27 Financial Data Schedules
</TABLE>
<PAGE>
EXHIBIT 10.15
AERIAL COMMUNICATIONS, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
DESCRIPTION OF TERMS OF SIGNING LETTER WITH DONALD W. WARKENTIN
DATED JUNE 7, 1995
Base salary at an annual rate of $200,000 per year, with an increase
effective 1/1/96 to $220,000.
$150,000 signing bonus payable on first anniversary date with TDS.
1995 guaranteed bonus of $40,000 and maximum bonus of $60,000.
Target bonus opportunity of 35% of base salary, starting in 1996.
Participation in the TDS Long Term Incentive Plan until such time as American
Portable Telecommunications, Inc. ("APT") is taken public. In the event APT
is taken public, participation in the APT stock option program, with the
unvested portion of the TDS Stock Option Grant offset by the APT Stock Option
Grant.
<PAGE>
EXHIBIT 11
TELEPHONE AND DATA SYSTEMS, INC.
COMPUTATION OF EARNINGS PER COMMON SHARE
YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<S> <C>
PRIMARY EARNINGS
Net Income..................................................................... $ 128,139
Dividends on Preferred Shares.................................................. (1,846)
---------
Net Income Available to Common................................................. $ 126,293
---------
---------
PRIMARY SHARES
Weighted average number of Common and Series A Common Shares Outstanding....... 60,464
Additional shares assuming issuance of:
Options and Stock Appreciation Rights........................................ 165
Convertible Preferred Shares................................................. 75
Common Shares Issuable....................................................... 28
---------
Primary Shares................................................................... 60,732
---------
---------
PRIMARY EARNINGS PER COMMON SHARE
Net Income..................................................................... $ 2.08
---------
---------
FULLY DILUTED EARNINGS*
Net Income..................................................................... $ 128,139
Dividends on Preferred Shares.................................................. (1,286)
---------
Net Income Available to Common................................................. $ 126,853
---------
---------
FULLY DILUTED SHARES
Weighted average number of Common and Series A Common Shares Outstanding....... 60,464
Additional shares assuming issuance of:
Options and Stock Appreciation Rights........................................ 158
Convertible Preferred Shares................................................. 545
Common Shares Issuable....................................................... 28
---------
Fully Diluted Shares........................................................... 61,195
---------
---------
FULLY DILUTED EARNINGS PER COMMON SHARE
Net Income..................................................................... $ 2.07
---------
---------
</TABLE>
- - ---------
* This calculation is submitted in accordance with Securities Act of 1934
Release No. 9083 although not required by footnote 2 to paragraph 14 of APB
Opinion No. 15 because it results in dilution of less than 3%.
<PAGE>
EXHIBIT 12
TELEPHONE AND DATA SYSTEMS, INC.
RATIOS OF EARNINGS TO FIXED CHARGES
FOR THE YEAR ENDED DECEMBER 31, 1996
(DOLLARS IN THOUSANDS, EXCEPT RATIO AMOUNTS)
<TABLE>
<S> <C>
EARNINGS:
Income from Continuing Operations before Income Taxes.......................... $ 251,785
Add (Deduct):
Minority Share of Losses................................................... (11,579)
Earnings on Equity Method.................................................. (54,025)
Distributions from Minority Subsidiaries................................... 25,453
Amortization of Non-Telephone Capitalized Interest......................... 4
Minority share of income in majority-owned subsidiaries that have fixed
charges................................................................... 26,912
---------
238,550
Add fixed charges:
Consolidated interest expense.............................................. 42,294
Interest Portion (1/3) of Consolidated Rent Expense........................ 8,901
Amortization of debt expense and discount on indebtedness.................. 559
---------
$ 290,304
---------
---------
FIXED CHARGES:
Consolidated interest expense.................................................. $ 42,294
Capitalized interest........................................................... 27,623
Interest Portion (1/3) of Consolidated Rent Expense............................ 8,901
Amortization of debt expense and discount on indebtedness...................... 559
---------
$ 79,377
---------
---------
RATIO OF EARNINGS TO FIXED CHARGES............................................... 3.66
---------
---------
Tax-Effected Redeemable Preferred Dividends.................................... $ 1,016
Fixed Charges.................................................................. 79,377
---------
Fixed Charges and Redeemable Preferred Dividends............................. $ 80,393
---------
---------
RATIO OF EARNINGS TO FIXED CHARGES AND REDEEMABLE PREFERRED DIVIDENDS............ 3.61
---------
---------
Tax-Effected Preferred Dividends............................................... $ 3,558
Fixed Charges.................................................................. 79,377
---------
Fixed Charges and Preferred Dividends........................................ $ 82,935
---------
---------
RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS....................... 3.50
---------
---------
</TABLE>
<PAGE>
EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Telephone and Data Systems, Inc. ("TDS" or the "Company") provides
high-quality telecommunications services to over 2.3 million cellular telephone,
telephone and radio paging customer units in 37 states and the District of
Columbia.
The accompanying financial statements present the results of operations of
the Company's three primary businesses: United States Cellular Corporation
("U.S. Cellular"), an 80.6%-owned subsidiary, TDS Telecommunications Corporation
("TDS Telecom"), a wholly owned subsidiary, and American Paging, Inc. ("American
Paging"), an 82.3%-owned subsidiary, as well as its developing personal
communications services ("PCS") business, Aerial Communications, Inc. ("Aerial",
formerly American Portable Telecom, Inc.), an 82.8%-owned subsidiary.
TDS's long-term business development strategy is to expand its operations
through internal growth and acquisitions, and to explore and develop
telecommunications businesses that management believes utilize TDS's expertise
in customer-based telecommunications.
1996 MAJOR ACCOMPLISHMENTS
The Company made substantial progress during 1996 with excellent growth in
the cellular business and the rapid build out of the PCS business. The telephone
business continues to produce steady returns and strong cash flow, while the
paging business posted disappointing results.
U.S. Cellular continued its rapid growth during 1996. Customer units
increased 51%, exceeding the 1,000,000 mark, following a 69% increase in 1995.
The increase in customer units drove a 44% increase in revenues, a 48% increase
in cash flow and a 104% increase in operating income. The sale of non-strategic
cellular interests generated gains of $132.7 million and cash proceeds of $213.0
million. Capital expenditures to add cell sites, expand coverage and add
capacity totaled $219.4 million and expenditures for acquisitions totaled $56.1
million.
Aerial made substantial progress building its business this year. The focus
for 1996 was directed toward recruiting an experienced management team,
developing and executing a business plan, raising capital, and designing and
constructing networks in each of its markets. These activities significantly
increased expenses in 1996. PCS development expenses (included in "Investment
and Other Income (Expense)") increased to $43.9 million in 1996 from $7.8
million in 1995. Aerial had no revenues in 1996 as commercial service is not
expected to begin until March 1997.
Aerial's investment in property and equipment, including network design and
equipment, site acquisition and information system development costs, totaled
$312.6 million in 1996. To finance the development of its business, Aerial
completed an initial public offering in 1996 raising $195.3 million. Aerial also
negotiated a $200 million vendor financing arrangement for digital radio channel
and switching infrastructure equipment.
TDS Telecom continues to provide steady growth in revenues and cash flow.
Telephone access lines increased 14% resulting in a 13% increase in operating
revenues, a 10% increase in cash flow and a 5% increase in operating income. TDS
Telecom's investment in outside plant facilities and upgrades of recently
acquired companies for new customer growth and new digital switches totaled
$144.4 million, and expenditures for acquisitions totaled $88.1 million.
American Paging posted disappointing results for the year. During the third
quarter of 1995, American Paging launched a comprehensive restructuring
initiative relative to its sales and customer service organization. The
objectives of the restructuring were to increase sales through the direct
distribution channel, improve customer mix, lower administrative costs and
improve customer service.
The disruptions caused by the restructuring were more severe than
anticipated. Customer service and sales support was affected due to the
elimination of field service employees and problems with the customer management
and billing system. Sales and marketing activities, hurt by a high level of
employee turnover, produced no customer growth resulting in a 3% decline in
revenue. The decline in revenues combined with a 21% increase in operating
expenses caused operating losses to jump to $36.6 million in 1996 from $9.0
million in 1995.
-36-
<PAGE>
To address these problems, American Paging appointed a new senior management
team, including a new President and CEO. The senior management team is in the
process of implementing a plan in 1997 centering on building a high quality,
focused sales and marketing organization, creating new, goal-oriented
distribution channel and pricing strategies, consolidating current systems to
reduce the cost of service and continually improving customer care practices.
RESULTS OF OPERATIONS
Telephone and Data Systems, Inc. reported net income available to common of
$126.3 million, or $2.08 per share, in 1996 compared to $102.0 million, or $1.74
per share, in 1995 and $58.0 million, or $1.06 per share, in 1994. Results of
operations primarily reflects significant cellular business unit growth and
steady telephone operations growth. Results of operations were negatively
impacted by Aerial's development costs as it proceeds to develop and construct
its PCS networks, as well as the losses incurred by American Paging. Gains on
sales of non-strategic cellular interests and other investments had a
significant impact on net income in 1996 and 1995.
Excluding PCS development costs and gains on the sales of cellular interests
and other investments, along with the related income taxes and minority
interest, net income available to common would have been $77.1 million or $1.27
per share, in 1996 compared to $68.1 million or $1.16 per share, in 1995 and
$53.2 million or $.98 per share in 1994.
OPERATING REVENUES increased 27% ($260.3 million) during 1996 and 31%
($223.6 million) during 1995 primarily as a result of growth in the cellular
telephone operations.
Cellular telephone revenues increased $215.4 million in 1996 and $160.0
million in 1995 on 51% and 69% increases in customer units, respectively, and
strong increases in inbound roaming revenues. Telephone revenues increased $47.8
million in 1996 and $48.5 million in 1995 as a result of acquisitions, increased
network usage, recovery of increased costs of providing long-distance services
and internal access line growth. Radio paging revenues decreased $3.0 million in
1996 and increased $15.1 million in 1995.
Cellular made up 58% of consolidated revenue in 1996, up from 45% in 1994.
Telephone and paging operations were 33% and 9% of consolidated revenue in 1996
and 42% and 13% in 1994, respectively.
OPERATING EXPENSES rose 29% ($238.2 million) in 1996 and 32% ($200.4
million) in 1995. Cellular telephone operating expenses increased $170.8 million
during 1996 and $134.6 million during 1995 due to the effects of additional
marketing and selling expenses to add new customers as well as the costs of
providing services to the larger customer base. Telephone operating expenses
increased $42.7 million during 1996 and $41.9 million during 1995 due to the
effects of acquisitions and growth in internal operations. Paging operating
expenses increased $24.7 million in 1996 and $23.9 million in 1995 due to
additional expenses to restructure certain business processes and additional
costs to serve current customers and to add new customers.
-37-
<PAGE>
OPERATING INCOME increased 17% ($22.1 million) in 1996 and 21% ($23.2
million) in 1995. Cellular telephone operating income increased 104% ($44.6
million) in 1996 and 146% ($25.4 million) in 1995 reflecting the increase in
customers and revenues. Telephone operating income increased $5.1 million in
1996 and $6.6 million in 1995. Paging operating loss increased $27.6 million in
1996 and $8.8 million in 1995.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1996 1995 1994
-------------- -------------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating Income
Cellular telephone.......................................... $ 87,366 $ 42,755 $ 17,385
Telephone................................................... 103,358 98,240 91,606
Radio paging................................................ (36,626) (8,997) (169)
-------------- -------------- --------------
$ 154,098 $ 131,998 $ 108,822
-------------- -------------- --------------
-------------- -------------- --------------
Operating Margins
Cellular telephone.......................................... 12.3% 8.7% 5.2%
Telephone................................................... 25.7% 27.7% 29.9%
Radio paging................................................ (35.2)% (8.4)% (.2)%
Consolidated................................................ 12.7% 13.8% 14.9%
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
In early 1997, Aerial expects to begin commercial service which will result
in Aerial's revenues and expenses being included in operating income. Operating
income is expected to decrease significantly in 1997 as a result of the
commencement of PCS operations.
INVESTMENT AND OTHER INCOME totaled $140.5 million in 1996, $103.9 million
in 1995 and $33.7 million in 1994.
CELLULAR INVESTMENT INCOME, the Company's share of income of cellular
markets in which the Company has a minority interest and follows the equity
method of accounting, increased 33% ($13.5 million) in 1996 and 56% ($14.6
million) in 1995 as income from the cellular markets increased. Cellular
investment income is net of amortization of license costs relating to these
minority interests.
GAIN ON SALE OF CELLULAR INTERESTS AND OTHER INVESTMENTS totaled $138.7
million in 1996, $86.6 million in 1995 and $7.5 million in 1994. TDS and U.S.
Cellular continue to assess the makeup of cellular holdings in order to maximize
the benefits derived from clustering markets. Certain markets, identified as
non-strategic, were sold or traded in the past few years resulting in the
recognition of gains.
PCS DEVELOPMENT COSTS totaled $43.9 million in 1996 and $7.8 million in
1995. Aerial has been devoting substantially all of its efforts to recruiting an
experienced management team, developing and executing a business plan, raising
capital, and designing and constructing its PCS networks. Costs incurred in the
development and administration of Aerial which do not relate to the design or
construction of specific identifiable assets have been expensed.
MINORITY SHARE OF INCOME, the minority shareholders' share of U.S.
Cellular's, American Paging's and Aerial's net income or loss and other minority
shareholders' and partners' share of subsidiaries' net income or loss, increased
$800,000 in 1996 and $16.8 million in 1995.
INTEREST EXPENSE decreased 16% ($8.0 million) in 1996 and increased 23%
($9.6 million) in 1995. Capitalized interest associated with expenditures for
PCS licenses and capitalized construction costs increased $14.4 million in 1996
and $13.2 million in 1995. Interest expense increased $6.9 million in 1996 and
$7.4 million in 1995 as a result of U.S. Cellular's convertible debt offering in
June of 1995. Interest expense from U.S. Cellular's vendor financing agreement
increased $5.3 million in 1995. TDS Telecom interest expense increased $1.2
million in 1996 and $1.4 million in 1995 due primarily to additional interest
expense of acquired telephone companies.
Corporate interest expense decreased $2.0 million in 1996 and increased $8.6
million in 1995 reflecting primarily changes in average short-term debt
balances. See "Financial Resources and Liquidity" for a further discussion of
short- and long-term debt.
-38-
<PAGE>
TDS capitalized $27.6 million of interest expense in 1996 and $13.2 million
in 1995. Interest expense will increase significantly in 1997 when TDS
discontinues capitalizing interest upon commencement of Aerial's operations.
INCOME TAX EXPENSE increased 53% ($42.6 million) in 1996 and 99% ($40.3
million) in 1995, reflecting primarily the 36% and 83% increases in pretax
income, respectively. The effective income tax rates were 49% in 1996, 44% in
1995 and 40% in 1994. The increase in the 1996 effective tax rate reflects
additional income tax expense of approximately $10.0 million due to tax gains in
excess of book gains associated with the sale of certain cellular interests. The
lower 1994 rate reflects deferred income taxes provided on the book/tax basis
difference related to certain telephone acquisitions and certain income excluded
due to the dividend exclusion rules.
NET INCOME AVAILABLE TO COMMON was $126.3 million in 1996, $102.0 million in
1995 and $58.0 million in 1994. EARNINGS PER COMMON SHARE were $2.08 in 1996,
$1.74 in 1995 and $1.06 in 1994.
Net income available to common for 1996 and 1995 included significant gains
from the sale of cellular interest and other investments as well as significant
PCS development costs. The table below summarizes the effects of the gains and
PCS development costs (along with the related impact on income taxes and
minority interest) on net income available to common and earnings per share.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
NET INCOME AVAILABLE TO COMMON
Core Business................................................................. $ 77.1 $ 68.1 $ 53.2
Gains......................................................................... 64.5 40.6 5.8
PCS Development Costs......................................................... (15.3) (6.7) (1.0)
--------- --------- ---------
$ 126.3 $ 102.0 $ 58.0
--------- --------- ---------
--------- --------- ---------
EARNINGS PER SHARE
Core Business................................................................. $ 1.27 $ 1.16 $ .98
Gains......................................................................... 1.06 .69 .10
PCS Development Costs......................................................... (.25) (.11) (.02)
--------- --------- ---------
$ 2.08 $ 1.74 $ 1.06
--------- --------- ---------
--------- --------- ---------
</TABLE>
TDS anticipates that start-up and development of high-quality networks and
the marketing of systems in Aerial's markets will reduce the rate of growth in
TDS's operating and net income from levels which would otherwise be achieved
during the next few years.
-39-
<PAGE>
CELLULAR TELEPHONE OPERATIONS
TDS provides cellular telephone service through U.S. Cellular Corporation
[AMEX: USM]. Results of operations include 1,073,000 customer units at the end
of 1996 compared to 710,000 customer units at the end of 1995 and 421,000
customer units at the end of 1994.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
--------------------------------------------
1996 1995 1994
-------------- ------------- -------------
(DOLLARS IN THOUSANDS,
EXCEPT PER CUSTOMER AMOUNTS)
<S> <C> <C> <C>
Operating Revenues
Local retail.................................................. $ 442,568 $ 289,518 $ 187,978
Inbound roaming............................................... 193,278 148,020 104,009
Long-distance and other....................................... 71,974 54,857 40,417
-------------- ------------- -------------
707,820 492,395 332,404
-------------- ------------- -------------
Operating Expenses
System operations............................................. 117,368 70,442 46,869
Marketing and selling......................................... 150,000 102,361 69,072
Cost of equipment sold........................................ 74,023 54,948 39,431
General and administrative.................................... 170,224 132,431 94,193
Depreciation.................................................. 74,631 57,302 39,520
Amortization.................................................. 34,208 32,156 25,934
-------------- ------------- -------------
620,454 449,640 315,019
-------------- ------------- -------------
Operating Income................................................ $ 87,366 $ 42,755 $ 17,385
-------------- ------------- -------------
-------------- ------------- -------------
Consolidated Markets:
Customers..................................................... 1,073,000 710,000 421,000
Markets....................................................... 131 137 130
Market penetration............................................ 4.94% 3.18% 1.98%
Cell sites in service......................................... 1,328 1,116 790
Average monthly service revenue per customer.................. $ 66.36 $ 72.48 $ 79.74
Churn rate per month.......................................... 1.9% 2.1% 2.3%
Marketing cost per gross customer addition.................... $ 367 $ 361 $ 408
-------------- ------------- -------------
-------------- ------------- -------------
</TABLE>
OPERATING REVENUES increased 44% ($215.4 million) in 1996 and 48% ($160.0
million) in 1995. The revenue increases in 1996 and 1995 were driven by the 51%
and 69% growth in customer units and the 31% and 42% growth in inbound roaming
revenues, respectively. Acquisitions, which were not material in 1996, increased
operating revenues 13% ($44.2 million) in 1995. Average monthly revenue per
customer was $66.36 in 1996, $72.48 in 1995 and $79.74 in 1994.
LOCAL RETAIL REVENUE (charges to U.S. Cellular's customers for local system
usage) increased 53% ($153.0 million) in 1996 and 54% ($101.5 million) in 1995
due primarily to the 51% and 69% growth in customers, respectively. Local
minutes of use averaged 107 per month in 1996 and 95 per month in 1995 and 1994.
Average revenue per minute was $.40 in 1996, $.46 in 1995 and $.50 in 1994. U.S.
Cellular's use of incentive programs in 1996 and 1995 that encourage
lower-priced weekend and off-peak usage, in order to stimulate overall usage,
resulted in an increase in average minutes of use and a lower average revenue
per minute of use. Average monthly local retail revenue per customer was $42.54
in 1996, $44.03 in 1995 and $47.04 in 1994.
-40-
<PAGE>
INBOUND ROAMING REVENUE (charges to customers of other systems who use U.S.
Cellular's cellular systems when roaming) increased 31% ($45.3 million) in 1996
and 42% ($44.0 million) in 1995 due to increased minutes of use. Minutes of use
increased 38% in 1996 and 60% in 1995. Average revenue per minute of use was
$.94 in 1996, $.99 in 1995 and $1.11 in 1994. Average monthly inbound roaming
revenue per U.S. Cellular customer was $18.58, $22.51 and $26.03 in 1996, 1995
and 1994, respectively. The decrease is the result of roaming revenue growing at
a slower rate than U.S. Cellular's customer base and negotiated reductions in
roaming rates.
LONG-DISTANCE AND OTHER REVENUE, including equipment sales, increased 31%
($17.1 million) in 1996 and 36% ($14.4 million) in 1995 primarily due to
increased long-distance revenue from the growth in the volume of long-distance
calls billed by U.S. Cellular.
The industry trend of declining average monthly retail revenue per customer
is believed to be related to the tendency of early customers in a market to be
the heaviest users during peak business hours. Newer customers have been added
through continued penetration of the consumer market, which tends to include
fewer peak business hour usage customers.
Management anticipates that average monthly revenue per customer will
continue to decrease as local retail revenue per minute of use declines due to
the usage patterns of incrementally added customers and as the growth rate of
the Company's customer base exceeds the growth rate of inbound roaming revenue,
diluting the roaming contribution per customer.
OPERATING EXPENSES increased 38% ($170.8 million) in 1996 and 43% ($134.6
million) in 1995. Acquisitions, which were not material in 1996, increased
operating expenses 13% ($40.7 million) in 1995. The increase in operating
expenses, excluding acquisition effects, is primarily due to the costs to expand
the customer base ($66.7 million in 1996 and $33.6 million in 1995); cost of
providing service to the expanding customer base ($46.9 million in 1996 and
$16.0 million in 1995); increased administrative expenses ($37.8 million in 1996
and $27.1 million in 1995) additional depreciation on the increased investment
in cell sites and equipment ($17.3 million in 1996 and $13.2 million in 1995)
and additional fraud charges ($13.9 million in 1996).
SYSTEM OPERATIONS EXPENSES increased 67% ($46.9 million) in 1996 and 50%
($23.6 million) in 1995 (34%, or $16.0 million excluding acquisitions) as a
result of increases in customer usage expenses, including significant increases
in fraud, and costs associated with operating the increased number of cell
sites.
Customer usage expenses (charges from other service providers for land line
connection, toll and roaming costs incurred by customers' use of systems other
than their local systems) grew 86% ($26.6 million) in 1996 and 62% ($13.4
million) in 1995. The increase was due primarily to inbound roaming usage.
Fraudulent use of U.S. Cellular's customers' telephone numbers increased
expenses $13.9 million to $18.0 million in 1996. U.S. Cellular continues to
implement procedures in its markets to combat this fraud, which is primarily
related to roaming usage.
Maintenance, utility and cell site expenses grew 18% ($6.5 million) in 1996
and 40% ($10.2 million) in 1995 reflecting the 19% and 41% increase in the
number of cell sites, respectively. The number of cell sites operated increased
to 1,328 in 1996 from 1,116 in 1995 and 790 in 1994.
MARKETING AND SELLING EXPENSES increased 47% ($47.6 million) in 1996 and 48%
($33.3 million) in 1995 (35%, or $24.3 million excluding acquisitions) due to
the increase in customer activations. COST OF EQUIPMENT SOLD increased 35%
($19.1 million) in 1996 and 39% ($15.5 million) in 1995 (23%, or $9.3 million
excluding acquisitions). Cost per gross customer addition (marketing and selling
expenses and cost of equipment sold less equipment revenues, divided by gross
customer additions) totaled $367 in 1996, $361 in 1995 and $408 in 1994.
GENERAL AND ADMINISTRATIVE EXPENSES increased 29% ($37.8 million) in 1996
and 41% ($38.2 million) in 1995 (29%, or $27.1 million excluding acquisitions).
The increases include the effects of an increase in expenses required to serve
the growing customer base and an expansion of both local administrative office
and corporate staff, resulting from growth in U.S. Cellular's business.
-41-
<PAGE>
Operating cash flow increased 48% to $196.2 million in 1996 compared to a
60% increase to $132.2 million in 1995. The improvement was primarily due to the
growth in customers and revenue. U.S. Cellular continues to provide increasing
operating cash flow to support its operating and construction activities.
DEPRECIATION EXPENSE increased 30% ($17.3 million) in 1996 and 45% ($17.8
million) in 1995 (33%, or $13.2 million excluding acquisitions), reflecting
increases in average fixed asset balances of 34% and 48%, respectively.
AMORTIZATION EXPENSE increased 6% ($2.1 million) in 1996 and 24% ($6.2 million)
in 1995 (15%, or $4.0 million excluding acquisitions) due to increases in
deferred systems development costs in both years and license costs in 1995.
OPERATING INCOME was $87.4 million in 1996 compared to $42.8 million in 1995
and $17.4 million in 1994. Operating margins improved to 12.3% in 1996 from 8.7%
in 1995 and 5.2% in 1994. The improvement was primarily due to the substantial
growth in customers and revenue.
Management believes there exists a seasonality at U.S. Cellular in both
service revenues, which tend to increase more slowly in the first and fourth
quarters, and operating expenses, which tend to be higher in the fourth quarter
due to increased marketing activities and customer growth. This seasonality may
cause operating income to vary from quarter to quarter.
Competitors licensed to provide PCS services have initiated service in
certain U.S. Cellular markets in recent months. U.S. Cellular anticipates that
PCS operators will initiate service in several other of its markets in 1997 and
1998. U.S. Cellular's management is monitoring these and other PCS providers'
strategies, but cannot at this time anticipate what effect, if any, this
additional competition will have on U.S. Cellular's future strategies and
results.
TELEPHONE OPERATIONS
TDS manages its telephone service through TDS Telecommunications Corporation
("TDS Telecom"). TDS Telecom served 484,500 access lines at the end of 1996
compared to 425,900 access lines at the end of 1995 and 392,500 access lines at
the end of 1994 ("telephone operations"). TDS Telecom also manages a
long-distance provider, an Internet access provider and certain other
non-telephone operations ("other operations").
OPERATING REVENUE totaled $402.6 million in 1996, up 13% ($47.8 million)
from 1995 and totaled $354.8 million in 1995, up 16% ($48.5 million) from 1994.
The increases were due to the growth in telephone operations ($39.6 million in
1996 and $35.6 million in 1995) and additional other operations revenues ($8.0
million in 1996 and $13.3 million in 1995).
OPERATING EXPENSES totaled $299.3 million in 1996, up 17% ($42.7 million)
from 1995 and totaled $256.6 million in 1995, up 19% ($41.9 million) from 1994.
The increases were due to the growth in telephone operations ($33.6 million in
1996 and $29.8 million in 1995) and additional other operations expenses ($8.9
million in 1996 and $12.3 million in 1995).
Operating cash flow increased 10% to $192.3 million in 1996 compared to an
increase of 9% to $175.6 million in 1995 due primarily to the growth in
telephone operations. TDS Telecom continues to provide steadily growing
operating cash flow to support its construction activities.
OPERATING INCOME increased 5% ($5.1 million) in 1996 and increased 7% ($6.6
million) in 1995. The reduction in the growth rate of operating income was
caused by the the reduction in the telephone operating margins and other
operations margins.
-42-
<PAGE>
Management expects TDS Telecom's revenues, operating income and operating
cash flow to increase modestly in 1997 from steady growth in operations. TDS
Telecom will continue to see pressures on revenue sources resulting from
regulatory changes and competitive pressures.
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS,
EXCEPT PER CUSTOMER AMOUNTS)
<S> <C> <C> <C>
Telephone Operations
Operating Revenue.................................................... $ 371,913 $ 332,287 $ 296,722
----------- ----------- -----------
Operating Expenses
Network operations................................................. 67,521 54,964 45,412
Depreciation and amortization...................................... 85,575 74,758 67,956
Customer operations................................................ 53,764 46,818 42,617
Corporate and other................................................ 62,276 58,998 49,706
----------- ----------- -----------
269,136 235,538 205,691
----------- ----------- -----------
Telephone Operating Income......................................... 102,777 96,749 91,031
----------- ----------- -----------
Other Operations
Revenues............................................................. 31,774 23,764 10,499
Expenses............................................................. 31,193 22,273 9,924
----------- ----------- -----------
Other Operations
Operating Income..................................................... 581 1,491 575
----------- ----------- -----------
Intercompany Eliminations
Revenues............................................................. (1,058) (1,210) (880)
Expenses............................................................. (1,058) (1,210) (880)
----------- ----------- -----------
Operating Income....................................................... $ 103,358 $ 98,240 $ 91,606
----------- ----------- -----------
----------- ----------- -----------
Companies.............................................................. 105 100 96
Access lines........................................................... 484,500 425,900 392,500
Growth in access lines from prior year-end:
Acquisitions......................................................... 33,100 13,500 19,700
Internal growth...................................................... 25,500 19,900 16,600
Telephone plant in service per access line............................. $ 2,461 $ 2,356 $ 2,283
Average monthly revenue per access line................................ $ 67.12 $ 66.87 $ 66.66
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
OPERATING REVENUE from telephone operations increased 12% ($39.6 million) in
1996 and 12% ($35.6 million) in 1995. Acquisitions increased telephone revenues
$18.8 million in 1996 and $16.8 million in 1995. Internal growth and increases
in the sales of custom calling features increased revenue by $8.0 million in
1996 and $6.0 million in 1995. Increased network usage resulted in revenue
increases of $4.5 million in 1996 and $5.8 million in 1995. Recovery of
increased costs of providing long-distance services resulted in increases in
revenue of $8.1 million in 1996 and $4.5 million in 1995. Average monthly
revenue per access line was $67.12 in 1996, $66.87 in 1995 and $66.66 in 1994.
OPERATING EXPENSES from telephone operations increased 14% ($33.6 million)
in 1996 and 15% ($29.8 million) in 1995. The effects of acquisitions increased
expenses 6% ($14.6 million) in 1996 and 7% ($13.8 million) in 1995. Depreciation
and amortization expenses increased 14% ($10.8 million) in 1996 and 10% ($6.8
million) in 1995 due primarily to increased investment in plant and equipment.
The development of a centralized network management center to provide more
effective network monitoring and maintenance and the development of groups to
explore new service offerings caused expenses to increase by $3.4 million and
$3.2 million, respectively, in 1996. These expenditures are expected to begin
producing cost efficiencies and new revenues in the next several quarters and
beyond. Additional routine maintenance activity and equipment write-offs
increased network expenses by $2.0 million in 1995. The remaining increase in
each year was due primarily to growth in internal operations.
-43-
<PAGE>
OPERATING INCOME from telephone operations increased 6% ($6.0 million) in
1996 and increased 6% ($5.7 million) in 1995. The effects of acquisitions
increased operating income 4% ($4.2 million) in 1996 and 3% ($3.0 million) in
1995. The telephone operating margin was 27.6% in 1996, 29.1% in 1995 and 30.7%
in 1994. The reduction in operating margin was caused by earnings pressures from
regulatory agencies and long-distance providers and increased costs associated
with the development of the centralized network management center.
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 accumulated
depreciation would be immaterial, as would be the write-off of regulatory assets
and liabilities.
RADIO PAGING OPERATIONS
TDS manages its radio paging business through American Paging, Inc. [AMEX:
APP]. American Paging provided wireless messaging communications through its
digital radio transmission systems to 777,400 subscribers at the end of 1996
compared to 784,500 subscribers at the end of 1995 and 652,800 subscribers at
the end of 1994.
American Paging posted disappointing results for the year. During the third
quarter of 1995, American Paging launched a comprehensive restructuring
initiative relative to its sales and customer service organization. The
objectives of the restructuring were to increase sales through the direct
distribution channel, improve customer mix, lower administrative costs and
improve customer service. The restructuring initiative continued through 1996,
and had a more severe impact on American Paging's results of operations than
anticipated.
An integral part of the restructuring plan included the creation of a
Customer Telecare Center ("CTC"). The consolidation and transfer of back office
and customer service operations from 17 offices to the CTC created many
disruptions throughout American Paging. The process of eliminating field
administrative personnel and moving their duties to the CTC hurt customer
service and sales support due to early inefficiencies encountered in the
operation of the CTC. During the consolidation, it also became apparent that the
customer management and information system did not provide the flexibility
needed to support future customer growth and retention. American Paging is
currently assessing two potential customer management and billing systems.
Disruptions within the sales and marketing department led to an increase in
sales employee turnover which produced no customer growth and contributed to a
3% decline in revenue. The decline in revenues combined with a 21% increase in
expenses caused operating losses to jump to $36.6 million in 1996 from $9.0
million in 1995.
To address these problems, American Paging appointed a new senior management
team, including a new President and CEO. The senior management team began
implementing a plan in 1997 centering on building a high quality, focused sales
and marketing organization, creating new, goal-oriented distribution channel and
pricing strategies, consolidating current systems to reduce the cost of service
and continually improving customer care practices.
-44-
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
-------------------------------------------
1996 1995 1994
------------- ------------- -------------
(DOLLARS IN THOUSANDS,
EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C>
Operating Revenue............................................... $ 104,187 $ 107,150 $ 92,065
------------- ------------- -------------
Costs and Expenses
Cost of services.............................................. 30,092 24,062 19,347
Selling, general and administrative........................... 67,060 53,296 41,196
Cost of goods sold............................................ 9,884 14,097 14,513
Depreciation and amortization................................. 33,777 24,692 17,178
------------- ------------- -------------
140,813 116,147 92,234
------------- ------------- -------------
Operating (Loss)................................................ $ (36,626) $ (8,997) $ (169)
------------- ------------- -------------
------------- ------------- -------------
Pagers in service............................................... 777,400 784,500 652,800
Average monthly revenue per unit................................ $ 9.88 $ 10.57 $ 11.92
Transmitters in service......................................... 1,048 1,018 943
Churn rate per month............................................ 3.1% 2.5% 2.6%
Marketing cost per gross customer unit addition................. $ 94 $ 50 $ 41
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
OPERATING REVENUES decreased 3% ($3.0 million) in 1996 primarily as a result
of a 27% ($3.8 million) decline in equipment sales. Operating revenues increased
16% ($15.1 million) in 1995, primarily as a result of a 20% increase in the
number of pagers in service.
Average monthly revenue per unit declined 7% to $9.88 in 1996 and 11% to
$10.57 in 1995. The decline in average revenue per unit reflects competitive
pressures in 1996 and 1995 as well as a shift to lower revenue producing
reseller channels in 1995. As a part of the restructuring efforts, American
Paging is refocusing its marketing strategy to the higher revenue producing
direct distribution channel.
OPERATING EXPENSES increased 21% ($24.7 million) in 1996 and 26% ($23.9
million) in 1995. Restructuring costs totaled $9.3 million in 1996 and $2.9
million in 1995. Duplicate staffing, employee severance and legal and consulting
fees, included in selling, general and administrative expense, totaled $4.0
million in 1996 and $2.1 million in 1995. Write-offs of $5.3 million for
obsolete inventory, software and other assets, included in depreciation and
amortization expense, were recorded in 1996. During 1995, an $800,000 write-off
of assets retired was incurred as a result of the restructuring.
Operating expenses, excluding restructuring costs, increased 16% ($18.2
million) in 1996 and 23% ($21.0 million) in 1995. Costs of serving the customer
base and maintaining systems to provide system reliability and coverage
increased 25% ($6.0 million) in 1996 and 24% ($4.7 million) in 1995. Selling,
general and administrative expense increased 23% ($11.8 million) in 1996 and 24%
($10.0 million) in 1995. The cost per gross customer addition, excluding
customers added through acquisitions, was $94 in 1996 compared to $50 in 1995
and $41 in 1994. The large increase was due to the slow unit growth caused by
high employee turnover in the sales function coupled with the increase in sales
and marketing costs. Depreciation and amortization charges increased 19% ($4.6
million) in 1996 and 39% ($6.7 million) in 1995, reflecting increased investment
in pagers and related equipment. A change in useful lives of pagers and
transmitters adopted in 1994 increased depreciation expense by approximately
$1.7 million in 1995.
OPERATING LOSS was $36.6 million in 1996, $9.0 million in 1995 and $200,000
in 1994. Management expects American Paging to have modest success in attracting
and retaining new customers and holding down operating expenses. However,
management anticipates that American Paging will incur significant operating
losses again in 1997.
BROADBAND PERSONAL COMMUNICATIONS SERVICES TDS manages its broadband
personal communications services business through Aerial Communications, Inc.
[NASDAQ: AERL], formerly American Portable Telecom, Inc. Aerial's licenses
include the Major Trading Areas ("MTAs") of Minneapolis, Tampa-St.
Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus with 27.6
million population equivalents.
Aerial's focus in 1996 has been the development of its PCS business in its
MTAs. This focus will continue until the expected launch of commercial service
in early 1997. As of December 31, 1996, a total of 150
-45-
<PAGE>
microwave paths have been cleared, with an additional 39 paths having agreements
with incumbents to be cleared. Management believes that sufficient paths have
been cleared to allow service launch in all six markets. Over 600 cell sites
have been secured as zoning and installation work continues. The National
Operations Center in Tampa is complete. Friendly user (customer) trials are
planned to conclude in the first quarter of 1997, with roll-out of commercial
service after successful customer trials.
Upon commencement of commercial operations, Aerial's revenues and expenses
will be included in operating income. Management expects to incur significant
expenditures for the continued development of PCS activities and start-up
operating losses during 1997.
To finance the development of its business, Aerial completed an initial
public offering in 1996 raising $195.3 million. Aerial also negotiated a $200
million vendor financing arrangement for digital radio channel and switching
infrastructure equipment. As part of the vendor financing arrangement, Aerial
issued 10-year 8.34% Series A Zero Coupon Notes due in 2006 for $100 million of
digital radio channel and switching equipment.
INFLATION
Management believes that inflation affects TDS's business to no greater
extent than the general economy.
FINANCIAL RESOURCES
TDS and its subsidiaries operate relatively capital-intensive businesses.
Rapid growth has caused expenditures for construction, expansion and acquisitio
programs to exceed internally generated cash flow. Accordingly, TDS has obtained
substantial funds from external sources to finance construction of cellular
telephone systems, to acquire PCS licenses, to build-out PCS markets and to fund
acquisitions. Although the steady internal cash flow from TDS Telecom and
increasing internal cash flow from U.S. Cellular have reduced the need for
external financing, Aerial's development and construction activities will
require substantial additional funds from external sources.
CASH FLOWS FROM OPERATING ACTIVITIES. TDS is generating substantial
internal funds from the rapid growth in customer units and revenues. Operating
cash flow (operating income plus depreciation and amortization) increased 19%
($62.2 million) to $385.7 million in 1996, and 24% ($63.2 million) to $323.5
million in 1995. The increases represent primarily cellular telephone operations
increases of 48% ($64.0 million) in 1996 and 60% ($49.4 million) in 1995. Cash
flows from other operating activities (investment and other income, interest and
income tax expense, and changes in working capital and other assets and
liabilities) required $90.7 million in 1996, $112.6 million in 1995, and $35.6
million in 1994.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
----------- ------------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Operating cash flow
Cellular telephone.................................................. $ 196,205 $ 132,213 $ 82,839
Telephone........................................................... 192,325 175,594 160,484
Radio paging........................................................ (2,849) 15,695 17,009
----------- ------------ -----------
385,681 323,502 260,332
Other operating activities............................................ (90,687) (112,626) (35,646)
----------- ------------ -----------
Cash flows from operating activiites.................................. $ 294,994 $ 210,876 $ 224,686
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
CASH FLOWS FROM FINANCING ACTIVITIES. TDS' long-term strategy is to provide
a strong yet flexible financial foundation for each of its principal
subsidiaries. Consolidated equity capital (common equity, preferred stock and
minority interest) was 68% of total capitalization at December 31, 1996,
compared to 73% at December 31, 1994. The change is primarily a result of
significant increases in long-term debt at U.S. Cellular and Aerial as well as
increases in TDS short-term debt. TDS targets a ratio of equity to total capital
in the range of 55% to 65%.
-46-
<PAGE>
TDS has used short-term debt to finance its PCS, cellular telephone and
radio paging operations, for acquisitions and for general corporate purposes.
TDS takes advantage of attractive opportunities to retire short-term debt with
the proceeds from long-term debt, equity sales and sales of non-strategic
assets.
In 1996, Aerial received $195.3 million in an initial public offering of
Common Shares. In 1995, U.S. Cellular received approximately $221.5 million from
the sale of 20-year 6% zero coupon convertible debt and TDS sold $39.2 million
of Medium-Term Notes. In 1994, American Paging received $45.6 million in an
initial public offering of its Common Shares and TDS sold Common Shares for cash
totaling $4.9 million.
Aerial, U.S. Cellular and TDS Telecom have also used long-term debt to
finance their construction and development activities. In 1996, Aerial issued
10-year 8.34% zero coupon notes for $100 million of digital radio channel and
switching equipment. U.S. Cellular financed cellular system equipment and
construction costs totaling $59.5 million in 1995 and $18.0 million in 1994
under vendor financing arrangements. TDS Telecom telephone subsidiaries borrowed
$12.2 million in 1996, $12.0 million in 1995 and $16.8 million in 1994 under the
Rural Utility Service and the Rural Telephone Bank long-term federal government
loan programs to finance their telephone construction programs.
CASH FLOWS FROM INVESTING ACTIVITIES. TDS makes substantial investments
each year to acquire, construct, operate and maintain modern high-quality
communications networks and facilities with the intention of exceeding its
customers expectations 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.
Cash expenditures for property, plant and equipment additions totaled $550.2
million in 1996, $360.0 million in 1995 and $319.7 million in 1994. In addition,
the acquisition and development of broadband and narrowband PCS licenses
required $26.5 million in 1996, $326.0 million in 1995 and $31.6 million in
1994. Cash used for acquisitions, excluding cash acquired, totaled $31.0 million
in 1996, $53.8 million in 1995 and $37.6 million in 1994. The sale of
non-strategic cellular assets and other investments provided $221.5 million in
net proceeds in 1996, $197.6 million in 1995 and $6.0 million in 1994.
PROPERTY, PLANT AND EQUIPMENT
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-
-47-
<PAGE>
enhancing and cost-reducing technological developments. In 1996, the Company
invested a significant amount of money to develop and construct Aerial's
systems. 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,
--------------------------------------
1996 1995 1994
------------ ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cellular telephone
Cell sites and equipment............................................ $ 133,832 $ 150,340 $ 128,479
Switching equipment................................................. 5,713 13,002 4,549
Systems development................................................. 28,753 10,148 9,886
Other............................................................... 79,825 37,388 24,250
------------ ----------- -----------
248,123 210,878 167,164
------------ ----------- -----------
Telephone
Central office...................................................... 47,208 38,697 46,618
Outside plant....................................................... 53,130 55,569 52,629
Other............................................................... 44,102 10,106 16,236
------------ ----------- -----------
144,440 104,372 115,483
------------ ----------- -----------
PCS
Cell sites and equipment............................................ 150,386 -- --
Switching equipment................................................. 123,470 -- --
Other............................................................... 38,713 8,521 --
------------ ----------- -----------
312,569 8,521 --
Less noncash items.................................................... (199,630) -- --
------------ ----------- -----------
112,939 8,521 --
------------ ----------- -----------
Radio paging
Pagers.............................................................. 12,081 15,582 15,641
Terminals and transmitters.......................................... 4,595 6,353 11,056
Customer Telecare Center............................................ 10,216 -- --
Other............................................................... 5,625 4,592 2,269
------------ ----------- -----------
32,517 26,527 28,966
------------ ----------- -----------
Other................................................................. 12,185 9,698 8,088
------------ ----------- -----------
$ 550,204 $ 359,996 $ 319,701
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
U.S. Cellular's capital additions include expenditures to add additional
cell sites and radio channels to expand coverage and add capacity. U.S. Cellular
constructed 242 cell sites in 1996, 292 in 1995 and 225 in 1994. TDS Telecom's
capital additions include expenditures for outside plant facilities and upgrades
of recently acquired companies for new customer growth and switch modernization.
TDS Telecom installed 35 digital switches in 1996, 39 in 1995 and 32 in 1994.
Aerial has completed the construction of the five planned switching centers and
the central Network Operations Center, cleared over 150 microwave paths and is
building over 600 cell sites.
The Company's expected 1997 property, plant and equipment additions reflect
the Company's construction and expansion programs and are anticipated to
aggregate approximately $810 million. In addition, Aerial's working capital and
operating expenses will require an estimated $255 million.
- The cellular capital additions budget totals approximately $300 million,
including about $258 million for new cell sites and about $30 million for
various information systems initiatives.
- The telephone capital additions budget totals approximately $130 million,
including about $56 million for new digital switches and other switching
facilities and $56 million for improvements to outside plant facilities.
-48-
<PAGE>
- The PCS capital additions budget totals approximately $345 million,
including $255 million for switching equipment and $38 million for cell
sites. In addition, Aerial's working capital and operating expenses will
require an estimated $255 million.
- The radio paging capital additions are anticipated to total about $35
million, including $15 million for systems and transmitters and $16
million for pagers.
The Company expects to finance the budgeted additions to property, plant and
equipment primarily with internally generated cash, short-term and
intermediate-term financing, vendor financing and the sale of minority equity
interests in Aerial's MTAs to strategic investors.
ACQUISITIONS
TDS seeks to acquire cellular telephone and telephone interests which add
value to the organization. The table below summarizes interests acquired through
purchases and trades at the respective dates of acquisition during the last
three years and the aggregate consideration paid, net of cash acquired.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Cellular interests acquired
Population equivalents (millions)........................................ .6 1.6 1.5
Units.................................................................... 17,000 79,000 18,000
Telephone interests acquired
Companies................................................................ 5 5 3
Access lines.............................................................. 33,100 13,500 19,700
Paging units acquired...................................................... -- 28,400 37,600
Consideration (millions)
Cash..................................................................... $ 31.0 $ 53.8 $ 37.6
TDS Common Shares........................................................ 113.1 127.8 173.7
TDS Preferred Shares..................................................... -- -- 12.5
USM Common Shares........................................................ -- 12.8 1.4
Other.................................................................... -- -- 1.4
--------- --------- ---------
Total Consideration.................................................... $ 144.1 $ 194.4 $ 226.6
--------- --------- ---------
--------- --------- ---------
</TABLE>
The Company continually reviews attractive opportunities for the acquisition
of additional cellular and telephone companies.
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.
In February 1997, U.S. Cellular announced that it had entered into an
exchange agreement with BellSouth Corporation, pursuant to which U.S. Cellular
will receive controlling interests in twelve contiguous markets adjacent to its
Iowa and Wisconsin/Illinois clusters. In exchange, U.S. Cellular will transfer
its controlling interests in ten markets, investment interests in 13 markets and
pay cash, the amount of which is dependent upon certain factors. U.S. Cellular
will receive controlling interests representing approximately 3.9 million
population equivalents ("pops") in the transaction, and will divest controlling
interests representing approximately 1.9 million pops and investment interests
representing 1.4 million pops. The transaction is subject to various regulatory
and other approvals.
U.S. Cellular expects that the completion of this transaction will have a
positive effect on its consolidated operations after the transition of operators
is complete. The transaction is also expected to significantly reduce investment
income immediately after it is completed. Because of the uncertainty of the
regulatory approval process, U.S. Cellular cannot estimate when the transaction
will be completed.
-49-
<PAGE>
LIQUIDITY
The Company anticipates that the aggregate resources required for 1997 will
include approximately $810 million for capital spending and $255 million for
working capital and operating expenses for Aerial.
The Company is generating substantial internal funds from the rapid growth
in customer units and revenues. Operating cash flow (operating income plus
depreciation and amortization), primarily from cellular and telephone
operations, increased to $385.7 million in 1996 from $323.5 million in 1995 and
$260.3 million in 1994.
U.S. Cellular plans to finance its construction program primarily with
internally generated cash supplemented by short-term and intermediate-term
financing. TDS Telecom plans to finance its $130 million construction program
using internally generated cash supplemented by long-term financing from federal
government programs.
Aerial plans to finance its construction expenditures and working capital
requirements with short-term and intermediate-term financing, vendor financing
and sales of minority equity interests in MTAs to strategic investors.
TDS and its subsidiaries have cash and temporary investments totaling $119.3
million and longer-term investments totaling $32.4 million at December 31, 1996.
These investments are primarily the result of telephone operations' internally
generated cash. While certain regulated telephone subsidiaries' debt agreements
place limits on intercompany dividend payments, these restrictions are not
expected to affect the Company's ability to meet its cash obligations.
TDS and its subsidiaries also have access to a variety of external capital
sources. TDS and its subsidiaries had $653 million of bank lines of credit for
general corporate purposes at December 31, 1996. Unused amounts of such lines
totaled $496 million. These line of credit agreements provide for borrowings at
negotiated rates up to the prime rate.
TDS has a universal shelf registration statement which may be used from time
to time to issue debt securities and/or Common Shares for cash. As of December
31, 1996, $238.4 million remained unused on the universal shelf.
TDS and U.S. Cellular have shelf registration statements covering the
issuance of equity for acquisitions. In addition, the Company has issued Common
Shares for acquisitions pursuant to registration statements filed specifically
for particular acquisitions.
In December 1996, the Company authorized the repurchase of up to 3.0 million
TDS Common Shares over a period of three years. The Company plans to finance the
repurchase program using internally generated funds and borrowings under
short-term lines of credit. The Company may use repurchased shares to fund
acquisitions and for general 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.
The Company anticipates requiring additional funding to finance Aerial's
expected capital expenditures and working capital requirements, to finance
acquisitions and for general corporate purposes. The timing and amount of such
funding requirements will depend on the timing of the completion of Aerial's
construction and operational plans, the timing of acquisitions, and other
relevant factors. There can be no assurance that sufficient funds will be
available to the Company on terms or at prices acceptable to the Company. If
sufficient funding is not made available to the Company on terms and prices
acceptable to the Company, the Company would have to reduce its construction,
development and acquisition programs. TDS and its subsidiaries anticipate
accessing public and private capital markets to issue debt and equity securities
only when capital requirements, financial market conditions and other factors
warrant.
-50-
<PAGE>
PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995 SAFE HARBOR CAUTIONARY STATEMENT
This Management's Discussion and Analysis of Financial Condition and Results
of Operations and other sections of this Annual Report contain "forward-looking"
statements, as defined in the Private Securities Litigation Reform Act of 1995,
that are based on current expectations, estimates and projections. Statements
that are not historical facts, including statements about the Company's beliefs
and expectations are forward-looking statements. These statements contain
potential risks and uncertainties and, therefore, actual results may differ
materially. TDS undertakes no obligation to update publicly any forward-looking
statements whether as a result of new information, future events or otherwise.
Important factors that may affect these projections or expectations include,
but are not limited to: changes in the overall economy; changes in competition
in markets in which TDS operates; advances in telecommunications technology;
changes in the telecommunications regulatory environment; pending and future
litigation; availability of future financing; start-up of PCS operations; and
unanticipated changes in growth in cellular customers, penetration rates, churn
rates and the mix of products and services offered in our markets. Readers
should evaluate any statements in light of these important factors.
-51-
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
------------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C>
OPERATING REVENUES
Cellular telephone........................................................... $ 707,820 $ 492,395 $ 332,404
Telephone.................................................................... 402,629 354,841 306,341
Radio paging................................................................. 104,187 107,150 92,065
------------- ----------- -----------
1,214,636 954,386 730,810
------------- ----------- -----------
OPERATING EXPENSES
Cellular telephone........................................................... 620,454 449,640 315,019
Telephone.................................................................... 299,271 256,601 214,735
Radio paging................................................................. 140,813 116,147 92,234
------------- ----------- -----------
1,060,538 822,388 621,988
------------- ----------- -----------
OPERATING INCOME............................................................... 154,098 131,998 108,822
------------- ----------- -----------
INVESTMENT AND OTHER INCOME (EXPENSE)
Interest and dividend income................................................. 15,569 13,024 10,612
Cellular investment income, net of license cost amortization................. 54,150 40,666 26,018
PCS development costs........................................................ (43,950) (7,829) (1,709)
Gain on sale of cellular interests and other investments..................... 138,735 86,625 7,457
Other income (expense), net.................................................. 2,726 (2,771) 387
Minority share of income..................................................... (26,690) (25,858) (9,079)
------------- ----------- -----------
140,540 103,857 33,686
------------- ----------- -----------
INCOME BEFORE INTEREST AND INCOME TAXES........................................ 294,638 235,855 142,508
Interest expense............................................................... 42,853 50,848 41,251
------------- ----------- -----------
INCOME BEFORE INCOME TAXES..................................................... 251,785 185,007 101,257
INCOME TAX EXPENSE............................................................. 123,646 81,029 40,713
------------- ----------- -----------
NET INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE....................... 128,139 103,978 60,544
Cumulative Effect of Accounting Change......................................... -- -- (723)
------------- ----------- -----------
NET INCOME..................................................................... 128,139 103,978 59,821
Preferred Dividend Requirement................................................. (1,846) (1,934) (1,809)
------------- ----------- -----------
NET INCOME AVAILABLE TO COMMON................................................. $ 126,293 $ 102,044 $ 58,012
------------- ----------- -----------
------------- ----------- -----------
WEIGHTED AVERAGE COMMON SHARES (000S).......................................... 60,732 58,356 54,197
EARNINGS PER COMMON SHARE:
Before Cumulative Effect of Accounting Change................................ $ 2.08 $ 1.74 $ 1.07
Cumulative Effect of Accounting Change....................................... -- -- (.01)
------------- ----------- -----------
Net Income................................................................... $ 2.08 $ 1.74 $ 1.06
------------- ----------- -----------
------------- ----------- -----------
DIVIDENDS PER COMMON AND SERIES A COMMON SHARE................................. $ .40 $ .38 $ .36
------------- ----------- -----------
------------- ----------- -----------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
-52-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income..................................................................... $ 128,139 $ 103,978 $ 59,821
Add (Deduct) adjustments to reconcile net income to net cash provided by
operating activities
Cumulative effect of accounting change....................................... -- -- 723
Depreciation and amortization................................................ 231,583 191,504 151,511
Deferred taxes............................................................... 75,015 19,602 14,529
Investment income............................................................ (58,455) (43,188) (30,083)
Minority share of income..................................................... 26,690 25,858 9,079
Gain on sale of cellular interests and other investments..................... (138,735) (86,625) (7,457)
Noncash interest expense..................................................... 17,042 12,761 26
Other noncash expense........................................................ 24,022 16,946 15,669
Change in accounts receivable................................................ (28,687) (33,346) (22,401)
Change in accounts payable................................................... 23,531 (11,630) 31,714
Change in accrued taxes...................................................... (8,249) 6,252 (4,638)
Change in other assets and liabilities....................................... 3,098 8,764 6,193
----------- ----------- -----------
294,994 210,876 224,686
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Long-term debt borrowings...................................................... 15,846 334,323 36,916
Repayment of long-term debt.................................................... (34,200) (30,734) (33,710)
Change in notes payable........................................................ (27,133) 80,351 92,318
Proceeds from the issuance of common stock..................................... 5,114 6,921 11,185
Minority partner capital (distributions) contributions......................... (4,100) 1,411 12,504
Redemption of preferred shares................................................. (605) (638) (9)
Dividends paid................................................................. (26,231) (23,972) (20,906)
Proceeds from the issuance of subsidiaries' stock.............................. 196,205 1,812 45,714
----------- ----------- -----------
124,896 369,474 144,012
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment..................................... (550,204) (359,996) (319,701)
Investments in cellular minority interests and license costs................... (23,134) (25,025) (25,494)
Distributions from partnerships................................................ 25,453 9,062 17,375
Investments in PCS licenses.................................................... (26,548) (326,035) (31,604)
Proceeds from investment sales................................................. 221,542 197,558 6,000
Change in other investments.................................................... (2,666) (3,632) 492
Acquisitions, excluding cash acquired.......................................... (31,019) (53,770) (37,552)
Change in temporary investments and marketable securities...................... (30,797) 11,871 (9,147)
----------- ----------- -----------
(417,373) (549,967) (399,631)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................. 2,517 30,383 (30,933)
CASH AND CASH EQUIVALENTS
Beginning of period............................................................ 55,116 24,733 55,666
----------- ----------- -----------
End of period.................................................................. $ 57,633 $ 55,116 $ 24,733
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
-53-
<PAGE>
CONSOLIDATED BALANCE SHEETS--ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1995
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents............................................................... $ 57,633 $ 55,116
Temporary investments................................................................... 61,664 25,735
Construction funds...................................................................... 1,405 1,588
Accounts receivable
Due from customers, less allowance of $6,090 and $5,104, respectively................. 97,093 77,148
Other, principally connecting companies............................................... 84,119 68,196
Materials and supplies, at average cost............................................... 29,125 20,738
Other................................................................................. 15,031 12,689
------------- -------------
346,070 261,210
------------- -------------
INVESTMENTS
Cellular license acquisition costs, net of amortization................................. 1,088,409 1,075,820
Cellular minority interests............................................................. 206,390 158,559
Broadband PCS license acquisition costs................................................. 322,420 301,196
Narrowband PCS license acquisition costs................................................ 59,003 55,365
Franchise and other costs in excess of the underlying book value of subsidiaries, net of
amortization........................................................................... 181,845 168,608
Other investments....................................................................... 84,537 87,726
------------- -------------
1,942,604 1,847,274
------------- -------------
PROPERTY, PLANT AND EQUIPMENT
Cellular Telephone
In service and under construction..................................................... 846,005 674,450
Less accumulated depreciation......................................................... 195,251 144,423
------------- -------------
650,754 530,027
------------- -------------
Telephone
In service and under construction, substantially at original cost..................... 1,301,654 1,099,714
Less accumulated depreciation......................................................... 527,266 442,699
------------- -------------
774,388 657,015
------------- -------------
PCS
Primarily under construction.......................................................... 324,703 12,025
Less accumulated depreciation......................................................... 1,980 47
------------- -------------
322,723 11,978
------------- -------------
Radio Paging
In service and under construction..................................................... 113,000 102,385
Less accumulated depreciation......................................................... 61,528 42,933
------------- -------------
51,472 59,452
------------- -------------
Other
In service and under construction..................................................... 74,906 75,910
Less accumulated depreciation......................................................... 45,354 40,972
------------- -------------
29,552 34,938
------------- -------------
1,828,889 1,293,410
------------- -------------
OTHER ASSETS AND DEFERRED CHARGES......................................................... 83,406 67,188
------------- -------------
$ 4,200,969 $ 3,469,082
------------- -------------
------------- -------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
-54-
<PAGE>
CONSOLIDATED BALANCE SHEETS -- LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1995
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
CURRENT LIABILITIES
Current portion of long-term debt and preferred shares.................................. $ 38,197 $ 49,233
Notes payable........................................................................... 160,537 184,320
Accounts payable........................................................................ 205,427 113,995
Advance billings and customer deposits.................................................. 32,434 27,706
Accrued interest........................................................................ 11,777 11,573
Accrued taxes........................................................................... 3,194 11,415
Other................................................................................... 57,701 29,482
------------- -------------
509,267 427,724
------------- -------------
DEFERRED LIABILITIES AND CREDITS
Net deferred income tax liability....................................................... 183,792 103,206
Postretirement benefits obligation other than pensions.................................. 11,451 12,146
Other................................................................................... 19,663 22,943
------------- -------------
214,906 138,295
------------- -------------
LONG-TERM DEBT, excluding current portion................................................. 982,232 858,857
------------- -------------
REDEEMABLE PREFERRED SHARES, excluding current portion.................................... 280 1,587
------------- -------------
MINORITY INTEREST in subsidiaries......................................................... 432,343 328,544
NONREDEEMABLE PREFERRED SHARES............................................................ 29,000 29,710
------------- -------------
COMMON STOCKHOLDERS' EQUITY
Common Shares, par value $1 per share; authorized 100,000,000 shares; issued and
outstanding 54,237,180 and 51,137,426 shares, respectively............................. 54,237 51,137
Series A Common Shares, par value $1 per share; authorized 25,000,000 shares; issued and
outstanding 6,916,546 and 6,893,101 shares, respectively............................... 6,917 6,893
Common Shares issuable, 30,977 and 31,431 shares, respectively.......................... 1,461 1,496
Capital in excess of par value.......................................................... 1,661,093 1,417,513
Retained earnings....................................................................... 309,233 207,326
------------- -------------
2,032,941 1,684,365
------------- -------------
$ 4,200,969 $ 3,469,082
------------- -------------
------------- -------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
-55-
<PAGE>
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
COMMON SHARES
Balance beginning of period............................................. $ 51,137 $ 47,938 $ 43,504
Add
Acquisitions.......................................................... 2,649 2,960 4,041
Dividend reinvestment, incentive and benefit plans.................... 100 186 175
Sales of Common Shares................................................ -- -- 100
Conversion of Preferred Shares........................................ 348 41 116
Conversion of Series A Common Shares.................................. 3 12 2
------------- ------------- -------------
Balance end of period................................................... $ 54,237 $ 51,137 $ 47,938
------------- ------------- -------------
SERIES A COMMON SHARES
Balance beginning of period............................................. $ 6,893 $ 6,887 $ 6,881
Add (Deduct)
Dividend reinvestment plan............................................ 27 18 8
Conversion to Common Shares........................................... (3) (12) (2)
------------- ------------- -------------
Balance end of period................................................... $ 6,917 $ 6,893 $ 6,887
------------- ------------- -------------
------------- ------------- -------------
COMMON SHARES ISSUABLE
Balance beginning of period............................................. $ 1,496 $ 1,995 $ 15,189
Add (Deduct)
Acquisitions.......................................................... 464 -- 1,995
Shares issued pursuant to acquisition agreements...................... (499) (499) (15,189)
------------- ------------- -------------
Balance end of period................................................... $ 1,461 $ 1,496 $ 1,995
------------- ------------- -------------
------------- ------------- -------------
CAPITAL IN EXCESS OF PAR VALUE
Balance beginning of period............................................. $ 1,417,513 $ 1,288,453 $ 1,069,022
Add (Deduct)
Acquisitions.......................................................... 111,305 125,886 182,812
Dividend reinvestment, incentive and benefit plans.................... 4,487 6,994 6,667
Sales of Common Shares................................................ -- -- 4,924
Capital stock expense................................................. (25) (124) (53)
Conversion of Preferred Shares........................................ 4,254 (3,127) 1,324
Gain on sale of subsidiary stock...................................... 123,246 714 21,184
Net unrealized gain (loss) on marketable equity securities............ 142 (2,090) 2,100
Income tax effects of capital stock transactions...................... 171 807 473
------------- ------------- -------------
Balance end of period................................................... $ 1,661,093 $ 1,417,513 $ 1,288,453
------------- ------------- -------------
------------- ------------- -------------
RETAINED EARNINGS
Balance beginning of period............................................. $ 207,326 $ 127,765 $ 89,689
Add net income.......................................................... 128,139 103,978 59,821
------------- ------------- -------------
335,465 231,743 149,510
------------- ------------- -------------
Deduct
Dividends
Common and Series A Common Shares................................... 24,274 21,910 19,287
Preferred Shares.................................................... 1,958 2,507 2,458
------------- ------------- -------------
26,232 24,417 21,745
------------- ------------- -------------
Balance end of period................................................... $ 309,233 $ 207,326 $ 127,765
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
-56-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of Telephone and Data Systems, Inc. and its
subsidiaries ("TDS" or the "Company") conform to generally accepted accounting
principles. The accounting records of the telephone subsidiaries are maintained
in accordance with the uniform systems of accounts prescribed by the regulatory
bodies under whose jurisdiction the subsidiaries operate.
NATURE OF OPERATIONS
TDS is a diversified telecommunications company which, at December 31, 1996,
provided high-quality telecommunications services to approximately 2.3 million
cellular telephone, telephone and radio paging customers in 37 states and the
District of Columbia. The Company conducts substantially all of its cellular
operations through its 80.6%-owned subsidiary, United States Cellular
Corporation [AMEX:USM], its telephone operations through its wholly owned
subsidiary, TDS Telecommunications Corporation ("TDS Telecom"), and its radio
paging operations through its 82.3%-owned subsidiary, American Paging, Inc.
[AMEX:APP]. The Company is developing its personal communications services
("PCS") operations through its 82.8%-owned subsidiary Aerial Communications,
Inc. [NASDAQ:AERL] (formerly American Portable Telecom, Inc.). PCS development
costs for each of the three years ended December 31, 1996 are set forth in the
Consolidated Statements of Income. See Note 14-Business Segment Information for
summary financial information on each business segment.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of TDS, its
majority-owned subsidiaries since acquisition and the cellular telephone
partnerships in which TDS has a majority general partnership interest. All
material intercompany items have been eliminated. Certain amounts reported in
prior years have been reclassified to conform to current period presentation.
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.
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, which
approximates market. Those investments with original maturities of more than 12
months are classified as marketable securities and are stated at amortized cost.
INVESTMENTS
Cellular license acquisition costs consist of costs incurred in acquiring
Federal Communications Commission ("FCC") licenses or minority interests which
have been awarded FCC licenses to provide cellular service. These costs include
amounts paid to license applicants and owners of interests in cellular entities
awarded licenses; amounts paid for legal, engineering, and consulting services;
amounts incurred by TDS in acquiring these interests; and goodwill. These costs
are capitalized and amortized through charges to expense over 40 years upon
commencement of operations. Amortization amounted to $28.5 million, $27.8
-57-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 (CONTINUED)
million and $24.2 million in 1996, 1995 and 1994, respectively. Accumulated
amortization of cellular license costs was $112.2 million and $90.6 million at
December 31, 1996 and 1995, respectively. Included in cellular license costs is
approximately $322 million and $363 million at December 31, 1996 and 1995,
respectively, of goodwill which resulted from various acquisitions structured to
be tax-free.
Investments in cellular minority interests consist of amounts invested in
cellular entities in which TDS holds a minority interest. The Company follows
the equity method of accounting, which recognizes TDS's proportionate share of
the income and losses accruing to it under the terms of its partnership or
shareholder agreements, for its long-term investments ($196.0 million and $146.1
million at December 31, 1996 and 1995, respectively). Income and losses from
these entities are reflected in the consolidated income statements on a pretax
basis. At December 31, 1996, the cumulative share of income from minority
cellular investments accounted for under the equity method was $184.3 million,
of which $94.7 million was undistributed. The cost method of accounting is
followed for certain minority interests managed by others ($10.4 million and
$12.5 million at December 31, 1996 and 1995, respectively).
Broadband and Narrowband PCS license acquisition costs consist of costs
incurred in acquiring PCS licenses ($341.8 million) and capitalized interest
($39.6 million). These costs will be amortized through charges to expense upon
commencement of operations.
Telephone franchise and other costs include the costs in excess of the
underlying book value of acquired telephone companies. Costs in excess of the
underlying book value relating to acquisitions initiated before November 1,
1970, aggregating $6.5 million, are not being amortized. Costs aggregating
$204.9 million and $186.9 million at December 31, 1996 and 1995, respectively,
relating to acquisitions since November 1, 1970, are being amortized on a
straight-line basis over a 40-year period. Amortization amounted to $4.9
million, $4.4 million and $3.3 million in 1996, 1995 and 1994, respectively.
Accumulated amortization of excess cost was $29.6 million and $24.7 million at
December 31, 1996 and 1995, respectively. Included in excess cost is
approximately $143 million and $142 million at December 31, 1996 and 1995,
respectively, of goodwill which resulted from various acquisitions structured to
be tax-free.
Other investments consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Minority telephone and paging interests................................................ $ 20,989 $ 30,422
Long-term notes receivable............................................................. 14,974 16,419
Rural Telephone Bank Stock, at cost.................................................... 6,639 6,350
Marketable equity securities........................................................... 2,673 346
Marketable non-equity securities....................................................... 29,735 24,871
Other.................................................................................. 9,527 9,318
--------- ---------
$ 84,537 $ 87,726
--------- ---------
--------- ---------
</TABLE>
The equity method of accounting is followed for minority telephone and
paging interests in which TDS holds common stock ownership of at least 20% or
can influence the policies of the affiliated company. At December 31, 1996, the
cumulative share of income from minority telephone and paging investments
accounted for under the equity method was $4.1 million, of which $2.2 million
was undistributed.
The Company's investment in debt securities with original maturities of more
than 12 months are classified as marketable non-equity securities and
held-to-maturity. They are stated at amortized cost.
-58-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 (CONTINUED)
Information regarding the Company's marketable nonequity securities is
summarized below.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
--------- ---------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Held-to-Maturity
U.S. Treasury and other U.S. government corporations and agencies
Aggregate Fair Value
Current.......................................................................... $ 46,622 $ 12,293
Noncurrent....................................................................... 29,882 25,200
Amortized Cost Basis
Current.......................................................................... 46,603 12,337
Noncurrent....................................................................... 29,735 24,871
Gross Unrealized
Holding Gains.................................................................... 175 343
Gross Unrealized...................................................................
Holding Losses................................................................... $ 8 $ 58
--------- ---------
--------- ---------
</TABLE>
The noncurrent investments have contractual maturities of more than one to
five years at December 31, 1996. No sales or transfers of securities classified
as held-to-maturity occurred during 1996.
REVENUE RECOGNITION
TDS's revenues are recognized when earned. Telephone network access and
long-distance services are furnished jointly with other companies, primarily
AT&T and the Bell Operating Companies. Compensation for interstate access
services is based on tariffed access charges to interstate long-distance
carriers as filed by the National Exchange Carrier Association with the FCC on
behalf of TDS. Such compensation amounted to 32%, 33% and 31% of telephone
revenues in 1996, 1995 and 1994, respectively. Compensation for intrastate toll
and access services is based on tariffed access charges, cost separation
studies, nationwide average schedules or special settlement arrangements with
intrastate long-distance carriers. Network access and long-distance revenues
based on cost separation studies represent estimates pending completion and
acceptance of final cost studies. Management believes that recorded amounts
represent reasonable estimates of the final amounts.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising costs
totaled $29.8 million, $17.2 million and $13.7 million for the years ended
December 31, 1996, 1995 and 1994, respectively.
EARNINGS PER COMMON SHARE
Earnings per Common Share were computed by dividing Net Income Available to
Common, less a minority income adjustment, by the weighted average number of
Common Shares, Series A Common Shares and dilutive common equivalent shares
outstanding during the year. The minority income adjustment, $271,000 and
$411,000 in 1995 and 1994, respectively, reflects the additional minority share
of USM's income computed as if all of USM's issuable securities were
outstanding. Dilutive common stock equivalents consist of Common Shares issuable
upon conversion of dilutive series of Preferred Shares and Common Share options.
Preferred dividend requirements include all dividends paid on Preferred
Shares which are not dilutive common stock equivalents. For the year ended
December 31, 1996, the preferred dividend requirement on all outstanding
Preferred Shares was $1.8 million.
-59-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 (CONTINUED)
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,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Interest paid.............................................................. $ 76,062 $ 49,414 $ 39,904
Income taxes paid.......................................................... 67,907 60,515 27,644
Common Shares issued by TDS for conversion of TDS Preferred Shares......... 4,602 948 1,714
Increase in PCS network equipment and prepaid infrastructure costs through
the issuance of long-term debt............................................ 100,000 -- --
Additions to property, plant and equipment financed through accounts
payable and accrued expenses.............................................. $ 87,109 $ 3,943 $ (9,958)
--------- --------- ---------
--------- --------- ---------
</TABLE>
TDS has acquired operating telephone and paging companies, certain cellular
licenses and operating companies and certain other assets since January 1, 1994.
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,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Property, plant and equipment....................................... $ 55,692 $ 56,132 $ 47,400
Cellular licenses................................................... 95,447 129,510 169,845
Franchise and other costs........................................... 17,679 25,657 41,692
Minority interest................................................... (1,109) (1,941) (259)
Increase (decrease) in equity method investment in cellular
interests.......................................................... (3,641) 977 (15,586)
Long-term debt...................................................... (22,979) (9,254) (21,571)
Deferred credits.................................................... (6,205) (538) (6,225)
Other assets and liabilities, excluding cash and cash equivalents... 9,297 (6,143) 9,808
Common Shares issued and issuable................................... (113,128) (127,836) (173,658)
Preferred Shares issued............................................. -- -- (12,500)
USM Common Shares issued and issuable............................... (34) (12,794) (1,394)
------------ ------------ ------------
Decrease in cash due to acquisitions................................ $ 31,019 $ 53,770 $ 37,552
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
-60-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2
INCOME TAXES
TDS files a consolidated federal income tax return. Income tax provisions
charged to net income before the cumulative effect of an accounting change are
summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
----------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal................................................................ $ 31,356 $ 44,690 $ 20,921
State.................................................................. 17,275 16,736 4,873
Deferred:
Federal................................................................ 67,040 19,253 13,440
State.................................................................. 10,072 2,386 2,963
Amortization of deferred investment tax credits.......................... (2,097) (2,036) (1,484)
----------- --------- ---------
Total income tax expense................................................. $ 123,646 $ 81,029 $ 40,713
----------- --------- ---------
----------- --------- ---------
</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.
The statutory federal income tax rate is reconciled to TDS's effective
income tax rate before the cumulative effect of an accounting change below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Statutory federal income tax rate................................................ 35.0% 35.0% 35.0%
State income taxes, net of federal benefit....................................... 8.3 6.9 5.1
Amortization of license acquisition costs and costs in excess of book value...... 1.7 2.4 3.5
Acquisition-related tax basis adjustment......................................... -- -- (2.7)
Dividend exclusion............................................................... -- (.1) (1.8)
Amortization of deferred investment tax credits.................................. (.8) (1.0) (1.5)
Effects of corporations not included in consolidated federal tax return.......... 1.7 2.1 1.4
Sale of cellular interests....................................................... 4.9 -- --
Other differences, net........................................................... (1.7) (1.5) 1.2
--------- --------- ---------
Effective income tax rate........................................................ 49.1% 43.8% 40.2%
--------- --------- ---------
--------- --------- ---------
</TABLE>
The increase in the 1996 effective tax rate reflects additional income tax
expense due to tax gains in excess of book gains associated with the sale of
certain cellular interests. The lower 1994 rate reflects deferred income taxes
provided on the book/tax basis difference related to certain telephone
acquisitions and certain income excluded due to the dividend exclusion rules.
The total income tax expense for the year ended December 31, 1994, including
the cumulative effect of an accounting change was $40.3 million. The effective
income tax rate including the cumulative effect of an accounting change was
40.3% in 1994.
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 $2.7 million and $3.2
million as of December 31, 1996 and 1995, respectively. The net current deferred
tax asset primarily represents the deferred tax effects of unearned revenues.
-61-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 (CONTINUED)
The temporary differences that gave rise to the noncurrent deferred tax
assets and liabilities as of December 31, 1996 and 1995, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Deferred Tax Asset:
Alternative minimum tax credit carryforward....................................... $ 10,433 $ 10,316
State operating loss carryforwards................................................ 17,055 10,537
Postretirement benefits........................................................... 4,819 4,502
Other............................................................................. 15,059 9,075
----------- -----------
47,366 34,430
Less valuation allowance............................................................ (16,891) (10,061)
----------- -----------
Net Deferred Tax Asset.............................................................. 30,475 24,369
----------- -----------
Deferred Tax Liability:
Property, plant and equipment..................................................... 86,056 83,131
Partnership investments........................................................... 26,965 20,047
Investment in equity securities................................................... 40,540 2,572
Minority share of USM income...................................................... (7,122) (1,500)
Effects of corporations not included in consolidated federal tax return........... 3,945 3,642
Licenses.......................................................................... 38,656 16,001
Other............................................................................. 25,227 3,682
----------- -----------
Total Deferred Tax Liability........................................................ 214,267 127,575
----------- -----------
Net Deferred Income Tax Liability................................................. $ 183,792 $ 103,206
----------- -----------
----------- -----------
</TABLE>
At December 31, 1996, TDS had $10.4 million of federal alternative minimum
tax credit carryforward available to offset regular income tax payable in future
years. In addition, TDS had $267.7 million of state net operating loss
carryforward at December 31, 1996, expiring between 1996 and 2010, which
generated a $17.1 million deferred tax asset. 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.
TDS's telephone subsidiaries have recorded additional deferred income tax
liabilities related primarily to temporary differences not deferred under
rate-making policy. A corresponding regulatory asset or liability has been
established to offset these deferred income tax adjustments. The unamortized
regulated asset and liability balances are $4.3 million and $4.5 million,
respectively, as of December 31, 1996, and $5.0 million and $5.8 million,
respectively, as of December 31, 1995. These amounts are being amortized over
the lives of the related temporary differences.
NOTE 3
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost.
Telephone plant in service and under construction 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"). The composite weighted average AFUDC rates were 7.3%, 9.3% and 10.4%
in 1996, 1995 and 1994, respectively.
-62-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 (CONTINUED)
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.
AERL capitalizes interest ($1.2 million in 1996) on certain work in process
expenditures. When the assets are placed in service, they will be depreciated
over their respective useful lives.
Certain costs relating to the development of computer software for internal
use are capitalized and are amortized over the estimated five-year life of the
software.
Depreciation is provided for book purposes using the straight-line method.
Composite depreciation rates, as applied to the average cost of depreciable
property, are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Cellular Telephone............................................................... 10.4% 10.0% 10.5%
Telephone........................................................................ 7.2 7.1 7.5
PCS.............................................................................. 20.2 2.2 --
Radio Paging..................................................................... 27.9 22.1 23.1
Other............................................................................ 15.9 10.0 12.8
--- --- ---
--- --- ---
</TABLE>
NOTE 4
ACQUISITIONS AND SALES
During 1996, 1995 and 1994, TDS and its subsidiaries completed the following
business combinations:
<TABLE>
<CAPTION>
CONSIDERATION
-----------------------------
TDS AND USM
COMMON STOCK,
CASH, NOTES TDS PREFERRED
AND SHARES, AND
LONG-TERM SUBSIDIARY
DEBT PREFERRED STOCK
----------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Acquisitions During 1996
Cellular interests............................................................ $ 13,596 $ 42,499
Majority interests in five telephone companies................................ 17,423 70,663
Acquisitions During 1995
Cellular interests............................................................ $ 41,885 $ 94,542
Majority interests in five telephone companies................................ 250 46,087
Paging interests.............................................................. 5,656 --
Acquisitions During 1994
Cellular interests............................................................ $ 29,599 $ 110,732
Majority interests in three telephone companies............................... 7,386 71,945
Paging interest............................................................... 4,875 4,875
----------- ----------------
----------- ----------------
</TABLE>
-63-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 (CONTINUED)
Assuming that these acquisitions had taken place on January 1, 1995,
unaudited pro forma results of operations from continuing operations would have
been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1995
------------- -------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C>
Operating revenues.............................................................. $ 1,229,053 $ 1,013,326
Net income...................................................................... 129,199 105,926
Earnings per share.............................................................. $ 2.08 $ 1.69
------------- -------------
------------- -------------
</TABLE>
SALES OF CELLULAR AND OTHER INVESTMENTS
The $138.7 million gain in 1996 reflects the sales of non-strategic cellular
and other investments. USM 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. AERL sold its majority interests in two markets.
These transactions, along with the sales of certain other investments by TDS,
generated net cash proceeds of $221.5 million.
The $86.6 million gain in 1995 reflects the sales and exchanges of
non-strategic cellular and other investments. USM sold its majority interests in
six markets and its minority interests in six markets during 1995. These sales,
along with the sales of marketable equity securities and certain other
investments by TDS, generated net cash proceeds of $197.6 million.
The $7.5 million gain in 1994 reflects the sale and exchange of
minority-owned cellular and telephone interests. The cellular gain represents
the excess of the fair market value of the cellular interests traded over the
book value of such interests. The Company also sold its minority interest in a
telephone company for preferred shares of the telephone company having a face
value of $5.9 million and $6.0 million in cash.
NOTE 5
NOTES PAYABLE
TDS has used short-term debt to finance its investments in PCS, cellular
telephone and radio paging operations, for acquisitions, and for general
corporate purposes. Long-term debt and equity financing from time to time have
retired such short-term debt. Proceeds from an AERL initial public offering
retired $131.2 million of short-term debt in 1996. (See Note 7-Sale of Stock by
Subsidiaries.) Proceeds from the sales of non-strategic cellular and other
investments from time to time in 1996 and 1995 have been used to retire
short-term debt. Proceeds from a USM convertible debt offering retired $131.4
million of short-term debt in 1995. Proceeds from an APP initial public offering
and TDS's sales of Common Shares retired $21.2 million of short-term debt in
1994.
TDS and its subsidiaries had $678.4 million of bank lines of credit for
general corporate purposes at December 31, 1996, $653.4 million of which were
committed. Unused amounts of such lines totaled $521.0 million, $496.0 million
of which were committed. These line-of-credit agreements provide for borrowings
at negotiated rates up to the prime rate.
-64-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5 (CONTINUED)
Information concerning notes payable is shown in the table below:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance at end of period............................................... $ 160,537 $ 184,320 $ 98,608
Weighted average interest rate at end of period........................ 6.0% 6.3% 6.5%
Maximum amount outstanding during the period........................... $ 204,140 $ 184,320 $ 106,077
Average amount outstanding during the period (1)....................... $ 112,341 $ 139,671 $ 50,499
Weighted average interest rate during the period (1)................... 5.8% 6.4% 5.2%
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
- - ------------
(1) The average was computed based on month-end balances.
-65-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6
LONG-TERM DEBT
Long-term debt as of December 31, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1995
------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Telephone and Data Systems, Inc. (Parent)
Medium-term notes, 8% to 10%, due through 2025.................................. $ 239,200 $ 239,200
Purchase contracts and other long-term notes 8% to 9.6%, due through 2003....... 3,175 3,676
------------ ------------
242,375 242,876
Less current portion............................................................ 232 418
------------ ------------
Total parent debt................................................................. 242,143 242,458
------------ ------------
Subsidiaries
RUS, RTB and FFB Mortgage Notes, due through 2031
0% to 2%...................................................................... 24,859 26,350
4% to 6%...................................................................... 178,499 172,231
6.04% to 9%................................................................... 103,800 84,464
9.5% to 11%................................................................... 1,213 1,233
------------ ------------
308,371 284,278
------------ ------------
6% zero coupon convertible debentures, matures June 15, 2015.................... 745,000 745,000
Unamortized discount............................................................ (494,893) (509,250)
------------ ------------
250,107 235,750
------------ ------------
Vendor financing, approximating 90-day Commercial Paper Rate plus 1.4% due
through 2002................................................................... 103,654 119,998
------------ ------------
8.34% zero coupon notes, matures November 1, 2006............................... 226,245 --
Unamortized discount............................................................ (122,502) --
------------ ------------
103,743 --
------------ ------------
Other long-term notes, 0% to 12.6%, due through 2009............................ 10,601 11,682
------------ ------------
776,476 651,708
Less current portion............................................................ 36,387 35,309
------------ ------------
Total subsidiaries' debt.......................................................... 740,089 616,399
------------ ------------
Total long-term debt.............................................................. $ 982,232 $ 858,857
------------ ------------
------------ ------------
</TABLE>
The Company sold $39.2 million of senior unsecured debt securities in 1995
under its Medium-Term Note Program. The proceeds were used principally to retire
short-term debt, as well as for working capital and general corporate purposes.
The 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.
USM sold $745 million principal amount at maturity of 20-year zero coupon 6%
yield to maturity convertible redeemable debt in June 1995 with proceeds to the
Company of $221.5 million. No debt has been converted as of December 31, 1996.
-66-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 (CONTINUED)
USM has financing arrangements with an equipment vendor for cellular system
equipment and construction costs. The borrowings are collateralized by a secured
interest in some or all of the assets of USM's operating subsidiaries.
Borrowings have terms of seven years at an interest rate of 1.4% over the 90-day
Commercial Paper Rate (for a rate of 7.03% at December 31, 1996).
AERL sold $226 million principle amount at maturity of 10-year zero coupon
8.34% yield to maturity debt in November 1996 at an issue price of $100 million.
The proceeds were paid to AERL's equipment vendor in satisfaction of all
outstanding and future obligations up to $100 million. The notes are fully and
unconditionally guaranteed by TDS.
The annual requirements for principal payments on long-term debt are
approximately $36.6 million, $39.3 million, $36.8 million, $31.8 million and
$27.9 million for the years 1997 through 2001, respectively.
NOTE 7
MINORITY INTEREST IN SUBSIDIARIES
The following table summarizes the minority shareholders' and partners'
interests in the equity of consolidated subsidiaries.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
USM
USM shareholders'................................................................. $ 285,835 $ 259,719
USM subsidiaries' partners'....................................................... 48,715 45,303
----------- -----------
334,550 305,022
TDS Telecom telephone subsidiaries'................................................. 21,810 17,108
AERL shareholders'.................................................................. 75,897 --
APP shareholders'................................................................... -- 6,280
Other............................................................................... 86 134
----------- -----------
$ 432,343 $ 328,544
----------- -----------
----------- -----------
</TABLE>
SALE OF STOCK BY SUBSIDIARIES
USM issued Common Shares during 1996, 1995 and 1994 in connection with
acquisitions and employee stock purchase plans. AERL issued 12.3 million Common
Shares in an initial public offering (at a price of $17 per share) in 1996. The
initial public offering reduced TDS's ownership percentage from 100% to 82.8%.
APP issued Common Shares during 1996 and 1995 in connection with employee stock
purchase plans, and in 1994 issued 3.5 million Common Shares in an initial
public offering (at a price of $14 per share). The initial public offering
reduced TDS's ownership percentage from 100% to 82.5%. The USM, AERL and APP
Common Share transactions were recorded at fair market values which were either
less than or in excess of TDS's book value investment in USM, AERL and APP. TDS
adjusted its book value investment as a result of these issues and increased
capital in excess of par value $123.2 million, $714,000 and $21.2 million in
1996, 1995 and 1994, respectively.
NOTE 8
PREFERRED SHARES
TDS Cumulative Voting Preferred Shares have a stated value of $100 per
share. The 5,000,000 authorized Preferred Shares are issuable in series by the
Board of Directors who establish the terms of the issue. Those
-67-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 (CONTINUED)
issues which contain mandatory redemption features or which are redeemable at
the option of the holder are classified as Redeemable Preferred Shares. Those
issues which are not redeemable or which are redeemable at the option of TDS are
classified as Nonredeemable Preferred Shares.
REDEEMABLE PREFERRED SHARES
Redeemable Preferred Shares include outstanding series of TDS Cumulative
Voting Preferred Shares with mandatory redemption features or which are
redeemable at the option of the holder. At December 31, 1996, 18,581 shares of
Redeemable Preferred Shares were outstanding, redeemable at $100 per share. All
other dividends are payable in cash.
The annual requirements for redemption of Redeemable Preferred Shares are
$1.6 million, $103,000, $100,000 and $77,000 for the years 1997 through 2000,
respectively.
The following is a schedule of the Redeemable Preferred Shares' activity.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of period............................................... $ 15,093 $ 25,001 $ 27,367
Add:
Stock dividends.......................................................... 113 546 839
Less:
Redemption of preferred.................................................. (9,456) (9,608) (1,005)
Conversion of preferred.................................................. (3,872) -- (1,000)
Expiration of redemption feature......................................... (20) (839) (1,200)
Change in redemption feature............................................. -- (7) --
--------- --------- ---------
1,858 15,093 25,001
Less current portion....................................................... 1,578 13,506 11,792
--------- --------- ---------
Balance, end of period..................................................... $ 280 $ 1,587 $ 13,209
--------- --------- ---------
--------- --------- ---------
</TABLE>
NONREDEEMABLE PREFERRED SHARES
Nonredeemable Preferred Shares include outstanding series of TDS Cumulative
Voting Preferred Shares which have no mandatory redemption features. At December
31, 1996, 290,002 shares of Nonredeemable Preferred Shares were outstanding.
Outstanding Nonredeemable Preferred Shares are generally redeemable at the
option of TDS at $100 per share, plus accrued and unpaid dividends. At December
31, 1996, certain series of Preferred Shares are convertible into TDS Common
Shares. (See Note 9 -- Convertible Preferred Shares)
The following is a schedule of the Nonredeemable Preferred Shares activity.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Balance, beginning of period............................................... $ 29,710 $ 29,819 $ 16,833
Add:
Acquisitions............................................................. -- -- 12,500
Reclassification from Redeemable Preferred Shares........................ 20 839 1,200
Less:
Conversion of preferred.................................................. (730) (948) (714)
--------- --------- ---------
Balance, end of period..................................................... $ 29,000 $ 29,710 $ 29,819
--------- --------- ---------
--------- --------- ---------
</TABLE>
-68-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9
COMMON STOCK ACQUISITIONS
During 1996, 1995 and 1994, TDS issued 2.6 million, 3.0 million and 4.0
million Common Shares, respectively, for the acquisition of cellular and
telephone interests.
COMMON SHARES ISSUABLE
Certain acquisition agreements require TDS to deliver 20,497 and 10,480
Common Shares in 1997 and 1998, respectively.
DIVIDEND REINVESTMENT, INCENTIVE AND BENEFIT PLANS
The following table summarizes Common and Series A Common Shares issued for
the employee stock ownership plans and dividend reinvestment plans described
below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Common Shares
Tax-deferred savings plan................................................ 36,269 40,624 30,764
Dividend reinvestment plan............................................... 28,827 105,001 85,754
Employee stock options, awards, stock appreciation rights and employee
stock purchase plan..................................................... 35,273 40,025 59,278
--------- --------- ---------
100,369 185,650 175,796
--------- --------- ---------
--------- --------- ---------
Series A Common Shares
Dividend reinvestment plan............................................... 26,445 17,855 7,783
--------- --------- ---------
--------- --------- ---------
</TABLE>
TAX-DEFERRED SAVINGS PLAN. TDS has reserved 110,965 Common Shares for issue
under the TDS Tax-Deferred Savings Plan, a qualified profit-sharing plan
pursuant to Sections 401(a) and 401(k) of the Internal Revenue Code.
Participating employees have the option of investing their contributions in TDS
Common Shares, USM Common Shares, AERL Common Shares, APP Common Shares or five
nonaffiliated funds.
DIVIDEND REINVESTMENT PLANS. TDS has reserved 486,015 Common Shares for
issue under the Automatic Dividend Reinvestment and Stock Purchase Plan and
192,254 Series A Common Shares for issue under the Series A Common Share
Automatic Dividend Reinvestment Plan. These plans enable holders of TDS's Common
Shares and Preferred Shares to reinvest cash dividends in newly issued Common
Shares and holders of Series A Common Shares to reinvest cash dividends in newly
issued Series A Common Shares. The purchase price of the shares is 95% of the
market value, based on the average of the daily high and low sales prices for
TDS's Common Shares on the American Stock Exchange for the ten trading days
preceding the date on which the purchase is made.
STOCK-BASED COMPENSATION PLANS
TDS has reserved 1,316,196 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 and stock appreciation rights for the officers and
employees. The options are exercisable over a specified period not in excess of
ten years. The options expire from 1997 to 2006 or the date of the employee's
termination of employment, if earlier.
TDS accounts for stock options, stock appreciation rights ("SARS") and
employee stock purchase plans under Accounting Principles Board ("APB") Opinion
No. 25. No compensation costs have been recognized for the stock option and
employee stock purchase plans. Compensation expense for SARS, measured on the
difference between the year-end market price of the Common Shares and SAR
prices, was $263,000, $408,000 and $218,000 in 1996, 1995 and 1994,
respectively. Had compensation cost for all plans been
-69-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9 (CONTINUED)
determined consistent with Financial Accounting Standards Board Statement of
Accounting Standards ("SFAS") No. 123, the Company's net income and earnings per
share would have been reduced to the following pro forma amounts:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1996 1995
----------- -----------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C>
Net Income
As Reported....................................................................... $ 126,139 $ 103,978
Pro Forma......................................................................... $ 126,495 $ 103,316
Earnings per Common Share
As Reported....................................................................... $ 2.08 $ 1.74
Pro Forma......................................................................... $ 2.05 $ 1.73
----------- -----------
----------- -----------
</TABLE>
Because SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
A summary of the status of the Company's stock option plans at December 31,
1996, 1995 and 1994 and changes during the years ended is presented in the table
and narrative below:
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED
NUMBER OF AVERAGE AVERAGE
SHARES OPTION PRICES FAIR VALUES
--------- ------------- -----------
<S> <C> <C> <C>
Stock Options:
Outstanding January 1, 1994 (107,661 exercisable)...................... 302,685 $ 15.35
Granted.............................................................. 221,275 $ 47.59
Exercised............................................................ (25,876) $ 5.30
Cancelled............................................................ (12,487) $ 27.47
---------
Outstanding December 31, 1994 (172,689 exercisable).................... 485,597 $ 30.25
Granted.............................................................. 59,995 $ 38.67 $ 14.84
Exercised............................................................ (26,101) $ 5.52
Cancelled............................................................ (3,046) $ 43.32
---------
Outstanding December 31, 1995 (240,160 exercisable).................... 516,445 $ 32.47
Granted.............................................................. 89,228 $ 41.00 $ 13.30
Exercised............................................................ (11,025) $ 13.10
Cancelled............................................................ (3,210) $ 39.89
---------
Outstanding December 31, 1996 (405,996 exercisable).................... 591,438 $ 34.08
--------- ------------- -----------
--------- ------------- -----------
</TABLE>
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1996 and 1995, respectively: risk-free interest
rates of 5.6% and 6.6%; expected dividend yields of 1.0% and 1.0%; expected
lives of 5.1 years and 6.9 years and expected volatility of 20.5% and 25.0%.
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 the Common Shares on the
exercise date. The following table summarizes the SARs outstanding at $4.43 to
$36.60 per share. These rights expire March 1997, or the date of the employee's
termination of employment, if earlier. The fair value of each stock appreciation
right grant is estimated on the date of grant using the Black-
-70-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9 (CONTINUED)
Scholes option pricing model with the following weighted-average assumptions
used for grants in 1996 and 1995, respectively: risk-free interest rates of 5.2%
and 5.5%; expected dividend yields of 1.0% and 1.0%; expected lives of 0.2 years
and 0.7 years; and expected volatility of 18.4% and 20.2%.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Outstanding beginning of period............................................... 16,034 12,096 9,100
Granted..................................................................... 5,923 8,174 7,796
Exercised................................................................... (11,887) (4,236) (4,800)
--------- --------- ---------
Outstanding end of period..................................................... 10,070 16,034 12,096
--------- --------- ---------
--------- --------- ---------
</TABLE>
Employee Stock Purchase Plan. TDS has reserved 201,638 Common Shares for
sale to the employees of TDS and its subsidiaries. The fair value of the
employees' purchase rights is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants rights in 1996: risk-free interest rate of 5.6%;
expected dividend yield of 1.0%; expected life of 0.5 year; and expected
volatility of 15.3%.
CONVERTIBLE PREFERRED SHARES
TDS convertible Preferred Shares are convertible into 933,838 Common Shares
(See Note 8 -- Nonredeemable Preferred Shares). TDS issued 347,707, 40,734 and
115,542 Common Shares in 1996, 1995 and 1994, respectively, for shares of TDS
and subsidiary preferred stock converted.
SERIES A COMMON SHARES
The holders of Common Shares and the outstanding Preferred Shares are
entitled to one vote per share. The holders of Series A Common Shares are
entitled to ten votes per share. Series A Common Shares are convertible, on a
share-for-share basis, into Common Shares. TDS has reserved 6,916,546 Common
Shares for possible issuance upon such conversion.
COMMON SHARE REPURCHASE PROGRAM
In December 1996, the Company authorized the repurchase of up to 3.0 million
TDS Common Shares over a period of three years. The Company plans to finance the
repurchase program using internally generated funds and borrowings under
short-term lines of credit. The Company may use repurchased shares to fund
acquisitions and for general 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.
NOTE 10
COMMITMENTS AND CONTINGENCIES
CONSTRUCTION AND EXPANSION
The primary purpose of TDS's construction and expansion program is to
provide for normal growth, to upgrade telephone service, to expand into new
communication areas, and to take advantage of service-enhancing and
cost-reducing technological developments. The cellular capital additions budget
totals approximately $300 million for 1997, including about $258 million for new
cell sites and $30 million for various information systems initiatives. The
telephone capital additions budget totals approximately $130 million for 1997,
including about $56 million for new digital switches and other switching
facilities and $56 million for improvements to outside plant facilities. The PCS
capital additions budget totals approximately $345 million
-71-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10 (CONTINUED)
for 1997, including $255 million for switching equipment and $38 million for
cell sites. The radio paging capital additions are anticipated to total
approximately $35 million in 1997, including $15 million for systems and
transmitters and $16 million for pagers.
PENDING ACQUISITIONS
At December 31, 1996, TDS has entered into definitive agreements to acquire
a controlling interest in one cellular market and one telephone company for an
aggregate consideration of approximately $39.8 million, primarily cash and TDS
Common Shares.
LEASE COMMITMENTS
TDS and its subsidiaries have leases for certain cellular plant facilities,
office space and data processing equipment, most of which are classified as
operating leases. For the years 1996, 1995 and 1994, rent expense for term
leases was $20.9 million, $13.6 million and $10.4 million, respectively, and
rent expense under cancelable and short-term leases was $7.6 million, $7.5
million and $6.5 million, respectively. At December 31, 1996, the aggregate
minimum rental commitments under noncancelable operating leases were as follows:
<TABLE>
<CAPTION>
MINIMUM FUTURE
RENTAL PAYMENTS
--------------------
(DOLLARS IN
THOUSANDS)
<S> <C>
1997.................................................................................... $ 21,917
1998.................................................................................... 19,428
1999.................................................................................... 17,353
2000.................................................................................... 15,348
2001.................................................................................... 13,367
Thereafter.............................................................................. $ 56,028
--------
--------
</TABLE>
LEGAL PROCEEDINGS
The Company is involved in a number of legal proceedings before the FCC and
various state and federal courts. In some cases, the litigation involves
disputes regarding rights to certain cellular telephone systems and other
interests. Management does not believe that any of such proceedings should have
a material adverse impact on the financial position or results of operations of
the Company.
NOTE 11
RESTRICTION ON COMMON STOCK DIVIDENDS
Under TDS's loan agreements at December 31, 1996, all of the consolidated
retained earnings were available for the payment of cash dividends on shares of
TDS common stock.
Certain regulated telephone subsidiaries may not transfer funds to the
parent in the form of cash dividends, loans or advances until certain financial
requirements of their mortgages have been met. All of the $326.6 million
underlying retained earnings of all TDS subsidiaries at December 31, 1996, was
available for the payment of dividends on the subsidiaries common stock. Of the
$2.7 billion underlying net assets of the TDS subsidiaries at December 31, 1996,
$2.1 billion was available for transfer to TDS.
-72-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12
INVESTMENTS IN UNCONSOLIDATED ENTITIES
The following summarizes the unaudited combined assets, liabilities and
equity, and the unaudited results of operations of the cellular and telephone
companies in which TDS's investments are accounted for by the equity method.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1995
------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Assets
Current assets................................................................ $ 324,780 $ 266,967
Due from affiliates........................................................... 6,232 24,765
Property and other............................................................ 1,121,676 937,609
------------- -------------
$ 1,452,688 $ 1,229,341
------------- -------------
------------- -------------
Liabilities and Equity
Current liabilities........................................................... $ 277,743 $ 240,480
Due to affiliates............................................................. 21,020 31,501
Deferred credits.............................................................. 3,380 5,766
Long-term debt................................................................ 41,591 40,220
Partners' capital and stockholders' equity.................................... 1,108,954 911,374
------------- -------------
$ 1,452,688 $ 1,229,341
------------- -------------
------------- -------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994
------------- ------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Results of Operations
Revenues........................................................ $ 1,394,781 $ 1,173,559 $ 892,530
Costs and expenses.............................................. (958,257) (808,008) (652,918)
Other income.................................................... 8,558 8,249 7,952
Interest expense................................................ (6,306) (6,414) (5,650)
Income taxes.................................................... (3,530) (4,670) (1,824)
Extraordinary item.............................................. (2,211) -- --
------------- ------------- ------------
Net income...................................................... $ 433,035 $ 362,716 $ 240,090
------------- ------------- ------------
------------- ------------- ------------
</TABLE>
NOTE 13
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 USM and AERL 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 $4.6 million, $4.6 million and $4.8 million in
1996, 1995 and 1994, respectively.
-73-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 (CONTINUED)
OTHER POSTRETIREMENT BENEFITS
The Company sponsors two defined benefit postretirement plans that cover
most of the employees of TDS and its telephone subsidiaries. One plan provides
medical benefits and the other plan provides life insurance benefits. Both plans
are contributory, with retiree contributions adjusted annually. The medical plan
anticipates future cost sharing changes that are consistent with the Company's
intent to increase retiree contributions by the health care cost trend rate. An
amount not to exceed 25% of the total contribution to the TDS Plan will be
contributed to fund the cost of the medical benefits annually. An additional
contribution equal to a reasonable amortization of the past service cost may be
made without regard to the 25% limitation described above. The Company will
limit overall contributions to the aggregate accruals recorded by its
subsidiaries. The Company's postretirement medical and life insurance plans are
currently underfunded. Total contributions to fund postretirement medical and
life insurance plans were $2.2 million, $3.1 million and $1.1 million in 1996,
1995 and 1994, respectively.
The following table sets forth the plans' funded status reconciled with the
amount shown in the Company's consolidated balance sheet at December 31, 1996:
<TABLE>
<CAPTION>
LIFE
INSURANCE HEALTH
PLAN CARE PLAN TOTAL
----------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Accumulated postretirement benefit obligation:
Retirees................................................................. $ 1,725 $ 3,144 $ 4,869
Fully eligible active plan participants.................................. 522 2,123 2,645
Other active plan participants........................................... 939 9,328 10,267
----------- --------- ---------
3,186 14,595 17,781
Plan assets at fair value.................................................. 1,305 8,954 10,259
----------- --------- ---------
Accumulated postretirement benefit obligation in excess of plan assets..... 1,881 5,641 7,522
Unrecognized prior service cost............................................ (68) (649) (717)
Unrecognized net gain from past experience different from that assumed and
from changes in assumptions............................................... 46 4,600 4,646
----------- --------- ---------
Accrued postretirement benefit cost at December 31, 1996................... $ 1,859 $ 9,592 $ 11,451
----------- --------- ---------
----------- --------- ---------
</TABLE>
Net postretirement cost for 1996, 1995 and 1994 includes the following
components:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Service cost................................................................... $ 796 $ 588 $ 810
Interest cost on accumulated postretirement benefit obligation................. 1,125 1,082 1,116
Actual return on plan assets................................................... (753) (656) --
Net amortization and deferral.................................................. 99 204 (224)
--------- --------- ---------
Net postretirement cost........................................................ $ 1,267 $ 1,218 $ 1,702
--------- --------- ---------
--------- --------- ---------
</TABLE>
For measurement purposes, a 10.2% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1996; the rate was assumed
to decrease over seven years to 6.1% and to remain at 6.1% thereafter. The
assumed rates of compensation increases and return on plan assets were 5.0% and
8.0%, respectively. The health care cost trend rate assumption has a significant
effect on the amounts reported. Increasing the assumed health care cost trend
rates by one percentage point in each year would
-74-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13 (CONTINUED)
increase the accumulated postretirement benefit obligation as of December 31,
1996, by $2.7 million and the aggregate of the service and interest cost
components of postretirement expense for the year then ended by $419,000.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0%.
NOTE 14
BUSINESS SEGMENT INFORMATION
TDS's businesses are classified into four principal segments: Cellular
Telephone, Telephone, PCS and Radio Paging operations.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Revenues
Cellular...................................................... $ 707,820 $ 492,395 $ 332,404
Telephone..................................................... 402,629 354,841 306,341
Paging........................................................ 104,187 107,150 92,065
------------- ------------- -------------
Total....................................................... $ 1,214,636 $ 954,386 $ 730,810
------------- ------------- -------------
------------- ------------- -------------
Operating Income (Loss)
Cellular...................................................... $ 87,366 $ 42,755 $ 17,385
Telephone..................................................... 103,358 98,240 91,606
Paging........................................................ (36,626) (8,997) (169)
------------- ------------- -------------
Total....................................................... $ 154,098 $ 131,998 $ 108,822
------------- ------------- -------------
------------- ------------- -------------
Depreciation and Amortization Expense
Cellular...................................................... $ 108,839 $ 89,458 $ 65,454
Telephone..................................................... 88,967 77,354 68,879
Paging........................................................ 33,777 24,692 17,178
------------- ------------- -------------
Total....................................................... $ 231,583 $ 191,504 $ 151,511
------------- ------------- -------------
------------- ------------- -------------
Identifiable Assets
Cellular...................................................... $ 2,116,592 $ 1,890,621 $ 1,584,142
Telephone..................................................... 1,181,084 1,058,241 984,563
PCS........................................................... 638,412 318,265 20,473
Paging........................................................ 153,374 159,170 146,107
Parent and Other.............................................. 111,507 42,785 54,842
------------- ------------- -------------
Total....................................................... $ 4,200,969 $ 3,469,082 $ 2,790,127
------------- ------------- -------------
------------- ------------- -------------
Capital Expenditures
Cellular...................................................... $ 248,123 $ 210,878 $ 167,164
Telephone..................................................... 144,440 104,372 115,483
PCS........................................................... 112,939 8,521 --
Paging........................................................ 32,517 26,527 28,966
Parent and Other.............................................. 12,185 9,698 8,088
------------- ------------- -------------
Total....................................................... $ 550,204 $ 359,996 $ 319,701
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
-75-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of Cash and Cash Equivalents, Temporary Investments and
Short-term Debt approximate fair value due to the short-term nature of these
instruments.
The carrying value and estimated fair value of the Company's long-term debt
was $1.0 billion and $969.5 million, respectively, at December 31, 1996, and
$894.6 million and $932.6 million, respectively, at December 31, 1995. The fair
value was estimated using discounted cash flow analysis based on the Company's
current incremental borrowing rates for similar types of borrowing arrangements.
The decrease in estimated fair value in 1996 was due to a change in the
incremental borrowing rate related to RUS, RTB and FFB Mortgage Notes.
At December 31, 1996 and 1995, the carrying value of the Company's
Redeemable Preferred Shares, $1.9 million, and $15.1 million, respectively, was
approximately equal to its fair value. The fair value was estimated using
discounted cash flow analysis based on the Company's current dividend yield on
issues of its non-convertible preferred shares and, for convertible series, the
net present value of the common stock to be issued upon conversion (valued at
quoted market prices).
It was not practicable to estimate the fair value of the Company's cost
method investments in other companies because of the lack of quoted market
prices. The carrying amounts at December 31, 1996 and 1995 represent the
original cost of the investments, which management believes is not impaired.
NOTE 16
SUBSEQUENT EVENT
Exchange of Markets with Another Cellular Operator. In February 1997, USM
entered into an exchange agreement with BellSouth Corporation pursuant to which
USM will receive controlling interests in twelve contiguous markets adjacent to
its Iowa and Wisconsin/Illinois clusters. In exchange, USM will divest its
controlling interests in ten markets and investment interests in 13 markets and
cash. USM will receive controlling interests representing approximately 3.9
million pops in the transaction, and will divest controlling interests
representing approximately 1.9 million pops and investment interests
representing approximately 1.4 million pops. The transaction is subject to
various regulatory and other approvals.
STANDBY LETTER OF CREDIT
The Company has entered into a standby letter of credit agreement effective
July 20, 1994 with a financial institution. This standby letter of credit, which
will not exceed $9.0 million, provides supplemental security in support of a
bank loan to an entity minority-owned by the Company. In the event of default
under the minority-owned entity's bank loan agreement, the bank may call upon
the Company's standby letter of credit to satisfy any amounts still due under
this loan agreement.
-76-
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED OR AT DECEMBER 31,
-------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Operating Revenues.......................... $ 1,214,636 $ 954,386 $ 730,810 $ 557,795 $ 432,740
Operating Income............................ 154,098 131,998 108,822 69,733 54,065
Net Income Before Extraordinary Item and
Cumulative Effect of Accounting Changes.... 128,139 103,978 60,544 33,896 38,520
Extraordinary Item.......................... -- -- -- -- (769)
Cumulative Effect of Accounting Changes..... -- -- (723) -- (6,866)
Net Income.................................. 128,139 103,978 59,821 33,896 30,885
Net Income Available to Common.............. $ 126,293 $ 102,044 $ 58,012 $ 31,510 $ 28,648
Weighted Average Common Shares (000s)....... 60,732 58,356 54,197 47,266 39,074
Earnings per Common Share:
Before Extraordinary Item and Cumulative
Effect of Accounting Changes............. $ 2.08 $ 1.74 $ 1.07 $ .67 $ .91
Extraordinary Item........................ -- -- -- -- (.02)
Cumulative Effect of Accounting Changes... -- -- (.01) -- (.17)
Net Income................................ $ 2.08 $ 1.74 $ 1.06 $ .67 $ .72
Pretax Profit on Revenues................... 20.7% 19.4% 13.9% 10.8% 15.8%
Effective Income Tax Rate (Before
Extraordinary Item and Cumulative Effect of
Accounting Changes)........................ 49.1% 43.8% 40.2% 43.9% 43.6%
Dividends per Common and Series A Common
Share...................................... $ .40 $ .38 $ .36 $ .34 $ .32
Cash and Cash Equivalents and Temporary
Investments................................ $ 119,297 $ 80,851 $ 44,566 $ 73,385 $ 58,145
Working Capital............................. (163,197) (166,514) (160,266) 16,025 (20,864)
Property, Plant and Equipment (Net)......... 1,828,889 1,293,410 1,063,656 846,089 695,623
Total Assets................................ 4,200,969 3,469,082 2,790,127 2,259,182 1,696,486
Notes Payable............................... 160,537 184,320 98,608 6,309 46,816
Long-term Debt (including current
portion)................................... 1,018,851 894,584 562,164 537,566 426,885
Redeemable Preferred Shares (including
current portion)........................... 1,858 15,093 25,001 27,367 27,967
Common Stockholders' Equity................. 2,032,941 1,684,365 1,473,038 1,224,285 877,419
Construction Expenditures................... $ 550,204 $ 359,996 $ 319,701 $ 200,984 $ 146,963
Current Ratio............................... .7 .6 .5 1.1 .9
Common Equity per Share..................... $ 33.23 $ 29.01 $ 26.85 $ 24.15 $ 21.27
Return on Equity............................ 6.8% 6.5% 4.4% 3.0% 4.8%
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
</TABLE>
-77-
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS
OF TELEPHONE AND DATA SYSTEMS, INC.:
We have audited the accompanying consolidated balance sheets of Telephone
and Data Systems, Inc. (an Iowa corporation) and Subsidiaries as of December 31,
1996 and 1995, and the related consolidated statements of income, common
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. 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, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Chicago, Illinois
January 29, 1997
(except with respect to the matter discussed in
Note 16, as to which the date is February 4, 1997)
-78-
<PAGE>
CONSOLIDATED QUARTERLY INCOME INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- ----------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
1996
Operating Revenues............................................. $ 263,387 $ 298,951 $ 315,924 $ 336,374
Operating Income............................................... 30,957 49,081 41,263 32,797
Gain on Sale of Cellular and Other Investments................. 41,758 86,494 7,797 2,686
Net Income..................................................... 33,689 59,692 22,669 12,089
Net Income Available to Common................................. 33,267 59,450 22,200 11,606
Net Income Available to Common -- Operations................. 12,959 18,969 19,271 10,852
Net Income Available to Common -- Gains...................... $ 20,308 $ 40,481 $ 2,929 $ 754
Weighted Average Common Shares (000s).......................... 59,393 61,259 61,321 61,305
Earnings per Common Share...................................... $ .56 $ .97 $ .36 $ .19
Earnings per Common Share -- Operations...................... .22 .31 .31 .18
Earnings per Common Share -- Gains........................... $ .34 $ .66 $ .05 $ .01
1995
Operating Revenues............................................. $ 209,975 $ 232,091 $ 256,508 $ 255,812
Operating Income............................................... 29,156 33,825 40,560 28,457
Gain on Sale of Cellular and Other Investments................. 19,488 16,886 43,375 6,876
Net Income..................................................... 23,193 22,580 42,596 15,609
Net Income Available to Common................................. 22,701 22,086 42,338 15,100
Net Income Available to Common -- Operations................. 13,908 12,185 21,256 14,227
Net Income Available to Common -- Gains...................... $ 8,793 $ 9,901 $ 21,082 $ 873
Weighted Average Common Shares (000s).......................... 57,292 58,508 59,038 58,741
Earnings per Common Share...................................... $ .39 $ .38 $ .72 $ .26
Earnings per Common Share -- Operations...................... .24 .21 .36 .24
Earnings per Common Share -- Gains........................... $ .15 $ .17 $ .36 $ .02
</TABLE>
Note: Certain 1996 quarterly amounts were reclassified for current period
presentation.
Net Income Available to Common for 1996 and 1995 included significant gains from
the sales of cellular and other investments. The table above summarizes the
effect of the gains on Net Income Available to Common and Earnings per Common
Share.
Management believes there exists a seasonality at USM 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.
In the first part of 1997, AERL is expected to begin commercial service which
will result in AERL's revenue and expenses being included in operating income.
Operating income is expected to decrease significantly in 1997 as a result of
the commencement of PCS operations.
-79-
<PAGE>
SHAREHOLDERS' INFORMATION
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 28, 1997,
TDS Common Shares were held by 4,274 record owners and the Series A Common
Shares were held by 99 record owners. TDS has paid cash dividends on Common
Shares since 1974, and paid dividends of $.40 and $.38 per Common and Series A
Common Share during 1996 and 1995, respectively.
The Common Shares of United States Cellular Corporation, an 80.6%-owned
subsidiary of TDS, are listed on the AMEX under the symbol "USM" and in the
newspapers as "US Cellu." The Common Shares of American Paging, Inc., an
82.3%-owned subsidiary of TDS, are also listed on the AMEX under the symbol
"APP" and in the newspapers as "AmPaging." The Common Shares of Aerial
Communications, Inc., an 82.8%-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:
<TABLE>
<CAPTION>
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
1996
High.............................................................. $ 48.75 48.88 45.63 40.50
Low............................................................... $ 39.00 43.38 37.75 34.75
Dividends Paid.................................................... $ .10 .10 .10 .10
<CAPTION>
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
1995
High.............................................................. $ 46.38 39.38 42.88 43.25
Low............................................................... $ 36.13 36.00 36.38 35.63
Dividends Paid.................................................... $ .095 .095 .095 .095
</TABLE>
-80-
<PAGE>
EXHIBIT 21 TELEPHONE AND DATA SYSTEMS, INC.
SUBSIDIARY AND AFFILIATED COMPANIES
DECEMBER 31,1996
<TABLE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
TELEPHONE COMPANIES
-------------------
TDS TELECOMMUNICATIONS CORPORATION DELAWARE
NORTHEAST REGION
----------------
CHICHESTER TELEPHONE COMPANY, INC. 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, INC. 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
GOSHEN TELEPHONE COMPANY ALABAMA
GROVE HILL TELEPHONE CORPORATION ALABAMA
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-BALL GROUND 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, INC. 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
1
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
WESTERN DIVISION
----------------
ARIZONA TELEPHONE COMPANY ARIZONA
ASOTIN TELEPHONE COMPANY WASHINGTON
CLEVELAND COUNTY TELEPHONE CO., INC. ARKANSAS
DECATUR TELEPHONE CO. ARKANSAS
DELTA COUNTY TELE-COMM, INC. COLORADO
HAPPY VALLEY TELEPHONE COMPANY CALIFORNIA
HOME TELEPHONE COMPANY OREGON
HORNITOS TELEPHONE COMPANY CALIFORNIA
LEWIS RIVER TELEPHONE COMPANY, INC. 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 TELEPHONE COMPANY 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
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
2
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
ISLAND TELEPHONE COMPANY MICHIGAN
LITTLE MIAMI COMMUNICATIONS CORPORATION OHIO
OAKWOOD TELEPHONE COMPANY OHIO
SHIAWASSEE TELEPHONE COMPANY MICHIGAN
TIPTON TELEPHONE COMPANY INDIANA
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
METROPLEX COMMUNICATIONS CORPORATION WASHINGTON
METROPLEX OLYMPIA CELLULAR COMMUNICATIONS CORPORATION WASHINGTON
METROPLEX PORTLAND CELLULAR COMMUNICATIONS CORPORATION WASHINGTON
METROPLEX RSA-7 CELLULAR COMMUNICATIONS CORPORATION WASHINGTON
METROPLEX SECURITY COMPANY WASHINGTON
US LINK, INC. MINNESOTA
CABLE COMPANIES
---------------
ACORN CABLE COMPANY WASHINGTON
21ST CENTURY T.V., INC. ARIZONA
CALHOUN ANTENNA SERVICE INC. MISSISSIPPI
CAROLINA CABLE T.V. CO., INC. SOUTH CAROLINA
COMVIDEO SYSTEMS, INC. CALIFORNIA
CONCORD CABLE COMMUNICATIONS CO. TENNESSEE
CONDON TV SYSTEMS INC. OREGON
INTERLAKE CABLEVISION, INC. MINNESOTA
HOME CATV SOUTH CAROLINA
KEARSARGE CABLE COMMUNICATIONS INC. NEW HAMPSHIRE
LEWISPORT CABLE T.V. KENTUCKY
METROPLEX CABLE INC. WASHINGTON
SEVIER COUNTY CABLE COMMUNICATIONS COMPANY, INC. TENNESSEE
SEVIERVILLE CABLE COMMUNICATIONS COMPANY TENNESSEE
TDS CABLE COMMUNICATIONS COMPANY, INC. IOWA
VOLUNTEER TV CABLE CO. TENNESSEE
WARREN CABLE COMPANY MAINE
SERVICE COMPANIES
-----------------
AFFILIATE FUND DELAWARE
AMERICAN COMMUNICATIONS CONSULTANTS, INC. TENNESSEE
AMERICAN RADIO COMMUNICATIONS, INC. DELAWARE
COMMVEST, INC. DELAWARE
INTEGRATED COMMUNICATIONS SERVICES, INC. WISCONSIN
MONROE COMMUNICATIONS CORPORATION WISCONSIN
NATIONAL TELEPHONE & TELEGRAPH COMPANY CALIFORNIA
RUDEVCO, INC. CALIFORNIA
RURAL DEVELOPMENT ACQUISITION CORP MARYLAND
SUTTLE PRESS INC. WISCONSIN
TCC, INC. TENNESSEE
TDS DATACOM, INC. DELAWARE
TDSNET ALABAMA
TDS REAL ESTATE INVESTMENT CORPORATION WISCONSIN
TEL RADIO COMMUNICATION PROPERTIES, INC. WISCONSIN
3
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
TELECOMMUNICATION TECHNOLOGIES FUND, INC. MARYLAND
RADIO PAGING COMPANIES
----------------------
AMERICAN PAGING, INC. DELAWARE
ADVANCED WIRELESS MESSAGING INC. DELAWARE
AMERICAN MESSAGING SERVICES, LLC MINNESOTA
AMERICAN PAGING, INC. (OF ARIZONA) ARIZONA
AMERICAN PAGING, INC. (OF DISTRICT OF COLUMBIA) D.C.
AMERICAN PAGING, INC. (OF FLORIDA) FLORIDA
AMERICAN PAGING, INC. (OF ILLINOIS) ILLINOIS
AMERICAN PAGING, INC. (OF INDIANA) INDIANA
AMERICAN PAGING, INC. (OF KENTUCKY) KENTUCKY
AMERICAN PAGING, INC. (OF MARYLAND) MARYLAND
AMERICAN PAGING, INC. (OF MINNESOTA) MINNESOTA
AMERICAN PAGING OF MISSOURI, INC. MISSOURI
AMERICAN PAGING, INC. (OF OKLAHOMA) OKLAHOMA
A.P. OF PENNSYLVANIA, INC. PENNSYLVANIA
AMERICAN PAGING, INC. (OF TEXAS) TEXAS
AMERICAN PAGING, INC. (OF UTAH) UTAH
AMERICAN PAGING, INC. (OF VIRGINIA) VIRGINIA
AMERICAN PAGING, INC. (OF WISCONSIN) WISCONSIN
APPNOC, INC. DELAWARE
APIXUS INC. MINNESOTA
PERSONAL COMMUNICATON SERVICE COMPANIES
---------------------------------------
AERIAL COMMUNICATIONS, INC. DELAWARE
APT OPERATING COMPANY, INC. DELAWARE
APT ALASKA, INC. DELAWARE
APT COLUMBUS, INC. DELAWARE
APT GUAM, INC. DELAWARE
APT HOUSTON, INC. DELAWARE
APT KANSAS CITY, INC. DELAWARE
APT MINNEAPOLIS, INC. DELAWARE
APT TAMPA/ ORLANDO, INC. DELAWARE
APT OF PITTSBURGH G.P., INC. DELAWARE
APT PITTSBURGH LIMITED PARTNERSHIP DELAWARE
CELLULAR COMPANIES
------------------
UNITED STATES CELLULAR CORPORATION DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY DELAWARE
UNITED STATES CELLULAR INVESTMENT COMPANY DELAWARE
USCC REAL ESTATE CORPORATION DELAWARE
USCC PAYROLL CORPORATION DELAWARE
CARRY PHONE, INC. DELAWARE
CELLVEST, INC. DELAWARE
ILP, INC. DELAWARE
CALIFORNIA RURAL SERVICE AREA #1, INC. CALIFORNIA
CALIFORNIA RSA #2, INC. DELAWARE
CALIFORNIA RSA #9, INC. CALIFORNIA
FLORIDA RSA #8, INC. DELAWARE
USCOC OF FLORIDA RSA #9, INC. FLORIDA
FLORIDA RSA #10, INC. FLORIDA
USCOC OF GEORGIA RSA #1, INC. GEORGIA
GEORGIA RSA #11, INC. GEORGIA
4
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
USCOC OF HAWAII 3, INC. DELAWARE
USCOC OF IDAHO RSA #5, INC. DELAWARE
USCOC OF ILLINOIS RSA #1, INC. VIRGINIA
ILLINOIS RSA #3, INC. ILLINOIS
USCOC OF ILLINOIS RSA #4, INC. ILLINOIS
USCOC OF INDIANA RSA #2, INC. INDIANA
INDIANA RSA #4, INC. DELAWARE
INDIANA RSA #5, INC. INDIANA
USCOC OF IOWA RSA #1, INC. IOWA
IOWA RSA #3, INC. DELAWARE
OHIO STATE CELLULAR PHONE COMPANY, INC. DELAWARE
IOWA RSA #9, INC. DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY - DES MOINES IOWA
IOWA RSA #12, INC. DELAWARE
IOWA 13, INC. DELAWARE
USCOC OF IOWA RSA #16, INC. DELAWARE
MAINE RSA #1, INC. MAINE
MAINE RSA #4, INC. MAINE
MAINE RSA NO. 4 LIMITED PARTNERSHIP
USCOC OF CUMBERLAND, INC. MARYLAND
MICHIGAN RSA #4, INC. MICHIGAN
USCOC OF MISSOURI RSA #5, INC. ILLINOIS
UNITED STATES CELLULAR OPERATING COMPANY OF COLUMBIA MISSOURI
USCOC OF MISSOURI RSA #13, INC. DELAWARE
MISSOURI #15 RURAL CELLULAR, INC. MISSOURI
PEACE VALLEY CELLULAR TELEPHONE COMPANY DELAWARE
NH #1 RURAL CELLULAR, INC. NEW HAMPSHIRE
USCOC OF NEW YORK RSA #6, INC. DELAWARE
HUDSON CELLULAR LIMITED PARTNERSHIP
NORTH CAROLINA RSA #4, INC. DELAWARE
RANDOLPH CELLULAR TELEPHONE COMPANY NORTH CAROLINA
NORTH CAROLINA RSA NO. 6, INC. CALIFORNIA
USCOC OF NORTH CAROLINA RSA #7, INC. NORTH CAROLINA
OHIO RSA #1, INC. OHIO
USCOC OF OHIO RSA #7, INC. COLORADO
UNITED STATES CELLULAR OPERATING COMPANY OF TULSA, INC. OKLAHOMA
OKLAHOMA OPCO. OF RSA #8, INC. OKLAHOMA
USCOC OF TEXAHOMA, INC. TEXAS
TEXAHOMA CELLULAR TELEPHONE CORPORATION TEXAS
TEXAHOMA CELLULAR LIMITED PARTNERSHIP
OKLAHOMA #9 RURAL CELLULAR, INC. OKLAHOMA
USCOC OF OKLAHOMA RSA #10, INC. OKLAHOMA
OREGON RSA #2, INC. OREGON
OREGON RSA #3, INC. OREGON
OREGON RSA NO. 3 LIMITED PARTNERSHIP
USCOC OF OREGON RSA #5, INC. DELAWARE
OREGON RSA #6, INC. OREGON
UNITED STATES CELLULAR OPERATING COMPANY OF WILLIAMSPORT PENNSYLVANIA
CANTON CELLULAR TELEPHONE COMPANY PENNSYLVANIA
USCOC OF PENNSYLVANIA RSA #9, INC. DELAWARE
UNIONTOWN CELLULAR TELCO, INC. DELAWARE
FAYETTE - GREENE CELLULAR TELCO, INC. DELAWARE
PA RURAL SERVICE AREA NO. 9 LIMITED PARTNERSHIP
BLOCK B CELLULAR CORPORATION PENNSYLVANIA
LAUREL HIGHLAND CELLULAR TELEPHONE COMPANY DELAWARE
TRI - STATE CELLULAR PARTNERSHIP
5
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
PENNSYLVANIA RSA NO. 10B (II) LIMITED PARTNERSHIP
USCOC OF SOUTH CAROLINA RSA #4, INC. SOUTH CAROLINA
UNITED STATES CELLULAR INVESTMENT CO. OF NASHVILLE TENNESSEE
TENNESSEE RSA #3, INC. DELAWARE
TENNESSEE RSA #4 SUB 2, INC. TENNESSEE
TENNESSEE RSA #6 B, INC. TENNESSEE
UNITED STATES CELLULAR OPERATING COMPANY OF KNOXVILLE TENNESSEE
UNITED STATES CELLULAR TELEPHONE COMPANY (GREATER KNOXVILLE), L.P.
TEXAS #20 RURAL CELLULAR, INC. TEXAS
TDS V2B ACQUISITION CORP. DELAWARE
LAKE CHAMPLAIN CELLULAR PARTNERSHIP
VERMONT INDEPENDENT CELLULAR TELEPHONE GENERAL PARTNERSHIP
USCOC OF VIRGINIA RSA #2, INC. VIRGINIA
USCOC OF VIRGINIA RSA #4, INC. ILLINOIS
VIRGINIA RSA #4, INC. VIRGINIA
VIRGINIA RSA #7, INC. VIRGINIA
USCOC OF WASHINGTON - 4, INC. DELAWARE
WASHINGTON RSA #5, INC. WASHINGTON
WESTERN SUB - RSA LIMITED PARTNERSHIP
MCDANIEL CELLULAR TELEPHONE COMPANY DELAWARE
USCOC OF WEST VIRGINIA RSA #2, INC. WEST VIRGINIA
HARDY CELLULAR TELEPONE COMPANY DELAWARE
GEORGIA RSA #13, INC. GEORGIA
USCOC OF WISCONSIN RSA #6, INC. DELAWARE
WISCONSIN RSA #7, INC. DELAWARE
WISCONSIN RSA #8, INC. WISCONSIN
WISCONSIN RSA GENERAL PARTNER, INC. DELAWARE
WISCONSIN RSA NO. 8 LIMITED PARTNERSHIP
USCIC OF FRESNO, INC. CALIFORNIA
USCIC OF COLORADO RSA #3, INC. DELAWARE
WESTERN COLORADO CELLULAR, INC. COLORADO
WESTERN COLORADO CELLULAR OF COLORADO LIMITED PARTNERSHIP
IDAHO INVCO OF RSA #1, INC. DELAWARE
IDAHO RSA NO. 1 LIMITED PARTNERSHIP
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
MINNESOTA INVCO OF RSA #10, INC. DELAWARE
MINNESOTA INVCO OF RSA #11, INC. DELAWARE
USCIC OF NORTH CAROLINA RSA #1, INC. DELAWARE
NORTH CAROLINA RSA 1 PARTNERSHIP
TEXAS INVCO OF RSA #6, INC. DELAWARE
COMMUNITY CELLULAR TELEPHONE COMPANY TEXAS
TEXAS INVCO OF RSA #17, INC. DELAWARE
USCIC OF SEATTLE, INC. DELAWARE
WISCONSIN INVCO OF RSA #7, INC. DELAWARE
UNITED STATES CELLULAR INVESTMENT COMPANY OF ROCKFORD DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY OF ATLANTIC CITY, INC. NEW JERSEY
UNITED STATES CELLULAR OPERATING COMPANY OF BANGOR MAINE
BANGOR CELLULAR TELEPHONE, L.P. DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY OF BILOXI MISSISSIPPI
UNITED STATES CELLULAR OPERATING COMPANY OF CEDAR RAPIDS DELAWARE
CEDAR RAPIDS CELLULAR TELEPHONE, L.P.
USCOC OF CHARLOTTESVILLE, INC. VIRGINIA
CHARLOTTESVILLE CELLULAR PARTNERSHIP
6
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
USCOC OF CORPUS CHRISTI, INC. TEXAS
UNITED STATES CELLULAR OPERATING COMPANY - QUAD CITIES IOWA
DAVENPORT CELLULAR TELEPHONE COMPANY, INC. DELAWARE
DAVENPORT CELLULAR TELEPHONE COMPANY
UNITED STATES CELLULAR OPERATING COMPANY OF DUBUQUE IOWA
DUBUQUE CELLULAR TELEPHONE, L.P. DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY OF EVANSVILLE, INC. INDIANA
EVANSVILLE CELLULAR TELEPHONE COMPANY
UNITED STATES CELLULAR OPERATING COMPANY OF FT. PIERCE FLORIDA
CENTRAL FLORIDA CELLULAR TELEPHONE COMPANY, INC. FLORIDA
UNITED STATES CELLULAR OPERATING COMPANY OF JOPLIN MISSOURI
JOPLIN CELLULAR TELEPHONE COMPANY, INC. DELAWARE
TRI - STATES CELLULAR COMMUNICATIONS, INC. MISSOURI
JOPLIN CELLULAR TELEPHONE COMPANY, L.P.
UNITED STATES CELLULAR OPERATING COMPANY OF LACROSSE, INC. WISCONSIN
LACROSSE CELLULAR TELEPHONE COMPANY, INC. DELAWARE
LAR - TEX CELLULAR TELEPHONE COMPANY, INC. DELAWARE
UNITED STATES CELLULAR OPERATING COMPANY OF LEWISTON - AUBURN MAINE
LEWISTON CELLTELCO PARTNERSHIP
UNITED STATES CELLULAR OPERATING COMPANY OF MANCHESTER - NASHUA, INC. NEW HAMPSHIRE
MANCHESTER - NASHUA CELLULAR TELEPHONE, L.P.
UNITED STATES CELLULAR OPERATING COMPANY OF MEDFORD OREGON
MEDFORD PAGING, INC. OREGON
UNITED STATES CELLULAR OPERATING COMPANY OF OWENSBORO DELAWARE
OWENSBORO CELLULAR TELEPHONE, L.P.
USCOC OF PORTLAND, INC. MAINE
UNITED STATES CELLULAR OPERATING COMPANY OF POUGHKEEPSIE, INC. NEW YORK
UNITED STATES CELLULAR OPERATING COMPANY OF RICHLAND WASHINGTON
TRI - CITIES PAGING, INC. WASHINGTON
UNITED STATES CELLULAR OPERATING COMPANY OF ROCHESTER MINNESOTA
DRGP, INC. DELAWARE
ROCHESTER CELLULAR TELEPHONE COMPANY, L.P.
USCOC OF TALLAHASSEE, INC. FLORIDA
TULSA GENERAL PARTNER, INC. DELAWARE
UNITED STATES CELLULAR TELEPHONE COMPANY (GREATER TULSA)
USCOC OF VICTORIA, INC. TEXAS
VICTORIA CELLULAR PARTNERSHIP
VICTORIA CELLULAR CORPORATION TEXAS
UNITED STATES CELLULAR OPERATING COMPANY OF WATERLOO IOWA
WATERLOO / CEDAR FALLS CELLTELCO PARTNERSHIP
UNITED STATES CELLULAR OPERATING COMPANY OF WAUSAU, INC. WISCONSIN
WAUSAU CELLULAR TELEPHONE COMPANY LIMITED PARTNERSHIP
UNITED STATES CELLULAR OPERATING COMPANY OF YAKIMA WASHINGTON
YAKIMA MSA LIMITED PARTNERSHIP
YAKIMA VALLEY PAGING LIMITED PARTNERSHIP
UNITED STATES CELLULAR INVESTMENT CO. OF ALLENTOWN PENNSYLVANIA
USCIC OF AMARILLO. INC. DELAWARE
UNITED STATES CELLULAR INVESTMENT COMPANY OF BATON ROUGE LOUISIANA
CAPITOL CELLULAR, INC. LOUISIANA
CSII OF BATON ROUGE, INC. DELAWARE
STAR CELLULAR COMMUNICATIONS, INC. LOUISIANA
STAR CELLULAR TELEPHONE COMPANY, INC. DELAWARE
BATON ROUGE MSA LIMITED PARTNERSHIP
UNITED STATES CELLULAR INVESTMENT COMPANY OF BINGHAMTON, INC. NEW YORK
CELLULAR AMERICA TELEPHONE COMPANY PENNSYLVANIA
7
<PAGE>
<CAPTION>
STATE OF
TDS COMPANIES INCORPORATION
------------- -------------
<S> <C>
USCIC OF BROWNSVILLE, INC. DELAWARE
UNITED STATES CELLULAR INVESTMENT COMPANY OF EAU CLAIRE, INC. WISCONSIN
UNIVERSAL CELLULAR FOR EAU CLAIRE MSA, INC. WISCONSIN
LAVACA CELLULAR TELEPHONE COMPANY OKLAHOMA
UNITED STATES CELLULAR INVESTMENT COMPANY OF GALVESTON TEXAS
UNITED STATES CELLULAR INVESTMENT COMPANY OF GREEN BAY, INC. WISCONSIN
UNITED STATES CELLULAR INVESTMENT COMPANY OF HUNTSVILLE, INC. ALABAMA
UNITED STATES CELLULAR INVESTMENT COMPANY OF IOWA CITY IOWA
USCIC OF JACKSON, INC. DELAWARE
UNITED STATES CELLULAR INVESTMENT COMPANY OF LAFAYETTE LOUISIANA
UNITED STATES CELLULAR INVESTMENT CORPORATION OF LOS ANGELES INDIANA
USCIC OF MCALLEN, INC. DELAWARE
USCIC OF OCALA, INC. FLORIDA
FOUR D, LTD. MICHIGAN
UNITED STATES CELLULAR INVESTMENT CO. OF OKLAHOMA CITY, INC. OKLAHOMA
UNITED STATES CELLULAR INVESTMENT COMPANY OF PORTSMOUTH, INC. NEW HAMPSHIRE
UNITED STATES CELLULAR INVESTMENT COMPANY OF RALEIGH - DURHAM DELAWARE
CAROLINA CELLULAR, INC. NORTH CAROLINA
UNITED STATES CELLULAR INVESTMENT COMPANY OF SANTA CRUZ, INC. CALIFORNIA
UNITED STATES CELLULAR INVESTMENT COMPANY OF SARASOTA FLORIDA
UNITED STATES CELLULAR INVESTMENT COMPANY OF ST. CLOUD, INC. MINNESOTA
UNITED STATES CELLULAR INVESTMENT COMPANY OF WHEELING WEST VIRGINIA
</TABLE>
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 29, 1997 (except with respect to the matter discussed in Note 16,
as to which the date is February 4, 1997) on the consolidated financial
statements of Telephone and Data Systems, Inc. and Subsidiaries (the "Company")
included in the Company's 1996 Annual Report to Shareholders, to the inclusion
in this Form 10-K of our report dated January 29, 1997 (except with respect to
the matter discussed in Note 16, as to which the date is February 4, 1997) on
the financial statement schedules of the Company, and to the incorporation of
such reports into the Company's previously filed S-8 Registration Statements,
File No. 33-1192, File No. 33-4420, File No. 33-35172, File No. 33-50747, File
No. 33-57257, File No. 33-64035 and File No. 333-01041, and into the Company's
previously filed S-3 Registration Statements, File No. 33-8564, File No.
33-8857, File No. 33-28348, File No. 33-68456 and File No. 33-59435, and into
the Company's previously filed S-4 Registration Statements, File No. 33-45570,
File No. 33-64293, File No. 33-62925 and File No. 333-00727.
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 20, 1997
<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, 1996, 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> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 57,633
<SECURITIES> 32,408
<RECEIVABLES> 140,532
<ALLOWANCES> 6,076
<INVENTORY> 29,125
<CURRENT-ASSETS> 346,070
<PP&E> 2,660,268
<DEPRECIATION> 831,379
<TOTAL-ASSETS> 4,200,969
<CURRENT-LIABILITIES> 509,267
<BONDS> 982,232
280
29,000
<COMMON> 61,154
<OTHER-SE> 1,971,787
<TOTAL-LIABILITY-AND-EQUITY> 4,200,969
<SALES> 0
<TOTAL-REVENUES> 1,214,636
<CGS> 0
<TOTAL-COSTS> 1,060,538
<OTHER-EXPENSES> (140,540)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 42,853
<INCOME-PRETAX> 251,785
<INCOME-TAX> 123,646
<INCOME-CONTINUING> 128,139
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 128,139
<EPS-PRIMARY> 2.08
<EPS-DILUTED> 2.07
</TABLE>
